The role of income tax in Scotland's budget

5 Income tax proposals in the 2016 manifestos of parties in the Scottish Parliament

This chapter is split into two parts. The first part provides a range of tools to estimate the revenue implications of various changes to the income tax system. The second part estimates the revenue implications of the income tax proposals which were put forward by each political party in the Scottish Parliament in the 2016 election.

5.1 Analysing the proposals

Income tax can be changed using a number of different building blocks such as changing existing tax rates, changing the number of tax bands and changing the thresholds at which different tax rates are paid. Box D shows how income tax proposals can be built up in different ways and provides a tool (a ready reckoner) which can be used to estimate what a particular proposal might raise in revenue.

For both the ready reckoner and for the manifesto proposals from each of the parties, the revenue implications are compared against the income tax rates and bands shown in Table 1 - these are the rates and bands that apply in 2018-19 if no changes were made. It is assumed that the PA and the HRT both increased in line with inflation from 2017-18 levels. ^[14]

Table 1: Rates And Bands Assumed In 2018-19

Gross income	Rates	Estimated number of people in band
£11,850 to £44,290	20%	2,165,000
£44,291 to £150,000	40%	346,000
Above £150,000	45%	20,000

In analysing all the proposals, the same model, data sets and underlying assumptions are used to ensure consistency (further information is in Annex A).

A key part of the analysis is to consider how individual taxpayers might respond to tax changes. Evidence shows that some people do change their behaviour in response to a tax change. For example, they may choose to change the number of hours they work or re- locate. The extent of any behavioural response is uncertain. However, it is vital to consider it in making revenue forecasts - not least because the Scottish Fiscal Commission ( SFC) will do so when making the forecasts that we must rely on in our Budget. The analysis therefore applies a range with low and high levels of responsiveness assumed. ^[15]

It is important to remember that the responsibility for producing the final income tax forecasts now sits with the SFC and its Commissioners may reach different views about responsiveness to tax changes than the ones included here. The analysis in this chapter has been undertaken by the Scottish Government and informed by advice from the Council of Economic Advisers. ^[16]

Box D: Income Tax Policy Building Blocks

The income tax policy choices available to the Scottish Parliament include:

• the number of tax bands
• the tax rates that apply to these bands
• the thresholds where bands begin and end.

These elements can be combined in various ways as shown below.

Different combinations of these building blocks raise (or reduce) revenue. To give a general idea of how much revenue can be raised over existing policy, ready reckoners can be used. The table shows the additional revenue (or cost) assuming low and high behavioural responses of taxpayers to policies.

Income Tax Option in 2018-19 No behavioural	Additional Revenue (+) or Cost (-) of Policy, in £ million
	No behavioural response	Low behavioural response	High behavioural response
Income Tax Rates
Only change Basic Rate by 1p	370	360	–
Only change Higher Rate by 1p	100	80	–
Only change Additional Rate by 1p	30	12	-2
Only change Additional Rate by 5p	150	53	-24
Income Tax Thresholds
Reduce HRT by approx. £1,300	100	90	–
Increase HRT by approx. £2,200 (to UK levels) [17]	-150	-140	–
Reduce ART to £125,000	30	10	–

The revenue implications of any combination of building blocks can be calculated by adding up the impact of each change. ^[18]

For example consider a policy which:

• increases the Higher Rate by 1p (an extra £80 million)
• increases the Additional Rate by 5p (which may raise receipts by £53 million or lower them by £24 million depending on the behavioural response).

Such a policy would generate between £56 million (£80 million minus £24 million) and £133 million (£80 million plus £53 million) in revenues for the Scottish Budget.

All political parties in the Scottish Parliament have advocated changes to the income tax system and have done so using different approaches.

The Cabinet Secretary for Finance and the Constitution wrote to the leaders of each of the opposition parties in the Scottish Parliament asking them to confirm their current policy in sufficient time to allow it to be considered by the Office of the Chief Economic Adviser for inclusion in this paper. ^[19] Replies were received from the Scottish Liberal Democrats, Scottish Greens and Scottish Labour. No reply was received from the Scottish Conservatives. The reply from Scottish Labour did not include details of tax rates and bands. The policies for these parties are therefore based on their manifestos for the 2016 Scottish Parliament election. The SNP policy is based on its manifesto for the 2016 Scottish Parliament election. Table 2 summarises the parties’ proposals with further details presented in the remainder of this section.

Table 2: Summary Of Parties’ Proposals On Income Tax

Component	Scottish Conservatives	Scottish Greens	Scottish Labour	Scottish Liberal Democrats	SNP
Basic Rate	No change	Lower basic rate by 2p up to £19k and increase by 2p above £19k	Add 1p	Add 1p	No change
Higher Rate	No change	Add 3p	Add 1p	Add 1p	No change
Additional Rate	No change	Add 15p	Add 5p	Add 1p	No change
Tax thresholds	Raise HRT to match rUK	Raise HRT by inflation (assumed)	Freeze HRT in cash terms at 2015-16 levels	Raise HRT by inflation	Raise HRT by a maximum of inflation until 2021-22
Tax bands	Retain 3 bands	Increase to 4 bands by splitting basic rate in two	Retain 3 bands	Retain 3 bands	Retain 3 bands

5.2 Tax rates and bands proposed

This section summarises the tax systems proposed by each party.

The Scottish Conservatives policy is shown in Table 3 and would see no change in income tax rates but changes in the HRT above which people start paying the 40p rate.

The Scottish Conservative manifesto from the May 2016 Scottish Parliament election stated that “income tax should not be any higher than the rest of the UK in Scotland, and lower when affordable”. ^[20] It is therefore assumed that the Conservatives would increase the HRT in Scotland to match the rest of the UK. This is assumed to be at £46,450, an inflationary increase from its current level, but will not be confirmed until the UK Budget in November.

Table 3: Rates And Bands (Scottish Conservatives)

Gross income	Tax rate	Number of people in band
£11,850 to £46,450	20%	2,209,000
£46,451 to £150,000	40%	302,000
Above £150,000	45%	20,000

In response to the Cabinet Secretary’s letter, the Scottish Greens replied: “It will clearly be impossible for a coherent tax policy to emerge, or even for annual rate resolutions to pass, if all political parties stick doggedly to 2016 manifesto positions and refuse to explore common ground. However, as a starting point I would remind you of the Scottish Green Party’s proposals.” In their manifesto from May 2016, the Scottish Greens proposed a four band system. ^[21] It has been assumed that the HRT is uprated with inflation in 2018-19, as set out in Table 4.

Table 4: Rates And Bands (Scottish Greens)

Gross income	Tax rate	Number of people in band
£11,850 to £19,000	18%	813,000
£19,001 to £44,290	22%	1,352,000
£44,291 to £150,000	43%	346,000
Above £150,000	60%	20,000

The Scottish Labour manifesto from May 2016 states that Labour would “set the basic and higher rates of income tax just one penny higher” and that the HRT will be set at £42,385, the same level as in 2015-16. ^[22] In addition, Labour would implement “a higher 50p rate for the top 1%, who earn over £150,000 a year”. ^[23] Scottish Labour propose to vary income tax rates across all bands and their proposals are shown in Table 5.

Table 5: Rates And Bands (Scottish Labour)

Gross income	Tax rate	Number of people in band
£11,850 to £42,385	21%	2,122,000
£42,386 to £150,000	41%	389,000
Above £150,000	50%	20,000

In response to the Cabinet Secretary’s letter, the Scottish Liberal Democrats set out their position as an increase of 1p on each rate of income tax and stated that they propose to index the HRT with inflation as shown in Table 6.

Table 6: Rates And Bands (Scottish Liberal Democrats)

Gross income	Tax rate	Number of people in band
£11,850 to £44,290	21%	2,165,000
£44,291 to £150,000	41%	346,000
Above £150,000	46%	20,000

The Scottish National Party proposal is shown in Table 7. The SNP’s manifesto from May 2016 committed to increase the HRT by no more than the rate of inflation in 2018-19. Table 7 uses a scenario where the HRT is frozen in cash terms at £43,000 (this shows the maximum revenue that could be raised from this position).

Table 7: Rates And Bands ( SNP)

Gross income	Tax rate	Number of people in band
£11,850 to £43,000	20%	2,136,000
£43,001 to £150,000	40%	375,000
Above £150,000	45%	20,000

There are estimated to be around 2.5 million income taxpayers in Scotland in 2018-19. Table 8 compares the impact of the parties’ proposals on these individuals by comparing the tax they would pay in 2018-19 under the new policy with that under the current tax regime. As set out in section 5.1, the current tax regime assumes that in the absence of any changes, the HRT and PA are uprated in line with inflation. ^[24]

Table 8: Impact On Scottish Taxpayers Of Changes To Rates/Thresholds (Relative To Current Regime In 2018-19)

Proposal	Taxpayers (million)	Percentage of Scottish taxpayers who pay
		same tax	more tax	less tax
Scottish Conservatives	2.53	86%	-	14%
Scottish Greens	2.53	-	45%	55%
Scottish Labour	2.53	-	100%	-
Scottish Liberal Democrats	2.53	-	100%	-
SNP	2.53	84%	16%	-

Table 8 shows that the Scottish Conservatives proposal would reduce tax for around 366,000 individuals, or 14% of taxpayers. Under the Scottish Greens proposal, 55% of taxpayers, or 1.4 million individuals with incomes up to £26,150, would pay less income tax in 2018-19 than under the current regime. The Scottish Labour and Scottish Liberal Democrat proposals would increase income tax for all taxpayers relative to the current regime. The SNP proposal would raise income tax for 16% of taxpayers.

An alternative calculation would be to compare people’s tax liability across years, i.e. between 2017-18 and 2018-19. Although this would take into account any changes in the PA, this is outwith the Scottish Parliament’s control and the impact cannot be confirmed until the UK Autumn Budget. ^[25] Moreover, comparing tax paid across years does not take into account the fact that over time tax allowances and thresholds are generally uprated in line with inflation as a matter of course to ensure that their real value is not eroded.

5.3 Revenue implications and impact

This section reports the revenue implications of each proposal along with analysis of the impact on an individual’s take-home pay and household income.

Revenue implications

The headline revenue figures take account of behaviour change and are therefore described as ‘post-behavioural’ estimates. For transparency, Table A1 in Annex A presents the revenue figures with and without behaviour change assumptions and Chart 5 also shows the revenue figures if taxpayer behaviour did not change. Given, however, that some change in taxpayer behaviour is likely, the remainder of the analysis focuses on the post-behavioural revenue figures.

Chart 5 illustrates the impact on revenues of each party’s proposals in 2018-19. All the proposals, with the exception of the Scottish Conservatives, would raise extra revenue for the Scottish budget, albeit to different degrees.

Chart 5 shows the mid-point of the revenue estimates (the range is shown in the bar and represents the low and high behaviour change assumptions). Chart 5 highlights that the revenue raised by the Scottish Greens’ proposal is the most uncertain. This reflects the fact that their proposal would represent the largest rise in tax for the highest earners and because this group is the most mobile, individuals in this group are most likely to adjust their behaviour in response to a tax change.

Chart 5: Revenue Implications Of Parties’ Proposals (Post-Behavioural Estimates)

Impacts on individual taxpayers and households

For each of the proposals, the impact on take-home pay (post-tax income) is calculated. Chart 6 shows the impact on an individual’s take-home pay for the 95% of Scottish adults who earn up to £55,000 with a further chart (Chart 7) showing the impact on an individual’s take-home pay for those earning above £55,000 (the top 5% of highest earning Scottish adults).

Chart 6: Impact On An Individual’s Take-Home Pay By Proposal (For Incomes Up To £55,000)

Chart 7: Impact On An Individual’s Take-Home Pay As A Proportion Of Income By Proposal (For Incomes Over £55,000)

The impact on the take-home pay of different occupations of each party’s proposal are shown in Table 9.

Table 9: Impact On Annual Take-Home Pay By Occupation And Proposal

Example gross income (annual)	Scottish Conservatives	Scottish Greens	Scottish Labour	Scottish Liberal Democrats	SNP	Occupations (average across profession)
£20,000	£0	+£123	-£82	-£82	£0	Nursing Assistant, Childminder
£25,000	£0	+£23	-£132	-£132	£0	Local Government administrative occupation, Bank and Post Office Clerk
£30,000	£0	-£77	-£182	-£182	£0	Nurse
£35,000	£0	-£177	-£232	-£232	£0	Primary School Teacher, Social Worker, Paramedic
£40,000	£0	-£277	-£282	-£282	£0	Solicitor, Police Officer, Secondary School Teacher, Chartered Accountant
£50,000	+£432	-£534	-£763	-£382	-£258	Head Teacher (primary school), Train Driver, Financial Institution Manager & Director
£60,000	+£432	-£834	-£863	-£482	-£258	Senior Police Officer, MSP
£70,000	+£432	-£1,134	-£963	-£582	-£258	Marketing & Sales Director, Medical Practitioner ( GP or Surgeon) and Director (above median)
£80,000	+£432	-£1,434	-£1,063	-£682	-£258	Air Traffic Controller, Senior Manager
£90,000	+£432	-£1,734	-£1,163	-£782	-£258	Chief Executive, Airline Pilot
£120,000	+£432	-£2,934	-£1,563	-£1,182	-£258	Partner in some professional services firms, Chief Executive of larger organisations

Source: Based on ASHE 2016, Table 14.7a. Median incomes by occupation for the UK as a whole. Income rounded to nearest £5,000 or £10,000

For each of the proposals, the impact on household income is also calculated. This is because household income differs from individual earnings since households may have more than one earner and more than one source of income. ^[26] The analysis therefore calculates the impact of proposals on household incomes after tax and social security payments, accounting for the number of people in the household.

Box E presents the impacts on household income by income decile. This approach divides the population into ten equal groups, with decile 1 representing the 10% of households with the lowest incomes and decile 10, the 10% of households with the highest incomes. Box E shows the average change in household income by income decile for each of the party’s proposals.

Box E: Average change in household income by income decile and proposal

The charts highlight that the Scottish Conservatives’ proposal leads to the largest increases in income for those households at the top of the income distribution.

All the other proposals lead to lower incomes for those households at the top of the income distribution, as a result of them paying more tax.

The Scottish Greens’ proposal leads to the bottom six deciles having slightly higher incomes as a result of paying less tax.