What are the proposals for income tax?
The Scottish Government set out its proposals for income tax from April 2020 as part of the Scottish Budget 2020-21. The proposed rates and bands are shown below.
Table 1: Proposed Scottish tax bands and thresholds, 2020-21
Bands |
Band name |
Rate (%) |
Over £12,500* – £14,585 |
Starter |
19 |
Over £14,585 – £25,158 |
Basic |
20 |
Over £25,158 – £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 (assumed to remain at £12,500 in 2020-21)
** Those earning more than £100,000 will see their personal allowance reduced by £1 for every £2 earned over £100,000
These proposals incorporate:
- A 0.2% increase in the threshold for the basic rate and a 0.9% 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 below 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 2019-20, the first £2,049 of taxable income was taxed at 19%. Under these proposals, the first £2,085 will be taxed at 19%, which represents an inflationary increase of 1.7%.
The proposals mean that all taxpayers will pay less income tax in 2020-21 than they did in 2019-20. However, the differences are tiny – only 36p a year for those earning less than £24,000 rising to £2.50 per year for higher earners.
The Scottish Fiscal Commission (SFC) estimates that this policy will raise an additional £51 million, relative to what would have been raised if all thresholds (other than the top rate threshold) had risen in line with inflation. This takes account of potential changes to behaviour as a result of the change in policy (see below).
How does this compare with the rest of the UK?
Because of the delay to the UK budget, the Scottish Government is in the unusual position of having to set its own income tax policy without knowing the UK Government’s plans. For the purposes of this blog, it is assumed that the UK income tax policy will not change, but we will not know for sure until 11 March 2020 when the UK Government announces its own budget. However, it is worth noting that the previous Conservative Government commitment to increase the personal allowance to £12,500 and the higher rate threshold to £50,000 was reached a year earlier than originally planned, so at the moment, the default position would be for no change in income tax for the rest of the UK.
Table 2: Assumed rUK tax bands and thresholds, 2020-21
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
The Scottish Government proposals mean that, assuming no change in policy in the rest of the UK (rUK), the gap between the higher rate thresholds in Scotland and rUK will remain at £6,570. 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.
Under the Scottish Government proposals, those earning less than around £27,000 will pay slightly less (around £21 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 44% 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. The difference will increase if the UK Government decides to increase the higher rate threshold in its March budget.
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 determined 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%. The UK Government has already announced that it will increase the NIC threshold from £8,632 to £9,500 in April 2020, a move that will benefit Scottish taxpayers.
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 change their behaviour increases.
In their February 2020 Economic and Fiscal Forecasts, the SFC judged that the Scottish Government’s proposed income tax policy (when compared with a policy which included uprating of the higher rate threshold) would generate £59 million, but that changes in taxpayer behaviour would reduce the actual amount generated to £51 million. The SFC also said that they had reviewed their assessment of potential migration in response to changes in tax policy and thought it could be higher than previously estimated. The Council of Economic Advisers have also been reviewing potential behavioural effects and the possible impact on future revenues.
Higher taxes than rUK: but does the Scottish budget see the benefits?
The Scottish Government’s decision not to replicate rUK tax policy means tax revenues are around £650 million higher than would otherwise be the case (before accounting for any behavioural changes). However, these higher tax revenues are almost entirely offset by the deduction to the Scottish budget (the “block grant adjustment”) which reflects the tax foregone by the UK Government due to devolution of tax powers.
The budget document shows that Scottish income tax policy is estimated to generate £12,365 million in 2020-21. This is only £46 million more than will be deducted through the block grant adjustment. So, rather than generating an additional £600 million or more for the Scottish budget, the different income tax policy is only just managing to offset the block grant adjustment.
In budgetary terms, we are effectively running to stand still. This is largely because of differences in earnings growth and the composition of taxpayers in Scotland compared to the rest of the UK. Because of these differences between the two economies, the Scottish Government is having to set higher taxes in order to generate enough revenue to offset the block grant adjustment. For around half of Scottish taxpayers, income tax devolution has meant higher tax bills, but no additional spending power for the Scottish Government. Meanwhile, as highlighted above, those benefiting from lower taxes are only seeing relatively small gains (£21 per year in 2020-21 if rUK policy is unchanged). These issues are explored in more detail in a previous SPICe blog.
Nicola Hudson, Senior Analyst, Financial Scrutiny Unit