UPDATE: Some of this post is a little bit out of date, since in the time between writing and publishing, the PM appears to have done a U-turn and re-committed to the coalition policy of a cap on care costs.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.

(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.

(£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.

(£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.

(£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.

(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.