The country that shows how raising taxes doesn’t always bring in more money

The political year goes in cycles, with regular parliamentary work interspersed with various different “tentpole” events. Right now, we are in the middle of conference season and it’s not long before we have the Budget, while the other major fiscal event, the Spring Statement, is held six months later. Gossip and scuttlebutt abound on the run-up to a Budget. As does kite flying by the Treasury – leaking a potential policy change to gauge public support without committing to it either way. The big “will he, won’t he” question doing the rounds in Westminster is whether Andy Burnham will use his first Budget to raise income tax. Shorts There are many siren voices encouraging him to do so, in order to raise revenue to pay for extra public spending. But there is a live example in Scotland which shows that raising tax at the upper end can actually cost the Government money, rather than raise it. As with all things tax, it is fiendishly complicated, so let me explain. Devolution means the Treasury only sets income rates for England and Northern Ireland. Both Scotland and Wales have powers to set their own tax rate, although Wales has – so far- mirrored rates in England. Scotland has further powers, too. In addition to setting the Scottish rate of income tax, it also has the power to set the thresholds at which workers pay, as well as the power to introduce new bands and rates. And, unlike the previously shy Welsh, the Scottish Government has tested those powers extensively. So, while readers of The i Paper in England, Wales and Northern Ireland have three income tax bands – Basic, Higher and Additional rates charged at 20, 40 and 45 per cent, respectively, readers in Scotland have six. The tax threshold (below which level of income, no income tax is charged) of £12,570 is the same everywhere, but after that, divergence happens fast. Scotland has a starter rate, basic rate, Intermediate Rate, higher rate, advanced rate and additional rate. They are levied at 19, 20, 21, 42, 45 and 48 per cent respectively. When the changes were introduced by the SNP in April 2024, the rationale was four fold. One of the objectives was to protect lower earners. While it is arguable to say the system does a small amount to achieve this – those earning under £16,537 save a maximum of £39.67 per year in income tax compared with taxpayers elsewhere – the crossover point where Scottish taxpayers start paying more than their English, Welsh and Northern Ireland equivalents is much lower than the national median wage of £39,039. This means many “lower paid workers” are caught up in the increase. Another aim was to foster sustainable economic growth – Scotland’s average annual growth rate over the last 10 years has been one per cent, lagging behind the UK’s still anemic 1.15 per cent. But the last two objectives – to enhance progressivity so higher earners pay proportionally more and generate additional revenues to invest in public services – are where the picture becomes very interesting, and where there are lessons for Burnham as he considers tax rises in the Budget. Let’s start with progressivity. A study by the Fraser of Allander Institute – Scotland’s leading independent economic research facility – shows that the marginal tax rate (taxation and mandatory national insurance contributions combined) is lumpy at best. The biggest gap between Scottish employees and those elsewhere in the UK is for those earning between £43,663 and £50,270, who face a combined marginal tax rate of 50 per cent – 22 percentage points higher than the rate faced by taxpayers elsewhere in the UK earning the same income. And those hit highest of all aren’t Scotland’s additional rate taxpayers earning over £125,000, who also have a combined marginal tax rate of 50 per cent, but those on the advanced rate whose income sits between £100,000 and £125,140. The gradual withdrawal of the personal allowance at that level creates a spike everywhere, but in Scotland it is more pronounced, with an effective marginal tax rate of 69.5 per cent for this earning group. Now, marginal tax rates of 50 per cent for the highest earners, and nearly 70 per cent for earners in the next group down, suggest that the Scottish Government has been raking in tax contributions, helping deliver the third reason for the change – generating greater revenues to invest in public services. Indeed, when the Scottish Government made its most recent changes, in 2024, it claimed that setting the additional rate at 48 per cent would raise an extra £53mn pounds per annum. In fact, forensic analysis found that the change did not raise extra revenue – it ended up costing the Scottish Government around £22m pounds in the first year. In short, Scotland fell off the Laffer curve – the economic theory first posited in the 1970’s that there is an optimum rate of taxation to raise revenue which, gone beyond, becomes so punitive as to actually reduce yield. It is a theory that has had its challengers down the decades, with many asking how likely it really is that workers either choose to relocate or opt for some form of behavioural avoidance – reducing working hours, increasing pension contributions or shifting income into dividends. If the example from Scotland is anything to go by, there is a taxation point where people are motivated enough to get good financial advice and act on it. Scotland shows that raising taxes doesn’t always raise money. Something for Burnham to ponder ahead of the Budget.