Derek Mackay faces a bitter battle over taxation policy as he prepares to deliver the first budget that will set Scottish income tax at a higher level than elsewhere in the UK.
When the Finance Secretary presents his draft 2017/18 budget to Holyrood this week, it will be a touchstone moment in the history of devolution.
Some Scottish taxpayers will lose 52 per cent of their income for the part of their salary that lies between Scottish and UK thresholds
For the first time a Scottish Government will propose an economic policy which will see higher-rate Scottish taxpayers subject to a more punitive tax regime than their English counterparts.
Mackay’s determination to press ahead with the SNP’s policy will dominate Holyrood this week and will expose the ideological differences across the chamber as the Scottish Government faces the challenge of growing the economy at a time of draconian cuts.
As the Finance Secretary in a minority government, Mackay will somehow have to win enough support to get his budget through a parliament full of opposition MSPs who disagree with his policy from both ends of the left/right political spectrum.
On the one hand, there are the left-leaning politicians of Labour, the Greens and Lib Dems who argue that Mackay’s existing tax-raising plans do not go far enough and want taxes to go up further. On the other are the Scottish Tories, who believe making Scotland the highest taxed part of the UK sends the wrong message to business and will damage family finances.
With Labour politicians warning they will vote against a budget that does not take account of their calls for further tax hikes and the Tories indicating that they will not support any tax rises above the rest of the UK, Mackay has much wheeling and dealing to do in the run-up to Thursday’s budget.
The day before the budget the Conservatives will turn the spotlight on the issue when they lead a debate on a motion stating that “Scottish families and businesses should not be taxed more highly than those elsewhere in the United Kingdom”.
Holyrood was born with the powers to raise the so-called “tartan tax”, the ability to vary income tax by three pence in the pound, but never used it.
New powers delivered by the Calman Commission came into force this year. From April ministers had the power to set a Scottish Rate of Income Tax (SRIT). The UK rate was reduced by 10p in the pound across all bands in Scotland, giving the devolved institutions the ability to set a SRIT that was either above or below the UK rate. The Scottish Government, however, shied away from using the powers, setting a SRIT of 10p in the pound to restore parity with the rest of the UK.
From April 2017 the Scottish Parliament will have the ability to set both income tax bands and rates.
The disparity between Scotland and the rest of the UK arises through the Scottish Government’s unwillingness to follow the UK government’s proposal to give a tax break to higher earners.
In his Autumn Statement Chancellor Philip Hammond outlined an increase in the threshold for the 40p upper rate of income tax from £43,000 to £45,000 next year – eventually reaching £50,000 by 2020/21.
This week Mackay will confirm that the Scottish Government does not intend to follow suit. Instead the increase in the Scottish threshold for the higher income tax rate will be tied to inflation – a decision that sees the 370,000 or so higher earners in Scotland miss out on Hammond’s tax break.
In Scotland the threshold will increase to £43,387 with inflation – less than the £45,000 proposed for the rest of the UK. Under this arrangement a Scot earning £50,000 will pay £9,023 in income tax. A £50,000 earner in the rest of the UK will pay £8,700 – £323 less.
The gap will grow over time. In 2020-21, Scotland’s threshold will have risen with inflation to £45,997 – still some way behind the UK threshold of £50,000. In 2020-21 a Scot with a £50,000 salary would pay £8,300 in income tax. South of the border someone on the same salary would pay £7,500 – a difference of £800.
“This will be the first time we have differential income tax rates between Scotland and the rest of the UK,” said Professor Graeme Roy, Director of the Fraser of Allander Institute and former head of the First Minister’s Policy Unit.
According to Roy, a further complication arises through the way the devolved income tax interacts with National Insurance payments, which remain reserved to Westminster.
Under the Westminster system the National Insurance rate drops from 12 per cent to two per cent when salaries hit the higher rate income tax threshold.
In Scotland, therefore, some taxpayers will lose 52 per cent of their income for the small proportion of their salary that lies between the Scottish and UK thresholds. Next year, for example, taxpayers who hit the £43,387 Scottish threshold will move into the 40 per cent Scottish income tax bracket while still in the 12 per cent Westminster national insurance bracket. Their National Insurance contributions will not drop to two per cent until they reach the rest of the UK 40 pence threshold of £45,000.
All this, say the Tories, sends out the wrong message to businesses and families at a time when the Scottish Government also intends to raise council tax, and it is why they intend to debate the issue on Wednesday.
“There is a basic principle at stake this week,” said Murdo Fraser, the Scottish Conservative finance spokesman.
“It is over whether people living here should have to pay more in tax for doing the same job as someone from elsewhere in the UK. We don’t believe they should and we don’t believe it’s fair.
“With an increase in funding from the UK government announced in the Chancellor’s Autumn Statement, the Scottish Government’s argument that it can’t afford to pass on a tax cut to workers here simply doesn’t hold water.”
Although the difference to people’s pay packets caused by the diverging rates is relatively small at the moment, the Tories argue that Scotland’s reputation will suffer from being the highest taxed part of the UK.
Many business leaders agree. “Scotland is an attractive place to live and work and for it to remain so we would urge MSPs to think twice about any moves which could see Scottish-based workers paying more in tax than elsewhere in the UK. Higher taxes might affect the ability of employers to retain or attract talent – either on a permanent or temporary basis,” said David Lonsdale, Director of the Scottish Retail Consortium.
But last night Mackay accused the Tories of “rank hypocrisy”, arguing that UK government policies were resulting in cuts to Scotland’s budget.
The Finance Secretary’s spokesman said: “We set out our tax proposals in our manifesto, on which we were resoundingly re-elected by the people of Scotland just over six months ago. Our budget proposals, including our tax plans, are founded on fairness and we will outline them in more detail this coming week.
“But this is rank hypocrisy from a Tory Party whose policies will see Scotland’s overall budget cut by £2.9 billion – nine per cent in real terms – by the end of this decade compared with when they took office at Westminster.”
The Scottish Government had calculated that blocking the UK’s tax break would raise over £1 billion for public services.
Since then it has been predicted that inflation could jump to four per cent by the end of next year as the pound falls following the EU referendum result.
Economists in the Institute for Public Policy Research (IPPR) have warned that rising inflation could reduce income tax revenue in Scotland by “many millions” of pounds.
This is against a background of Scotland’s growth lagging behind the rest of the UK with an increase of just 0.4 per cent recorded in the second quarter of this year compared with 0.7 per cent in the rest of the UK.
Mackay also has to deal with the challenge presented by budget cuts. The IPPR has calculated that Scotland’s day-to-day budget will fall by £800m between 2016/17 and 2019/20.
Once spending commitments for protected departments such as the NHS and police is taken into account, the IPPR calculates spending on non-protected departments is due to fall by £1.3bn per year by 2019/20.
For Labour the way to protect public services when budgets are under such pressure is to raise more tax. Labour (and the Lib Dems and Greens) believe taxpayers should pay more.
Kezia Dugdale wants to see an extra one pence on income tax across all bands plus raising the top rate for those earning more than £150,000 increased from 45 per cent to 50 per cent. The Lib Dems also want a one pence increase across all bands, while the Green plans for tax increases include raising the top rate to 60 per cent.
“If the SNP minority Government does not accept these proposals, and tries to force another austerity budget through Holyrood, we will vote against it.”
An independent report produced by the Scottish Parliament Information Centre (SPICe) said that raising an extra 1p across all bands would generate £475 million extra for the Scottish Government. Labour has estimated their plans would raise £500m.
The other side of that argument is that raising taxes takes that cash out of the pockets of consumers and therefore takes money away from business.