Last week, the UK government announced long-awaited plans for reforming social care – and how it plans to pay for these reforms.
First of all, it is important to note that the plans announced for social care only affect England, as the delivery of social care is a devolved area. The Scottish Government, Welsh Government and Northern Ireland Assembly make their own decisions on social care services and what funding to allocate to these services. Indeed, the Scottish Government has been providing free personal care to certain groups for almost 20 years, funded through the devolved budget.
However, the UK government’s plans for funding the changes to social care in England involve changes to taxation that will affect all UK taxpayers. This doesn’t mean that Scottish taxpayers see increased tax bills without seeing any benefits. But the relationship between the costs and benefits for Scotland is not a direct one, as this blog explains.
Funding the plans
The UK government has announced that the reforms will be initially funded through increases to National Insurance Contribution (NIC) rates which will take effect from April 2022. Then – from April 2023 – there will be a separate Health and Social Care Levy.
NIC rates will increase by 1.25 percentage points for the first year (April 2022-March 2023). Then, from April 2023, a separate Health and Social Care Levy will be introduced and the NIC rates will return to their current levels. The new levy will also be 1.25% and will apply to the same earnings as NICs. However, from April 2023 it will also be paid by those of pensionable age, unlike current NICs. Employers also pay NICs on the earnings of their employees above a certain threshold and these rates will also increase by 1.25 percentage points. The UK government website provides further details on the current NIC rates for both employees and employers. Rates of taxation on dividends will also increase by 1.25 percentage points from April 2022, so that those who receive income in this way will also contribute towards the additional revenues.
How much will the new taxes raise?
In total, the new taxes are expected to raise around £17 billion per year, of which £16.4 billion is expected to come from the increase in NICs and £0.6 billion from the increase to taxes on dividends. The net amount available to support additional spending on health and social care will be around £12 billion per year, as some of the additional revenue will be offset by additional costs to government. For example, as major employers, the UK government and devolved administrations will face additional costs by way of employer NICs. For the UK government, there will also be some additional benefit costs as eligibility for some benefits (such as Universal Credit) is based on income after taxes (including income tax and NICs). As income after tax will fall as a result of this new levy, more people will become eligible for benefits that are awarded on the basis of post-tax income.
The UK government will transfer some of the £12 billion available for health and social care spending to devolved administrations through the operation of the Barnett formula. Under the Barnett formula, the devolved administrations receive a population-based share of any UK additional government spending in devolved areas, such as health and social care. So, if the UK government spends an additional £10 billion on health, the Scottish Government could expect to get roughly £1 billion in Barnett consequentials.
The exact details of the settlement will be confirmed as part of the UK Spending Review and Budget, which will be published on 27 October 2021. The document outlining the plans states that Scotland will receive an additional £1.1 billion in 2024-25. However, this figure includes spending in Scotland by the UK government, such as on the vaccine programme, as well as the anticipated Barnett consequentials. The document also notes that “the precise profile [of net revenues] will vary, particularly in the earlier years after the tax changes have been introduced, due to the behavioural response of taxpayers to these changes”. The figures given for total Barnett consequentials to all devolved administrations over the next three years would suggest that Scotland should receive around £1 billion per year in Barnett consequentials from this policy.
Is this a good deal for Scotland?
The UK government states that “Scotland, Wales and Northern Ireland will benefit by around 15 per cent more than is generated from their residents”. That is, according to the UK government, the amount that Scotland will receive in Barnett consequentials (around £1 billion) is around 15 per cent more than the additional amount that Scottish residents will be paying as a result of the tax rises. By implication, this would suggest that Scottish residents will be paying around £850 million more in taxes as a result of the changes.
So, Scotland will receive £1 billion more to spend, but its residents will only pay around £850 million more in taxes. This differential arises because the Barnett consequentials are determined by a population share (Scotland as a % of English population, which is around 9.7%). However, Scotland’s NICs represent a lower proportion (8.7%) of English NICs. This will be because the distribution of earnings differs between Scotland and England, so a given tax change will impact on the two countries differently. So, on the basis of the latest data on NICs, Scotland could expect to get around £150 million more in Barnett consequentials than it has paid in extra taxes. However, the exact net position will depend on actual tax paid in the year in question which won’t be known until much further down the line.
Can the UK government direct how this money is spent?
The UK government’s document states that:
“There will be a legal requirement to allocate the Levy revenues for spending on health and social care”
It is not clear whether that statement just relates to England, but the document goes on to state that:
“Receipts from the 2022-23 increase will go to the NHS or equivalent in Scotland, Wales and Northern Ireland as with the current NHS NICs allocation. From April 2023, receipts from the Levy will go to those responsible for health and social care in the devolved administrations, including NHS Scotland, NHS Wales and Health and Social Care (HSC) in Northern Ireland.”
Also, the legislation introduced to implement the new Levy makes reference to the proceeds of the Levy going towards the cost of health care and social care in Scotland.
However, the details around the funding mechanism remain unclear and this would appear to go against the principles of devolution, whereby the Scottish Government is able to determine how it allocates the resources at its disposal, except in very specific circumstances, such as City Deals.
This lack of clarity led Kate Forbes, Cabinet Secretary for Finance and the Economy, to write to the UK government to seek clarification. In her letter she said:
“…there have been mixed messages about the interaction between the general administration of NIC revenues, the hypothecation of a proportion of NIC revenues to provide funding for health and social care, and the relationship with the Barnett formula. There have also been unhelpful assertions about the impact of the announcement on the competence that Scottish Ministers and the Scottish Parliament rightly hold over decisions relating to funding for devolved public services.”
She sought clarification on how the funding would be allocated and the amount of funding that Scotland could expect.
There is already (a little bit) of hypothecation
In England, a small proportion of NIC receipts are already “hypothecated” to the NHS i.e. specifically earmarked for the NHS. Similarly, an amount is also specifically identified in the Scottish Consolidated Fund as being for the NHS in Scotland from the National Insurance Fund. However, the sums involved are small relative to the total NHS budgets in both England and Scotland, so there would never be a situation where this ‘ring-fencing’ was not achieved. However, this could be the route for ‘directing’ that the new funds are allocated to health (if not social care) in Scotland as the document states:
“Receipts from the 2022-23 increase will go to the NHS or equivalent in Scotland, Wales and Northern Ireland as with the current NHS NICs allocation.”
A phoney war?
In reality, the debate around how or whether the UK government will dictate the way in which the funds are spent is academic as the Scottish Government has already stated that it will allocate them to health and social care. But the principle is important as the UK government would not normally dictate how Barnett consequentials are allocated by a devolved administration.
In practice, it would also be very difficult for the UK government to prove categorically whether any additional funds had been allocated to a specific area. Devolved administrations could move funding around in other areas to achieve their own desired profile of spend, whilst ensuring that the “new” funding went on health and social care.
Choices still remain for the Scottish Government
Whatever the rhetoric and whatever the reality of the funding settlement, there are still choices to be made by the Scottish Government. The UK government has stated that, in England, the additional revenues generated by the higher taxes will initially be spent on health rather than social care. However, the Scottish Government will be free to determine the balance between health and social care and could choose to prioritise differently.
It is also worth remembering that if the Scottish Government felt that it did not want Scottish taxpayers to face additional tax burdens, it could reduce income tax to offset the higher NICs for employees. Due to the different structures of the two taxes, it would be difficult to offset the higher NICs exactly for each individual, but the higher taxes could be broadly offset for most individuals, although employers would still face higher tax bills.
However, this would reduce the money available in the Scottish budget. And given that the Scottish Government has committed to passing on the health and social care Barnett consequentials of around £1 billion to its own health and social care budget, this means it would need to reduce spending elsewhere to achieve this.
Nicola Hudson, Senior Analyst, Financial Scrutiny Unit