Scotland's higher taxes could help or hinder economic growth. It depends how well the money is spent – Alexandra Colalillo

The negative effects of the SNP’s new higher tax rates on the economy could be offset by prudent investment in education, infrastructure, childcare and help for struggling businesses

Scotland’s journey to economic recovery is likely to face some curveballs with the introduction of new income tax policy, due to take effect in April. With the commencement of a new advanced tax band and higher rates, the top end of income earners will feel the pinch the most.

The plan is to use the extra revenue to improve public services, but will the imposition of higher income taxes just undermine Scotland’s global competitiveness and pose additional obstacles to ongoing economic recovery?

Last quarter saw a stronger dip in Scotland’s real gross domestic product than the UK overall. While this may seem to reflect poorly on Scotland, it doesn’t take into account the full story. The UK is now technically in a recession following two consecutive quarters of negative growth. However, Scotland seems to be holding its own a bit better. Before this little economic hiccup, Scotland, in isolation, experienced 0.4 per cent growth in the third quarter and a solid 0.2 per cent growth throughout the last calendar year, largely attributed to consumer spending.

Looking ahead, Scotland’s economic outlook remains positive. Strong earnings growth, improvements in consumer sentiment, and resilience in the labour market are keeping it all steady. Plus, inflationary pressures are expected to relax, with the rate hitting 3 per cent this year before reaching the Bank of England's target of 2 per cent by mid-2025. With prices plateauing, we also aren’t expecting to see additional interest rate increases this year, giving growth prospects a little extra boost.

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However, following Scotland’s recent Budget, which announced the new tax rate for higher income earners, paired with a new tax threshold, these positive growth prospects are likely to confront challenges, given the increased disparity between Scottish and UK taxpayers.

According to Finance Secretary Shona Robison, the changes in Scotland’s tax policy are designed to “deliver high-quality public services”, and raise an estimated £18.8 billion in 2024-25. How these tax changes will affect economic growth in Scotland boils down to whether the drop in what households are spending will hurt more than the boost from government spending.

The tech scene in Scotland is likely to feel the pinch the most, given the industry already struggles to retain skilled staff and changes to tax policy are likely to negatively impact competitiveness, making it even tougher. Businesses are now probably feeling like they need to up their salary game to remain competitive with other companies.

There is a risk that skilled tech workers might start looking for gigs elsewhere in the UK where tax rates are weaker. There's the risk of a ripple effect as it could also have knock-on implications for investment in plant, machinery, research, training and development should firms seek savings elsewhere.

On the flipside, depending on how the government splashes the tax revenue around, if extra resources are invested into backing up at-risk industries and putting a focus on education, childcare, and infrastructure, this may serve a purpose to boost the economy’s overall productive capacity.

So if the government plays its cards right, it may well achieve its goal of providing better public services to support Scotland’s economic recovery through the income tax increases. However, it will need to tread cautiously to avoid a mess of its own making.

Alexandra Colalillo is an economist