Scottish tax ready reckoners: direct effects of illustrative tax changes for 2024 to 2025

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 announced policy for 2024-25 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 £583 million in estimated revenue (over and above the changes announced for 2024-25). 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 broadly 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, as top earners are much more likely to be 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 £172 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 tax 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 6.7% (the September 2023 Consumer Price Index typically used for uprating) would be equivalent to a £2,905 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 Income taxation of 67.5% 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] and this risk could increase the greater the divergence with the highest marginal rate in the rest of the UK.
• 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.

Areas of uncertainty

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. Building on this, over the last year the Scottish Government has worked with HMRC to develop 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 area of uncertainty relates to the economic assumptions underpinning the costings. As the SFC notes in their latest report, the uncertainty about the outlook for inflation, and its impact on nominal earnings growth, lead to uncertainty in their Income tax forecasts.^[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 some Scottish bands and thresholds are frozen in 2024-25.

Finally, COVID-19 is likely to have reshaped the structure of the labour market and therefore the Income Tax base, however, detailed Income Tax data is only available with a significant lag. The Income Tax model continues to be based on pre-COVID microdata, yet aligned to 2021-22 Income Tax outturn. As noted by the SFC, this introduces uncertainty as this approach may not fully capture changes in the income distribution in response to economic developments or policy changes since 2021-22. For example, should the strength of the 2021-22 outturn data not be persistent, the ready reckoners might overstate the impact of some policies, especially those targeted at the top end of the income distribution.