The role of income tax in Scotland's budget
A discussion paper that aims to provide useful background to help inform the debate on future use of the income tax powers devolved to the Scottish Parliament.
3 Scale and scope of Scottish income tax powers
This chapter sets out the extent of the Scottish Parliament’s income tax powers, the relevant tax base (i.e. where tax can be raised from) and the interactions with powers held by the UK Government and Westminster Parliament. It also provides comparative information on the tax systems of other countries.
3.1 The scope of income tax powers and their interactions with reserved matters
“Scottish income tax cannot be considered in isolation because the powers are only partly devolved. The tax is intricately interwoven with UK taxes, and the Scottish Parliament has only a limited number of pieces of the jigsaw.  ”
The Scottish Parliament does not have a full set of policy options available when it comes to taxation. Given the current fiscal settlement, there are a number of interactions with reserved systems that affect tax policy options in Scotland.
Non-Savings, Non-Dividend Income Tax
The Scottish Parliament has the power to set rates and bands for non-savings, non-dividend income tax only. This is largely earned income (e.g. from employment and pensions) and so for any income people get from savings or dividends the rates are still set by the UK Government and that money goes to HM Treasury and forms part of the UK budget. 
As a result, there are flexibilities that the UK Government can exercise over income tax that are not available to the Scottish Parliament. For example, the Scottish Parliament cannot use income tax to incentivise savings or equity investments in new companies. Any changes could also raise the risk of tax avoidance if people were able to switch income from salary to dividends or vice versa. This would both reduce the amount of tax paid overall and also mean payments are made to the UK Government as opposed to the Scottish Government.
Allowances and reliefs
The PA is the amount that taxpayers are able to earn before they pay income tax. It is determined by the UK Government. The Scottish Government can set a zero rate of tax, but unlike for the PA, we cannot easily remove the benefit of this policy from the very highest earners. 
The power to create new tax allowances and reliefs remains reserved. Again, this limits the fiscal levers available to the Scottish Parliament. So, for example, the Scottish Parliament could not provide further income tax relief for individuals who wish to invest in enterprise (such as via HM Treasury’s Enterprise Investment Scheme) and the Scottish Government bears the risk of any lost revenue from reliefs if they impact on Scottish taxpayers more than in the rest of the UK.
National Insurance and social security
Income tax is inextricably linked with National Insurance and social security.
National Insurance ( NI) is a tax payable by employees, employers and the self-employed on earnings and profits. It is entirely reserved to the UK Government. As a result, any changes in Scottish income tax rates and thresholds could lead to unintended anomalies for taxpayers when considered alongside the NI thresholds set by the UK Government. For example, the threshold for the 2% rate of NICs has historically tracked the HRT of income tax, but since 2017-18 the HRT in Scotland has differed from the rest of the UK. This means that some Higher Rate taxpayers in Scotland continue to pay the Higher Rate of NI. The way to avoid this impact would be for the Scottish Government to also have control over NI rates.
There are also interactions between income tax and reserved social security powers. In particular, under UK tax legislation, income from certain social security payments, including the State Pension, is liable to income tax. An increase in income tax, therefore, could result in a decrease in net income for some social security recipients. And in other cases, such as Universal Credit, entitlement is determined by net (i.e. after-tax) income. As a result, in making income tax decisions, the Scottish Government and Parliament must be mindful of any unintended impacts on the income of people in receipt of those payments, as the Scottish Parliament does not have powers to legislate to mitigate them.
3.2 The Scottish income tax base
There are projected to be 4.5 million adults in Scotland in 2018-19 and 2.5 million income taxpayers. Around 2 million adults, or 44% of the total number of adults, will not pay income tax as they will earn less than the PA.
As illustrated in Chart 1  the large majority of taxpayers, around 2.2 million individuals, will pay the Basic 20p rate of income tax. Around 346,000 individuals, or 8% of Scottish adults, also pay the Higher 40p rate, and only 20,000 taxpayers (or 0.4%) in Scotland pay the 45p rate.
Chart 1: Number And Proportion Of Adults In Scotland By Their Marginal Rate Of Income Tax, 2018-19
Further key facts on Scottish taxpayers are shown in Box A. 
Box A: Key Facts on Scottish Taxpayers
The median income of taxpayers in Scotland is expected to be around £24,000 in 2018-19
Looking across all Scottish taxpayers, i.e. those with taxable earnings above the Personal Allowance, and including employees, pensioners and the self-employed, the median income is estimated to reach around £24,000 in 2018-19. This means that half of all taxpayers in Scotland earn below this level. The highest income groups can be set out as follows:
|Highest income groups||Starting income|
By comparison, the lowest income groups can be set out below. For example, 10% of income tax payers in Scotland earn less than £14,000, with 5% earning less than
|Lowest income groups||Have income less than|
Chart 2 shows the estimated income distribution of Scottish taxpayers for 2018-19, split into quarters. This shows, for example, that someone earning between £11,850 (the expected level of the Personal Allowance next year) and £17,000 would be amongst the lowest earning 25% of taxpayers in Scotland. For illustrative purposes, various salary points are presented along this scale too.
Chart 2: Estimated Income Distribution Of Scottish Taxpayers, 2018-19
Higher and Additional Rate taxpayers account for nearly 60% of all income tax paid Chart 3 groups Scottish taxpayers according to the highest rate of tax they pay and also shows the proportion of total income tax revenue that each group accounts for. This highlights how, despite making up less than 10% of adults, Higher and Additional Rate taxpayers account for 60% of all income tax paid.
Chart 3: Contribution To Income Tax Liabilities By Taxpayers And Band, 2018-19
3.3 International comparisons
International comparisons of tax systems are undertaken using information compiled by the Organisation for Economic Co-operation and Development ( OECD)  (see Box B).
Box B: What do other income tax systems look like?
Countries have made different choices about the number of tax bands, tax rates and the progressivity of their tax systems.
There is significant variation in how countries design their income tax systems. Broadly speaking, the more tax bands a system has the more progressive it is, as tax is more closely linked to ability to pay. Scotland currently has three bands. The majority of OECD countries have more tax bands. For example, New Zealand and the Netherlands have four, Belgium and Norway have five and Japan and the US have seven bands.
However, the number of bands is not a definitive measure of the relative progressivity of a tax system. For example, Denmark and Sweden have only two bands at the central government level, but are still seen as broadly progressive. This is partly because Denmark and Sweden apply their top marginal rates (55.8% and 60.1% respectively) including local taxation on a relatively large proportion of higher earners.
A few countries have flat rate systems where everyone pays the same tax rate - this is not progressive (although the overall system could be progressive depending on how spending is targeted).
When considering income tax as a proportion of Gross Domestic Product ( GDP), the corresponding level of public spending is also important.
Tax is only one side of the equation, as taxpayers also benefit from public services. Generally, lower tax countries, such as the US, also have lower public spending as a proportion of GDP and vice versa for higher tax countries. Therefore, people with the same level of income but facing different tax rates may still achieve the same quality of life if the higher tax country uses these extra tax revenues to fund public services rather than expecting the individual to meet their own costs. In this context it is important to note that Scotland has a much greater level of universal provision of services than the UK as a whole.
Scotland’s overall tax as a proportion of GDP is below the OECD average.
If we look at tax as a proportion of GDP  across 31 OECD countries in 2014, OECD figures show that the overall tax take in Scotland as a proportion of GDP (including oil and gas) is below the OECD average. Looking at income tax as a proportion of GDP, Scotland’s figure (7.2%) is lower than the UK’s (8.6%), partly due to the concentration of high income earners in London and the South East of England. 
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