Increases to top rate income tax may have reduced revenues, says IFS

Increases to Scotland’s top rate of income tax may have reduced revenues, according to analysis from the Institute for Fiscal Studies (IFS).  

Using available evidence from Scotland, the UK and other countries, the independent economic research institute says the raised tax has affected the reduction of work, increasing avoidance or evasion of tax, and has impacted migration.  

It estimates the behavioural effects from Scotland’s income tax reforms in 2018-19, which introduced an additional two tax bands and increased the top rate from 45 to 46 per cent, “are a little larger than assumed” when reforms were announced.

Scottish Labour’s finance spokesperson Michael Marra described the analysis as “damning” and said it “lays bare how financially and economically illiterate this SNP government is”.  

He said: “For too long the SNP has tried to use income tax hikes as a sticking plaster to cover for low growth and government waste, but it’s just not working.  

“Working people cannot keep picking up the bill for the SNP’s failure – the government must not repeat its mistakes in this year’s budget.”  

Scottish Liberal Democrat economy spokesperson Willie Rennie said: “When these tax changes were introduced I noted that the government would need to take careful note of the impact on behaviour.”  

He added: “Each individual change the Scottish Government makes may seem logical on its own but the cumulative impact of rising taxes and increasing red tape is strangling economic growth and hurting the public finances.  

“The forthcoming budget must give no fresh reasons for highly skilled professionals to head for the exits.”

However, the IFS says findings from its analysis are “subject to a high degree of uncertainty” as the bigger changes to income taxes were made in the last two years – which has not yet been analysed.  

Evidence of the impact of the larger increases in income tax seen over the last two years is much more limited due to lags before tax records are submitted and processed.

David Phillips, an associate director at the IFS and head of devolved and local government finance, said: "The scale of divergence in income tax bills between Scotland and the rest of the UK for high-income earners has increased significantly over the last two years.

“Someone on £125,000 a year, for example, would now pay around £5,200 more in income tax in Scotland than an otherwise-equivalent high earner living south of the border. That is up from £2,400 just two years ago.

“Research from Scotland, the wider UK and other countries points to such differences affecting taxpayers’ behaviour – how much they earn, migrate, and avoid or evade taxes. These responses are most significant for the highest-income individuals who, while few in number, contribute a large share of overall tax revenue. As a result, increases in the top rate of tax are unlikely to raise much – with evidence from the first of Scotland’s reforms in 2018–19 suggesting they may even reduce revenue.

“There is still considerable uncertainty about this though. The bigger changes to income tax seen over the last two years – which have yet to be analysed – will provide a useful opportunity to learn more about taxpayers’ behaviour. In the meantime, the evidence currently available suggests that if the aim is to raise revenue, the Scottish Government should at least pause any plans for further increases in Scotland’s tax rates on higher incomes.”