Tag Archives: progressive

The Conservative manifesto, social care and taxing inheritance

UPDATE: Some of this post is a little bit out of date, since in the time between writing and publishing, the PM appears to have done a U-turn and re-committed to the coalition policy of a cap on care costs. I’m not going to update the whole post to reflect this, since I think it’s still worth understanding the impact of the manifesto policy, but I’ve added a section at the end discussing the implications of the U-turn.

The dementia tax as an inheritance tax

The Conservatives’ new social care proposals have caused a stir. Their manifesto promises changes to the way in which state support is means-tested. People with assets less than £100,000 will now be entitled to state support – up from £23,250 – but the definition of assets has changed, so that your house is now included even if you are still living in it. Previously the house was only included if you went into a care home (and you didn’t have any family still in the house). To get around the fact that it’s difficult to sell something you are living in, people won’t have to pay up-front but the money will be claimed from their estate when they die.

The backlash has been fairly predictable, although one must wonder if the Tories underestimated it when they put this in their manifesto. The changes have been labelled a “dementia tax”, referring to the fact that people who get dementia and need support in their own home now incur much higher costs while those with other illnesses continue to get free treatment on the NHS. There are echoes of the Tory cries of “death tax” that sounded the death knell of the last-but-one attempt to reform social care: Labour’s National Care Service.

But there has been support for the policy and some of it has come from a surprising angle, given that this is a Conservative reform relating to the inheritance of wealth. Some commentators have praised the reforms as progressive because they take away some wealth that would otherwise be passed on to children, while additional protection is only provided to those with lower levels of assets. This is set in contrast to Andrew Dilnot’s proposals to cap lifetime social care costs, which offered risk-pooling to everyone, including the wealthy.

Broadly speaking these arguments are correct. The Tory proposals are progressive, in that they make small inheritances (passed on by people who need social care) a bit bigger and medium to large inheritances (passed on by people who need social care) a bit smaller. But if we want to see the dementia tax as a sort of inheritance tax then we don’t need to discuss it in the abstract. We can do some analysis to see exactly what sort of inheritance tax it would be.

Estimating the total rate of “taxation” on inheritance

If we are going to think about social care costs as a tax on inheritance then we need to consider them alongside the other major tax on inheritance: inheritance tax. As well as the changes to social care, the Tories are also cutting inheritance tax by raising the threshold at which it kicks in from £325k to £500k per person. This allowance can be passed on to a spouse, meaning that mum and dad’s estate won’t incur any tax unless it’s worth more than £1m. So what is the combined effect of these two “taxes”?

It’s easy to calculate the effective tax rate on an estate in any given scenario. For example, under Tory policy, someone starting with a £200k estate who needs expensive social care would have £100k of their estate protected and have to spend the other £100k on social care. The “dementia tax” on this person would be levied at a rate of 50%, but they wouldn’t pay any inheritance tax. Meanwhile, someone with an estate of £1.5m who never needs any social care would pay 40% inheritance tax on all assets over £1m, working out as an effective tax rate of 13%, but they wouldn’t be hit by the dementia tax.

The chart below shows how the combined tax rate relates to the value of someone’s house (assuming they also have £50k in savings) under the current system and the Tories’ proposals for social care and inheritance tax. The “dementia tax” rate also depends on how much social care someone needs, so two scenarios are shown: people who don’t need any social care; and those who have very high costs of £250k over their lifetime, which they can’t afford from their income.

There’s quite a lot going on in this chart, so I’ve marked on four changes that will see different groups passing on more or less to their children.

People who will pass on more to their children as a result of these changes

1. Non-homeowners who need social care

There is one group of people that absolutely benefits from the manifesto policy, and that is people who don’t own their own home. The increase in the means-test rules mean they won’t have to use their assets for social care unless they have more than £100k in the bank. People with very low value houses will also benefit: if someone has a house worth £50k and another £50k in the bank, they won’t have to use their assets either. In the current system they do.

2. Most homeowners who go into a care home

People who go into a care home already have to use their housing wealth to pay for care – that is, they already pay a “dementia tax”. If their costs are high enough, they will only be left with £14,250. The Tory proposals raise this to £100k, so many homeowners will be better off. Of course, this only affects people who are going to reach this limit. With £250k of lifetime care costs, you would benefit from the new limit if your total estate is less than £350k. Given that the median house price in England is £220k, this is most homeowners. Fewer people benefit in London, where the median house price in London is £435k.

But while most homeowners who go into a care home are better off under Tory proposals, it’s still not great for their chances of passing on money to their children. Someone with a median-value house who has expensive residential care is still going to see about 60% of their estate going into social care costs.

3. Rich people, unless they need social care at home

Only rich people pay inheritance tax. Assuming that the person in question has a partner who dies before them, the first £650k of their estate will not be taxed. In 2016-17, only 8% of the population paid any inheritance tax – and that was a record high. By raising the threshold to £500k for individuals and £1m for couples, the Tories are giving a tax cut of up to £140k to the heirs of wealthy people.

However, the proposed social care changes take this money back – but only for some rich people. Those who are lucky enough to not need social care are fine – they can still pass on the additional £140k. Those that go into care homes are also unaffected by the rule changes. But those who need care at home are going to find themselves paying more towards it. If they need a lot of home care, they may find that this completely cancels out the inheritance tax cut.

(In reality, people with £1m plus estates are likely to have high incomes, so may be paying most or all of the cost of home care under the current system. In this case they would be unaffected by the social care proposals and their inheritance tax cuts would be safe.)

People who will pass on less to their children as a result of these changes

4. Most homeowners who need care at home

Most people who own a home have most of their wealth tied up in it. Under the current system, this wealth is not considered as part of the means test as long as they are still living in the house. The Tories propose to change that, meaning that anyone who owns a house worth more than about £75k (assuming they also have £50k of savings) will have to pay more out of their assets for home care. This is the vast majority of homeowners.

For people with homes worth around £75-300k, there is a trade-off between coverage for different risks: they pay more for home care, but if they go into residential care they are better protected. However, for those with homes worth £300-600k it is all downside. Even with £250k of care costs they won’t hit the proposed £100k floor, so won’t benefit from that change, but if they need home care they will pay more – sometimes a lot more. Meanwhile they aren’t rich enough to pay inheritance tax in the first place, so won’t benefit from the tax cuts.

Many London homeowners fall into this category. The median house price in London is £435k. Someone with a house worth that much won’t benefit from the £100k floor even if they have £250k of care costs. If they go into a care home they will pay the same as under the current system. But if they have care at home, they will pay much more: more than 50% of their estate will go towards social care costs, compared to around 7% in the current system. Their children will need to sell their house to pay the debt.

Another group that will lose out is people who go into residential care and leave a spouse at home. The value of the house isn’t considered as part of the current means test in this scenario, but under Tory proposals it would be included, leaving people paying a lot more in care home fees.

Summarising the effect on people with different levels of assets

The chart below shows another way of looking at this. It segments the population by house value (again assuming they also have £50k of savings) and identifies which groups win from the changes (shaded green), which lose (red) and which get a mixed bag (orange).

The effect of the changes can be summarised as follows.

  • Non-homeowners (or those with very low-value homes) do better thanks to the rise in the means-test floor.
  • People who own low-middle value homes (£75-300k) get a mixed bag and see an equalisation of their risks between home and institutional care. Home care will be much more expensive for them, but their residential care costs will be limited. This group includes the median homeowner in England.
  • People who own middle-high value homes (£300-600k) lose out. They already faced a risk of losing more than half of their estate paying for residential care. Now they face the same fate if they need home care. Meanwhile, even if they spend the majority of their assets on social care, they are very unlikely to benefit from the increased means test. This group includes the median London homeowner.
  • People who own high value homes (£600k-£1.2m) get a mixed bag. If they need a lot of social care in their own home, they are going to have to use up more of their assets paying for it. If they are lucky enough not to need social care (or if they have to go into a care home) then they benefit from the inheritance tax cut.
  • Very rich people get to pass on more of their money thanks to inheritance tax cuts. Although people who are asset rich and income poor might see this gain cancelled out if they need home care, they are unlikely to be worse off than in the current system.

In short, the changes to the treatment of assets and inheritance in the Conservative manifesto help the poor and the very rich while hurting the people in the middle.

Comparing Tory policy with the Dilnot proposals

In setting out a new approach to social care funding, the Conservative manifesto also rejects the approach recommended by Andrew Dilnot and adopted by the Coalition: a cap on lifetime care costs. Dilnot recommended that the cap should be set between £35k and £50k, but the Coalition thought this was too expensive and set it at £75k.

It’s not quite fair to compare a cap on care costs with the Tory proposals since the cost isn’t going to be the same. The new proposals help some people and hurt others. It’s not clear what the net effect on government spending would be, but it is plausible that the proposals are cost-neutral. The Coalition’s version of Dilnot’s proposals costs around £1bn a year, so if we are to make a fair comparison we need to consider where this money would come from. As it happens, this is about what the inheritance tax cuts were reported to cost, so capping social care costs and cancelling these tax cuts could be roughly cost-neutral.

The chart below compares these two options: the Tory proposal versus a cap on care costs funded by cancelling the planned inheritance tax cuts.

Some people do better from the Tory proposals.

  • Non-homeowners (and those with very low value homes) pay little or nothing towards social care under the Tory proposals. Under the Dilnot proposals these people do much better than in the current system, but they still might use up to half of their assets on social care costs.
  • Rich people who don’t get sick are the big winners under Tory policy. There is a tax cut for all estates over £650k which is worth as much as £140k for estates worth more than £1m – although people who need a lot of home care might see it cancelled out.

Other people do better if we cap social care costs instead of cutting inheritance tax.

  • Almost all homeowners who need social care (with the exception of those with houses worth in excess of £1m) would be better off with a cap on care costs. People with houses worth the median house price or just above benefit most. Under Tory proposals, someone with a median-value house and £50k of savings would lose over 60% of their estate to social care costs, compared with less than 30% under Coalition policy.

Conclusions

Tory policies in relation to inheritances seem designed to benefit those with the least and those with the most. Those with low levels of assets (mostly non-homeowners) are better protected from social care costs and very rich people get a big tax cut – provided they don’t need social care. But the proposals leave the vast majority of homeowners either worse off full stop or just facing a different distribution of risk between home and residential care.

Reverting to the Coalition policy of a £75k cap and cancelling inheritance tax cuts could be roughly cost-neutral – meaning that the total amount of money coming out of the assets of older people would be the same – but the impact would be different. Non-homeowners would pay less than in the current system, but more than under Tory proposals, while the very rich would pay more inheritance tax. The beneficiaries would be the vast majority of homeowners. Under Tory proposals, the median homeowner could have up to 60% of their estate claimed after their death to pay for their social care, while the Coalition policy would limit this to less than 30%.

Update

Just before hitting publish, word has reached me that the Prime Minister may be in the process of a U-turn on this policy. Despite the Conservative manifesto explicitly rejecting the Dilnot recommendations, the PM appears to now be insisting that we must all be mistaken and that the policy was always going to include a cap on care costs. This puts Tory policy squarely in line with the Dilnot Report, which suggested that the means-test changes for home care could be a good idea if coupled with a cap.

So what would it look like if the manifesto changes to the means were combined with the Coalition’s £75k cap? In short, it looks much better for homeowners.

But if everyone is now going to pay less from their estates, where will the money come from? If the PM is indeed performing a U-turn here, she has just made a spending commitment in the billions. There is one blindingly obvious way to finance at least some of the cost – cancel the inheritance tax cuts. The chart above shows that even with the U-turn, the effective tax rate on estates from social care and inheritance tax combined is regressive: people with assets of £175k (in the chart, a home worth £125k plus £50k of savings) pay the highest rate. Funding the U-turn by cancelling inheritance tax cuts would be both progressive and intergenerationally fair. But it may be too much to ask from a Conservative Prime Minister.

In defence of universality

Writing for the Independent, Ben Chu is not happy about proposals to extend public support for social care to the asset-rich. Universality, it seems, is terribly unfair. Ben’s main complaint is that it will help a generation of asset-rich pensioners to pass on even more, exacerbating the increased importance of inheritance recently highlighted by the IFS. I get Ben’s concerns, but his argument is muddled and he ends up attacking ideas I think he should support.

Before I explain why, let’s separate two issues. Ben is right to point out that demand for social care is projected to rise and that this will cost more money. It’s actually worse than Ben lets on, since the Treasury has been slashing local government funding. Social care budgets are falling at a time when they need to be rising. This does not seem like a sustainable situation.

However, I’m not sure anyone is suggesting that the “solution to the crisis is to scrap means testing and to load more costs on to taxpayers in order to protect the inflated housing inheritances of the already well-off”. Whether more support should be provided to people who currently use their assets to pay for care is a separate question, and this is where Ben’s article misses the point.

Risk pooling

To see this, we need to address a concept that is fundamental to this question, but is entirely missing from Ben’s piece: risk-pooling. This is best illustrated by an example.

Ben tells us that one in ten older people will face costs of over £100,000 in their lifetime. For simplicity let’s imagine that out of every ten older people, one will spend a few years in a care home costing £100,000 while the other nine will die without any significant care costs.

Now take ten people who each retire with £150,000 in housing assets. Under the current system whichever of these people gets sick enough to end up in a care home will have to sell their house and spend two-thirds of the value on care home fees, while the others will not have to pay a penny. Since social care needs are unpredictable, none of them know ahead of time if they will be the unlucky one.

Now imagine another system where each of these people agrees to pay £10,000, either up-front or from their estate after death. This money will be used to pay the social care costs of whichever of them ends up in a care home. Economists usually assume that people prefer this option because they are risk averse. Indeed, this is why we buy insurance in other areas of our lives and why we pool the risk of health care costs through the NHS.

We can buy many types of insurance privately, but others are best provided publicly. Health insurance is the classic example: a set of well-known market failures mean that private health insurance works badly, so all advanced countries (except the USA) provide it primarily via the state. Social care insurance has some similar characteristics. In fact, it’s virtually impossible to buy at the moment because there are very few products on the market in the UK. So if the government can help people to pool their risks, surely this is a good thing.

This is what Andrew Dilnot’s proposals are about. In fact, he proposed a rather modest version whereby risk pooling only applies to people who have already spent tens of thousands on social care. As Ben notes, these proposals have a (fairly modest) cost.

This is all predicted to cost around £6bn to the public purse over five years. And remember: those billions of pounds would otherwise have been extracted from the property assets of pensioners.

There’s a word missing from that last sentence. The billions of pounds will be extracted from the property assets of sick pensioners. Pensioners who don’t end up in care homes won’t have anything extracted from their property assets.

Distributional consequences

Notice that in my example above there is no distributional impact. I’ve taken ten equally rich people and shared a risk between them. The total amount of money passed on as inheritance hasn’t increased, it’s just more evenly distributed. Things are a bit more complicated in reality, but it is important to remember that the Dilnot proposals are about how to structure a risk-pooling scheme, not where to get the money from to pay for it.

So when Ben says:

That’s a £28,000 boost to the inheritance of the children, ultimately courtesy of the taxpayer.

I’m not quite sure who the “taxpayer” is. If we are talking about the people that pay the most income tax, then (insofar as there is a correlation in earning between generations) we are talking about many of the same people who stand to inherit significant wealth from their parents.

But who says we have to fund this from income tax? It may be politically toxic, but if you are worried about the increasing importance of inheritance, you could argue for increasing inheritance tax. This would get you pretty close to my example above – in fact, it would be much more redistributive, as inheritance tax is only paid by the very richest. Alternatively, you might want to suggest changing the tax rules around pension lump sums. These possibilities get only a passing reference in Ben’s article.

Political constraints notwithstanding, we can get pretty much any distributional effect we want by choosing where the money comes from to pay for reform. But we really shouldn’t be trying to solve our distributional problems through the social care system. This system is there to make sure that people get the care they need and to limit the financial disadvantages they face as result of becoming sick. As a way of getting at the assets of old people it is pretty terrible. If we care about distributional effects (and we should) we would better off looking at the tax system.

Taxing wealth is hard. It’s tough to figure out how much people have when they are alive and inheritance tax is unpopular. The IFS tells us that the importance of inheritance is increasing, which is hard to see as a good thing. But – at risk of repeating myself – letting the one in ten old people who become severely dependent spend down their assets while letting the other 90% keep everything is a shoddy way of dealing with it.

An assault on universality

The arguments in Ben’s article aren’t specific to social care. The same arguments can be used to attack universality in all its forms. Ben could have made all of the same arguments against universal coverage for health costs – after all, it is mostly old people who use NHS services and mostly working age people who pay for it. Why not ask them to sell their homes to contribute the cost of their latest operation? Except I don’t think that Ben, or many other people, would make that argument.

Universality does involve governments providing services and support to people who have money. It’s not how most of the public sector works in the UK, but it is not “pro-rich” – in fact, it’s probably the opposite. Its corollary is higher taxes, so the rich pay for it, while the main beneficiaries are the people who fall just outside the criteria of means-tested systems. It is no accident that the countries that we see as the most “progressive” – such as the Nordics – have a wide range of universal benefits and high taxes. It is also arguable that means-testing is divisive, splitting people into those that pay into the state and those that take out.

Priorities – a caveat

In defending universality, I don’t mean to say that it is always better. By all means give me an argument that political limits on taxation make means-testing necessary to achieve certain distributional aims. Please, tell me that wealth taxation is so hard and inheritance such a problem that letting the sickest 10% of old people use up their assets is the lesser of two evils. I am listening.

Nor do I mean to say that universal coverage is the priority for the social care system. Cuts to budgets mean that councils are struggling to fund even the means-tested system that we have now. If we can’t even support the poorest in society then a lack of risk-pooling may not be our most pressing problem.

But if we are going to talk about universality, let’s be clear about what it means. It is not a hand-out to the rich and it is not about protecting people’s inheritances – any more than the NHS is either of those things. Coupled with a fair tax system, it is a progressive goal and one worth defending. I invite Ben to reconsider which side of the argument he is on.

Three golden rules for discussing progressivity

What does it mean for a policy to be progressive? The way this question is addressed by the media (and often by government) can be infuriating. It’s got to the point where I am tempted to say the term should be banned, but instead I am going to make one last attempt to clarify it by proposing three golden rules.

I was reminded of this issue when reading Jo Maugham’s analysis* of the impact of the new “social care precept”. This is essentially a £2bn rise in council tax, a significant proportion of which will be paid by poorer households. Here are the figures that Jo gives:

Who pays what in council tax

So is this tax progressive or not? Well, rich people pay more, and for some that’s good enough. Fraser Nelson, for example, likes to point out that “the top 3,000 taxpayers in Britain stump up more income tax than the lowest-paid 9 million”. It is more common to look at how paying tax affects the living standards of different groups by comparing tax paid as a proportion of income. By this measure, council tax is regressive.

This is as far as the discussion usually goes. But both of these comparisons have no basis in reality – unless that reality involves collecting these taxes and throwing the money in the sea. The fact is that this money will show up somewhere else, either as increased spending or lower taxes. Which brings me to my first golden rule: the distributional effect of a policy change can’t be assessed without looking at both sides of the equation.

Since this is called the “social care precept”, we might think that it will lead to increased spending on social care. It’s not easy to find numbers on how social care spending is split between income groups, but modelling done in 2011 for the Dilnot Commission (see figure 11 here) made some estimates. Reading the numbers off the chart, I get something like this.

Council tax and social care by income group

Social care spending is more heavily weighted towards poor people than council tax collection, so lower income groups make a net gain from this policy. That is, the introduction of this policy increases the total amount of redistribution that the government does, which is the only sensible definition I can think of for the word “progressive”, with reference to a change in policy.

Gain from spending council tax on social care

But is higher spending on social care really the effect of this policy? That is, if it weren’t for the social care precept, would we see lower social care spending? You could argue that social care spending is going to rise either way, since we’ve got more old people than ever. If it’s not paid for by council tax rises it will be paid for by higher taxes elsewhere, higher borrowing, or cuts to other services.

So this is my second golden rule: identify a realistic counterfactual. We need to know whether the policy leads to more redistribution than what would otherwise have happened. That “what” can have a huge impact on how we view the distributional consequences.

Let’s say we believe that without the social care precept higher social care spending would have to be funded through an increase in income tax – or perhaps higher borrowing now, funded by future increases in council tax. As Jo points out, income tax is much more targeted on rich people than council tax. Here’s the net effect of raising £2bn through council tax instead of income tax.

Gain from raising council tax vs income tax

This policy change would give money to the richest 20% at the expense of everyone else. I think we can all agree that’s regressive. So depending on the counterfactual, the social care precept is either highly progressive or highly regressive. Take your pick. We need to decide which counterfactual is more realistic. In this case, the first one is probably closer to the truth (raising income tax and borrowing more are not top of this government’s agenda) so I’d argue that the policy is probably progressive.

But there’s another more fundamental question here: how much redistribution do we want? Requiring all policy changes to be “progressive” implies that we think we don’t currently have enough. But at some point, if we were to go on increasing redistribution, we’d have too much. Views will differ wildly as to what the optimal level is, but in principle there must be one. I imagine few people think that there should be no redistribution and few think that redistribution should fully equalise living standards.

And even if we want more redistribution, we might not care if a policy is regressive if its effect on the overall level of redistribution is small and it achieves some other aims. The state does not exist solely for the purpose of moving money from the rich to the poor. My third golden rule is therefore this: the overall level of government redistribution is what matters. We need to know whether we want to increase or decrease it, and how much we care about small changes relative to other policy aims.

These rules really are essential. It is impossible to say anything about whether a policy change is progressive without considering both sides of the equation and being clear about what you think the alternative scenario is. It is impossible to know whether you actually want the policy to be progressive, or whether you care, without considering the overall level of redistribution.

These are not new insights and many organisations (the IFS, the OBR, sometimes even the Treasury) are quite diligent about doing distributional analysis properly. But much of the public discussion of “progressivity” fails to follow a single one of these rules, giving us a rather poor standard of debate on the state’s role in reducing inequalities.


* I’m not picking on Jo’s analysis because it is a particularly egregious example. On the contrary, I am picking on it because is one of the better examples of someone tackling this question, so Jo has done most of my work for me.