Chancellor urged to scrap residence nil-rate band, raising £2bn annually, but could face backlash from middle-class families.

Rachel Reeves, Chancellor of the Exchequer, is under increasing pressure to remove the £175,000 residence nil-rate band as part of her upcoming October Budget. The proposal, pushed by the left-leaning think tank Resolution Foundation, could raise £2bn each year by eliminating a tax relief introduced in 2017. This relief allows homeowners to shield an additional £175,000 of property value from inheritance tax, on top of the standard £325,000 nil-rate band. By scrapping this allowance, the government could potentially close a portion of the £22bn fiscal shortfall facing the UK.

The residence nil-rate band currently enables individuals to pass on a total of £500,000 tax-free, while couples can share their allowances, allowing them to leave up to £1m to their heirs without incurring a 40% inheritance tax. For example, a married couple with a home worth £800,000 and £200,000 in other assets would owe no inheritance tax under the current system. However, if the residence nil-rate band were removed, they would only be able to pass on £650,000 before triggering the 40% tax, resulting in a potential £140,000 tax bill for their beneficiaries.

Reeves has been critical of the Conservatives’ introduction of this tax relief, which she previously condemned as benefiting “a wealthy elite” when it was announced in 2010. At the time, she argued that raising the inheritance tax threshold to £1m for couples would help only a tiny fraction of families while the NHS faced funding crises and disability benefits were cut.

Proponents of abolishing the residence nil-rate band argue that it adds unnecessary complexity to the tax system, with many taxpayers either unaware of the benefit or unable to utilize it fully due to restrictions. For instance, only those leaving property to “direct descendants” can claim the relief, disadvantaging childless individuals or those without immediate heirs.

Although eliminating the relief could streamline inheritance tax rules, it would also result in larger tax bills for thousands of homeowners. In the 2021-22 tax year, 25,800 families claimed the allowance, sheltering £6.5bn worth of property from inheritance tax and saving £2.6bn. The pressure to raise taxes in the face of a significant budget deficit makes it likely that Reeves will consider changes, but she must balance the potential revenue boost against the risk of angering middle-class families who are increasingly being drawn into the inheritance tax net due to rising property prices.

Some experts suggest that if Reeves does decide to eliminate the relief, she could soften the impact by lowering the overall inheritance tax rate. At 40%, the UK’s inheritance tax rate is one of the highest in the Organisation for Economic Co-operation and Development (OECD). The Resolution Foundation has proposed introducing tiered tax rates, such as 20% or 30% for smaller estates, with the 40% rate reserved for estates over £1.5m.

Analysis:

Political:
The proposed removal of the residence nil-rate band aligns with Reeves’ past critique of the Conservatives’ approach to taxation, which she argued favoured the wealthy. Scrapping this tax relief would symbolize a Labour government addressing fiscal inequities by closing what is perceived as a loophole benefiting the wealthier minority. However, this decision could backfire politically if middle-class voters, many of whom now own high-value properties due to soaring house prices, view the change as an attack on family wealth. With the next general election approaching, the Labour Party must consider how to balance its traditional base with the expectations of middle-income homeowners who may be alienated by an inheritance tax increase.

Social:
The debate over inheritance tax highlights broader societal discussions about wealth distribution and intergenerational equity. While critics argue that inheritance tax disproportionately impacts families who have benefited from rising property prices, others believe that it serves as a necessary tool for redistributing wealth and supporting public services. Removing the residence nil-rate band could exacerbate tensions between different socioeconomic groups, particularly as it would disproportionately affect homeowners in regions where property prices have soared. In essence, it raises fundamental questions about fairness, social mobility, and the role of taxation in addressing economic inequality.

Racial:
Inheritance tax has often been viewed through a lens of class and wealth, but its impact can also intersect with racial inequality. In the UK, ethnic minorities are statistically less likely to own property compared to white Britons, which means they are less likely to benefit from tax breaks like the residence nil-rate band. If the government were to eliminate this relief, it could, in theory, reduce disparities in the tax system that primarily benefit wealthier, often white homeowners. However, broader economic reforms addressing housing affordability and access to property ownership would be necessary to truly tackle racial inequities in wealth accumulation.

Gender:
Inheritance tax policy can also have gendered implications. Historically, women are more likely to live longer and become widowed, meaning they are more likely to inherit property and pass it on to descendants. Scrapping the residence nil-rate band could disproportionately affect older women who may rely on passing down family homes to children or grandchildren as a form of financial security. Any changes in the tax system should consider how gendered wealth disparities play out, especially in later life, when many women may face financial vulnerability.

Economic:
From an economic standpoint, removing the residence nil-rate band offers a potential revenue stream to help fill the £22bn budget deficit Reeves is facing. The allowance, which costs the Treasury £2bn annually, has increasingly come under scrutiny as property prices rise and more middle-income families benefit from the relief. By eliminating the tax break, the government could raise additional funds to support public services or reduce debt, potentially avoiding more drastic cuts elsewhere. However, the decision must be weighed against the risk of discouraging property ownership or estate planning, as higher inheritance taxes could lead to more aggressive wealth management strategies that ultimately reduce the tax take. Moreover, the middle class, particularly in regions with high property values, may feel penalized by this change, potentially leading to economic repercussions in sectors like housing and real estate investment.