Income tax is Government’s biggest revenue raiser. And income tax in Scotland is set for changes, whatever the result of the independence vote.
The Scottish Parliament already has the right – not yet exercised – to vary income tax rates by up to three per cent. From April 2016, this will be broadened into a requirement to set a Scottish rate of income tax (SRIT).
Technically what this means is that the three UK rates of income tax (20%, 40% and 45%) will each fall by 10% for Scottish taxpayers; this will reduce the tax revenues available to Scotland. The Scottish Parliament must then set one rate for the SRIT, which will apply to each tax band, with the money flowing to Scotland. If the SRIT is 10%, Scottish taxpayers will not notice any difference in their rate of income tax and the money flowing in will be the same as it would have been without devolution. If the SRIT were to be raised to 11% the rates would rise to 21%, 41% and 46% respectively and more revenue would be expected to come in. If the SRIT were lowered to 9% the rates would fall to 19%, 39% and 44% with a commensurate fall in revenue. The rates would still be subject to possible change as a result of decisions taken at Westminster. For example if the additional rate were raised from 45p to 50p by a Chancellor at Westminster that would mean a 5p increase in the additional rate for Scottish taxpayers; if the rate had earlier been cut from 45p to 44p as a result of a 1p cut in the SRIT it would go back up to 49p in Scotland.
The SRIT is not a devolved tax, which means that HM Revenue & Customs (HMRC) will administer it in parallel to their administration of UK income tax.
The income tax system is pretty complex. It is not just that there are four different rates (including the untaxed personal allowance), there are numerous reliefs and exemptions, and there are even differences as to how you pay income tax on different types of income.
Under devolution the SRIT offers the ability to raise or lower income tax by a substantial amount, but by requiring all rates to be moved up or down together it is a pretty blunt instrument. An independent Scotland would have a much wider set of options. The Scottish Government could set its own allowances, bands and rates. It could alter the types of income subject to tax and the reliefs available.
So, for example, the Scottish Government could decide to increase the additional rate for the highest earners to 50p (as some on the left would like), or abolish it altogether (as some on the right have called for), without having to change rates for the majority. They could decide to increase the personal allowance (the portion of income you pay no income tax on) further or reverse the Westminster Government’s increases. They could alter the point at which people start paying the 40% rate. They could decide to keep the higher personal allowance for pensioners that the Westminster Government is phasing out. They could decide to scrap the right of married couples to transfer part of their allowance between them (due to come in next year) or make it more generous. They could even play around with the different treatments given to different kinds of income, such as the lower rate for interest from savings.
There are also all sorts of changes that could be made to the 445 (yes, really!) reliefs currently available for income tax, as well as potentially the creation of new ones. The biggest of the current reliefs is tax relief on pension contributions. Designed to encourage people to save for their retirement this relief currently costs the Westminster Government a whopping £42 billion a year (including relief of national insurance too). The Westminster Government has been gradually reducing the amount well-off contributors can get relief on. An independent Scotland could continue this trend, reverse it, or change the relief entirely so that all contributions are relieved at the same rate, whether that’s the basic rate (saving the Government a large amount of money) or a higher level (which would boost incentives to save among low and middle earners).
The other 444 reliefs could all be fiddled around with too. Gift aid could be made more or less generous. Exemptions for visiting sportspeople (like the one put in place for the Commonwealth Games) could be widened, or scrapped altogether. New reliefs could be created, to reward and incentivise particular kinds of activity and sectors of the economy. Of course, given the number of reliefs already in place some would argue that the priority should be getting rid of a few of the reliefs already in place before creating any new ones.
There are three kinds of risk the Scottish Government would need to be aware of if reframing the income tax system post-independence: mobility, complexity and revenue loss.
Individuals in the UK are fairly mobile. Some people who currently live and work in Scotland may be able to relocate to England, if Scottish income tax rates are higher than those in England. The converse is also true, however, and different individuals will have differing views over when the tipping point is reached, particularly when one considers other factors, such as family, friends, lifestyle and cost of relocation. In addition, if a higher rate of income tax results in better local services, for example, people may be willing to accept it. This risk would be present in a non-independent Scotland too, if the SRIT is adjusted.
The greater the differences between the Scottish income tax system and the (rest of the) UK the greater the complexity for taxpaying individuals, businesses and the tax authorities themselves. Independence would undoubtedly mean a significant increase in the number of people who have to consider cross-border issues and double taxation, for example people who live (and work) in Scotland, but are employed by a UK employer with a UK payroll. This might result in more taxpayers having to complete personal tax returns for Revenue Scotland and/or HM Revenue & Customs, as well as creating headaches for payroll departments and tax advisers.
The other risk is of course to the Government’s revenues. More generous allowances and reliefs are always tempting but the money usually needs to be made up from somewhere, whether that is increased taxes elsewhere, cuts in spending or higher borrowing.
Under greater devolution or independence, Scotland will have the opportunity to frame more of its own income tax policy in future. But caution is likely to remain the order of the day. The policies of the Westminster Government and the effect of cross-border issues are likely to weigh heavily on the minds of decision makers in Edinburgh.
Moira Kelly, Chair of the CIOT sub-committee on Scottish Taxes
Chartered Institute of Taxation
Thursday 11 September 2014
NB. The CIOT is a strictly non-partisan organisation and is strictly neutral in the referendum campaign. This posting is intended to inform and nothing within it should be interpreted as advocating or opposing any of the options mentioned. We are pleased to have been closely involved in discussions on the devolution of tax powers, working with both the Westminster and Scottish Governments, regardless of their political complexions, to assist them at a technical level in the implementation of their objectives.