From 1 April 2016 the Scottish Parliament will have responsibility for a Scottish Rate of Income Tax.
This responsibility will be a partially devolved power.
Essentially, Westminster will still set the overall rate of tax for the UK - but for Scotland, this basic rate will be reduced by 10p for every pound across the various tax bands. This means the Scottish Government will have to set an additional tax rate to compensate for the 10p reduction. This 'Scottish Rate' will be generated from Scottish taxpayers and affords a degree of flexibility for the Government. If they set the Scottish rate at 10p, they will have restored the UK national rate and overall, Scottish taxpayers will pay the same rate of tax as everyone else in the UK. If they decide to increase this 10p base figure, the Scottish Government will generate more tax from Scottish taxpayers. Conversely, if they decide to reduce the base figure, Scottish taxpayers would pay less in taxes and the Scottish Government would reduce their tax revenue.
At a first glance, this looks like a useful power - but there is a sting in the tail.
The terms and conditions attached to the power dictate that any change to the 10p base rate must affect ALL tax bands. This makes the new power an extremely blunt instrument because there is no ability to set a reduced tax rate for income in a low tax band and a higher tax rate for income in a higher band at the same time.
To see how this would affect the tax generated, let's make a start by looking at the way the tax bands are set.
Table 1: Tax Bands and Rates (2015/2016)
(10% + SR)
Note: Personal Allowance reduces by £1 for every £2 of income above a £100,000 limit. It can go down to zero.
Source: HM Treasury. SR = Scottish Rate of Income Tax.
Tax is collected according to 'bands'. These bands define ranges of income and apply a specific tax rate to each.
The bands (for 2015/2016) and their associated rates are shown in Table 1.
These bands are set by the UK government and currently (February 2016), apply to Scotland too. The current values are shown in the first and second columns.
When the partial income tax power is devolved in April 2016, a reduction of 10p in every taxable pound will be implemented. This translates as one percentage point for every penny and is shown in the third column.
To appreciate how this system works in practice, let's take a brief look at how tax is calculated on annual earnings. To keep things simple, we will stick to the UK national rates and won't confuse the picture with tax credits and other factors. For the time being, we just want to see how the tax bands work.
Example 1. Income of £18,800.
From the total income, £10,600 is regarded as tax-free (your Personal Allowance). For tax purposes, this amount must be subtracted from the total income:
£18,800 - £10,600 = £8,200
This amount falls into the Basic Tax Band and is taxed at 20% returning £1,640 to the Treasury.
Example 2. Income of £48,300.
As in Example 1. the personal allowance of £10,600 is subtracted from the total.
£48,300 - £10,600 = £37,700
This time, the taxable amount is greater than the Basic rate of 20% as it lies in the Higher Tax band. However, the whole amount doesn't attract a tax burden at the Higher rate - only the amount that exceeds the Basic rate is charged at the Higher rate, the rest is charged at the 20% Basic rate.
So, we subtract the Basic rate limit from the total to find out how much will be taxed at the higher rate, then calculate the two tax amounts.
£37,700 - £31,785 = £5,915.
This gives us:
£31,785 taxed at the Basic rate of 20% = £6,317
£5,915 taxed at the Higher rate of 40% = £2,366.
Adding these two amounts returns a total of £8,683 to the Treasury.
Example 3. Income of £160,000.
When an income exceeds £100,000 the Personal Allowance is affected. For every £2 over the £100,000 limit, the Personal Allowance reduces by £1. In this example of £160,000, anything over £121,200 would wipe out the Personal Allowance (£10,600 x 2 = £21,200). Clearly this is the case here, there is no Personal Allowance, so the full £160,000 is taxable and is decided by the usual banding method.
This income spans all three taxable bands and the values and tax generated is as follows:
£31,785 taxed at the Basic rate of 20% = £6,317
£118,215 taxed at the Higher rate of 40% = £47,286
£10,000 taxed at the Additional rate of 45% = £4,500
Adding these three amounts returns a total of £52,423 to the Treasury.
Setting the Scottish Tax Rate
In April 2016, the UK government will reduce each tax band by 10% in Scotland (or reduce each taxable pound by 10p if you prefer). This will immediately affect the financial calculations that determine the funds allocated via the Barnett Formula due to the reduced revenue sent to London in income tax. The recently devolved tax power will allow John Swinney to determine what additional tax raising measures he would recommend to restore the budget shortfall.
In response to the new power, on the 11th February, 2016, the Scottish Parliament took its very first vote on setting the tax rate. With an overwhelming majority, MSP's voted to adopt John Swinney's recommendation of 10p (10%) and this will be the rate that will apply for the 2016/2017 financial year. This will restore the rates back to the UK national values. From this point on, we will refer to this as the Scottish Rate (SR). Essentially, we are neither up nor down and everything is roughly as it was (except Scotland now has to foot the bill for the collection of the devolved tax).
As previously mentioned, at first glance, the new power would appear to offer a way of collecting more tax - and it does if the rate is set beyond the confirmed 10p base rate. However, its not as straightforward as that. Like so many 'concessions' from Westminster, there are often hidden consequences. In this case, the terms and conditions specify that any increase or decrease from the 10p base rate must happen equally across all the bands.
Surely that would mean the same rise for every tax payer if the rate was increased? Isn't that fair?
Well, yes and no... Let's look at some examples of how the rate change would work for a range of incomes. We will assume an increase from 10p to 11p for the SR. I've put the results in a table (Table 2) so we can see the comparisons better.
Table 2: Comparisons between a 10p Scottish Rate and an 11p Scottish Rate
What is immediately obvious is that those with low earnings see a greater percentage increase than higher earners. Low earners will have all their taxable income firmly within the Basic Tax Band and the effect of raising the tax by just a single penny results in a whopping 5% increase in the tax they pay. Compare this to the higher earners who have part of their taxable income in the High Tax Rate Band and the percentage drops considerably. The higher earners pay a lot more in tax in terms of hard cash, but the percentage of their overall earnings is very much reduced.
The reason for this is actually quite simple. If you add a penny to the 20% Tax Band, it becomes 21% and you have effectively added 5% to the rate. When you add the same penny to the 40% Tax Band, it becomes 41% and this means you have only increased it by 2.5%. Adding a penny to the 45% Tax Band produces an even lower percentage. When all the tax from all the appropriate bands are added up, those with the majority of their income in the Basic 20% band will take the biggest percentage rise in their tax.
Essentially, lower paid earners will feel the increase in tax a lot worse than the higher paid earners will. For those at the lowest end of the pay scale, this will definitely mean additional hardship and in many cases will actually push them further into in-work poverty. In-work poverty is the ridiculous situation where an income derived through employment is not enough to sustain an acceptable standard of living.
Clearly, this is extremely unfair for the majority of Scotland's workforce who have earnings that lie, for the most part, in the Basic Tax Bracket (20%). Since there is no provision to adjust individual rates, the Scottish Government has set a 10p rate, effectively ignoring the new 'power'.
We are now in the position of possessing a devolved power, but because it is practically useless, no sane administration would fall into the trap of using it.
This brings us on to the recent proposals from Labour and the LibDems - who want to use the power and raise income tax by a penny!
It all sounds great, but...
The Scottish branches of Labour and the LibDems have announced they support an increase in the Scottish Rate from 10p to 11p. We have already covered most of the general impact this would have on Scotlands tax payers and acknowledge that the majority view is to leave the rate at 10p. However, Labour and the LibDems have been pretty adamant they could make the increase work. The LibDems have been somewhat vague about countering all the problems the increase would cause low earners, but Labour have announced they have the answer in the form of a rebate, paid via local authorities.
These are bold claims. The Holyrood elections are getting close and this proposal has already been used to criticise the decisions made by the Scottish Government concerning the use of the "new tax raising powers". It would be fair to assume this may become a political football in the campaigning period.
As the main opposition to the Government, Labour is tasked with holding it to account. However, their activities in this area must be credible and based on well thought-out planning.
Let's see how their tax proposals stack up.
Kezia Dugdale has announced that Labour will propose setting the Scottish Rate of Income Tax in the 2016/17 budget at 11p - 1p higher than it currently stands
They say that to offset the impact on the poorest workers, taxpayers earning less than £20,000 will receive a £100 annual rebate through a payment scheme implemented by local authorities.
They also plan to make a similar rebate available for pensioners.
SPICe (Scottish Parliament Information Centre) say such a move would raise £475m, while Labour say that they would pay back £75m in rebates, raising £400m in total, before the costly impact of administering any rebate is considered.
So that's all we know about the proposed changes - no fine details, in fact, no rough details either.
However, we should attempt an analysis anyway and see if there is a way to implement the tax raising power with some sort of mitigation for those who will be hardest hit.
Starting with point 1, we already know the impact a 1p increase will have on the tax paid by lower paid workers - and it isn't a rosy prospect. Despite Labour's plan to mitigate the effects on the lowest paid, it will still push other folk into working poverty. In addition, the 1p tax increase will favour higher paid workers - causing an unwelcome increase in the wealth gap. So much for those with the broadest shoulders carrying more of the load.
Point 2 covers the rebate - but doesn't give any details. Questions that need to be answered are:
Would the rebate be legal?
The proposed rebate will be riddled with complexity - how will it be administered?
Will the rebate be taxable and how will this impact on other benefits?
There is clear evidence that many people don't claim benefits which require them to fill out forms to claim them. How would Labour ensure that their proposed rebate would reach the people who need it most?
Under the proposed scheme, someone earning £19,999 would be £99 better off than someone who earns £20,001. Is that fair?
Point 3 mentions the rebate for pensioners. This didn't appear on the original proposal, but was hastily added after scrutiny under questioning in the Holyrood chamber - surely this shows a lack of planning and understanding and also hints at the complexity of the whole idea.
Point 4 addresses the amounts that would be raised and repaid by rebate. It doesn't give any detail about the administration methods or costs. Due to the complexity of the proposed rebate, this will likely be a very costly undertaking.
It looks like any attempt to gain extra revenue from this rather devious power is a non-starter. There are clearly issues of serious inequality, increased hardship and the administration looks like a complete nightmare.
After weighing up the pro's and con's, the majority decision to keep the SR at 10p is surely a resounding testament to the unsuitability of this route to extra tax generation.
Much is made of the 'generous powers' that have been devolved to the Scottish Parliament. The media and most of the Westminster MP's delight in pointing out the apparent reluctance of the SNP government to use all these 'amazing tax raising powers', and in addition, they are accused of unreasonably asking for more.
In reality, this partially devolved Income Tax power is fraught with problems. It is extremely inflexible and as a consequence is practically useless. The naïve attempt by Labour to incorporate it into a fund raising mechanism has showed just how problematic this so called 'power' is and it also highlights the difficulty in mitigating the effects on those who are most disadvantaged by its use.
Using this power in its present form is something that most people would consider morally wrong - and this was demonstrated by the vote to retain the 10p rate, effectively ignoring the tax raising facility of the power. Its rather telling that the Westminster establishment thought this was an appropriate implementation to devolve. They must also be aware that by failing to use this tainted power, Scotland has been forced to embark on a costly tax-raising venture that ultimately will make no difference to the amount of tax generated.
The amount of underhand manipulations in such a simple piece of legislation is far-reaching and it must be concluded that this devolved power was designed with no other purpose than to hamper the governance of Scotland, financially undermine the majority of tax paying Scots and consequently damage confidence in the competence of the Scottish Government.
So, with our amazing tax raising power finally put to work, nothing has changed for the better. It will be interesting to see what devious ploys are set to come our way in the near future.
Its so nice to be "Better Together".