Taxation will be focal point of Scottish budget

Public Finance, by Kerry Lorimer
03.12.18

The Scottish Government’s draft budget this month will reveal not only the impact of an improving economic outlook on public finances but the extent of Holyrood’s determination to plough a distinctive furrow on taxation.

Against a backdrop of growth outstripping that of the rest of the UK, finance secretary Derek Mackay’s third budget will be buoyed by significant additional funding as a result of spending decisions in the recent UK budget.

However, the boost to the block grant will be partially offset by weaker than expected income tax yield north of the border – at least, if the Scottish Fiscal Commission confirms its gloomy outlook on earnings and employment in its updated forecasts, which will be published alongside the budget.

Overall, the Scottish budget is expected to rise by 3% over the next three years, although it will remain below its pre-austerity peak.

Tom Waters, research economist at the Institute for Fiscal Studies, said the focus would be on the Scottish Government’s response to chancellor Philip Hammond’s decision to increase the higher rate income tax threshold in the rest of the UK.

“It’s already the case that those earning over the higher rate threshold would pay more tax in Scotland than in the rest of UK.

Now that there is a higher rate threshold in the rest of UK, that discrepancy is only going to be increased further,” he said.   “Freezing the higher rate threshold would mean a moderate difference in tax liabilities for somewhat higher earners between Scotland and the rest of the UK, which to some extent means there is an incentive for people to relocate.”

According to David Eiser, who leads the Fraser of Allander Institute’s work on fiscal policy, it is “extremely unlikely” that Mackay will duplicate Hammond’s largesse towards higher earners, not least because to do so would cost some £280m.

The question of where the higher rate threshold will be set depends on parliamentary arithmetic.

Especially critical is the position of the Scottish Greens – who have traditionally insisted on lower than inflationary increases to the threshold – because the minority SNP government has relied on the support of Green MSPs to pass its budget for the past two years. “The higher rate threshold has been the main thing the deal has hinged on, and we could see something like that again,” said Eiser.

However, this year the Greens have indicated that their support will be contingent on meaningful reform of local taxation. That could mean a new power for councils to introduce a discretionary local tourist tax – a move now being consulted on following vocal lobbying by local government – and a commitment to replace the council tax in the longer term.

In headline terms, modest increases in the block grant indicate that austerity is ending north of the border. However, the focus on health, education and social care will leave unprotected areas vulnerable to further cuts. Health alone is expected to account for almost half of all public spending by the end of this Parliament.

Local government, which has seen its core resource budget fall by over 8% in the past eight years, has called for a 2.5% increase in funding in this year’s budget, claiming that tough settlements and lack of fiscal autonomy have left councils no room to manoeuvre.

The Scottish Government may be able to dig deep enough to produce a settlement that represents a small increase on last year, said Eiser, but the real question is what councils will be expected to do in return.

“What will be interesting is whether there will be new commitments for local government… or an increase in the proportion of the local government allocation that is specific grants rather than general grant,” he added.

The Scottish draft budget will be announced on 12 December.