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2 November 2018updated 24 Jul 2021 5:12am

The Tories’ tax cuts leave Scotland with an economic headache

Greater divergence between England and Scotland on tax risks reducing revenue for the SNP government. 

By Chris Deerin

At what point do the pips squeak – when does low-level grumbling among the wealthy about the tax burden tip into action? That’s the issue Scotland’s political community is mulling after this week’s Westminster Budget.

No one must consider it more attentively than Derek Mackay, the Finance Secretary, who in a few weeks will present his Scottish Budget. In last year’s statement, Mackay raised income tax slightly on Scotland’s better-off. Now Philip Hammond has cut it for their equivalent in England. The gap between what the wealthy pay north and south of the Border is growing.

The two nations appear set on different tax journeys. No one expects Mackay to pass on Hammond’s changes in full. The Chancellor’s main offer was a big increase in the threshold at which the higher rate of tax kicks in, from £46,350 to £50,000. When tweaks to the personal allowance and national insurance are taken into account, the measures are estimated to mean a saving of around £500 a year for higher-rate taxpayers in England.

What will the Scottish Budget propose in response? Mackay has already said he intends to take a “more progressive approach”, which, reading between the lines, suggests something akin to a lesser, inflation-linked rise in the higher-rate threshold. This, if the minority SNP administration can secure the necessary support from the Greens, would address the Chancellor’s measures a little, but not eradicate the gulf or address the fact that it is growing.

These are matters not just of economics, but of politics and philosophy. It suits the SNP’s ultimate goal of independence for the Scottish and rUK economies to diverge to the point where a clean break seems less radical and disruptive than it currently does. It suits the party’s strategy going into the next Holyrood election campaign to paint the Tories as tax-cutters who care only for society’s winners. It also raises real issues about Holyrood’s autonomy on economic matters – if, for example, the Tories produce a post-Brexit Budget containing serious tax cuts next year, how does the Scottish government respond? Where does the balance lie between its professed “centre left and social democratic” values and cold economic reality?

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Nicola Sturgeon and her ministers wish to pose a fundamental question to Scots: what kind of society do you want to live in? As they might put it, should we be a lower-tax economy and risk the underfunding of public services, or do we aspire to the Scandinavian model of higher taxes and well-resourced services? No prizes for guessing the answer they want to hear.

The problem is that this might not be the answer they get. Last year’s Holyrood Budget saw Mackay increase the higher rate – for those earning above £43,431 – to 41p, and the additional rate – for those earning above £150,000 – to 46p. If this change hasn’t led the better off either to move their money to kinder tax jurisdictions or into dividends – and there is no firm evidence of this happening yet – it has certainly caused consternation about the direction of travel. If the gap between north and south grows yet again due to this year’s Budget round, that concerned chatter will only grow. And as one of Scotland’s top economists said to me, no one really knows the point at which grousing will tip over into action. We are living through a real-time experiment in economic theory.

Alarm bells will perhaps have rung in Bute House at comments from the Office for Budget Responsibility, which warned this week of “potential economic behavioural responses” in relation to income tax divergence. The OBR’s Andy King told the Treasury select committee that “if you’re a relatively high income individual with a property in Scotland and one elsewhere in the UK, writing to HMRC to say, ‘I live more than half the year in London rather than Scotland’ is not difficult. It’s a particularly significant risk for the Scottish government because if someone changes their address, the Scottish government loses all of that income tax.”

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Mackay’s allies admit that “we have to remain competitive – there can’t be divergence to the point it puts people off.” They are alert to the danger that high taxes could impact on revenues, inward investment levels and Scotland’s international attractiveness as a place to work and live. But they are also bullish. A source says: “The divergence in income tax last year landed well, and people didn’t really notice it in their pay packets. No company has said a single employee has left or refused to join because of our tax decisions.

“And tax is only one part of the proposition. There are no tuition fees in Scotland, and no prescription costs. There is lower council tax and lower water rates. Scotland is the lowest-taxed part of the UK for 70 per cent of people – the majority are better off living here than in England. It’s not a race to the bottom on tax, it’s a race to the top as the best place to live in the UK. Poll after poll tells us that on the whole, a majority are in favour of fair tax, and are willing to pay a bit more when it’s needed. So long as people can see what they are getting for their money, tax is not a dirty word.”

Tax may not be a dirty word, but Scots are hardly more immune to the offer of cold hard cash than anyone else. Mackay is an impressive man who has chosen a bold path. But he is also walking a fine line.