Guest blog - Why Scotland needs radical tax reform

The scale of the fiscal challenge facing Scotland was laid bare in the Scottish government’s recent spending review where efficiency savings and budget cuts were deemed necessary to help address a potential £3.5 billion spending gap.

Making government more efficient is a worthwhile goal but no amount of tinkering can solve the SNP’s current fiscal dilemma. The Finance Secretary herself commented that you cannot prioritise everything and hard choices lie ahead.

Unfortunately, the longer-term brings additional challenges. As well as addressing  the global problem of climate change, Scotland faces a particular demographic problem – our population will begin to fall during this decade. By 2045, Scotland’s population will reduce by 1.5% while the UK’s will be 5.8% larger. More worryingly for tax revenues, Scotland’s population of over 76’s will be up by over two-thirds, whilst the population of those in their 30s, 40s and 50s will be static, and the population of under 30s will fall by 16%. 

This will have significant implications for tax raising as well as for government spending.  While it is obviously a good thing that we are living longer, a revenue problem will be created if the current tax structure is retained. Under our current tax arrangements, working age people contribute more in terms of tax revenue, while those over pension age have greater costs, particularly around the state pension and health care.

Health and care already account for nearly half of devolved expenditure. Although health spending is set to increase over the course of the review period, the Fraser of Allander Institute has questioned whether that increase is enough to meet the challenges ahead.^[1] The Institute for Fiscal Studies has also suggested that promises of additional resources for health were ”unrealistic” without raising taxes or cutting other services.^[2]

Additional revenue will, therefore, need to be found regardless of our constitutional future. However, the Scottish government is currently overly reliant on NSND income tax which accounts for 70% of its tax revenue and leaves policy makers without the broad basket of taxes needed. Instead innovative and new ways to increase revenue will need to be considered.  

Reform Scotland recently published ‘Taxing Times: Why Scotland needs new, more and better taxes’ by international public policy expert Heather McCauley. The report argued that Scotland required a fundamental rethink of tax structures – the balance across income, consumption and wealth taxation, the extent of taxation, and the scope for Scotland to establish new tax bases.

The report highlights that too often public debate tends to focus on very specific tax choices – what an individual tax rate should be or whether a group or activity should receive a relief or exemption – in isolation from the wider tax system and its impact as a whole.  Indeed, such a bidding war has been seen in the Conservative leadership contest where candidates have often tried to outdo each other on promising uncosted tax cuts and made little, if any, comment about the wider fiscal situation.

Instead, tax policy needs to be considered ‘in the round’ – it is the combined effect, including the distribution of cash transfers and public goods, not the progressivity of each tax individually, that matters for outcomes.

The primary purpose of a tax system is to raise revenue. If a less progressive tax is efficient, it can raise more revenue that can then be redistributed or used to reduce tax rates to achieve greater progressivity overall. Therefore, McCauley argues, countries need to consider the system as a whole and identify which mechanism is best for each purpose within it.

International comparisons suggest that there is no one optimal way to raise revenue. Countries vary significantly in the level of tax and tax mix, and there are different ways to achieve quite similar levels of redistribution. In general, high spend countries are also high tax countries, but countries can raise significant revenues with lower tax rates if their taxes have a very wide base and few exemptions.

However, while lessons can be learned from other countries, it is important to also consider the context within which Scotland operates. Scotland has fewer top rate tax-payers than the UK as a whole and our close proximity to the rest of the UK means that there is a risk of tax flight, whether we are independent or not.

As a result, McCauley recommends that higher or additional taxes in Scotland should focus on less mobile factors – particularly immobile wealth. The report notes “Taxes on the ownership of wealth are relatively economically efficient, help encourage positive wealth creation rather than “passive” wealth accumulation and are needed if a country wants to reduce (or prevent the further increase of) wealth inequalities. If they result in personal or capital flight they will tend to lead to a reduction in values which, in many cases, would improve affordability for Scottish residents.”

In the UK, the level of wealth has increased from around three times national income in the 1970s to more than seven times in 2020, yet that growth has not been accompanied by increases in tax revenues. The amount of tax collected has remained almost flat, below 4% of GDP.

The Resolution Foundation has estimated that a person could inherit £1 million from their parents and pay no tax while someone working 40 hours a week on the National Living Wage from age 18 to 70 would only earn £753,000 in their lifetime and pay almost £100,000 in tax.

The rising scale, increasing concentration and ‘unearned’ nature of wealth accumulation has fuelled arguments for greater wealth taxation internationally, with the OECD concluding that there is a “strong case for greater wealth taxation” as a way of addressing wealth inequality.

There are arguments for introducing a wealth tax at a UK level, but it could also be considered in Scotland under the devolved powers to create new taxes.

Tax reform is also required at a local level. Currently, local taxes – business rates and council tax – are local in name only. Scotland is a diverse place, priorities and circumstances vary considerably and, as a result, it is important that local authorities have the tools necessary to take account of their different situations.

However, despite nearly three decades passing since local government reorganisation and the creation of the Scottish parliament and subsequent devolution of additional powers to it, there has been no review of the capabilities or structures of local government. Indeed, if anything, more power has been reserved to Holyrood.

Reform Scotland believes that in addition to a fundamental review of taxation, there needs better balance of powers between Holyrood and local government, enabling local authorities to raise more of the money they spend, and to improve accountability and transparency. 

As a result, we have called for local authorities to have complete control over their local tax - including the rates, bands, reliefs and indeed form of the tax. This would allow individual councils, should they choose, to retain, reform or replace council tax with another form of local taxation, including different forms of wealth taxation. Crucially, this would be a decision about a local tax made by a local authority for its local area, taking into account local circumstances and priorities.

McCauley notes in her report that many other countries have set up independent expert commissions to undertake ‘root and branch 'reviews of their tax systems every five or ten years while retaining democratic oversight of decision making. A commission of this kind, perhaps chaired by an organisation such as the OECD, which has carried out other reviews for the Scottish Government with regard to education, could be a good starting point for Scotland in developing a Scottish tax system that is fit for the 21st century.

Alison Payne is Research Director with Reform Scotland.

^[1] First Spending Review in a decade provides welcome insight on Government priorities, and highlights scale of challenge facing public services | FAI (fraserofallander.org)

^[2] Scottish parties making unrealistic spending promises, warns IFS | Scottish politics | The Guardian