Inheritance tax is one of the few taxes the Labour Government hasn’t ruled out raising. This is an opportunity for the UK to make the tax more fair and progressive, generating more income that could pay for contentious policies like the two-child benefit limit and universal winter fuel allowance. Dan Goss argues that the UK has a lot to learn from Norway and South Korea about  taxing inheritance. 

A defining moment for the new Labour government is just around the corner. At their first budget on October 30, Starmer and Reeves will lay out their plans to fill the so-called “£22bn fiscal black hole”. Some spending will be cut, and some taxes will be raised. The question is, how much will we see of each, and how will these changes be done?

Having been adamant about its promise not to raise taxes “on working people”, the Government will have to unlock funds from lower-revenue taxes – like those on wealth. Among these, they will have to identify reforms that simultaneously make the system fairer while raising revenue. An obvious place to start – and which the government is reportedly looking at – is inheritance tax.

Reforms to inheritance tax could provide a big boost to public finances while bearing no cost on the vast majority of families.

Why inheritance tax?

Inheritance tax is ripe for reform. Its poor design – with multiple tax reliefs and allowances – make it overly complex and easy for the wealthy to avoid. But also, inheritances are becoming increasingly valuable and very few estates are charged any tax; just one in 20 estates pay it and almost half the tax is paid by the wealthiest one per cent. Reforms could therefore provide a big boost to public finances while bearing no cost on the vast majority of families.

The political challenge is also not as great as some assume. Upon considering trade-offs for the funding of services, the public generally thinks we should keep inheritance tax, as long we make it fairer, simpler, and clearly linked to public spending.

France, Japan and South Korea, for example, all tax higher proportions of their inheritance and gift flows than the UK.

What are the options for reform?

We should start by realising how unusual the UK is compared to our peers. We are in a small minority of OECD countries where the amount of tax paid on inheritance varies depending on how much is given, rather than how much each person receives. We also use a flat rate, while most countries – including Japan, France, Germany, and Spain – use a progressive rate (like we have for income tax). Unlike many peers, we’ve also opened up opportunities for the well-advised to reduce their inheritance tax bills, for example by putting their money in pension pots, buying shares in certain businesses or creating trusts.

This illuminates a range of opportunities for reform, many bringing us in more in line with peer countries. Alongside this, more revenue is possible. France, Japan and South Korea, for example, all tax higher proportions of their inheritance and gift flows than the UK. South Korea, in particular, is an essential case study for the UK, raising more money in a more progressive way.

The economics of South Korea

Of all the money and assets passed on in the UK in 2019-20 (the most recently available data), around four per cent was paid in tax. In South Korea, the figure in 2022 was 10 per cent. If the UK taxed the same proportion of inheritance in 2019-20, we could have raised around £11.6bn – an additional £6.5bn compared to what was actually raised. This could cover the cost of both scrapping the two-child benefit cap and reversing the reduction in winter fuel payments – more than twice over. On top of this, South Korea has a tax on lifetime transfers, while the UK doesn’t tax any transfers given more than seven years before death.

The South Korean approach is particularly intriguing because of how progressive it is. Many Brits are concerned that the wealthy are able to pay lower tax rates than others – and the current state of inheritance tax might justify those concerns. While the effective rate peaks at 25per cent for estates worth £3-5m, it falls to 20 per cent for those over £10m. This is because the wealthiest estates make use of the tax reliefs on offer, such as those for business assets, or of non-dom status. By comparison, the South Korean model is stricter on these reliefs, offering an exemption only to smaller businesses run by the deceased for 10 years, and taxing any property given by a resident regardless of domicile status. Accordingly, the wealthiest estates pay the highest rates – increasing from 33 per cent for estates worth £6m-£30m to 44 per cent for those over £30m.

While the UK can’t simply copy the South Korean tax system given economic and societal differences, its model has myriad lessons for British policy makers. The government has already introduced plans to remove avoidance opportunities for non-doms from 2025 – a positive step. The introduction of higher rates for the top inheritances and greater restrictions on business relief would also help. Delivering this, however, is a clear political challenge.

Currently, for inherited assets in the UK, only gains accrued after the point of inheritance face capital gains tax, while gains accrued before then escape the tax.

The politics of Norway

Inheritance taxes are controversial in many countries. But they’re not our only tool to tax the generational build-up of wealth. We can, wholly or partly, shift taxation away from inheritance per se, and onto the capital gains (accrued profit) on inherited assets. Currently, for inherited assets in the UK, only gains accrued after the point of inheritance face capital gains tax, while gains accrued before then escape the tax. This creates the bizarre situation whereby, if you make half a million pound profit by selling a second home, you pay around 28 per cent in capital gains tax, but if someone inherits the home and sells it the day after, no capital gains tax is paid.

Norway took a bold step on this in 2014. They abolished inheritance tax, but began taxing all the capital gains on inherited assets, rather than just any gains after the inheritance.

The new system has broad appeal. First, rather than getting a tax bill after the death, the heir only gets a bill when they sell the asset. This means they definitely have cash to pay it, and the tax is detached from the sentimentality around inheritance. Second, while inheritance tax may tax savings from income, capital gains tax only applies to the profit from rising asset prices (which has not yet been taxed). This can help ease concerns about double taxation.

Norway’s experience provides a useful case study in how to tax inherited wealth while easing public concerns.

As such, Norway’s reforms seemed popular. Research suggests the government received “great support from the Norwegian people”, and news reporting often overlooked the capital gains reform. An expert that Demos spoke to also suggested the reforms also did not reduce revenue, with capital gains taxed at 22 per cent in most cases vs inheritance generally taxed at 10 per cent at most.

Norway’s experience provides a useful case study in how to tax inherited wealth while easing public concerns. Importantly, however, the UK government would not be able to replicate these reforms while avoiding a large revenue loss. Instead, we should look to introduce capital gains tax on inherited assets while offering measured cuts to inheritance tax, rather than abolishing it.

What next?

The government faces big decisions on whether to reshape inheritance tax. But to achieve the revenue and progressivity of South Korea and the political nous of Norway, they need to look at the evidence and make bold decisions. To put the public at the heart of that process, the think tank Demos has run an in-depth deliberation with the public. Based on this, Demos will be recommending a package of reforms that would both raise revenue while making the tax more progressive. We hope policymakers will listen.

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

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