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Scotland’s devolved taxes: A never-ending story

19th Feb 2016
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Scottish political parties may find it hard to convince voters about their tax policies, suggests Donald Drysdale, if the ground rules for further devolution remain unclear.

What is devolved already?

The Scotland Act 1998 gave the Scottish Parliament power from 1999 over income tax, business rates and council tax. Holyrood was able to vary the basic rate of income tax on Scottish taxpayers by up to 3% either side of the UK basic rate but this power, known as the Scottish Variable Rate (SVR), was never used.

The Scotland Act 2012 gave Holyrood wider powers over income tax and certain land taxes. It introduced the Scottish rate of income tax (SRIT), which will be implemented on 6 April 2016 and administered by HMRC. Each of the UK basic, higher and additional rates of income tax on non-savings non-dividend income of those defined by statute as Scottish taxpayers will be cut by 10%. The Scottish Parliament may then substitute a new SRIT rate for that reduction, allowing the effective basic, higher and additional rates to be reduced by up to 10% or increased by any amount without limit.

On 1 April 2015 Stamp Duty Land Tax (SDLT) and Landfill Tax were replaced in Scotland by Land and Buildings Transaction Tax (LBTT) and Scottish Landfill Tax (SLfT). LBTT pioneered a new progressive rate structure, which SDLT now mimics following abolition of the old ‘slab’ structure. LBTT resembles SDLT, including a 3% supplement on additional residential properties from 1 April 2016, but the rates and other aspects of the rules differ. SLfT remains similar to Landfill Tax in the rest of the UK. LBTT and SLfT are administered by Scotland’s own tax authority, Revenue Scotland.

What further devolution is proposed?

Before the independence referendum in September 2014, each of the three largest political parties at Westminster wooed the Scots with additional devolved powers if they voted to remain in the UK – which they did. In November 2014 the Smith Commission, on which all five main parties at Holyrood were represented, published its recommendations on this further devolution.

It was recommended that income tax would remain shared between the UK and Scottish Parliaments, administered by HMRC, but with Holyrood having wide control over rates and thresholds applied to non-savings non-dividend income of Scottish taxpayers. The first 10% of standard rate VAT raised in Scotland would be assigned to the Scottish budget – later extended also to the first 2.5% of reduced rate VAT. Air Passenger Duty would be devolved, and Aggregates Levy would be devolved once certain legal issues had been resolved. In addition, Holyrood would have limited powers over some aspects of Universal Credit and certain other state benefits.

Scotland’s fiscal framework

Smith recommended that Scotland’s fiscal framework be updated to encompass several elements including the funding of the Scottish budget, planning, management and scrutiny of public revenues and spending, mechanisms for adjusting the Scottish block grant, borrowing powers and cash reserve, fiscal rules and independent fiscal institutions.

It had been expected that this new fiscal framework would have been agreed by early this month, but it is the subject of prolonged negotiations still taking place behind closed doors between the UK and Scottish governments.

Meanwhile a recent report on ‘Revising Scotland’s fiscal framework’ from the House of Commons Scottish Affairs Committee explains in helpful detail why the fiscal framework is needed to set and coordinate Scotland’s sustainable fiscal policy. This will require fiscal rules – for example, constraints on fiscal policy, typically by setting limits on borrowing and/or debt – and fiscal institutions responsible for overseeing fiscal policy decisions.

The further devolution proposed will double Holyrood’s direct revenues to £16bn, while adding £5bn more in assigned VAT revenues – together comprising more than half the Scottish government’s annual budget. Holyrood will also assume the Scotland-specific fiscal risks associated with its revenues, including volatility. To manage these effectively, Holyrood will need greater borrowing powers. Agreeing those powers is a key element of the negotiations on revising the fiscal framework.

The block grant from Westminster is Scotland’s other main source of funding. When taxes are devolved to Holyrood, receipts are paid directly into the Scottish budget and the block grant is reduced by the amount of revenue forgone by the UK government. Both governments must agree how to calculate that initial reduction – without detriment to Scotland or the rest of the UK. They must also agree how to index this adjustment over time to ensure that it is not eroded by inflation and economic growth, and in a way that is fair to taxpayers across the UK.

The Scotland Bill 2015-16

The Scotland Bill is draft UK legislation intended to devolve further powers and responsibilities to the Scottish Parliament in accordance with the Smith proposals. It has been substantially amended by the House of Commons, but not in respect of tax matters.

Back in November 2015 a report entitled ‘A Fracturing Union? The Implications of Financial Devolution to Scotland’ from the House of Lords Select Committee on Economic Affairs expressed concern that the bill had gone through the commons without MPs having any details of a revised fiscal framework for Scotland. The bill is now awaiting its committee stage in the House of Lords, where further debate has been postponed until the outcome of current negotiations on the fiscal framework are known.

The Holyrood elections

Elections to the Scottish Parliament will take place on 5 May. Parties may wish to campaign on issues relating to tax policies, but could find it hard to convince voters if both the legislation on further devolution and the revised fiscal framework are still unfinished business.

Donald Drysdale of Taxing Words is a freelance author and series editor of Bloomsbury Professional's Scottish tax list.


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