Income tax in Scotland: using the powers
Author: Nicola Hudson
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Executive Summary

The powers of the Scottish Parliament in respect of income tax have increased over time. The current powers allow the Scottish Parliament to set rates and bands for non-savings, non-dividend (NSND) income tax. The Scottish Government has used these powers to implement changes to the Scottish income tax policy so that it now differs from the income tax policy in place in the rest of the UK (rUK).

Income tax is considered to be a partially devolved tax, rather than a fully devolved tax, because decisions on certain aspects on income tax remain the responsibility of the UK government. These include the taxation of any income from savings and dividends, and the setting of the level of allowances, including the personal allowance.

Scottish income tax policy first diverged from the rUK income tax policy in 2017-18. In this year, the rate at which the higher rate of tax became payable in Scotland was frozen at £43,000 whereas it was increased to £45,000 in rUK. Over subsequent years, further changes have been introduced, including two new tax bands (a "starter" and "intermediate" tax band) and changes to the higher and top rates of tax. Income tax policy in Scotland now looks quite different from that in place in rUK.

A 'Fiscal Framework' was agreed between the UK and Scottish governments to manage adjustments to the Scottish 'block grant' after the devolution of income tax powers. The UK government reduces the 'block grant' provided to the Scottish Government to reflect the fact that the Scottish Government now generates its own income tax revenues.

The Fiscal Framework is designed so that the amount deducted from the Scottish block grant should be the same as the amount raised in NSND income tax revenues if the Scottish Government keeps the same income tax policy as in rUK and income tax receipts per head grow at the same rate as in rUK. However, policy changes and/or differing economic performance will affect the final impact on the Scottish budget. In practice, over the last five years, changes in Scottish income tax policy have generated additional revenues for the Scottish Government, but these have been partially offset by less favourable growth in income tax per head in Scotland. The net result is that some of the additional spending power that would be implied by the Scottish Government's income tax policy choices has been offset by differential economic performance.

Over the three year period of income tax devolution for which actual tax receipts are known (2017-18 to 2019-20), the different income tax policy adopted by the Scottish Government has generated an estimated £900 million in additional revenues than would have been available if the Scottish Government had mirrored rUK income tax policy. That is, Scottish taxpayers have paid an estimated £900 million more in income tax than they would have if rUK income tax policy had been implemented in Scotland. This estimate is after taking account of any changes in taxpayer behaviour that might result from the changes in tax policy e.g. taxpayers working different hours or seeking to change the way in which they receive income.

However, the net effect on the Scottish budget over the same period is much smaller than £900 million. For the same period, the net benefit to the Scottish budget totals a much smaller £170 million. This represents the difference between the NSND income tax revenues generated and the adjustments to the Scottish block grant over the same period.

The Scottish Government budget has not seen the full impact of the differential tax policies due to differences in economic factors affecting the amount of tax that Scottish taxpayers have generated, such as differential wage growth, differences in the composition of the tax base and differences in the balance between taxpayers and non-taxpayers across the population. The gap between the £170 million budget impact and the £900 million impact on taxpayers reflects the risks inherent in tax devolution. Weaker growth in Scottish income tax receipts per head compared with rUK has meant that some of the revenue generated by the different income tax policy has been offset.

The policy changes have also had impacts on individual taxpayers and households. When compared with the rUK income tax policy, the 2021-22 Scottish income tax policy results in modest benefits of up to around £20 per year for those in the lower half of the earnings distribution (those earning below £27,000 per year). At a household level, the benefits for the poorest third of households are negligible (gains of less than 0.1% of household income).

However, the different income tax policy in Scotland has a much more significant impact on higher earners and richer households. Those earning more than £50,000 per year are paying over £1,500 more per year in income tax than they would be in rUK. The richest 10% of households have £1,800 less per year than they would if they were paying income tax according to the rUK policy.

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Last Updated: 24/11 10:27pm