Financing inheritance tax cuts

Some of today's papers suggest that the Conservatives have softened their inheritance tax policy while others have suggested that their promise to cut this tax remains. But is this pledge affordable given the state of the public finances?

In October 2007 George Osborne, the Conservative Shadow Chancellor, proposed a large increase in the inheritance tax threshold to £1 million, and an increase in the stamp duty threshold for first time house buyers to £250,000. He also proposed a new charge for UK residents not paying tax on any overseas income as a result of being domiciled outside the UK for tax purposes. The main redistribution achieved by this package of policies would be from those non-doms with foreign incomes to those wealthy enough to pay inheritance tax. First time house buyers - and those with homes worth between £125,000 and £250,000 - would also benefit.

After the November 2007 Pre-Budget Report (which reduced inheritance tax and introduced a new charge for those non-doms resident in the UK for seven years or more) Mr Osborne's inheritance tax cut was costed at an estimated £2.0 billion and the stamp duty cut an estimated £0.4 billion. The Conservatives assumed that the £2.4 billion cost of these policies could be met by their non-dom charge. In contrast the Treasury's costing implied this charge would raise less than £0.5 billion. Since the distribution of foreign income of non-doms is not known both these are necessarily guesses relying on strong assumptions.The recent economic turmoil has led to sharp falls in UK equity markets and house prices. This will reduce the cost of the Conservatives' tax cuts. However it will also reduce the overseas income of non-doms which will mean that their proposed charge will also raise less.

The Conservatives also have a number of other commitments to cut taxes: for example reducing council tax in England, exempting interest income from basic rate income tax, increasing the income tax personal allowance for those aged 65 and over, introducing new tax breaks for married couples, and reducing the headline rates of corporation tax. These measures are intended to be financed by a combination of tax increases and spending cuts.

Judging whether or not the Conservatives' plans "add up" would require an assessment of the costs of all of these policies - many of which we do not yet have in sufficient detail. But even this would miss the bigger picture. Public sector net borrowing in 2009-10 is forecast to be at the highest level since the Second World War. To reduce this, the 2008 Pre-Budget Report (PBR) contained a £4 billion net tax increase and a £19 billion net spending cut. Even this might not be enough - the January 2009 IFS Green Budget forecast implied that a further £20 billion of tax increases or spending cuts would be required to bring about the reduction in borrowing sought by the PBR. Any additional shortfall that needed to be met as a result of errors in the costing of the Conservatives' policies would, relative to these figures, be small beer.