On 18th January 2015, the Cabinet Secretary for Finance, John Swinney, announced that he is revising the residential tax element of the land and building transaction tax (LBTT). Mr Swinney had announced the rates for LBBT in his draft budget in October 2014. These are shown below:
Source: Scottish Government
In December 2014, the Chancellor of the Exchequer announced new rates and a new structure for Stamp Duty Land Tax (SDLT) in the rest of the UK. This new structure was introduced from December 4, 2014. Its rates are shown below:
Residential land or property SDLT rates and thresholds
Source: HM Treasury
There is a considerable discrepancy between the rates announced by the Chancellor for the rest of the UK and those proposed for Scotland. The difference is greatest in the range between £250,000 and £925,000, where the Scottish rate of 10% looks punitive compared with the 5% that applies in the rest of the UK.
So has the review of the Scottish rates been prompted solely by the adverse publicity that the Scottish Government received following the Chancellor’s Autumn Statement? It is not quite so simple. The Scottish and UK governments have been negotiating for some time about the size of the reduction in Scotland’s Block Grant (determined by the Barnett formula) to be made in 2015-16 to compensate for Scotland’s new tax-raising powers. If Scotland can raise some of its own tax revenues, then its need for funds from the rest of the UK is reduced.
Agreement was reached earlier this week. It has been decided that for 2015-16, Scotland’s block grant will be reduced by £494 million to cover the revenues from LBTT and Landfill Tax. However, the Scottish Draft Budget 2015-16, written prior to the agreement on the Block Grant Adjustment, suggested that:
“Until agreement is reached on the adjustment mechanism, we have assumed that the block grant in 2015-16 will be reduced by a sum that will enable us to meet the funding requirements of the Budget and potentially establish the first payment into the cash reserve.”
Assuming that payment into the cash reserve is purely an aspiration, based on hoped-for savings, this would imply that the Scottish Government expected the block grant adjustment for 2015-16 to be £558 million, which would exactly offset its tax revenues, leaving it no better nor worse off. These tax revenues were forecast as follows:
Forecast tax revenues 2015-16
Source: Scottish Draft Budget 2015-16
This implies that the actual reduction in the Scottish Block Grant of £494 million in 2015-16 will be £64 million less than the forecast reduction of £558 million in the Scottish Draft Budget. There is an explanation of how this has come about. The Autumn Statement documents show that HM Treasury expected that the changes to Stamp Duty in England and Wales would reduce revenues by £605m. In the first year, the Block Grant Reduction should be based on how much would have been raised in Scotland from the equivalent UK taxes. Since the UK tax had been changed, the calculation should be based on how much SDLT would have raised, had it been applied to Scotland in the form announced on December 4th, 2014. Since it would have raised less (approximately one tenth of £600m), Scotland’s block grant adjustment was reduced, providing the Scottish Government with an unexpected windfall. This presented it with a choice: it could choose to stick with the LBTT as announced in the Draft Budget and generate extra revenue, since the Block Grant for 2015-16 will be reduced by less than it had expected. This extra revenue could be spent on other priorities – such as those concerned with social justice or health, or to build a cash reserve.
However, it appears that the savings will be used to reduce the rates of LBTT, bringing them more into line with those that apply south of the border. Mr Swinney implied as much on BBC Scotland’s “Good Morning Scotland” on January 19th, when he argued that his motive for the review of LBTT was to maintain “revenue neutrality” – which seems to imply that LBTT would be reduced to keep the overall size of Scotland’s budget unchanged from that set out in the Draft Budget. There would be no attempt to expand spending in Scotland because of the smaller than expected reduction in the block grant.
Instead, the focus will be on a cut in LBTT: the yield from its residential component is £295m, which implies that a £64 million cut would reduce this yield by 22%. Given that only around 14% of Scottish house purchases are made at prices exceeding £250,000 (Source: Registers of Scotland), it should be possible use this windfall to make a significant cut in the 10% rate that has attracted so much adverse publicity.
The change in LBTT can be explained by the difference between the actual and forecast Block Grant Adjustment. If this had not occurred, the Finance Secretary would have had to raid spending departments if he wished to narrow the gap between rates of LBTT in Scotland and SDLT in the rest of the UK. This would have posed a much more difficult political challenge, because it would be clear which priorities had been set aside to reduce the pain felt by middle-class homebuyers.
The LBTT affair also shows the impact of tax competition: when markets are closely linked, changes in taxes in one market inevitably affect behaviour in the other. Irrespective of the constitutional arrangements, these linkages affect the decisions of politicians as well as the buyers and sellers operating in these markets. This is an early lesson for the Scottish Government, which no doubt will be repeated.