Cross-border tax dilemma for Sturgeon

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Nicola Sturgeon is facing a taxation dilemma. 

If the cut in the 20p rate of income tax to 19p proposed by Prime Minister Liz Truss goes ahead, Scots will pay the same or more tax than their counterparts south of the Border.

Up to now, the First Minister has been able to say that the majority of taxpayers in Scotland pay "slightly less" north of the Border.

Those earning less than £27,850 a year - 54% of Scottish taxpayers or 1.5 million people - are paying less in 2022-23, though it is by a very small amount per year - £21.62 to be precise.

If the First Minister does not act, then next year if you live in in Gretna, you could be paying more or the same as someone who lives in Carlisle, some ten miles away. That would apply between Canonbie and Longtown, some six miles away. 

Probably only a bit more, if you are on an average income, and for others it might be the same, but the difference will have disappeared.

Now Ms Sturgeons' political opponents have always been scathing about this tax differential, arguing that this difference was so small it was introduced for presentational purposes, rather than sound tax policy.

What practical difference does £20 a year make, even to the poorest Scots, the SNP government's opponents ask? And they say those earning more than that, particularly top earners, pay a lot more than their counterparts in England.

Nonetheless, the difference is a fact, but a fact the SNP government will no longer be able to rely on if they do not change the income tax rates in their budget due in December.

With an estimated £600 million coming from the Treasury because of the changes the UK government is planning, the First Minister could cut taxes in Scotland so she can continue to say the majority of Scots pay less.

Or she could spend the money in another way. For example, by further increasing the ground-breaking Scottish Child Payment, soon to go up to £25 a week, next month.

This new Scottish benefit has met with widespread praise as it goes to lower income families and is a targeted, not a universal benefit. So what will Ms Sturgeon do?

If the Scottish government keeps the current income tax policy, then those earning £25,000 will pay around £100 per year more in Scotland than they would in England.

That would rise to almost £2,000 for those earning £50,000, according to research for the Scottish parliament's information centre, SPICe.

To govern is to choose, and this is one of the many issues she and her acting finance minister, John Swinney, will have to grapple with over the next month or so.

However, there is a more fundamental debate which has arisen out of the Scottish government's ability to set income taxes and bands.

The First Minister and her colleagues frequently say Scottish taxation is more progressive than the rest of the UK, and that is true - those on higher incomes do pay more.

This year if you earn £45,000 a year in Scotland you pay £439.10 more per year than you would if you lived south of the Border. It rises quite steeply after that to £1,489.10 more if you earn £60,000 a year, and even higher after that.

But a key question is whether it is those higher taxes or the funding from Westminster which has enabled the creation of what you might call social democratic SNP Scotland?

In her interview with the BBC's Laura Kuenssberg on Sunday the First Minister was asked about taxation and highlighted benefits in Scotland which do not exist south of the Border.

She cited the child payment, free university tuition fees, free prescriptions for all, and free personal care for the elderly, though the latter was introduced under a Labour/Liberal Democrat government in Holyrood.

Before that BBC interview I asked David Eiser, of the independent Fraser of Allander Institute, whether it is Scottish taxation or money received from Westminster that allows the Scottish government to fund these policies.

Speaking to Representing Border, his reply was that it was "virtually all down" to funding which comes to Scotland from the Treasury under what is known as the Barnett formula.

There are two reasons for that. The first is fairly straightforward. As the Scottish government's own figures show, spending north of the Border is nearly £2,000 per head higher than that south of the Border.

To be precise, the figure is £1,963, according to the governments Government Expenditure and Revenue Scotland document (GERS).

The second reason is rather more complicated, and involves the way the Treasury and the Scottish government allocate funding after taking into account Holyrood's tax raising powers.

Obviously, a sum from the block grant from the Treasury has to be deducted to account for the fact the Scottish government can raise taxes. It's called the block grant adjustment.

It's complicated - it is tax after all - but Eiser looked at the 2019/20 year and found that income tax in Scotland raised some £500m extra than if the tax rates had been the same as the rest of the UK.

That's a large sum of money. And if the Scottish tax base per head had grown at the same rate as that of the UK, that would have meant £500 million extra to spend. 

But it didn't. And under the way the funding works, the net gain to Scotland - the extra money the higher taxes actually raised - was only £148 million.

In that year GERS told us spending per head in Scotland was £1500 higher than in the UK.

David Eiser concluded: "So devolved tax accounts for about 3% of the spending per person differential. Most of the rest of the gap is accounted for by Barnett, and a small amount by slightly higher social security spending in Scotland (largely on reserved rather than devolved social security)."

Eiser has done the same calculation for 2020/21. His verdict, that spending per head will actually be lower than they would have been without devolved taxation powers.

He says: "The latest forecasts for that year imply that the net tax position will be negative £191m, in other words, spending per capita will be lower as a result of devolved taxation than it would be without devolved tax. So devolved taxation accounts for less than nothing of that £1,963."

Now, despite signing up to a system which can produce "less than nothing" for Scotland if taxes are raised, the SNP Scottish government object to this mechanism, and are seeking to change it.

But that is not going to happen any time soon, and certainly not in time for the tax setting budget SNP ministers have promised in December.

Which leaves Nicola Sturgeon with that dilemma. Two dilemmas in fact. What does she do in terms of raising income tax? On top of that, because of the way the system works, is it worth raising taxes above the rest of the UK levels at all?

And if she does decides to increase income tax there is the wider question of whether she can continue to claim it is that intervention, rather than funding from Westminster, that allows her government to deliver those Scotland-specific policies. 

A Scottish Government spokesperson said: "Scottish Government decisions on taxation have created a fairer and more progressive tax system in Scotland – protecting lower- and middle-income earners, while raising extra revenue to invest in public services and Scotland’s economy.

"Scottish Income Tax revenue exceeded the Block Grant Adjustment by £96 million in 2020-21, providing more money to invest on key priorities such as net zero and tackling child poverty.

"The Scottish Government has always been clear that full fiscal responsibility would provide greater flexibility and opportunities to encourage sustainable economic growth, increase tax receipts, and invest in public services.

"Where the Scottish Parliament’s powers fall short of this, the Scottish Government believes that the Barnett formula should continue to underpin the block grant, in line with the principles set out by the Smith Commission."

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