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We inherit too much and earn too little

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The first day of 2017 was marred by the death of one of Britain’s greatest economists, Sir Anthony (or Tony as he was universally known) Atkinson.

Tony had worked for decades on how to measure, and tackle, inequality. He was focused not just on inequalities in income and earnings, but also inequality in wealth. And with good reason. Wealth is vastly more unequally distributed than income. It is ownership of wealth that confers security, and often power, in a way that unreliable earnings may not. And while high-earning parents do tend to beget high-earning children, the inheritance of wealth is even more direct.

One of Tony’s important insights was that wealth matters more now than at any time since the 1930s because household wealth has been rising relative to income — from less than three times national income in the mid-1970s to more than five times national income today.

Wealth is also concentrated among the older generation. It’s bound to be. You pay off your debts and your mortgage, and save for retirement as you get older. But this concentration is growing as younger generations struggle to get on the housing ladder, cannot access decent occupational pensions, and bear the brunt of a decade of earnings stagnation. At the same time, average wealth among the oldest has risen dramatically even in the past decade, not least as a result of rising house prices. Those now in their 60s and 70s will be wealthier still when they reach their 80s and 90s.

Much of that wealth will be inherited. Three quarters of those born in the 1970s expect an inheritance compared with only half of their parents. For much of the 20th century the role of inherited wealth in determining our economic wellbeing was in decline. Now it is getting more important again.

In part it is important because it is so unequally distributed. Even ignoring the super-wealthy, the poorer half of oldest households have only a quarter of the wealth of the richest tenth. And those lucky enough to inherit also tend to be those who have been helped in other ways. Higher income people — those in the top 20 per cent of lifetime income — are ten times as likely to have received an inheritance of more than £250,000 as those in the bottom half of lifetime incomes.

Different people will see those facts in different lights. Some will see an increased role for inheritance as something to be celebrated. Some will see it as a cause of deep anxiety.

The case against inheritance — and for an effective inheritance tax — has been put by philosophers for centuries. John Stuart Mill wanted to fix “a limit to what any one may acquire by the mere favour of others, without any exercise of his faculties”. If I get taxed on what I work hard to earn, how much more appropriate that I should be taxed on what I am merely gifted through the good fortune of having wealthy parents.

Yet when, in 2007, George Osborne offered to cut inheritance tax to facilitate wealth “cascading down the generations” he was credited with a political masterstroke. Nobody much likes being taxed, but inheritance tax is specially hated. In the US “no taxation without respiration” is the rallying cry.

Two things explain this antipathy. One is the natural human desire to leave the fruits of one’s labour to one’s children. Up to a point this is always likely to trump considerations of wider social equity. A second, though, is the inadequacy of the current system. It is not hard to avoid inheritance tax if you have serious money, not least by the simple expedient of passing it on at least seven years before you die — not an option for those of us whose wealth is tied up in a home and a pension. There is also the complete absence of inheritance tax on agricultural land and on certain business assets. And that’s before you get into trusts and other such vehicles.

All of which is another way of saying the current inheritance tax doesn’t seriously try to tax transfers of wealth between the generations, certainly not for the really wealthy. That inevitably undermines support for it among the home-owning classes who are, or might be, caught in its net.

So it’s really time to look again at this tax and try to close some of the most obvious loopholes. It hasn’t been seriously reviewed since it was introduced in its present form in 1986. One option, favoured by Tony Atkinson, is to move to a system of taxing receipts of gifts and inheritances. This would both tax what we presumably want to tax — the receipt of wealth — and get round the advantage enjoyed by those lucky enough to be able to pass on a lot during their life without paying tax.

There is no pretending, though, that this would be easy politically or administratively. It really is hard to tax transfers of wealth. We should do what we can to make the tax system fairer and more effective. But the real challenge must be to make inheritance matter less. That means action in the housing market — building more houses, cutting stamp duty, increasing council tax on more expensive properties. It means doing still more to promote social mobility through education and skills policy. And it means tilting policy away from supporting the relatively wealthy old towards the less wealthy young.

This article was first published by The Times and is reproduced here in full with permission.

Paul Johnson is Director of the IFS. Follow him on twitter @PJTheEconomist

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Press release
New IFS analysis examines the importance of inheritance amongst different cohorts.