A longer-term tax strategy for Scotland: what needs to change?

But we need to find a way to have a more constructive debate about tax – and spending – in Scotland. The recent UK budget has only partially alleviated the challenges facing Shona Robison in this budget and future ones. Spending pressures are only likely to intensify. We need a serious national debate on how sufficient tax revenues can be generated in as fair and sustainable a manner as possible.

The Scottish government’s tax strategy will be published alongside the Budget on Wednesday. The following are some of the areas we hope the subsequent debate starts to address.

Total revenues will have to rise

In the long-term, total tax revenues are only going one way: up. Higher public investment is desperately required to reverse the impact of years of austerity. An ageing society will continue to increase demand for health and care services. Addressing the climate crisis effectively will entail a range of direct public investments and subsidies to encourage consumer investments such as heat pumps.

We need to decide how much of our collective resource and effort should go to meeting these challenges and, in so doing, avoid the costs of inaction. Tax is the means by which effective collective action can be taken.

Wages in the public sector will also need to broadly keep pace with private sector wage growth to secure the recruitment and retention of appropriately trained workers. Productivity growth is intrinsically slow in the labour-intensive personal services – health, education, care, policing etc – provided by the public sector (and also in those personal services provided mainly or exclusively by the private sector such as fine dining and hairdressing), making them relatively more expensive over time. The costs of delivering these services tend to increase at a rate above the whole economy rate of inflation. Data shows this to be true for all countries, at all times (see here for the theory and here, here and here for examples of its proof). These costs will have to be met.

Yes, it is important to improve the efficiency of public services where possible, but it’s not credible to pretend there are clever things we can do to reduce spending in the short or long term. It is more a matter of managing the increases. This is why the preventative approach proposed by the Christie Commission in 2011 (2011!) is so crucial. The Scottish government needs to finally start getting serious about ways in which demand might be better managed.

We will all have to pay more

Some won’t want to hear this, but the responsibility for paying higher taxes must be spread across society. We cannot simply rely on taxing high earners and businesses more. ‘Progressivity’ – the amount of tax paid by high earners relative to low earners – is important in a tax system but it isn’t everything. Ultimately, it is the progressivity of the tax and spend system as a whole that matters, not the progressivity of the income tax schedule.

Let’s look at the Nordic nations, often held up as exemplars for Scotland. The Nordic countries regularly collect significantly higher total tax revenues than Scotland and the UK but they rely on the stable revenues collected through high indirect regressive taxes like VAT and income tax schedules which ensure everyone pays more – not just higher earners. Revenues are then redistributed in a variety of ways to ensure those at the bottom enjoy higher living standards.

In Denmark the top rate of income tax is 55 per cent; so, yes, higher earners pay more than they do in the UK where the top rate is 45 per cent. But we also have to look at the threshold at which the top rate applies: in Denmark it is 1.3 times the average earnings; in the UK it is 3.8 times the average earnings. In Finland the top rate of 51 per cent is paid at a threshold of 1.8 times the average earnings; in Sweden the top rate of 45 per cent is paid at 1.1 times the average earnings (source OECD Top statutory personal income tax rates).

So, if we were to replicate the Danish system, workers in Scotland would be paying a marginal income tax rate of 55 per cent on earnings above £46,380 (1.3 tines the Scottish average – mean – wage of £35,677 in 2024) compared to the current 42 per cent applying at that level of income.

The UK rate of VAT is 20 per cent. It is 25 per cent in Denmark, Sweden and Norway and 24 per cent in Finland and Iceland (Source OECD Consumption Tax Trends 2024). These countries also exempt fewer goods and services than the UK. In the UK we often hear VAT criticised as a regressive tax. It is indeed regressive. But it also generates stable and high revenues.

Nobody is suggesting that Scotland jump to a more Nordic taxation system tomorrow. That would be politically impossible and high-risk economically. Rather, these systems imply an important lesson that should help inform the longterm development of our tax system: generating stable and high revenues is likely to mean trading off some progressivity in order to generate revenues of sufficient scale.

We should aim to tax more locally

We should think more about the balance between national and local taxation. Countries that manage to regularly collect higher total revenues, tend to tax more locally.

In 2022, Denmark collected 27 per cent of all taxes locally. For Finland, it was 23 per cent, for Sweden it was 29 per cent and for Iceland it was 28 per cent. (EU Commission Annual Report on Taxation Table 34). Post-Brexit, the UK no longer participates in this Eurostat survey but, when it was a part of the European Union it was regularly assessed as taxing less than 2 per cent locally. In 2023-24 Council Tax accounted for 4 per cent of total non-North Sea taxes in Scotland ( GERS 2024 Table 1.1).

Of course, other nations’ ability to collect a much higher proportion of total taxes on a local basis is tightly related to much higher engagement with, and trust in, local democratic institutions. Any efforts to increase local taxation in Scotland are dependent on fundamental reform of Scotland’s moribund system of (not very) local government.

It’s a worryingly poor reflection on 25 years of devolved governance that the council tax has only been subject to minor tinkering rather than fundamental reform. This should give us all pause for thought about what is achievable in Scotland. Nevertheless, the very minimum we should expect of any government willing to take taxation seriously as a core component of a good society is a council tax revaluation and a commitment to not impose freezes with no prior consultation.

We need to think about effective and sustainable ways to tax wealth – it won’t be easy

To be clear, new wealth taxes are not an option in the short term; the abject failure of successive governments to reform council tax reflects the difficulty of taxing wealth as do the problems experienced by the UK Government after introducing largely sensible and moderate changes to capital gains and inheritance taxes in the autumn budget. The losers from tax changes always shout the loudest and the wealthy can always rely on sections of the media to eagerly amplify their gripes.

But household wealth in the UK has risen from three to over seven times the national income since the 1980s, while wealth taxes have not risen at all as a share of that income. Taxing unearned wealth more fairly and efficiently is a legitimate longer-term goal. There are examples of effective wealth taxes and a large and accumulating academic literature to learn from.

Tax policy should be an empirical matter

It’s a shame that the tax debate in Scotland is often characterised by a lack of evidence and rigor. Arguments built on flimsy theory and dodgy assumptions are regularly employed to undermine any move to raise tax, particularly so if higher earners are the target.

Yes, we should be mindful of behavioural responses. Of course, reasonable forecasts are based on assumptions which may, in retrospect, look dubious. Some speculation on the impact of recent tax choices is justified given the data lag.

But, as far as possible, tax policy should be an empirical matter. Greater weight should be given to what we can evidence in the Scottish context. So, what do we know?

We know that: “Scottish income tax revenues grew strongly in 2022-23, with growth in Scotland higher than in the rest of the UK...Real Time Information (RTI) income tax data suggests continued high growth in 2023-24.” (Scottish Fiscal Commission August '24).

We know that: “Beyond year ending 2017, the first year where Income Tax was (partially) devolved, net migration to Scotland increased on a yearly basis, to around 8,000 individuals in year ending 2022.” (HMRC April '24).

We know that: “After the 2018 to 2019 tax year, there were large increases in income moving from UK to Scotland... an increase of 27 per cent between 2019 to 2020 and 2021 to 2022. This results in increasing amounts of overall net positive income movements to Scotland" (HMRC April '24).

We know that: “Net migration into Scotland in 21-22 was substantially higher than any other year in the past decade. Net migration more than doubled between 2020-21 and 2021-22, from 22,200 to 48,800.” (National Records of Scotland July '24).

We know – although this area is ripe for further research – that people make decisions on where to live (which region/country) for a variety of reasons: quality of life, family relationships, house prices, employment opportunities etcetera; and, yes, tax. (An aside: many colleagues in my previous job in the Scottish government had moved from Whitehall. Their income was generally well past the threshold for paying higher Scottish tax rates. But they still chose to come and live/work here. Why? Housing costs, standard of living, job prospects. All the usual stuff. Tax is only one consideration and often a minor one).

We know that gross migration flows between Scotland and the UK are significantly lower than flows between, for instance, US and Canadian states or Australian provinces.

So, it’s reasonable to conclude that the recent divergence of Scottish and UK income tax rates has not, at least not yet, resulted in lower overall revenues or out-migration.

What don’t we know? Lots! We don’t know the full impact of last year’s decision to raise the top rate of Scottish income tax. We don’t know the precise make-up of the Scottish top 1 per cent and the extent to which they receive income in ways that enables tax avoidance or minimisation.

Therefore, it makes sense to proceed cautiously. It wouldn’t be a surprise if this year’s budget contained no tax changes of any significance. But justified caution in the short term should not be an excuse for timidity or lack of imagination in the longterm. There is much that can be done to improve Scotland’s tax system. IPPR Scotland looks forward to engaging in the debate.