A Research Paper on Taxation
Taxation has been at the heart of the economy throughout history. Taxes are “a compulsory levy, imposed by a government or other tax raising body, on income, expenditure or capital assets, for which the taxpayer receives nothing specific in return.” In particular taxes may be imposed upon the wealth of an individual where they are subject to paying tax according to their “accumulated wealth”. A form of this is the inheritance tax where the wealth of an individual is taxed upon their death. Historically this was a way in which revenues were raised for public expenditure but in more recent centuries this taxation has been predominately a way of ensuring that the rift between the rich and poor does not increase. Death duties were introduced into the UK in the 17th century as Probate duty. The tax has since significantly developed to form the inheritance tax presently in force today. The principles of this taxation remain, however its role through history has changed. Developing from a revenue raising tax, the inheritance tax is now also a tool used by the government to help reduce the inequality between the rich and the poor. Inheritance tax was initially introduced by the conservative government, but is now currently still in force under the New Labour government.
Taxing the assets of an individual after ones death is a concept that can be traced back through to the Ancient Egyptians, for evidence suggests that it is here where the first death duties were imposed. These are taxes payable on a deceased person's estate. The Egyptians are thought to have had a highly complex system of taxation. It seems that efficiency was achieved for taxes were paid “in the form of grain, labor, and agricultural commodities.” This illustrates Adam Smith's `Canons of Taxation' whereby “tax ought to be levied…in the manner…it is most…convenient for the contributor to pay.” It highlights the sophistication of the Egyptians as these were principles developed much by Smith much later in the 18th century. The inheritance tax was established in Rome AD 6 by Emperor Augustus Caesar who imposed a “5% inheritance tax on the estates of deceased persons”. However this tax was levied “only on those with an estate worth over 100,000 sestertii.” This tax was “revenue raising” and was imposed “to provide retirement funds for the military.” This tax was also part of the “fairer system of tax” he “introduced to improve the stability of the…Empire.” This imposition reflects the idea of hypothecated taxation where “taxes are raised to pay for specific activities;” Augustus specifically raised the tax for military expenditure. It can be thought that taxes are “essential for a prosperous economy.” The way in which taxes existed in ancient history emphasises this, and more importantly implies that the inheritance tax is also `essential for a prosperous economy.'
Economy through the middle ages imposed a tax on “on mortis causa transfers.” In particular these were “A gift in prospect of death”. In feudal times death duties were used to redistribute land and property to avoid it being concentrated in too few hands, furthermore these principles were reflected upon in the UK as the industrial revolution fuelled the increase in wealth among individuals. Since the “expansion of trade…increased demand for labour,” individuals were effectively earning more. Evidently the “expansion of the middle classes in the 18th century” supports this, and thus highlights the importance of having an inheritance tax in force to capture the effects of an increase in wealth. In “reducing inequality in the distribution of wealth,” the government was effectively ensuring that the rich did not get richer or vice versa; the poor did not get poorer. The taxes also helped to reduce “concentration of wealth” among generations; an effective tool as inheritance without taxation weakens the beneficiary's incentive to work.' Therefore the tax worked in favour with the UK's growing economy thus ensuring that beneficiaries contribute to the rising demand of labour created through the industrial revolution.
The Roman's introduction significantly influenced the economy “for the English and Dutch referred to the inheritance tax of Augustus in developing their own inheritance taxes.” However the use of death duties in Britain did not appear “until the introduction of Probate Duty in 1694. The next few centuries prompted a rise in the complexity of the tax and the scope of taxes payable increased. Specifically, the introduction of Legacy Duty in 1796 ensured “tax was payable on money left in wills or received from an administration of personal estate.” Close relatives and children were exempt from this tax until 1805 when the Legacy Duty was extended. The introduction of the Stamp Act in 1815 also extended the duty to include all beneficiaries except spouses. These duties potentially increased the revenues raised. Succession Duty introduced in 1853 applied to the taxation of transference of property at death. This applied to any sort of property transfer with or without the existence of a will and furthermore, acknowledged that wealth of an individual could be held in multiple forms. Account Duty introduced in 1881 protected the probate duty which could have otherwise been avoided through the transference or a gift made when alive as opposed to upon death. Also a `temporary' estate duty imposed in 1889. This duty was levied upon all property regardless of whom was receiving it or their relation to the deceased. The continual introduction of new duties suggests that individuals were finding a way of transferring wealth without taxation; a concept otherwise known as tax evasion. Avoidance of this tax would allow the rift between the wealthier individuals and the poorer to increase; thus wealth would continue to accumulate among the wealthier generations and burden the poor.
It appears that the complexity of these `death duties' was addressed by Sir William Harcourt in his 1894 budget who `although facing a £4,000,000 deficit…proposed to carry through the long overdue reform of the death duties.” The five death duties in place were a complicated structure that Harcourt wished to simplify; echoing Smith's principles in that tax should be easy to administer. Apparently simplification occurred through the Estate Duty; however this tax was also subject to flaws. This duty was
“levied according to the principal net value of all property, real or personal, settled or unsettled, which should pass on the death of any person, whether by a disposition of the deceased or by a settlement made by others.”
The `modern' estate duty was introduced to not only reform the structure of death duties but also to partially pay for an expanding navy. The taxation varied from a rate of 1 per cent on an estate between £100 and £500 in value to a maximum of 8 percent on estate over £1,000,000 in value. Harcourt's budget also allowed for depreciation allowances for immovable property at a rate of 10 percent in respect of land and 16 percent in respect of houses. This in effect compensated for the increased burden of death duties on land since the estate duty charged would be at a reduced value with the depreciation allowance. It could be suggested that this overall `increased burden' may have been intentionally imposed by Harcourt so as to assist with the £4,000,000 deficit upon the economy. Through enacting this duty Harcourt also aimed to “equalise the burden of taxation on the owners of personal and real property respectively.” The current collection of death duties meant that there was a distinction between the taxes paid on personal and real property. Personal property taxes were paid on net capital value whereas real property taxes were paid on life interest; the latter being more favourable. Although Succession duty was introduced to neutralise this distinction it appears that it did not quite “fully offset the advantage real property had on its valuation.” Therefore the introduction of the `modern' estate duty ensured that all property, both personal and real, was taxed at principal net value. Through this Harcourt perhaps eliminated the way in which property values fluctuate over time, ensured taxes were paid on principal sums. The `modern' estate duty also fulfilled Harcourt's aim in introducing a tax that was “boldly and openly progressive.” In having such a system he was ensuring that the tax “takes an increasing proportion of income as the income rises” thus those who inherit more wealth pay proportionately more in tax. Again this reiterates Smith's `Cannon's of taxation' whereby tax systems should be equitable, reinforcing that those who earn more will be able to pay more. Perhaps in capturing the wealth of those who can pay more the government ensured to minimise the disincentives for individuals to contribute to the increase in demand for labour bought about by the UK's booming economy.
As estate duty was a tax that could be strategically avoided, development led to Capital Transfer Tax replacing the estate duty in 1975. This was a tax that was chargeable on the capital values of transfers of property made both in life as well as death. Essentially, the tax was introduced “to reduce the avoidance associated with estate duty.” Whereas the estate duty levied tax upon property “which should pass on the death of any person,” capital transfer tax captured the way in which it was “easy to avoid by the transfer of wealth seven years before death.” By investing “in assets which were subject to low rates of duty…and manipulation of legal trusts” the inheritance charge could be lowered by the individual. Although the tax collected from the estate duty formed a maximum of “3% of total tax revenue” the importance of taxing all the wealth, so as to help minimise the accumulated wealth, still remained. Therefore in implementing this capital transfer tax ensured that tax was `levied on the cumulative total of gifts made during a person's lifetime” including “the property passing at death”
This tax was “levied at progressive rates” and, reflecting Harcourt's principle of the estate duty, ensured that those who were better off pay proportionately more of their income. This was achieved through the tiered rates; an individual had £25,000 exemption, after this the tax rates rose from 5% on wealth above £25,000 but under £30,000 and continued to rise until 75% was charged on wealth over £2,010,000. The average UK house price rose significantly in the decade that capital transfer tax began. From £11,278 in 1975, the prices reached £31,103 in 1985. This suggests that as inflation caused the house prices to rise, fewer properties were falling within the exemption band. Implying that more people were subject to tax the government could raise more revenue, especially as property in both the UK and abroad were subject to tax for individuals domiciled in the UK.
Although this was a progressive tax it lacked fairness is the sense that it did not reflect the circumstance of those who were in receipt of the inheritance. Essentially horizontal equity, that is the concept “that people of a similar taxable capacity should be taxed similarly,” was not achieved. This is because capital transfer tax based tax liability on the amount given and not the amount received. This potentially decreased the value of inheritance that the beneficiary would otherwise have been entitled to for it implies that more would be received if the tax were to be administered on a vertical equity basis. Perhaps then the level of revenues raise would be distorted as those who iherit the wealth may not be as wealth as those who passed away; thus implying that less revenues would be raised. However since only a very small proportion of this tax contributes to the total tax revenues, the change would be insignificant.
The tax of Ancient Rome was used to specifically raise funds for the military, whereas the inheritance tax implemented in the UK has specifically been a tool used to redistribute wealth in the economy. The development of the tax in the UK ensured that the increase in wealth, arising through the industrial revolution, were subject to tax and were not able to accumulate with beneficiaries; thus encouraging them to provide labour. Its development within the UK also reflects the importance of instigating such tax. However, flaws in the inheritance tax system were only visible when actually in force, which led to a continual development through the centuries.