John McLaren: Income tax changes have economic and political risks

The Scottish Government yesterday announced Budget plans for 2018-19. What is failed to do was give a clear picture of how it intends to manage the new world of lower economic growth and the implications for budgets.

Finance Secretary Derek Mackay addresses the Scottish Parliament during the Draft Scottish Budget. Picture: Jeff J Mitchell/Getty Images)

Both the Office for Budget Responsibility and the new Scottish Fiscal Commission have judged that economic growth will be slower, due to lower productivity growth. As a result, tax revenues will suffer. The question then is how to compensate for this?

The temptation had been to significantly raise more taxes from high earners. However, there are problems with this, as even a rise of 5p raises little and may even end up losing money. Furthermore, there is a risk that such a shift reinforces the perception that Scotland is a “high tax” location. In practice, as the Scottish Government’s own publications have shown, you have to raise the basic rate of income tax to bring in serious amounts of extra revenue.

The Scottish Government’s solution therefore has been to go well below the highest earners, down to those earning £24,000, and start imposing higher taxes over a far broader range of tax-payers. It also means that, by increasing the rate by 1p at each of the new Intermediate rate (effectively now the Basic rate), the Higher rate and the Additional rate, high earners now pay an extra 1p on most of their earnings, not just at the top end. (Note that many higher earners will be harder hit by this change than they would have by a 3p increase in the Higher rate alone.) It also means that medium-to-high earners pay more tax, not just high earners. Such a change is not easy to model and so the behavioural impacts on net revenues gain will be difficult to estimate.

Clearly there are both economic and political risks involved in such a strategy, as the laboured attempts to show how many taxpayers would be better off by the new arrangements proved. The bottom line remains that tax revenues are up and someone has to pay for this and may attempt to avoid paying.

An interesting alternative strategy existed - to cut the tax rate for high earners. Such a choice would actually have been a return to previous SNP policy, based on Alex Salmond’s beloved Laffer Currve. However, instead of focusing on attracting wealthy companies, by cutting corporation tax, such a policy would focus on attracting wealthy individuals. With a larger pool of such taxpayers to attract from London than might be lost from Scotland this policy could raise overall tax. But, for now, such thoughts are forbidden.