Using its devolved powers, the Scottish Government has introduced a system of five tax bands and rates that will apply from this Friday (6 April 2018) - compared to the three bands in the rest of the UK. These bands and rates will apply to most taxable forms of income but not savings and dividends.
The Scottish Government expect over half of Scottish taxpayers to pay less tax in the 2018/19 tax year than they would do if they were resident elsewhere in the UK and that the new bands and rates will raise revenue overall.
One thing is for sure, a partially devolved income tax regime adds complexity to a tax system where it is already difficult for taxpayers to understand what they pay. On the basis that the additional revenue will raise in the region of £164m and the annual fiscal deficit in Scotland is around £12bn, you have to question whether the additional layers of complexity are really worth it.
It does, however, expose the interaction between devolved and retained tax powers and the potential issues this may bring. In particular, the interplay between how the new tax changes could change behaviour as taxpayers who may opt to take a dividend rather than incur the increased cost of income tax through PAYE.
The Scottish Fiscal Commission have provided a forecast of how taxpayers might react to the recent tax increases which will take effect in Scotland from 6 April 2018. They concluded that, over the next five years, the £1.5bn tax that is predicted to be collected will be reduced by over 20 per cent to £1.2bn.
It seems to be the opinion of the Commission that higher-rate taxpayers will determine the amount of reduced tax revenue. However, there are over 360,000 enterprises in Scotland of which some 300,000 of these have five employees or less. These owner-led enterprises are more likely to be able to mitigate income tax by paying a dividend instead of salary; and most could well be earning under £32,000.
Instead of paying 21 per cent income tax they would only pay 7.5 per cent by taking a dividend, so why would they not. If this happens it would be a double blow for Scotland, as that 7.5 per cent tax is a savings tax and that tax is reserved to Westminster – so Scotland will see nothing and effectively lose 21 per cent in full. This does not seem to have been considered by the Commission fully and instead the focus is on those taxpayers earning more.
Ultimately, this is a best guess, taking into account a number of potential, and sensible, parameters and estimating what might happen. Who knows what Scottish taxpayers might do, but the focus on the higher-rate taxpayers may not be the best approach and it could be that middle-earners hit the tax take harder than those earning the most.
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