Scottish Tax - changes for 2023 to 2024: ready reckoners

Income Tax

The Scottish Parliament has the power to set Income Tax rates and bands for the non-savings non dividend (NSND) income of Scottish taxpayers. The Scottish Parliament must pass a Scottish Rate Resolution before the start of the tax year setting Income Tax policy for the yearahead. It is not possible to make any in-year changes to Income Tax policy. The responsibility for defining the Income Tax base, which includes the setting or changing of Income Tax reliefs and exemptions, and the tax-free Personal Allowance, remains reserved to the UK Parliament. Income Tax on savings and dividends is also reserved. Table 2 sets out the rates and bands under the existing policy for 2023-24 which forms the counterfactual for the policy costings.

The Income Tax policy choices available to the Scottish Parliament include: the number of tax bands; the tax rates that apply to these bands; and the thresholds where bands begin and end. The ready reckoners in Table 1 can be used to show the additional revenue raised (or foregone) from individual components as well as any combination of these, for example:

• The revenue implications of any combination of policies can be broadly estimated by summing the impact of each individual change. For example, a policy which adds 1p to each rate would raise around £529 million. However, if thresholds are changed substantially, and combined with rate changes, there might be interactions which mean that the policy effects are not purely additive.
• The estimates can also be scaled up or down to some extent, in that a 2p rise in a tax rate will raise twice as much as a 1p increase. This approach is reasonable for changes of up to a few percentage points. However, caution should be applied when assessing larger changes, particularly to the Top Rate of Income Tax, as top earners are much more responsive to tax changes.
• For rate changes, the impacts of tax increases and tax decreases are also broadly symmetric so that a 1p cut in the Intermediate Rate would cost around £164 million. However, caution needs to be applied for threshold changes where the effects of increases and decreases are not fully symmetric.
• Threshold changes cannot be scaled up or down as easily, as any change in the band or threshold would affect the cost base itself, i.e. the number of taxpayers affected by the policy.
• The table illustrates increases to the Bands and Thresholds of +/-£100 and +/-£1,000 respectively. To put this into context, inflationary uprating at 10.1% (the applicable September CPI figure) would be equivalent to an £219 increase in the Starter Rate Band, a £1,325 increase in the Basic Rate Band and a £4,410 increase in the Higher Rate Threshold.
• No further policy changes to the Top Rate Threshold have been assessed at this stage. This is because the Scottish Government cannot make changes to the Personal Allowance taper rate or taper thresholds. The UK-wide Personal Allowance is withdrawn for taxpayers who earn more than £100,000 at a rate of £1 for every £2 earned over£100,000. Taxpayers earning more than £125,140 do not benefit from the Personal Allowance. These taxpayers face a marginal rate of taxation of 63% on earnings between£100,000 and £125,140. Reducing the Top Rate Threshold below £125,140 would increase this marginal rate further.
• In the case of the Top Rate, revenue effects are particularly uncertain as there is a risk that behavioural responses might significantly reduce the additional yield, or costs, from a rate change. Based on the SFC's current behavioural framework, these policies would have a relatively modest impact on tax revenues. However, as illustrated in the Scottish Government's evaluation of the 2018-19 policy changes, there is also a risk that any increase in the Top Rate might lose revenue.^[7]
• The ready reckoners do not include any potential effects of forestalling which might occur when taxpayers move income across years to minimise their tax liabilities. This is particularly relevant where tax policy changes are known well in advance of the beginning of the tax year.
• It should be noted that the Scottish Government's policy costings in relation to the Higher and Top Rate differ from the figures presented in the SFC's May report (£93 million and£3 million respectively). This is because the Scottish Government's counterfactual is different, i.e. it assumes that the Top Rate Threshold sits at £125,140 rather than £150,000.

Areas of uncertainty

There are a number of uncertainties when it comes to producing ready reckoners. There are a number of uncertainties when it comes to producing ready reckoners. The first is in the scale of the behavioural response. Evidence on behavioural responses is an essential consideration for tax policy decisions. For example, analysis published by HMRC in December2021^[8] highlighted a high degree of uncertainty regarding top earners' responsiveness and a potentially stronger than expected response amongst Higher Rate taxpayers. The Scottish Government and HMRC are developing new, and robust, data sources and evidence to help better understand potential behavioural responses, including taxpayer movements across the UK over time. The SFC regularly review their behavioural assumptions, and the ready reckoners set out above are based on their latest behavioural parameters.

The second major area of uncertainty relates to the economic assumptions underpinning the costings. As the SFC notes in their latest report, the outlook for inflation remains one of the key sources of uncertainty and, together with a relatively tight labour market, continues to put upward pressure on nominal earnings growth.^[9] How fast nominal earnings grow ultimately determines the extent to which people are pulled into higher tax bands, also known as fiscal drag. This effect is even more pronounced as UK-wide allowances and Scottish bands and thresholds are frozen in 2023-24.

COVID-19 is likely to have reshaped the structure of the labour market and therefore the Income Tax base. Since the Income Tax model remains based on pre-Covid tax data, this is not fully reflected in the ready reckoners. While detailed Income Tax micro data for 2020-21 will become available over the summer, it is likely to take a number of years until the full implications of Covid-19 on the tax base, and whether these effects are temporary or permanent, will be understood.