The Scottish Rate of Income Tax: Progressive or regressive?

Scotland’s First Minster suggested recently that the Scottish Rate of Income Tax is ‘anything but progressive’, but, says David Eiser, this is not strictly true.
In December’s Budget, John Swinney chose not to raise the Scottish Rate of Income Tax (SRIT). His reason for not doing so is that it would not have been possible to protect those on the lowest incomes and would thus have been unfair.
The view that increasing the Scottish Government’s new tax powers do not allow the Scottish Government to raise revenue without disadvantaging the lowest income earners was reiterated recently in an interview that Nicola Sturgeon gave to Peter MacMahon of ITV Border. The First Minster argued (16 mins in) that increasing the SRIT would have been ‘anything but progressive’. 
The SRIT is just a 10p flat tax on all incomes above the Personal Allowance. Increasing it to 11p would result in basic rate income taxpayers paying a 21p tax rate rather than the 20p basic rate that they pay currently. Higher Rate taxpayers would pay 41p tax on incomes above £43,000 (rather than 40p currently), and Additional Rate taxpayers would be 46p tax on incomes above £150,000 (rather than 45p currently).
The SRIT is sometimes said to be regressive. This claim is made on the basis of the change in marginal rates of taxation. For example a basic rate taxpayer sees their tax rate increase from 20p to 21p, an increase of 5%, whereas an upper rate taxpayer sees their marginal tax rate increase from 40 to 41p, an increase of 2.5%. This means that, following a 1p increase in SRIT, basic rate taxpayers see the amount of tax they pay increase by 5%, whereas those earning above the upper rate face a smaller percentage increase in the amount of tax they pay. 
So, when John Swinney said in his Budget statement ‘By its nature, exercising that power [increasing the SRIT] would have a disproportionate effect on the amount of tax paid by the taxpayers on the lowest incomes’, he is correct (as long as, by ‘taxpayers on the lowest incomes’ he is referring to anyone earning less than the Upper Rate threshold, i.e. £43,000).
However, in assessing the progressivity of an increase in SRIT, it is more relevant to consider the change in after tax income, not the change in the amount of tax paid. What is critically important in this respect is the role of the Personal Allowance in influencing the average tax rate.
The Personal Allowance is now £10,000 (actually it is £10,600, but I’ll assume its £10,000 for simplicity in the examples that follow). Clearly, anybody with income less than £10,000 (including low-paid part-time workers and those with low pension income) pays no income tax at all, and is not affected by an increase in the SRIT. What about those with incomes above £10,000? Consider the following scenarios:
Somebody with an income of £12,000 (equivalent to working full-time on the minimum wage) pays tax on 17% of their total income (the bit above £10,000). An increase in the SRIT from 10p to 11p results in the amount of tax they pay increase by 5%, but their after tax income falls by just 0.2%, from £11,600 to £11,580.
Somebody earning £23,000 (the median Scottish wage for all workers) pays income tax on 57% of their income. An increase in the SRIT from 10p to 11p results in the amount of tax they pay increase by 5%. But because this person is paying tax on a greater proportion of their income, their after tax income falls by proportionately more than the minimum wage worker. Specifically, this person sees their after tax income fall by 0.6%, from £20,400 to £20,270.
As income increases beyond the Personal Allowance, a greater proportion of that income is subject to tax, and thus to an increase in the SRIT. So somebody earning £50,000 sees their after tax income fall by 1%, from £40,400 to £40,000.
And for those lucky enough to earn above £100,000, the Personal Allowance is gradually withdrawn. This means that somebody earning say £150,000 would pay the additional 1p SRIT on all of their income – their after tax income would thus fall by 1.5%.
Average change in disposable income following a 1p rise in the SRIT
None of this should be news really. Back in 2014, David Comerford and I considered the redistributive effects of an increase in the SRIT using a formal model developed at the University of Stirling. The result is summarised in Figure 1 above. The poorest fifth of Scottish households would experience a fall in net income of slightly less than 0.2%, whereas the richest fifth of households would experience income falls greater than 1%. So a rise in the SRIT is slightly progressive.
Now people might still object to a rise in the SRIT on the grounds that a 0.2% cut in income for the poorest households might cause those households greater financial difficulty than a 1.4% cut in disposable income might pose for the richest households. This might be the case, although I have no evidence to accept or refute this.
One thing that is clear is that a 1p rise in the SRIT would generate over £400m in revenue for the Scottish Government, even after accounting for behavioural effects and the administrative cost that it would have to pay HMRC for varying income tax in Scotland.
John Swinney has hinted that he might be more inclined to increase higher rates of income tax only, when the Scottish Government gains the power to do so in future. A rise in the Higher Rate of income tax, from say 40p to 41p, would indeed protect those with incomes less than £43,000 from tax rises. But it would generate far less revenue than a rise in the SRIT, probably around £60m, and that’s before ‘behavioural effects’ and administrative costs are considered. (Increases in Higher Rate tax generate relatively little additional income, because there is less total income to tax!)
Furthermore, it is not clear that concentrating tax increases on a relatively small subset of income earners will be politically any easier than increasing the SRIT. A rise in the SRIT could in theory have been framed as a broad-based measure to reverse austerity, whereas a rise in higher tax rates will always be attacked as an attempt to soak the rich while raising relatively little revenue. 
So the message is that increasing the SRIT would have been a slightly progressive way to raise over £400m. Concentrating tax increases on those with higher incomes would undoubtedly be more progressive, but might not raise as much revenue.

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post by David Eiser
Fraser of Allander Institute
6th January 2016

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