IHT - the fairest of them all?

Last week, The Economist wrote this about Inheritance Tax:

Taxes should be assessed on three grounds: how they affect incentives, how fair they are and how simple. Estate taxes score well on the first two, less satisfactorily on the third.

Are they right? On the first point, efficiency, the answer at the moment is that we just don’t know. The efficiency of IHT depends heavily on whether people who die rich have intentionally remained rich to pass on their wealth to their kids. If this is the case (and these parents actually care about how much their kids receive, rather than gaining utility from the act of giving itself) then IHT will distort behaviour, tending to reduce the incentives to work and save. If, however, most people who die with assets were holding them as insurance against living a lot longer, then IHT would cause next to no distortions and would be a very efficient tax. Unfortunately, it is very difficult to empirically disentangle peoples' motives, so we don't currently know which is more prevalent.

The Economist are right, however, in pointing out that IHT improves the work and savings incentives of children of the rich. Expecting to receive a huge inheritance surely can’t be good for your entrepreneurial zeal.

IHT does fare better on the second point, equity, as it is paid exclusively by the rich. Only 6% of estates pay it and the fact that this will rise slightly over the next few years indicates simply that more people are becoming rich (it doesn't matter whether this is from a property boom or from anything else). On the downside, the many loopholes allow the very rich to avoid paying any IHT, leaving the rising middle classes to shoulder the burden. There is also Tim Worstall’s argument that rich kids are an equalising force in themselves, through their profligate spending habits. Overall, IHT does seem to promote a more equal society, based on merit rather than fortune (and would do a better job with a lower threshold than £600k).

On the third point, simplicity, the UK's tax is actually a better option in many ways than a pure inheritance tax (the option favoured by The Economist - along with the crazy French idea of varying the rate according to the closeness of blood ties between bequester and inheritor). While taxing inheritances directly would be far more equitable and would encourage the spreading of bequests, it would be an administrative nightmare compared to the relatively simple single probate system currently in force. It would also create a whole new raft of avoidance possibilities. A better option for the UK would be to simplify the current regime and cut out many of the loopholes currently exploited by the rich, especially the use of trusts.