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Scottish income tax: Progressive or not?

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19th Nov 2015
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The Scottish government is constrained in its wish to make income tax more progressive, explains Donald Drysdale

On 16 December Scottish Deputy First Minister and Finance Secretary John Swinney will publish his government’s draft Budget for 2016/17.  In doing so he’s expected to reveal the proposed Scottish rate of income tax (SRIT) to apply from 6 April 2016.

There has been widespread speculation that SRIT will be set at 10% for at least the first year of implementation.  This would leave income tax rates paid by Scottish taxpayers on non-savings non-dividend income in line with those levied on taxpayers elsewhere in the UK.

Wouldn’t this be history repeating itself?  After all, Holyrood has had power since 1998 to flex the basic rate of tax on Scottish taxpayers by up to 3 percentage points in either direction (the ‘Scottish variable rate’ or SVR, sometimes referred to as the ‘tartan tax’), but has chosen not to use it.

Experience suggests that, while the Scots want powers over income tax, they’re reluctant to use them. Even if there’s been some truth in this, things may change soon.  The SVR and SRIT haven’t given Holyrood the powers it wants. Instead, the current SNP administration may hold fire until they get the full range of income tax powers proposed by the Smith Commission – contained in the current Scotland Bill and likely to take effect from April 2017 or April 2018.

A more progressive income tax system

Swinney has made clear that Scotland will seek to establish a tax system that is fair and progressive.  And therein lies a conflict – at least for as long as SRIT is their only income tax tool.

On 30 October the Scottish Parliament’s Financial Scrutiny Unit published a briefing [Berthier (2015)] analysing the available statistical data on income tax in Scotland and discussing what progress had been made on the implementation of SRIT.

As the briefing points out, income tax is a progressive tax in that the average rate of tax increases as income rises, so high-income individuals pay a higher tax rate than lower-income individuals.  Of the current UK income tax rates, the higher rate is 100% higher than the basic rate, and the additional rate is 125% higher than the basic rate.  In this way a progressive income tax aims to achieve a more equal distribution of income after tax than before tax.

SRIT will apply uniformly across all the income tax bands, so all Scottish taxpayers will pay broadly the same percentage in SRIT on their non-savings non-dividend income.  In this sense SRIT in isolation is not progressive as it doesn’t increase as the incomes on which it is levied rise.  However, as SRIT will not be paid separately from the rest of the UK income tax charge, this doesn’t alter the progressive nature of the whole income tax regime.

Holyrood’s dilemma in setting SRIT

Once Holyrood has determined SRIT for a fiscal year, any deviation between that rate and 10% will apply uniformly across all the main tax rates.  Thus income tax will still be progressive – high-income individuals will still pay a higher tax rate tax than lower-income individuals.  For example, if SRIT was set at 9p, the Scottish basic, higher and additional rates would be 19p, 39p and 44p respectively.

It’s important to recognise that setting SRIT above 10p would make income tax in Scotland less progressive.  The briefing illustrates this with an extreme example:  setting SRIT at 15p would mean that the higher rate of income tax was only 80% higher than the basic rate (45p compared with 25p) and the additional rate was only 100% higher than the basic rate (50p compared with 25p).  The Scottish government’s coffers might overflow, but those with higher incomes would benefit while those with lower incomes would suffer.

Conversely, setting SRIT below 10p would make income tax more progressive.  For example, setting SRIT at 5p would mean that the higher rate was 133.3% higher than the basic rate (35p compared with 15p) and the additional rate was 166.7% higher than the basic rate (40p compared with 15p).  This could meet the Scottish government’s aim of benefiting those with lower incomes at the expense of those with higher incomes.  However, could the administration withstand the resulting loss of tax revenues?

Why Smith will change everything

The Scottish Parliament will have a much freer hand as soon as the new ‘Smith proposals’ have been implemented.

These will give them unrestricted power to set the income tax rates and bands applied to non-savings non-dividend income of Scottish taxpayers.  Although Westminster will still control the definition of income, granting of exemptions and reliefs, taxation of savings and dividend income, and the personal allowance, Holyrood could effectively increase (but not decrease) the personal allowance by introducing a nil rate income tax band.

With enhanced control over the rates and bands, the Scottish government should have greater scope to make income tax more progressive without decimating their tax revenues.

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

Berthier, A. (2015), Income tax in Scotland, SPICe Briefing 15/72. Edinburgh: Scottish Parliament

This article contains information licensed under the Open Scottish Parliament Licence V.2

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