The UK’s Institute for Fiscal Studies (IFS) said in a new report that Scotland has made its tax and benefit system more progressive than the rest of the UK — but made them “unnecessarily complex and distortionary.”
The IFS said: “Compared with the income tax and benefit system in place in the rest of Great Britain, the second-lowest-income tenth of Scottish households are £790 a year (3.6%) better off under the devolved system, due to higher benefit entitlements.
“Conversely, the highest-income tenth of Scottish households are around £4,000 a year (3.8%) a year worse off.”
The IFS said that building on reforms in the 2016-21 parliament, the Scottish Government has continued to make its devolved tax and benefit system more progressive over the last five years.
“Income tax has been increased for high-income residents of Scotland through a combination of real-terms reductions in the higher- and top-rate tax thresholds, and increases in tax rates,” said the IFS.
“Meanwhile, devolved benefits have been increased for low-income families with children. The combined effect of these two sets of changes is to reduce average (mean) household net income by £510 a year.
“But effects differ significantly across the income distribution, with low-income households gaining and high-income households seeing their net incomes reduced by more than average.”
These are among the key findings of the third Scottish election briefing from the Institute for Fiscal Studies, funded by the Nuffield Foundation and the Robertson Trust.
“Similar redistribution could be achieved with fewer income tax bands,” added the IFS.
“Land and buildings transaction tax distorts the housing market, damages the economy, and penalises landlords and renters. Proper council tax reform has seemingly been kicked into the 2030s.
“And ‘cliff edges’ in many of Scotland’s benefits – most notably the Scottish child payment – create inefficiencies and unfairness. A strategy to reform Scotland’s taxes and benefits is needed – a task that is even more vital if the next Scottish Government chooses to continue increasing taxes and/or benefits.”
Jed Michael, a Research Economist at IFS and a co-author of the report, said: “The Scottish Government has made use of its powers to substantially boost the incomes of lower-income households, particularly those with children. Indeed, households with children in the second-lowest tenth of the income distribution are £2,760 a year better off than under the income tax and benefit system in place in England – equivalent to 9% of their net incomes.
“But as the Scottish benefit system grows in size, the way support is adjusted as incomes or other circumstances change becomes increasingly important. Currently, benefits such as the Scottish child payment are withdrawn in full if earnings rise above a certain point.
“This creates a ‘cliff edge’ in benefit entitlement – a small increase in wage rates or hours of work can mean losing thousands of pounds of benefits income.
“This is both inefficient and unfair: inefficient because it acts as a strong disincentive for some households to increase their earnings; unfair because households with very similar pre-benefits income either side of the ‘cliff edge’ end up with post-benefits incomes that differ by thousands of pounds a year.
“The Scottish and UK governments should work together to allow for the more gradual tapering of Scottish benefits as income increases.”
Stuart Adam, a Senior Economist at IFS and a co-author of the report, said: “The current Scottish Government has used its devolved tax powers to raise revenue from higher-income taxpayers and higher-value properties. Beyond that, and despite publishing a ‘tax strategy’ last year, it lacks a coherent strategy for the devolved tax system as a whole.
“Scotland’s property tax system is a case in point. Despite the SNP complaining about the unfairness of the current council tax system for 20 years and stating its commitment to reform in its 2021 manifesto, the current SNP government says meaningful reform will not be possible until after 2030.
“Freezes in thresholds are increasing the burden of land and buildings transaction tax, while higher rates on rental properties hurt tenants as well as landlords.
“And an expanding set of reliefs is further complicating Scotland’s business rates system. Scotland shares these problems with England, but with property tax an area where most of the key powers are devolved, a proper reform strategy would enable an ambitious Scottish Government to both improve fairness and benefit the economy.”