Moves to freeze Scottish income tax rates are adding risk and volatility to the Scottish tax regime and could lead to behavioural changes among the wealthy, the Chartered Institute of Taxation (CIOT) has warned.
MSPs yesterday (February 19) voted to approve the Scottish government’s income tax rates for the 2019/20 tax year by 61 votes to 52.
They put a freeze on the higher rate of income tax at 41 per cent for workers earning between £43,430 and £150,000 a year.
The top rate of tax was also frozen at 46 per cent for those earning above £150,000, while in the rest of the UK the higher tax rate threshold will rise to £50,000 from April.
This means the gap between Scottish income tax and that in the rest of the UK continues to widen.
For those earning between £24,944 and £43,430 an income tax rate of 21 per cent will apply while earnings between £14,549 and £24,944 will incur a 20 per cent charge, and a starter rate of 19 per cent was passed for income between £12,500 and £14,549.
Scotland's five-band tax system means lower earners pay less in tax than those in the rest of the UK but higher earners pay more.
According to the CIOT, the maximum impact on taxpayers from the Scottish government’s decision to increase the starter and basic rate thresholds would be £9.93 per year.
This compares to the £130 resulting from the UK government’s decision to increase the tax-free personal allowance to £12,500.
Alexander Garden, chair of the CIOT’s Scottish technical committee, said: "Some Scottish taxpayers may find they pay less income tax in the coming year.
"This can be attributed in part to the Scottish government’s policy to increase the starter and basic rate bands of income tax, which protect lower paid employees by reducing their tax burden relative to the rest of the UK.
"But the UK government’s decision to increase the tax free personal allowance, an area that Holyrood has no control over, has a far greater impact. This also has the effect of reducing the total number of Scottish taxpayers by taking them out of income tax altogether."
But Mr Garden warned while the changes may be perceived as positive, in fact they added further risk and volatility to the Scottish tax regime by reducing Scotland’s ability to control how much tax revenue it directly raises, and its ability to forecast the amounts of revenue that are raised.
The CIOT said of the 4.5m adults in Scotland, 2m (55 per cent) earned enough to pay income tax.
The number of taxpayers was mostly concentrated in the basic (1m taxpayers) and intermediate (864,000 taxpayers) rate bands, with 351,000 and 16,000 higher and top rate taxpayers respectively, he said.
Mr Garden also warned about the potential for higher rate taxpayers to alter their behaviour as a result of income tax changes.
He said: "As the tax bills for those paying the higher and top rates of tax increase relative to the rest of the UK, there are concerns that some of those taxpayers, being less than 15 per cent of all Scottish taxpayers but contributing almost 60 per cent of all devolved income tax revenue, will seek to take steps to legitimately limit their tax liabilities."
Mr Garden suggested those taxpayers might choose to limit the number of hours they worked to avoid being pushed into higher rates of tax.
"They may also choose to increase the amount of pension contributions that they make, effectively increasing the thresholds above which they pay higher rates of tax," he added.
He added for the self-employed, the opportunity to pay lower rates of corporation tax by incorporating their businesses, as opposed to paying income tax, may also become a more attractive option.
Higher earners, or those with greater mobility, may also choose to relocate away from Scotland, according to the CIOT.
A poll commissioned by CIOT in September 2018 found 84 per cent of Scots thought they needed better information about how taxes are decided in Scotland.
Dean Mullaly, managing director at Mark Dean Wealth Management, said Scotland seemed to "want to have its cake and eat it too".
He said: "This is all a result of devolution. Scotland wanted more choice, and now they have it. As far as I can see, they run things as they see fit.
"They seem to provide more free public services, but if you spend more, you have to get more in. Seems to me they’re whining a bit."
Julie Mitchell, wealth planner at Edinburgh-based financial firm Independent Women, said: "The Scottish government made the decision not to replicate the increase in the higher rate threshold to £50,000 announced for the rest of the UK.
"This means that there would be a marginal rate of tax and NI totalling 53 per cent on the slice of the earned income between £43,430 and £50,000, as compared to 32 per cent in the rest of the UK. For those earning £50,000, they will pay £1,600 more In Scotland.
"Planning for someone earning over £43,430 has become increasingly important. It will be interesting to see the difference in the revenue collected from the earners over £43,430 as opposed to the revenue missed out on due to the UK government increasing the tax free personal allowance to £12,500."
