Deputy First Minister and Finance Secretary, Shona Robison has set out the Scottish Government’s spending plans for the next year, describing the 2024/25 budget as “the toughest since the creation of the Scottish Parliament in 1999”. The Deputy First Minister set out her plans to plug an estimated £1.5bn hole in Scotland's books with income tax increases for Scottish high earners, along with fiscal drag, her main means to do so.
High earners in Scotland will now pay up to 5% more tax than those earning the same amount in the rest of the UK.
It was widely predicted that Shona Robison’s first Scottish Budget would include a new income tax rate band for those earning between £75,000 and £125,140 and that was what she delivered - however, it was 1% higher than many had anticipated.
The new 45% Advanced Rate band was one of a handful of income tax changes announced, along with the Starter and Basic Rate bands increasing in line with inflation. Meanwhile, the additional 1p added to the Top Rate of income tax (now 48%) was less widely predicted. There were no changes to the Starter, Basic, Intermediate and Higher tax rates, with the Higher Rate threshold maintained at £43,662.
While it’s important to note, today's announcements are a draft budget, due to be finalised in early 2024, if they are implemented this means that for all but the lowest earners in Scotland, there is now a further divergence of the tax burden of higher-earning Scots compared to equivalent colleagues living south of the Border, especially for those earning above £125,140 per annum. This has two potential behavioural impacts that could have unintended consequences for the tax take in Scotland.
Firstly, we may see some migration from Scotland to England of highly skilled employees, particularly in the professions as well as entrepreneurially-minded people. This will be particularly relevant to the Scottish Borders and Dumfries & Galloway, where there is a relatively short commute from Edinburgh to Berwick, or from Dumfries to Carlisle. Any such migration does not of course lose just the extra tax levied, but the entire tax take for that individual.
Secondly, there is the added impact on growth and entrepreneurial businesses trying to attract skilled employees to work in Scotland. The high taxes levied in Scotland will act as a blocker to a skilled individual looking at similar new opportunities in Glasgow or Newcastle. Depending on salary levels, the difference in Net pay could run into several thousands per annum depending on which side of the Border they relocate to.
Today’s confirmation of the new ‘Advanced Rate’ tax band of 45% is also unlikely to be welcomed by employers north of the Border as well as those south of the Border who employ Scottish taxpayers.
This will increase the tax bandings in Scotland to six different levels, compared to the three levels adopted by the rest of the UK. From an employer perspective, this means yet more payroll system changes over and above the changes that need to be accommodated in January in relation to the Chancellor’s reduction to the main employee National Insurance rate by 2%, announced in the Autumn Statement.
The cost and resource required to implement these changes comes at a time when Scottish businesses are facing unprecedented rises to general business costs, including wages and salaries through inflationary pay increases or rises to the National Living/Minimum Wage rates. Adding to an already complex tax system in Scotland will also cause more work for employers in respect of certain tax reports that are filed with HMRC on staff benefits.
The ever-widening gap between the Scottish and English tax systems is also becoming an increasing concern for employers operating close to the Border. Employees taking home significantly less pay than their colleagues they work with each day, solely because of which side of the Border the employee lives on, is causing real HR issues for many employers and this looks set to worsen as that pay gap becomes greater from April 2024. Rather than employers providing extra pay to Scottish employees to address the problem, we may see some senior employees renegotiating their pay packages to more tax-efficient arrangements which may lessen the extra tax revenues the Scottish Government believes the new advanced rate will bring to the table.
However, it is important to note, that for business owners operating through Limited Companies who take their income mainly by Dividends, the maximum tax rate remains at 39.35% as taxation of unearned income is not devolved.
The Scottish Government expects its “targeted tax decisions” to increase income tax revenue by £389m, however, in reality, this looks optimistic, given the possible behavioural and tax planning factors that will come into play as it could drive away high earners, professionals and entrepreneurs who may look to move to a more favourable tax system elsewhere in the UK.