Scottish budget increases the tax gap to the rest of the UK

19 January 2024

December’s Scottish budget announcement was delivered against a backdrop of:

  • an anticipated £1.5bn hole in the Scottish budget (analysis from the Fraser of Allander Institute);
  • an estimated 39% of Scottish adults not paying any income tax;
  • an increasing economic inactivity rate (proportion of people aged 16 to 64 who are not working or seeking/available to work) of 22.9% (the rate for the whole of the UK is 21%); and
  • 20% of workers in Scotland being employed by the state.

Added to that, commitments had already been made to:

  • freeze council tax; and
  • increase welfare payments such as the Scottish Child Payment and the Adult Disability Payment.

A tax-raising budget

As a result, and despite an increase in Scottish funding from the Westminster budget announced in November, the Finance Secretary had a tough job on her hands.

Her response to the economic and fiscal landscape facing Scotland was broadly a tax-raising one. Whilst there were welcome increases in the starter and basic rate thresholds (1% and 3.4% respectively), the Finance Secretary announced a new advanced tax rate of 45% for Scottish taxpayers earning between £75,000 and £125,140, a freeze of the threshold at which individuals start paying higher rate tax, and an increase in the top rate of tax from 47% to 48%. These changes substantially increase the gap between the personal tax rates on earned, pensions and property income of Scottish taxpayers, and those that apply on their other income and generally in the rest of the UK. The introduction of the new advanced rate will have those earning between £100,000 and £125,140 paying an effective tax rate of 69.5% when National Insurance contributions (NICs) and the tapering of the personal allowance is factored in.

Concerns for Scottish business

There are concerns that the increasing complexity of a six rate system, the eye watering effective rates within those rate bands, and the increasing gap between the rates of Scottish income tax and those of the rest of the UK may put Scotland’s tax base at risk. 

The highest 5% of Scotland’s earners will be affected by these changes, and the top 1%, being those earning over £125,140, will be those most concerned. Taxpayers in this category are most likely to be among those who contribute significantly to creating wealth through running and owning businesses that, in turn, create employment opportunities for others. They will likely be entrepreneurial in nature, agile thinkers and therefore not averse to change. They may also have transferable skills and be able to relocate readily to take advantage of more favourable tax regimes.

A small difference between tax rates in Scotland and the rest of the UK is unlikely to provoke a wholesale move south of the border, but an additional 3p in the pound for those with income falling in the higher rate tax bracket is significant, and the impact of the latest changes may focus the minds of higher earners. A Scottish resident individual taxpayer earning £140,000 a year, for example, is in a far worse immediate tax position than an equivalent taxpayer who is resident in England, paying almost £5,700 per annum more in income tax and NICs. Whether the budget measures will be regarded as a step too far by some, encouraging them to move their businesses and wealth elsewhere, remains to be seen. If these steps do become the catalyst for such behavioural change (which to date has not been widespread) the Scottish government may find itself in a hole it cannot dig itself out of, as a tax base consisting of mainly public sector and lower earning private sector roles is unlikely to deliver the tax take it needs, particularly if it wants to continue with similar spending decisions to those in the past.

Instead, the Scottish government might consider turning its attention to alternative strategies that seek to attract skilled workers and entrepreneurs to Scotland to increase the population of workers paying taxes at higher rates.

For more information, please get in touch with Ross Stupart or your usual RSM contact.