In the first of a series of analyses of the Scottish parties’ manifesto proposals from the University of Stirling and Centre on Constitutional Change, David Bell and David Eiser consider the Labour proposals for income tax announced recently.
After years of silence on the tax powers which Scotland already had, the Labour Party has put forward proposals to increase the Scottish Rate of Income Tax (SRIT) – which comes into force in 2016/17 – by 1p. The SRIT is effectively a flat rate of tax of 10p on all non-savings, non-dividend income above the personal allowance. Therefore, if SRIT is raised by 1p, the basic rate of income tax in Scotland is raised from 20p to 21p, the higher rate from 40p to 41p, and the additional rate from 45p to 46p.
The advantages and disadvantages of raising the SRIT to 11p have been hotly debated in the Scottish Parliament
and elsewhere. A 1p increase would raise about £470m revenue for the Scottish Government. But where would the burden of paying for this increase fall?
Arguments that an increase in the SRIT is regressive are wrong. A flat tax is progressive as long as there is a tax-free personal allowance. The personal allowance has the effect of increasing the average tax rate as income rises, so the burden falls more on the rich than on the poor. However, everyone earning above the personal allowance would pay more tax. Because of this, the policy has been rejected by the SNP, who argue against any tax increase for workers who are relatively low paid.
Earlier this week, the Labour party announced that its election manifesto would contain a proposal to increase SRIT by 1p. To counter the argument that this would inevitably increase the tax bills of the lowest paid, it proposed a £100 payment to any taxpayer earning less than £20,000. The payment would be administered by local authorities. This part of the proposal would require a comprehensive data sharing arrangement between HMRC and local authorities in Scotland, and it would impose a substantial administrative burden on local authorities. There are also questions as to whether such an arrangement would be possible under the Scotland Act 2012.
Notwithstanding these issues, what would be the distributional effects of the Labour proposals? We can explore this question using the University of Stirling’s microeconomic model of the Scottish economy, developed by David Bell.
Figure 1 below divides the Scottish population into ten deciles of household net equivalised income, from the poorest to the richest. It then shows the average change in household income in each decile that would follow from implementing both parts of Labour’s proposal.
Adding 1p to the SRIT alone is clearly progressive – it reduces the incomes of all households on average, but reduces the incomes of higher income households by proportionately more than those on lower incomes.
The £100 payment compensates households in the bottom four deciles completely from the tax increase. It also mitigates the effects of the tax increase for a large number of households in the middle and upper-middle of the income distribution: those individuals earning between the personal allowance and £20,000 are actually fairly evenly spread throughout the household income distribution because they are often second earners living with a higher earning partner; or working children living with their parents (Figure 2). In contrast there are relatively few such people living in households in the bottom two deciles (in other words, if a household contains an income taxpayer, there is a reasonable chance the household will not be in the poorest 20% of households ranked by income).
The relationship between individual and household income is complex and is sometimes ignored in debates about who will gain and who will lose from tax changes. This complexity also explains why benefits policy usually operates at a household level (or more particularly benefit unit), rather than at the individual level.
So, Labour’s £100 payment mitigates the impact of the SRIT increase for individuals earning less than £20,000. But because many such individuals live in households that are close to, or above, median income, the policy also reduces the tax liability of higher income households.
Our analysis is based on 2013/14 income data and the 2013/14 tax system. This means that we are likely to overestimate the effect of the Labour £100 payment (the personal allowance has increased in real terms since 2013/14, and there are likely to be relatively fewer people earning below £20,000 now than in 2013/14). With this caveat in mind, we estimate that some 970,000 individuals in Scotland would have been eligible for the payment in 2013/14, of whom 150,000 were of pensionable age. The implied cost of the policy is just short of £100m, excluding administration costs, although this is likely to be an overestimate of the policy cost for the reasons discussed above.
New tax powers for Scotland have been talked about for a long time. The recent debate began with the Calman Commission in 2009 and was an integral part of the arguments surrounding the 2014 referendum. However, the shadow boxing is now over: real decisions have to be made. Changing taxes invariably creates losers as well as winners. This already seems to have had a galvanising effect on Scotland’s politicians.