Scottish Budget December 2018: will the gap between English and Scottish income tax widen further?

The difference between the amount of tax paid by middle- and higher-earners in Scotland and those in England is likely to rise unless the Scottish government follows Westminster’s lead and adjusts tax thresholds in its 12 December Budget.

If Scotland decides not to raise the threshold, many taxpayers north of the border will see an additional slice of their income taxed at the top total rate of 53%.

At the moment, the complex Scottish system (which has five income tax bands as opposed to the rest of the UK’s three, see box below) sees the higher-rate of tax – 41% – apply to earnings in the band £43,431 to £150,000.

In England, following Philip Hammond’s Budget announcement, the equivalent higher-rate band of 40% will apply to income between £50,000 and £150,000 from the 2019-2020 tax year.

The net effect for Scottish taxpayers? Someone earning £50,000 will pay £1,600 more in Scotland than in England

“Scotland will have to follow Westminster and raise the personal allowance, which is the first band of earnings that are entirely free of tax, up to £12,500,” explains Bob Hair, who oversees Cazenove Capital’s Edinburgh office. “We expect lower earners in Scotland to continue to be slightly better off than their English counterparts.

“But it’s widely expected that the Scottish Government won’t push up the higher-rate threshold to £50,000, as has been announced in England,” Bob says. “If so, middle-earners in Scotland could find themselves paying substantially more total tax than their English equivalents.”

The impact on Scottish taxpayers is complicated by the way in which National Insurance Contributions (NICs) interact with income tax. Currently there is a band of income where Scottish taxpayers pay both the higher-rate of income tax (41%) and the higher rate of NICs (12%). At the moment this effective 53% total rate of tax applies to £2,919 of income.

If the Scottish Government doesn’t increase the higher-rate threshold, the slice of income attracting this 53% total rate will rise to £6,569 (see table below).

“In the rest of the UK the highest combined rate of income tax and NICs is 47% and that applies to those earning more than £150,000,” says Bob. “But in Scotland we already have the anomaly of many people earning less than £50,000 paying an effective total tax rate of 53%. In other words, they get to keep less than half of a portion of their income. And unless the threshold is increased, more of their income will be taxed at that 53% rate from next year.”

Assuming the personal allowances are brought into alignment but that Scotland doesn’t increase the higher-rate threshold, Cazenove Capital calculates that someone earning £50,000 and living north of the border will pay a total £13,599.01 in tax and NICs from April 2019. That would result in after-tax income of £36,440. In England the tax would total £11,999.68 giving £38,000 after tax. Meaning that someone north of the border would be £1,559 worse off per year. In fact, someone earning £25,000 in Scotland will only be around £4 a year better off under these changes. So who benefits? Those earning up to £13,850 will benefit, but only very slightly by £13.81 per year. Middle earners therefore pay heavily for a very small benefit to lower earners.

Planning becomes increasingly important for those earning more than £43,000, especially where earnings sit between £43,000 and £50,000. Where possible, the use of a pension to help increase the basic rate band will help to mitigate the additional tax burden. Anyone with an income of up to £110,000 per annum can add £40,000 into a pension without being affected by the reduced annual allowance. 

How Scottish tax differs

In 2017 Scotland was granted the power to set its own income tax rates and bands and since April 2018 income tax rates in Scotland have differed from those in England.

In general, the introduction of a slightly lower “starter” rate and slightly increased top rates have been of benefit to low earners. This was the aim of the changes which, when announced in the December 2017 Budget, were described as “a more progressive approach” by Scottish Finance Secretary Derek Mackay. Scotland also has the power to set tax bands or “thresholds”, above which the different rates kick in.

But because Scotland cannot control the rate of National Insurance Contributions, the combinations of income tax and NICs can lead to anomalies in the total tax rates applied to certain bands of income. This gives rise the to 53% rate of tax applied to a certain portion of income, as explained above.

How Scotland and the rest of the UK may differ from April 2020*

*Assumes personal allowance is brought into alignment at £12,500. Assumes Scotland does not raise the higher-rate tax threshold

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