If the Scottish Government makes no changes to its income tax policy at the upcoming budget, in 2023-24 Scottish taxpayers will be paying an estimated £1.2bn more in income tax than they would be paying if the English policy applied.
This was the warning from the latest Scottish Parliament Information Centre (SPICe) blog, responding to the changes outlined in the UK Government’s Growth Plan on 23 September.
From 1 April 2023, the plan had been to cut the basic rate of income tax for taxpayers in England from 20p to 19p and abolish the 45p additional rate of tax - although the abolition of the additional rate were quickly reversed.
Nicola Hudson, a senior analyst in the SPICe Financial Scrutiny Unit, wrote that while many of the announced changes do not apply directly in Scotland, they will have implications for the Scottish budget, as a result of the operation of the Fiscal Framework.
Under the terms of this framework, when income tax decisions were devolved to Scotland, the Scottish budget was adjusted downwards to reflect the income tax revenues that would have been generated in Scotland under the income tax policy of the rest of the UK - known as the income tax ‘block grant adjustment’ (BGA).
This BGA is calculated each year to broadly reflect the tax that would have been raised in Scotland under rest of the UK tax policy.
So, if the UK government changes its income tax policy in a way that results in lower income tax revenues, this means a smaller income tax BGA for Scotland, which in turn means a larger Scottish budget than would otherwise have been the case.
The Treasury's estimates suggest that the earlier-than-planned reduction in the basic rate will result in an additional £340m for the Scottish Government budget in 2023-24 compared to previous plans, and an additional £30m in 2024-25.
The Scottish Government's income tax policy will be set out in the next budget, which is expected in December - although this will be preceded by an Emergency Budget Review in late October.
With funding over the next two years now higher than had previously been expected, ministers in Holyrood could opt to introduce their own tax, or could direct the additional funding towards public spending.
Prior to Westminster’s reversal of its additional rate plans, Deputy First Minister John Swinney said: “We will not be replicating the UK Government’s tax cuts but will consider carefully the correct measures for Scotland.”
Hudson explained that if no changes - other than potentially uprating thresholds - are made to income tax policy, all Scottish taxpayers will be paying the same or more income tax in 2023-24 than they would do in England, regardless of how much they earn.
"This is in contrast to the position in recent years, where at least half of Scottish taxpayers have paid less in income tax in Scotland than in England (although the differences have been small at around £20 per year for those earning less than around £27,850," she wrote.
If the Scottish Government chooses to keep the current income tax policy, then those earning £25,000 will pay around £100 per year more in Scotland than they would in England, rising to almost £2,000 for those earning £50,000.
For those earning more than £50,000, the differential continues to widen, reaching a gap of more than £4,000 for those earning £250,000.
The Scottish Government could opt to reduce its own basic rate of income tax from 20p to 19p to bring it in line with the starter rate, reducing the number of taxpayers paying more tax in Scotland compared to what they would pay in England.
However, anyone paying the intermediate rate - currently applied at 21% to all earning more than £25,688 in Scotland - would still be paying more than they would in England.
Compared with keeping the current income tax policy, cutting the basic rate to 19p in Scotland would cost the Scottish Government an estimated £200m to £250m in reduced income tax revenues in 2023-24, depending on their decisions on uprating the thresholds at which the different rates apply.
"All this makes for a challenging set of decisions ahead for the Scottish Government in respect of its income tax policy," concluded Hudson.
"Does it move closer to the UK Government policy for lower earners, or even do something more generous? This would come at a cost in terms of reduced revenues at a time when budgets are already under severe pressure."
"Or does it maintain its current five-band policy and no longer be able to claim that more than half of Scottish taxpayers pay less income tax than they would in the rest of the UK?"
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