Economists have warned Labour they face a number of difficult choices in the upcoming Budget, with chancellor Rachel Reeves already indicating that more tax rises and spending cuts can be expected.
The government may need to find at least £22bn at the fiscal event on 26 November, recent research by the Institute for Fiscal Studies (IFS) indicated, with speculation about the chancellor’s options mounting.
Ms Reeves has said she remains committed to Labour’s manifesto commitment not to raise taxes on ‘working people,’ meaning no increase to the headline rate of income tax, national insurance, or VAT.
With these three largest revenue streams ruled out, the Treasury must now look at smaller tweaks to the tax system to raise the funds it needs. This was recently referred to as a “scrabble bag” by tax expert Dan Neidle to the cross-party Treasury Committee.
Instead of this approach, the Tax Policy Associates founder recommended Ms Reeves “steps back and thinks about ways that you could reform the tax system to be pro-growth”, adding: “Which we have rarely seen in last few decades but now has become quite desperate.”
One possible area the chancellor may be looking at ahead of 26 November is the inheritance tax system. Both Ms Reeves and prime minister Sir Keir Starmer have previously they want those with the “broadest shoulders” to pay a fair share of tax, with inheritance tax policy being one of the more obvious ways to achieve this.
How does inheritance tax work?
Inheritance tax is a levy applied to the estate of someone who has died, but only around four per cent of families end up paying it, as most estates fall below the £325,000 tax threshold.
Key to this exemption is that anything left to a spouse or civil partner is not subject to inheritance tax, regardless of the estate’s value. So if a deceased individual leaves their entire estate to their partner, even if valued at £10m, no inheritance tax will be charged.
However, this exemption does not extend to partners who live together but are not married or in a civil partnership.
Each individual has the £325,000 inheritance tax-free allowance. Estates valued below this threshold incur no tax, while those above it are taxed at 40 per cent on the excess.
What changes has Labour already made to IHT?
However, two major changes already came to how inheritance is taxed at last year’s Budget, making it less clear-cut if Labour will look at this option again this year.
Most controversial was the so-called ‘tractor tax’ – reforms to agricultural property relief which are still set to come into force in April 2026.
This will see the inheritance tax relief for business and agricultural assets capped at £1 million, with a new reduced rate of 20 per cent being charged above that (reduced from the standard 40 per cent IHT rate. The tax will be payable in instalments over 10 years, interest free.
The government says that the actual threshold before paying inheritance tax could be as much as £3 million, once exemptions for each partner in a couple and for the farm property are taken into account.
Private pension wealth that is passed on will also be brought into inheritance tax from April 2027, the chancellor announced. Ms Reeves also opted to extend the freeze on the IHT tax-free allowance at £325,000 until at least April 2030 – it has been frozen at that rate by successive governments since 2009.
How could Labour change IHT further?
The Treasury is now reported to be considering a lifetime cap on the value of gifts that a person can pass on before they die, which is sometimes done in a bid to reduce the final inheritance tax bill.
Relief on gifts given before death is also tapered, with no tax due on gifts given seven years before death, up to 32 per cent on gifts given 3 to 4 years before death. The full 40 per cent is due on those given just one or two years before death.
This is understood to also be under review by the Treasury.
Finally, the chancellor may look at extended the freeze to tax-free allowances even further. Recent data from the Treasury showed that HMRC pulled in £4.4bn extra over the last six months due to the frozen threshold, making it an attractive option thanks to its relative obscurity.
