Challenging income tax decisions ahead for the Scottish Government

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The UK government’s ‘Growth Plan’, announced on 23 September 2022, set out some major policy decisions in relation to income tax in England.  From 1 April 2023, the plan had been to cut the basic rate of income tax for taxpayers in England from 20p to 19p and abolish the 45p additional rate of tax.  However, the plans for the abolition of the additional rate were quickly reversed (on 3 October 2022), so this aspect of the changes will no longer go ahead.

Although these changes do not apply directly in Scotland, they have important implications nonetheless. 

The ‘block grant adjustment

Firstly, the UK government’s income tax decisions will have implications for the Scottish budget as a result of the operation of the Fiscal Framework.  Under the terms of this framework, when income tax decisions were devolved to Scotland, the Scottish budget was adjusted downwards to reflect the income tax revenues that would have been generated in Scotland under the income tax policy of the rest of the UK (rUK).  This is known as the income tax ‘block grant adjustment’ (BGA). 

This BGA is calculated each year to (broadly) reflect the tax that would have been raised in Scotland under rUK tax policy.  So, if the UK government changes its income tax policy in a way that results in lower income tax revenues, this means a smaller income tax BGA for Scotland.  A smaller BGA in turn means a larger Scottish budget than would otherwise have been the case.  HM Treasury have provided estimates to the Scottish Government suggesting that the earlier-than-planned reduction in the basic rate will result in an additional £340 million for the Scottish Government budget in 2023-24 compared to previous plans, and an additional £30 million in 2024-25.

Scottish Government tax policy decisions

The Scottish Government now faces decisions of its own in relation to income tax.  The Scottish Government income tax policy for 2023-24 will be set out in the next budget, which is expected in December.  (Note that this will be preceded by an Emergency Budget Review in late October, but income tax announcements will probably not come until the main budget in December.)

With funding over the next two years now higher than had previously been expected, the Scottish Government could opt to introduce some tax cuts of its own, or could direct the additional funding towards public spending.  Or a combination of both.  Or indeed, it could opt to increase taxation. 

Prior to the UK government’s reversal of its additional rate plans, the Deputy First Minister, John Swinney MSP said:

“We will not be replicating the UK Government’s tax cuts but will consider carefully the correct measures for Scotland.”

What would no change to income tax policy mean for Scottish taxpayers?

At present (in the current 2022-23 financial year), the Scottish Government has a five-band income tax policy, as set out in this chart, which shows the difference between 2022-23 for Scotland and the plans as know them for 2023-24 in the rest of the UK.

If the Scottish Government makes no changes to its income tax policy, this would mean that, in total, in 2023-24, Scottish taxpayers will be paying an estimated £1.2 billion more in income tax than they would be paying if the English income tax policy applied.  [Static estimate based on SPICe modelling using UKMOD.]

If no changes (other than potentially uprating thresholds) are made to Scottish income tax policy, all Scottish taxpayers will be paying the same or more income tax in 2023-24 than they would do in England, regardless of how much they earn.  This is in contrast to the position in recent years, where at least half of Scottish taxpayers have paid less in income tax in Scotland than in England (although the differences have been small at around £20 per year for those earning less than around £27,850). If the Scottish Government chooses to keep the current income tax policy, then those earning £25,000 will pay around £100 per year more in Scotland than they would in England, rising to almost £2,000 for those earning £50,000.  For those earning more than £50,000, the differential continues to widen, reaching a gap of more than £4,000 for those earning £250,000.

What about changes to lower rates of tax?

Both the First Minister and Deputy First Minister had voiced their opposition to the scrapping of the 45p additional rate in England.  However, the Scottish Government’s comments to date on the UK government’s tax plans would still leave room for tax changes at the lower end of the income distribution.

The Scottish Government could, for example, opt to reduce its own basic rate of income tax from 20p to 19p to bring it in line with the starter rate.  This would reduce the number of taxpayers paying more tax in Scotland compared to what they would pay in England.  However, anyone paying the intermediate rate (currently applied at 21% to all earning more than £25,688 in Scotland) would still be paying more than they would in England.

Compared with keeping the current income tax policy, cutting the basic rate to 19p in Scotland would cost the Scottish Government an estimated £200-250 million in reduced income tax revenues in 2023-24, depending on their decisions on uprating the thresholds at which the different rates apply.

Difficult decisions ahead

All this makes for a challenging set of decisions ahead for the Scottish Government in respect of its income tax policy.  Does it move closer to the UK government policy for lower earners, or even do something more generous?  This would come at a cost in terms of reduced revenues at a time when budgets are already under severe pressure.  Or does it maintain its current five-band policy and no longer be able to claim that more than half of Scottish taxpayers pay less income tax than they would in the rest of the UK?  We will find out at budget time.

Nicola Hudson, Senior Analyst, Financial Scrutiny Unit