things you do which you'd rather not
down on the farm, a difficult economic category
What’s the difference between being “asset-rich, cash poor” and being “asset-poor, cash poor”? Not a difficult question – as Woody Allen said, it’s better to be rich than poor, if only for financial reasons.
Does it make a difference to the general truth “it’s better to be rich than poor” if you plan to never sell the asset?
OK, I’m tired of pretending – this post is completely off brand, I’m talking about inheritance tax on family farms. But I think there are some on-topic elements to the reasoning, because it took me quite a while to understand why British farmers hate the recent budget proposals so much.
The answer to the question above is “no it does not make a difference, it is still much better to be asset rich”. And the reason is that while you might plan to never sell the asset, the world often turns in a way which makes it necessary to do things that you really didn’t plan to do.
Bringing foreign readers up to speed – farmland in the UK, up until the last budget, was not subject to inheritance tax. This made it popular as an investment for very rich people, which pushed the price up markedly. It’s quite tricky to precisely model the value of the tax shield, but the marginal rate[1] of inheritance tax is 40%; if you’re close enough to the Grim Reaper to be thinking seriously about estate planning, you might be willing to accept a really quite low annual rate of return in order to avoid that.
Which is what happened – in the thirty or so years since Agricultural Land Relief was brought into the tax code, the price per acre of farmland has gone up roughly fourfold, and according to credible numbers I’ve seen, there are plenty of farms which, considered as businesses, are earning a return on assets of less than 1% (£35,000 of annual profit on a farm valued at £3m is apparently pretty good going).
In that sort of situation, you have to value the tax shield separately – what the yeopersons of Olde Englande actually own might be a farm worth about £700,000, with a mortgage on it, and a £2.3m tax asset. So if the tax position changes, the value of the farm should be expected to plummet, and they go from being asset-rich-cash-poor to just poor.
And this matters a lot for the reason I hinted at earlier. The asset value of a family farm, although it’s for the most part not realised or consumable wealth, is potentially a big part of the contingency reserve of that family against uncertainty. If things get really bad, either in a business context or some other family emergency, you can borrow against the value of the land or, in extremis, sell off a few acres.
There’s a lot of uncertainty in farming! If the backstop of being able to sell bits of tax-advantaged assets isn’t there, then rather than being gradually eroded over four or five generations (which seemed like the natural outlook for the small farm sector), you’re likely to see lots of them wiped out suddenly in the next drought or foot & mouth disease outbreak.
Which is where we get to my point about economics, because I think it helps to answer the question “why are so many farmers so up in arms about this when the tax change has generous allowances in it which means that small family farms are very unlikely to have to pay?”. Whether or not you end up paying it yourself, the effect on farmland prices is the same, so this is a direct cost to an asset which isn’t quite experienced by the farmers in the same way as £2.3m in the bank might be, but which is definitely there and which will be missed when it’s gone.
Some people writing to newspapers have suggested that this is a positive side-effect (as lots of British farmers are tenants, who might get the chance to buy land). But the asset price move is a big change to the economics of farming, and definitely might have serious medium-to-long term effects on the viability of small farmers who will never actually pay. And the reason that professional economists and tax wonks have been slow to understand this is that we’re equilibrium thinkers, in a world where a lot of the interesting things happen outside of equilibrium.
[1] Kind of odd to be talking about marginal rates in the context of something (death) that is very definitely not a continuous quantity, but I mean that this is the rate on estate value above the threshold.
Most of my family, on both grandparent sides, are farmers. North West England, mixed dairy and arable. (I'm not. I'm an economist). The farm assets are very substantial, in capital value, but the income or rate of return is very low, so the farms provide a good level of "middle class" income, but not beyond that.
If inheritance tax had to be paid on the full capital values, this would mean finding a very large cash sum on succession, requiring significant liquidation of assets. In other words, the family business model would not work. So the issue really is the extent to which the new rules will hit this type of "working farmer".
One could argue that such liquidation is somehow desirable, I suppose, and too bad for the farmers. Rationalization a good thing, and why should farmers be exempt. Corporatize it. It's a point of view, but that attitude is one that, not surprisingly, would not find much favour with the farming community, and cuts across the whole "stewardship" approach to land management that you (one would hope) have with land staying within a family for generations.
This is also the same self-reinforcing dynamic behind nimbyism, and why usually nimbys are also niybye too (not in your back yard either.) If I have purchased an expensive home, then I don't want the housing crisis to be solved by making my home cheaper; and if I needed a mortgage to buy my property, expensive homes aren't just something I want but something I need.