Modelling the implications of inheritance tax reforms in the UK

Our Assessing the Implications of Inheritance Tax Reforms in the UK report estimated that a full inheritance tax (IHT) exemption for primary residence combined with an increase in the nil-rate band to £500,000 would cost £6.0 billion in 2029/30. Tax Policy Associates’ (TPA) have estimated the cost at between £7.7 and £10.9 billion.  

This note provides further detail on our analysis. However, at the outset it is worth highlighting that there are a range of approaches that can be used to cost reforms to IHT, all policy costings are uncertain, and debate around them is valuable. 

Our approach aligns closely with that used by the IFS in their Reforming Inheritance Tax Report, as was acknowledged, by the report’s author. As detailed in our report’s methodology, the model first estimates a static cost before going on to account for a behavioural response. 

Our static costing for the policy comes in at £6.2 billion in 2029/30, which is lower than either of the static cost estimates included in the TPA report (£7.0 billion and £9.0 billion). It is not possible for us to fully disentangle the reasons for this, but we would note the following points:

• The TPA’s £9.0 billion estimate is based on data taken from Wave 8 of the Wealth and Assets Survey (WAS) from the ONS – a version that has had its accredited statistical status suspended. For this reason, we used data from Wave 7 as our starting point.  
• Estimates from our model for both IHT liabilities and the percentage of estates liable for IHT closely track data from HMRC over the 2019/20 to 2023/24 period (see section 2.2 of our report for further details). In contrast, the TPA model significantly overestimated both measures when back tested.  
• Any forward-looking costing will also be sensitive to associated forecasts of liability growth, savings rates, and wealth drawdowns which are inherently uncertain. We have used forecasts consistent with Oxford’s current baseline view for the UK economy.  

The remainder of the gap comes from differences in the assumed behavioural response. As noted in our report and in work by others on this topic, there is significant uncertainty regarding how individuals will respond to IHT reforms. 

Our costing includes an allowance for reduced tax planning as inheritance tax bills fall, which lowers the cost by around £200 million. For this, we followed Advani, Hughson, and Tarrant (2021). They apply an elasticity of taxable wealth of 0.2 to the change in each estate’s net-of-average tax rate. We adopted their approach for consistency with that work, and because much inheritance tax planning involves fixed costs, so its value depends on the size of the overall bill as well as on the rate at the margin. 

TPA also model a series of additional behavioural responses based on their own judgements which significantly increase the cost of the policy. For example, their upper bound estimate assumes that 15% of households’ taxable financial wealth will shift into their main residence based on the rationale that it will lead to a 40% saving on a future IHT bill. We agree that a full residence exemption would create an incentive to shift wealth into housing but chose not to seek to model this effect due to a lack of available precedent and our view that the short-term impact (by 2029/30) is likely to be marginal, due to a range of reasons.  

Firstly, primary residences are not productive assets. Over the last 10 years the average annual growth in UK house prices was around 4%, while global equities (inclusive of dividends) grew around 12%.¹ This difference plus upkeep costs and increased council tax payments (including the High Value Council Tax Surcharge) on a larger home is significant enough to mean that this decision makes less and less financial sense the longer someone lives after upsizing. 

Secondly, housing wealth is illiquid, while this may not matter for the ultra-rich it will matter for many households with financial wealth above the standard nil-rate band. They will be reluctant to tie up wealth that they need to depend on in their later years.  

Thirdly, the tax system disincentives this behaviour. Individuals would face a significant stamp duty bill which could be in the region of 10% of the new property’s value². At the outset, this would significantly erode the IHT savings that the individual is seeking to avoid. Furthermore, many individuals accessing the funds needed to upsize will face either a Capital Gains bill, which could approach 24%, or pay high rates of tax when withdrawing from their pension. 

Finally, on a more human level, individuals in their later years will be reluctant to upsize due to emotional attachment to their homes and wanting to avoid the stresses of moving or extending their family home. 

Overall, we are confident in our tried and tested modelling approach. Our static costing has been thoroughly tested against outturn data and aligns closely with the approach used by the IFS. While a full exemption for primary residences would create incentives for some individuals to hold more wealth in households at death, we judge these effects to be marginal.