Bill Jamieson: High risk gamble if Mackay defies Chancellor

Derek Mackay raised the higher rate by a penny last December. Picture: Jeff J Mitchell/Getty

Finance Minister Derek Mackay has until his budget on 12 December to decide whether to follow Chancellor Philip Hammond in raising the threshold at which higher earners here pay more tax, or allow the tax differential between Scotland and the rest of the UK to widen.

It is a defining moment of truth for the SNP – and one deeply uncomfortable for First Minister Nicola Sturgeon. She has been an avowed champion of big government spending and raising taxes on the better off. The SNP, supported in Holyrood by the pronounced left of centre Greens, are committed to tackling income and wealth inequality.

The starter level for higher income tax in Scotland is already lower than in England and Wales. And the administration has taken pride in using its devolved powers to create a five-band income tax system that lightens the tax take for low earners and raises it for middle earners and the better off. It is not predisposed to widening tax breaks for the wealthy – and would certainly recoil from being seen to follow the tax changes of a Tory Chancellor at Westminster.

But as matters now stand, that differential will widen. And that growing gap may encourage those on higher incomes to change the way they are taxed, to step up contributions to their pension scheme to gain tax relief, or move out of Scotland. Any one of these options would run the risk of lowering tax revenues for the Scottish Government.

First, a numbers check on where we stand. Philip Hammond announced in his Budget that for taxpayers in England and Wales he will raise the threshold for liability to the 40p higher rate tax on earnings from £46,350 to £50,000 and above from next April, a year earlier than planned.

In Scotland, there is a 41p higher rate for those earning between £43,431 and £150,000, and a 46p top rate for those earning more than £150,000. If unchanged, that would impact on take-home pay. For example, a police inspector in Scotland earning £48,200 will pay £1,183 more in tax than an officer of similar rank elsewhere in the UK. A headteacher on £45,111 will pay £533 more, while a GP on £56,500 will pay £1,625 more.

Much now depends on the behavioural response of Scottish taxpayers if Mackay chooses not to follow the Chancellor. One obvious option would be to move residence out of Scotland. But for those contemplating a move to London or the southeast of England, the notoriously higher level of house prices would be a big deterrent. Families with offspring at university would also lose out on free tuition fees.

However, the widening of the differential in tax treatment would send an unfriendly signal to middle and higher income earners and confirm a hostile direction of travel by the SNP that the tax burden is significantly higher – and likely to stay so.

A more worrying though hard-to-measure effect would be to discourage skilled and qualified middle-income earners to move to Scotland. For a country seeking to raise the skills and qualifications of its workforce this would be a regressive step.

Many may take comfort that they are not currently liable for higher rate tax and so need not worry about the discomfort for those better off. But beware of the “fiscal drag” effect – the process by which ever more people find themselves liable to higher tax over time. In 1988, when chancellor Nigel Lawson took the top rate of tax down from 60 per cent to 40 per cent, just five per cent of all taxpayers paid the higher rate. Today it is 15 per cent – an additional three million taxpayers.

And there are other means by which liability to higher rate tax can be mitigated. For example, self-employed business owners would find it advantageous to opt out of Scottish income tax and into UK-wide corporation tax to reduce their liabilities.

Another option is to step up additional voluntary contributions to pension savings, which would enjoy significant tax relief.

For Mackay it would be a high risk strategy to proceed on the basis that any such behavioural response would have little impact on the Scottish Government’s tax revenues. This is because the administration is dependent on those middle and higher earners for a disproportionate amount of tax revenue. It may well be that just 14.8 per cent of Scotland’s 2.52 million taxpayers are liable to tax at the higher rate, and just 0.7 per cent for the top rate. But higher and additional rate taxpayers account for more than 34 per cent of all income tax revenue. A flight of these – or moves to mitigate their tax liability – could result in a fall in tax revenue.

A warning of just such a “genuine economic effect” came in the wake of last week’s Budget from the Office for Budget Responsibility. Chairman Robert Chote and colleague Andy King, giving evidence to the Commons Treasury select committee, pointed out that Scotland’s tax revenue in 2016-17 was much lower than estimated – £550 million less, based on Scottish Fiscal Commission (SFC) forecasts, and £700m lower than the OBR’s estimate.

The SFC said the difference was down to “data issues”, with estimates based on samples of taxpayer records rather than real data. However, King suggested the gap could be down to “anticipatory behaviour”, with taxpayers already shifting their tax residency out of Scotland ahead of higher rates coming into effect north of the Border.

“If you’re a relatively high-income individual with a property in Scotland and one elsewhere in the UK, writing to HMRC to say, ‘I live more than half the year in London rather than Scotland’ is not difficult. It’s a particularly significant risk for the Scottish Government, because if someone changes their address, the Scottish Government loses all of that income tax. It does not leave the UK, so our UK-wide forecast is less vulnerable to this type of activity.”

Oh dear: a gain for England and a loss for Scotland? That would be a most uncomfortable moment of truth for the SNP Finance Minister.