The suggestion that an increase in the additional rate would lead to a mass migration of wealthy Scots has been widely - and rightly - criticised, says David Eiser. However, the likelihood of widespread tax avoidance by higher earners is a very real one.
The SNP has been taking a lot of criticism for its failure to support a rise in the Additional Rate to 50p.
The SNP’s argument that a rise to 50p would – if not matched in the rest of the UK – trigger some mass exodus of Additional Rate taxpayers from Scotland, has rightly been lampooned.
But Nicola Sturgeon is right to express concerns about tax avoidance.
There is an extensive system of income tax reliefs in the UK, which makes avoiding tax relatively easy – especially if you have plenty of spare cash.
The most obvious example is pension tax relief.
Pension tax relief is available at a taxpayer’s marginal rate of tax. So, if you are an Additional Rate taxpayer and you put £100 into your pension, you can claim back £45.
To see why this is important in the Scottish debate, consider this example.
Imagine for a moment that you earn £200k a year. The Scottish Government decides to raise the Additional Rate to 50p. You are initially beside yourself with worry – this will cost you an additional £2500 per year in tax!
Briefly, you consider relocating to Swindon, but then you hit on a much brighter idea. You decide to invest £5000 in your pension. This £5000 that you invest in your pension is not taxed – this is the meaning of ‘tax relief on pension contributions’.
But the fact that you have reduced your income by £5000 (by sticking £5000 in your pension) means that – with a marginal tax rate of 50% - you pay £2500 less tax. So your tax bill is now the same as it was when the Additional Rate was 45%.
You are now no worse off than you were before the Scottish Government’s tax increase – but you have £5000 less income this year and £5000 more sitting in your pension for the future.
At some future point of course you will withdraw your pension and pay tax on it. But if you are canny, you will make full use of your tax free lump sum, and dribble the rest out sufficiently slowly that you only pay basic rate tax on it.
In this example, the rise in the Additional Rate has generated no immediate revenue increase for the Scottish Government, (although it may generate some in future) and it has not really reduced inequality (technically it has reduced inequality in a cross-sectional sense, but not in terms of lifetime earnings).
Now clearly, not all taxpayers will be able to react in this way. But the point is that there are other ways that taxpayers can react to tax rises that have nothing to do with the tax rate in rUK, and nothing to do with migration. A rise in the Additional Rate might not generate much additional revenue for the Scottish Government – and this is not simply because the benefit is being absorbed by the UK Government.
This does not completely undermine the case for a rise in the Additional Rate. But migration is not the only (or even the main) behavioural effect we might be concerned about.