Taxing inheritances might be unpopular, but it's fair - Grattan Institute

Published by The Sydney Morning Herald, Wednesday 19 December

We all hope for an overflowing stocking on Christmas morning. But for most people, the biggest gift they will ever receive is an inheritance.

Whether a house, a car or a share portfolio, inheritances can change lives. And as wealth grows and inheritances get larger, these intergenerational transfers will also play more of a role in shaping Australian society.

National wealth has grown by $2.8 trillion – or more than a third – since the Global Financial Crisis. And a lot of this is in the hands of older Australians. Net wealth of people in their 60s, 70s and 80s has grown more than 40 per cent since 2004.

That equates to some healthy nest eggs. The average household headed by someone older than 75 has more than $1 million in net assets. Households headed by someone 65-74 have $1.4 million.

This is a big increase since just 12 years earlier, when the average household aged 65-74 had just under $840,000 in today’s dollars. The reason for the big jump would be well understood by most Australians – increases in superannuation and strong growth in property prices over two decades has made many long-term property holders unexpected millionaires.

But despite these windfall gains, the “spending the kids’ inheritance” movement doesn’t seem to be catching on. Older households are spending more than previous generations in retirement, particularly on recreation, insurance and healthcare. But they are still net savers. Recent Grattan Institute analysis found that the average household over 60 increased their financial worth (not including the home) in the past five years.

There is an awfully big pot of wealth to be passed on. And the major beneficiaries will be older and wealthier Australians. Children of well-off parents are more likely to be financially comfortable themselves.

Big inheritances boost the jackpot from the birth lottery. Among those who received an inheritance over the past decade, the wealthiest 20 per cent received on average $110,000 more than others in the same age group.

And inheritances are increasingly coming later in life. As the miracles of modern medicine have extended life expectancy, the age at which children inherit has increased. The most common age to receive an inheritance is late-50s or early-60s. This means inheritances are more likely to supplement retirement savings than help young people into the housing market.

Of course some parents are also dipping into their savings to help their children into housing now – but this, too, is mainly the domain of the wealthy.

Large intergenerational wealth transfers can change the shape of society. French economist Thomas Piketty has warned of a “Jane Austen world” where inequality is exacerbated by ever-growing inheritances. This is the antithesis of the “fair go” society that most Australians say they want to live in.

A recent German study offers another warning. It found large inheritances were associated with lower work effort, even before the inheritance was received. In other words, Australia’s future “leaners” might be people in the otherwise productive years of their late working life deciding to retire early and wait out their birthright.

Growing inheritances pose a quandary for our political leaders. Taxing inheritances makes a lot of sense from both an economic and fairness perspective. Taxes on inheritances drag on the economy less than other taxes, such as income taxes. Inheritances taxes also promote what economists call “horizontal equity” – ensuring that people in similar economic circumstances pay similar amounts of tax.

People without well-off parents are entitled to feel miffed that they are taxed on their income from working while others can derive a similar sum from an inheritance and pay no tax whatsoever. Australia is an outlier among developed countries in not taxing inheritances.

But despite their shining economic credentials, inheritance taxes are deeply unpopular. The idea of taxing gifts seems to jar with the public. In surveys in the US and the UK, inheritance taxes are routinely nominated as the most unfair. And politicians have responded to the public’s antipathy, upping thresholds and tinkering with rates to the point where these taxes raise far less than they used to in many countries.

So it’s not surprising that no Australian government has seriously touched the idea since estate taxes were abolished in the 1970s. But history suggests that if clearly explained, political parties can make the case for tax changes formerly deemed untouchable.

The Howard government won the 1998 election promising to introduce the “never, ever” GST. The Labor Party will go to the 2019 federal election with a platform to wind back negative gearing.

Estate taxes are worth serious consideration. They are not a tax on giving but a tax on unearned income. Well designed, they could help fund a reduction in the ever-growing income tax burden and help mitigate increasing wealth inequality.

With society-shaping wealth transfers expected to grow over the next two decades, the time to have the conversation is now.