What are the proposals for income tax?
The Scottish Government set out its proposals for income tax from April 2019 as part of the Scottish Budget 2019-20. The proposed rates and bands are shown below.
Table 1: Proposed Scottish tax bands and thresholds, 2019-20
Bands |
Band name |
Rate (%) |
Over £12,500* – £14,549 |
Starter |
19 |
Over £14,549 – £24,944 |
Basic |
20 |
Over £24,944 – £43,430 |
Intermediate |
21 |
Over £43,430 – £150,000** |
Higher |
41 |
Above £150,000** |
Top |
46 |
* Assumes individuals are in receipt of the standard UK personal allowance (£12,500 in 2019-20)
** Those earning more than £100,000 will see their personal allowance reduced by £1 for every £2 earned over £100,000
These proposals incorporate:
- An increase to the personal allowance to £12,500 which is determined by the UK Government.
- A 5% increase in the threshold for the basic rate and a 4% increase in the threshold for the intermediate rate.
- No change in the higher rate threshold or top rate threshold, which remain at £43,430 and £150,000 respectively.
The proposed increases to the basic rate and intermediate rate thresholds are above inflation, but have the effect of ensuring that the amount of income at which starter rate tax and basic rate tax is paid increases in line with inflation. For example, in 2018-19, the first £2,000 of taxable income was taxed at 19%. Under these proposals, the first £2,049 will be taxed at 19%, which represents an inflationary increase of 2.5%.
The proposals mean that the gap between the higher rate thresholds in Scotland and the rest of the UK (rUK) will widen. The higher rate threshold in rUK will increase to £50,000 from April 2019, which is £6,570 higher than the proposed threshold for Scotland. In addition, Scottish taxpayers earning above the higher rate threshold will be paying 41% tax compared to 40% in rUK and will pay 46% on earnings above £150,000, compared to 45% in rUK.
Table 2: rUK tax bands and thresholds, 2019-20
Bands |
Band name |
Rate (%) |
Over £12,500* – £50,000 |
Basic |
20 |
Over £50,000 – £150,000** |
Higher |
40 |
Above £150,000** |
Additional |
45 |
* Assumes individuals are in receipt of the standard UK personal allowance (£12,500 in 2019-20)
** Those earning more than £100,000 will see their personal allowance reduced by £1 for every £2 earned over £100,000
What do these changes mean for Scottish taxpayers?
Income tax at various levels of earning under the Scottish Government proposals is shown in Table 3. All those earning up to £124,375 will pay less tax in 2019-20 than they did in 2018-19, although much of this gain is due to the increase in the personal allowance that was a decision of the UK Government. The Scottish Government estimates that those benefitting from the changes represent 99% of all taxpayers. For the majority, only around £10 of the benefit results from the Scottish Government’s decisions; the rest (£120-£130) is the result of the UK Government’s change to the personal allowance.
When compared with what individuals would be paying in the rUK, the comparisons are less favourable. Under the Scottish Government proposals, those earning less than £27,000 will pay slightly less (around £20 per year) than they would in rUK. However, those earning more than £27,000 will pay more tax in Scotland than they would in rUK. This accounts for 45% of taxpayers, according to the Scottish Government, and the differential is in excess of £1,500 a year for those earning more than £50,000.
Table 3: Differences between Scottish and rUK income tax, 2019‑20
Scottish Government proposals £ per year |
Difference compared with 2018-19 £ per year |
Difference compared with rUK £ per year |
|
15,000 |
480 |
-130 |
-20 |
20,000 |
1,479 |
-130 |
-20 |
25,000 |
2,480 |
-140 |
-20 |
30,000 |
3,530 |
-140 |
30 |
35,000 |
4,580 |
-140 |
80 |
40,000 |
5,630 |
-140 |
130 |
45,000 |
6,994 |
-140 |
494 |
50,000 |
9,044 |
-140 |
1,544 |
60,000 |
13,144 |
-140 |
1,644 |
70,000 |
17,244 |
-140 |
1,744 |
80,000 |
21,344 |
-140 |
1,844 |
90,000 |
25,444 |
-140 |
1,944 |
100,000 |
29,544 |
-140 |
2,044 |
What about National Insurance Contributions (NICs)?
The analysis above focuses entirely on income tax and does not account for NICs which are also paid on earned income, but which are entirely set by the UK Government. NICs are linked to UK tax thresholds and the NIC rate drops from 12% to 2% at the UK higher rate threshold, which will be £50,000 from April 2019. This means that Scottish taxpayers who earn between the Scottish higher rate threshold (£43,430) and the rUK higher rate threshold (£50,000) will pay 41% income tax and 12% NICs on their earnings between these two amounts – a combined tax rate of 53%.
What effect might the tax changes have on the behaviour of taxpayers?
Any changes to tax policies can result in individuals changing their behaviour so as to minimise the tax that they pay. If they are able to, taxpayers might try to change how they receive their income (for example, by taking it in the form of dividends or setting themselves up as a company). Or, they might move to a different location where tax rates are lower (again, if this is a realistic possibility). As Scottish tax policy diverges further from rUK tax policy, the risk that individuals might relocate from Scotland increases. Giving evidence to the House of Commons Treasury Select Committee after the October 2018 UK budget, Andy King of the Office for Budget Responsibility (OBR) said:
“…when we were looking, and when the SFC [Scottish Fiscal Commission] was looking, at the effect of raising the top rate of income tax, HMRC was looking at this behaviour and whether people would change their addresses. It is a particularly significant risk for the Scottish Government because if someone changes their address, the Scottish Government loses all of that income tax.”
In their December 2018 Economic and Fiscal Forecasts, the SFC also refer to the behavioural effects that might result from the tax differences. Commenting on the 53% marginal tax rate that results from the combination of income tax and NICs for those earning between £43,430 and £50,000, the SFC say:
“We expect that this higher marginal tax rate will start to affect taxpayer behaviour, for example decisions on how many hours to work. We estimate that in 2019-20 around 120,000 taxpayers in Scotland will be subject to this higher marginal rate. Using our standard approach to modelling taxpayer behaviour, we have estimated that this effect will lead to a reduction in income tax in Scotland of £7 million in 2019-20.”
And, commenting on the divergence between Scottish and rUK tax policy, the SFC say:
“We expect this to start to have an effect on tax residency decisions.”
In his budget statement, the Cabinet Secretary for Finance, Economy and Fair Work said he was asking the Council of Economic Advisers to expand their analysis of the impact of potential behavioural effects and the possible impact on future revenues.
What are the implications for the Scottish budget?
The Scottish Government’s decision not to replicate the UK Government’s proposals for the higher rate threshold means that there is more money for the Scottish Government, as tax revenues will be higher than if the UK policy was implemented.
The Scottish Government estimates that its proposed income tax policy will generate around £500 million more in tax revenues for the Scottish Government than if they had chosen to implement the UK Government’s tax policy. So, by choosing a different income tax policy, the Scottish Government can boost tax revenues, but the price is that Scottish taxpayers will face higher income tax bills than in the rest of the UK.
The extra tax revenues should be enough to offset the reduction in the Scottish budget (the “block grant adjustment”) that results from the devolution of tax-raising powers. However, the budget document shows that estimated income tax revenues in 2019-20 will only exceed the block grant adjustment by £182 million, considerably less than the £500 million that the Scottish Government say its policy will generate relative to the UK Government tax policy. This will reflect a combination of:
- different policy choices over the period since income tax powers were partially devolved in 2017-18
- differences in the forecasts made by the SFC and the OBR, which will be resolved in time when actual tax receipts are known
- different rates of per capita tax revenue growth between Scotland and rUK, which could be a more persistent issue.
The ‘Fiscal Framework’ that determines how the block grant adjustment is calculated protects Scotland from reductions in revenue that result from slower population growth, but do not insulate Scotland from any reductions in revenue that result from wider economic changes, such as a fall in the number of taxpayers, slower wage growth, or a change in the mix of taxpayers (such as lower numbers of higher rate taxpayers). If these types of changes hit Scotland harder than rUK, then it will be harder for the Scottish Government to generate the tax revenues that it needs to offset the block grant adjustment.
Nicola Hudson, Senior Analyst, Financial Scrutiny Unit