Tax and Benefit Reform in Scotland

The Institute of Fiscal Studies’ (IFS) recent publication titled ‘Analysis of Scottish Tax and Benefit Reforms’ touches upon the tax and benefit policy changes that have taken effect since April 2022, many of which were announced at the Scottish Budget in December 2022.

The benefits changes that took effect from November 2022 and tax changes announced in December 2022 include:

• Basic, intermediate and higher rate income tax thresholds frozen at £14,733, £25,689 and £43,663, respectively, rather than increasing by inflation;
• Reduction of the top rate threshold to £125,140;
• Increasing the higher and top rates of income tax by 1p to 42% and 47%, respectively;
• Increasing the Scottish child payment to £25 per week (was £20 per week) plus expanding eligibility from children aged up to 5 to those aged up to 16.

The findings make for interesting reading on how the Scottish and England & Wales fiscal policy divergence continues. The report rightly acknowledges that these measures continue the trend of the Scottish government using its devolved powers to increase the progressivity within the devolved taxes and the benefits system.

The report finds that the combined changes to the tax and benefits system since 2017 will on average reduce Scottish household incomes by £210 when compared to a similar household in England & Wales. However, the majority of this burden is borne by higher income earners. The lowest income households will on average benefit by £580 per year compared to equivalent households in England & Wales, with increased Scottish child payment and Best Start grants delivering the additional income. The report also finds that the richest 10% of households will be on average £2,590 worse off compared to England & Wales taxpayers.

One key point to draw out is that the benefit systems changes for lower income households appear to be targeted at families with children. This means lower income working households with no children or children beyond school age may be slightly worse off due to the freezing of the tax thresholds (‘taxing by stealth’), with no uplift in disposable income from these changes to defend against inflationary pressures on living costs. Households without children are also less likely to benefit from the Scottish government’s free University policy.

The report notes that taxpayers with earnings more than £28,000 will be taxed more heavily in Scotland than they would be in England & Wales and as earnings increase, the difference between Scottish and England & Wales taxpayers’ after tax incomes widen as a result of Scottish tax policy.

Interestingly, the report alludes to the Scottish Child payment changes quadrupling the number of children eligible. That, along with the £5 per week increase in the payment will increase the annual cost of the Scottish Child payment by over £300m in the 2023-24 tax year, according to the Scottish Fiscal Commission’s cost analysis. By comparison, the IFS report estimates that freezing the higher rate threshold will raise around £150m and the 1p increase in the higher and top tax rates, plus the reduction in the top rate threshold will raise around £103m (these estimates anticipate some behavioural responses from Scottish taxpayers). This suggests that the cost of the changes to the benefits system could materially outweigh the increased tax take from the income tax changes. This is against a backdrop of an already overstretched Scottish budget which is struggling to deliver on public service commitments.

An interesting takeaway from the report is the Scottish government’s ideology of creating a more progressive tax and benefits system than England & Wales appears to put a continued stain on the Scottish budget.

Do these latest Scottish government policies risk households with aspirations of moving up the income ladder with no children being attracted to relocating to England & Wales where they will be better off? If it did, this would be a significant blow to Scotland’s productivity.