Tax: Scotland's budget for 2019/20

As the Fraser of Allander Institute publishes ‘Scotland’s Budget Report 2018’, Donald Drysdale notes that ICAS has provided valuable input on tax matters.

Fraser of Allander briefing

The Fraser of Allander Institute (FAI) at the University of Strathclyde is a leading economic research institute with over 40 years’ experience of researching, analysing and commentating on the Scottish economy.

On 8 November FAI held a seminar at which it published its annual briefing, Scotland’s Budget Report 2018. This sets out the economic context for Scotland’s ‘Budget 2018’, which is the budget for financial year 2019/20. The briefing looks at the Scottish Government’s resource budget and questions whether the country will see an end to austerity.

FAI considers choices and trade-offs for public spending, given the particular pressure to fund health. It examines trade-offs in funding capital investment, options for reforming taxes, and issues relating to the funding of higher education. In a chapter contributed by ICAS, the briefing also examines a range of practical tax considerations.

Tax considerations

It is good news that the Scottish Government has reorganised its finance function with a dedicated tax resource, with the appointment of a Minister for Public Finance and Digital Economy and the establishment of a post of Director of Taxation.

It may appear as though the Scottish Government has significant control of Scottish revenue-raising, but the practical realities may be limited – and more so than anticipated at first sight.

Devolution has introduced new opportunities but also new complexities. There are many moving parts to manage – including the interaction with the UK Budget, the impact of block grant adjustments, and the politics of managing perceptions. ICAS continues to call for minimum complexity, maximum transparency, and pro-active collaboration between the Scottish and UK Governments to ensure that the two tax systems operate cohesively.

Scottish income tax was implemented on 6 April 2017 and its profile has been raised as the
differentials between Scotland and the rest of the UK have increased across rates and thresholds. In 2019/20 these differentials may widen, and debate will likely focus on the extent to which Holyrood should or should not follow UK policy and increase the higher rate threshold by significantly more than inflation.

VAT assignment is scheduled to start in April 2019. It is a funding mechanism, designed to further link Scottish tax revenues to the country’s economy. Although it may bring significant revenue, the Scottish Government will have no direct means of influencing its amount. Assigned VAT will be calculated using an extrapolation methodology, so thankfully businesses won’t face the administrative burden of having to report VAT separately for Scotland and the rest of the UK.

The Scottish Government’s legislative programme for 2018/19 includes a pledge to reform the way in which devolved tax decisions are planned, managed and implemented, and it is hoped that this will be put in place as soon as possible.

FAI and ICAS have also called for a five-year roadmap setting out the objectives of Scottish tax policy. This should provide clarity of purpose and tie in with the Scottish fiscal framework. Transparency of data and the link between Scottish tax receipts and the operation of the fiscal framework will be crucial if the public are to maintain faith in the process.

Options for tax reform

FAI notes that taxes and charges serve a variety of purposes, including raising revenue and influencing behaviours, and refers to some recent proposals put forward to reform existing taxes or create new taxes. As some of these are party-political hot potatoes, ICAS has not commented on the relative merits of these – and nor shall I in this article.

Possibilities for local authorities include a levy on visitors staying in short-term accommodation (see Auld Reekie weighs up a tourist tax), a levy on parking spaces provided by employers to employees, and a tax on vacant land. These might raise relatively little revenue, but could help local councils meet their own particular funding and broader policy objectives.

FAI sees a strong case for reforming council tax, especially given the lack of recent revaluation and the regressive nature of the banding system. Revenue-neutral changes could be made to achieve a fairer tax structure. Alternatively, additional revenue could be raised with minimal distortion – for example by changing the ratios between bands. Replacing council tax with a land value tax is seen as a longer-term option (see Should we expect a land value tax in Scotland?).

Income tax remains Holyrood’s most powerful weapon. Upping Scottish income tax rates would raise extra revenues; so would holding down the higher rate threshold instead of increasing it in line with inflation – or by even more, as in the rest of the UK. But increased differentials north and south of the border will encourage tax planning behaviours by Scots.

FAI also suggests that Scotland might learn from Wales, which is exploring whether capped, income-linked contributions might be used to establish a fund to support growing demand for social care.

Behavioural consequences

Devolution creates the potential to have higher taxes in Scotland than the rest of the UK, and particularly to have income tax rates and thresholds that impose higher tax on Scottish taxpayers than on those elsewhere in the UK. But the scope for this may be constrained by both political considerations and potential behavioural changes.

Scottish income tax is poorly-understood by those who pay it. If Scots were to understand it more clearly, some might see it is a valuable part of the social contract, while others might resent living in the most highly-taxed part of the UK. It is only to be expected that those in the latter group would look for opportunities to pay less. Some might even be discouraged from undertaking more work – especially those in the pay bracket between the Scottish and the UK higher rate thresholds where the marginal rate of tax and employee NICs is 53% in Scotland compared with only 32% south of the border. With only limited differentials to date, tax planning to avoid Scottish income tax seems to have been slight, but this could change.

A Scottish taxpayer might be able to arrange, quite legitimately, to reduce their exposure to Scottish income tax. For example, they could incorporate their business so that its profits would be subject to corporation tax instead, and they could then receive all or most of their personal remuneration as dividends instead of salary.

Typically, high-earners are more mobile than those on lower incomes. Professionals and senior executives might find it relatively easy to avoid being Scottish taxpayers – commuting instead from homes south of the border to perform their working responsibilities in Scotland. The tax revenues lost by the Scottish Government could be very considerable.

In the simplest of circumstances, high tax rates fuel the black economy. While neither FAI nor ICAS mention this in the briefing, any perception that taxes were higher in Scotland than elsewhere could encourage evasion.

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