If the Scottish Government doesn’t follow the Tories’ abolition of the 45p additional rate, I expect its revenues from Scotland’s own 46p rate will fall by half. Here’s why.
In 2017, the Scottish Government raised the additional rate from 45p to 46p. They called this the “top rate”. On paper, the differences between Scottish and rest of UK (rUK) rates should have raised £378m. A year later, HMRC estimated the actual figure was £239m. The top rate alone would naively have raised £27m – the actual figure was £5m.
Why? “Behavioural response”. That could mean a variety of things:
- Taxpayers “avoiding” tax in the broadest sense of the word, for example by making additional pension contributions, investing in venture capital trusts, or taking other entirely uncontroversial steps to reduce their taxable income.
- Taxpayers actually moving house (their place of residence) to escape the Scottish rates. It doesn’t seem very likely that high earners would go to that trouble just to save 1%, but at the margin it may affect choices, particularly if taxpayers expect more Scottish tax increases in the future.1
- Another marginal effect will be people taking the reasonable position that they’re resident in England, not Scotland, when the facts support that, but they wouldn’t have bothered before.2
- People slightly adjusting their behaviour so they’re resident in England, not Scotland; in many cases this may just amount to spending a few more days outside Scotland.. You might call this “avoidance“. But if it’s real, not not fictitious, it can’t be challenged.
- People lying that they’re resident in England when they’re actually resident in Scotland. Tax evasion – but probably hard for HMRC to detect.
- Simple tax evasion as people fail to declare revenue. Again doesn’t seem very likely to me that such small rate differences would make anyone tip into criminality. Most high income tax payers are employees, who can’t realistically evade tax.
Whatever the reason – these are pretty impressive behavioural responses to a small change. Much more than I would have guessed – and it surprised HMRC too (the table above shows they anticipated a 20% response). The response to the top rate is extraordinary – 80% of the income you’d expect, on paper, to arise, simply disappeared.
So we can expect at least a 40% behavioural response to the new gap of 5p between the UK and Scottish rates on high incomes. Possibly 80% or more if the previous history of the top rate is any guide. And we may start seeing a real response (people moving house, rather than just changing where they claim residence). A prudent ballpark estimate would be that Scottish revenues from its 46p top rate will fall by about half; they may disappear entirely (or even become negative).
Of course this doesn’t mean the Scottish Government will simply fall in line with the rest of the UK, and abolish its top rate. They may well take the view that half the revenues are better than none (particularly if it doesn’t expect a real response, i.e. an actual economic cost to Scotland of people moving). And the political signalling of the additional/top rate has always been much more important than the (modest) revenues it collects. £2bn across the whole UK is chicken feed, in the context of about £200bn from income tax as a whole. £5m across Scotland is less than chicken feed.
The moral of the story – the interdependence of the Scottish and rUK economies means that differential tax rates are a Really Bad Idea.3 An independent Scotland would find its tax policy in practice heavily constrained by the tax policy of rUK.
Inevitable caveat: I haven’t covered the effect of the rate changes on the Barnett formula, because I know nothing about it…
Photo thanks to chris robert on Unsplash