Want to close the class gap? Try taxing the rich when they're dead

Inheritance taxes

The Royal Family may have just made their most modernising decision yet. By decreeing, after what looks like some initial hesitation, that Princes William and Harry will have to pay up pounds 7m in death duties on Princess Diana's estate, the Queen and the Prince of Wales have at a stroke exposed what may prove to be one of the few truly ideological issues left at the end of the 20th century: taxation of inherited wealth. By rejecting an entirely legal scheme to avoid paying the tax - transfer of the assets into a trust for the two Princes - they have chosen to stump up what anyone this rich with the savvy to employ a tax lawyer and/or accountant knows is one of those taxes you just don't need to pay. And in the long run they may have taken a more significant - and entirely welcome - step in making the case for inheritance tax than they realise.

That isn't, of course, how everyone will see it. The most enjoyable weekend remark on the saga was from the anonymous tax lawyer who told the Sunday Telegraph: "What might be perfectly acceptable for an ordinary family with a very large estate might not be acceptable for this particular family." There is a pleasing subtext of underlying panic here: good grief, we don't want this kind of thing catching on. If the Royal Family behave like this, all sorts of people could start paying inheritance tax. And how then would we earn our money? But he's right, of course. All those "ordinary families with very large estates" will continue avoiding inheritance tax; until, that is, something is done to make it a good deal more difficult to do so.

Which is what quite a lot of people, possibly including those advising the Royal Family, thought Gordon Brown would announce in his Green Budget today. Whether or not this was one of the reasons why the Royal Family recently considered the trust option - before rejecting it - the personal finance and business pages of the newspapers have for the past few weeks been full of stories that Brown would use his Commons statement today to start closing the biggest inheritance tax loopholes. These reports were fuelled by those who make a living setting up avoidance schemes. It's always good for business if you can frighten potential customers with a cut-off point. And no doubt quite a few wealthy people were gullible enough to set up trusts to beat the alleged deadline.

As it happens, the Chancellor isn't going to make any such announcement today. Nor would he, whatever he intended to do in the March budget. Significantly, he will emphasise, in general terms, that the very rich, as opposed to middle Britain, are currently, and unacceptably, free to avoid taxes of all kinds. But as every ex-Chancellor knows, to give five months' notice of a tax measure like this would indeed trigger a wholesale flight by the wealthy into every possible avoidance scheme - legal and perhaps not so legal. Which leaves open between now and spring the question of whether or not Gordon Brown, having heavily attacked avoidance of inheritance tax before the election, now intends to reinforce and expand the coverage of the tax next March. Will he? And should he?

The answer to the first question is "probably"; to the second "certainly". Let us nevertheless first consider the counter-case. The Conservatives didn't do much to make more people pay inheritance tax because, with the possible exception of Kenneth Clarke, they didn't believe in it. Indeed, in the 1992 manifesto, they even committed themselves to eventual abolition of both inheritance and capital gains tax. The ostensible argument most frequently used was that wealth should "cascade down the generations" and that the honourable desire to pass on your accumulated fortune to your children was part of what encouraged you to make money in the first of place - a positive motor of the economy.

Partly, however, I blame that Friedrich Hayek. The guru of the right helped to lend the cause of abolishing what is after all the most painlessly redistributive of taxes a kind of respectability. In a distinctly weird passage of his 1960 book The Constitution of Liberty, Hayek used other arguments in favour of untaxed inheritance: such as that parents denied the opportunity of passing on riches to their children would be more likely to use unreasonable influence to lever them into well-paid jobs (something which in a properly meritocratic society would anyway be impossible), and - most breathtakingly of all - that inheriting wealth makes you behave better; according to Hayek "the grosser pleasures in which the newly rich often indulge have usually no attraction for those who have inherited wealth". (Sadly, Friedrich was writing too early to enjoy the daily doings of minor aristocrats, Eurotrash and businessmen's brats in the Nigel Dempster column.)

But not everyone on the right agrees. You can talk to brighter Tories who see all this for the bunkum it is. In particular they point out that if a more dynamic, entrepreneurial society is what you're after, it makes little sense to create a new generation of rich layabouts who don't need to work. Inheriting wealth is a rather more potent disincentive, perhaps, than the allegedly dreadful prospect of having your assets over pounds 215,000 (the present threshold) taxed at 40 per cent at the point of your death would be. In other words, so far from inheritance tax being an obsolete instrument of the politics of envy, it helps to underpin free enterprise.

But inheritance tax is also an essential component of a fair tax system, particularly when increasing income tax is regarded as less and less compatible with winning elections. It's certainly legitimate to examine whether disability benefit only goes to deserving cases. But the corollary is surely that the scams which allow those at the other end of the income scale to avoid paying taxes, including capital taxes such as inheritance tax, have to be outlawed too - whether by buying a farm and working it for just two years or spuriously allowing occasional public visits to your stately home to see a painting or two.

Avoidance isn't everything; there is a strong case, which needs to be built, for extending the scope of the tax. But ending the schemes and wheezes would be a big start. At present pounds 1.5bn is raised each year through the tax. No one, least of all the Inland Revenue, will tell you how much more could be raised if the rich actually paid it. This is one issue about which Tony Blair should be immune to the squealings of the rich and powerful. After all the Royal Family has made it just a little bit less respectable to avoid paying inheritance tax. This is a tax which promotes equality of opportunity and militates against class division. It was Gordon Brown's role model, David Lloyd George, who said that "Death is the most convenient time to tax rich people." It's still true.