Hansard

A number of the issues that I will raise are covered in the submissions provided by Drew Scott, John McLaren and Ken Gibb, as well as to some extent in the paper from David Bell.In my opening remarks, I will talk about three sets of issues. The first, fairly trivial point is that one implication of the 2012 act is that, across a range of policies in the future, people will need to start to think about not just their policies’ implications for the conventional objectives of Government policy—growth, fairness, sustainability and so on—but their policies’ effect, whether beneficial or harmful, on the income tax base and on the amount of revenue that is available in Scotland to spend on various projects. Essentially, in contemplating any kind of policy change, people will need to ask the additional question whether the policy is likely to have an impact on the income tax base and, if so, whether that will be positive or negative.One challenge will be whether we have the expertise and knowledge to try to understand what those effects will be. We have already had some discussion of that in considering Jeremy Peat’s question on whether migration policy should be looked at more actively as a policy that might have an impact on the income tax base. The point might be fairly trivial but, across a range of policies, we will see a systematic shift towards policies that promote the income tax base. Some policies that might otherwise have been accepted will be rejected in favour of policies that favour rather than lower the tax base.A second set of questions, which were covered mostly in Drew Scott’s paper, concerns the fact that the 2012 act will expose Scotland to a series of tax risks to which it is not currently exposed. Those risks will arise through the forecasting of tax revenue but also through the variability in the tax base in Scotland vis-à-vis the rest of the UK.I should say that, in my remarks, I use the term “tax base” in a slightly different sense from that which David Bell used. By the tax base, I mean the total amount of taxable revenue that is available in Scotland on which income tax can be levied. The tax base is therefore the product of the number of people who have income above the tax threshold and of the amount of income that they have above that tax threshold—it is not just a head count.One big question that Scotland will need to face, which I will spend a little time thinking about, is whether to set the Scottish rate of income tax at 10p, which would basically restore the position to the basic rate of income tax; whether to raise it to 12p, as David Bell suggested; or whether to go below 10p by cutting the rate to, say, 8p. In other words, do we make the overall rate of income tax in Scotland higher than 20p in the pound or lower than 20p in the pound? We will need to think about a number of factors in making that decision.One of the key questions that we might want to think about is how changing the tax rate would affect the amount of tax revenue available in Scotland for spending on various projects. As economists, we think about that question quite a lot. Normally, we think about how changing the tax rate has two different effects on tax revenue. First, for a given size of tax base, if we have a higher rate of tax on that tax base, we generate more tax revenue. The second effect that we think about is that raising the tax rate might affect the size of the tax base. On the whole, we tend to think that, the higher the tax rate, the lower will be the tax base, because work and other types of enterprise will be discouraged. The overall effect on tax revenue—whether it goes up or down—depends on the balance of those two effects.The essential question that we need to consider is, even if we assume that tax revenue goes up when we raise the tax rate and down when we lower the tax rate, how sharply or moderately does tax revenue go up? Conversely, if we cut the rate of tax, how sharply or moderately does tax revenue fall? Other things being equal, if the impact of the tax rate on tax revenue is more moderate—that is, if an increase in the tax rate would produce only a small impact on tax revenue—we will tend to want to cut tax rates. On the other hand, other things being equal, the more sharply tax revenue goes up when we raise the tax rate, the more we will be inclined to raise the tax rate. The question is how sharp or how moderate the effect of a change in the tax rate would be on tax revenue. Economists have spent a lot of time thinking about and trying to measure that.In the specific context of the 2012 act, two factors arise that make the answer to that question different from that which we normally face in economics. One factor is that the tax base is shared between Scotland and the rest of the UK. That implies that, if we raise the income tax rate, we will get all the benefits of the higher income tax rate but suffer only some of the consequences of the reduction in the tax base, because some of that will be picked up by England or the rest of the UK.On the other hand, if we cut the tax rate, we will suffer all the loss of tax revenue but get only some of the gains from the higher tax base, because some of that revenue will accrue to the rest of the UK—to HM Treasury. If that factor was at work, it would suggest quite a sharp response in tax revenue to the tax rate. Other things being equal, that would imply that we would want to raise tax—that would be a factor in arguing for pushing above the 10p rate.A second effect that is at work is that, if Scotland set a different tax rate from the 10p rate, that would mean that the overall basic rate of income tax in Scotland was different from that in the rest of the UK. The question is: what effect would that have on the tax base in Scotland?We might think that, if Scotland set a lower basic rate of income tax than that in the rest of the UK, that could have a positive effect on the tax base in Scotland because, other things being equal, economic activity that might otherwise have taken place in the rest of the UK might transfer to Scotland. On the other hand, if Scotland raised the tax rate above 10p, activity that could have taken place in Scotland might be displaced to England. That effect would suggest that tax revenue will move rather shallowly in response to changes in the tax rate, which would tend to make us want to lower the rate of income tax in Scotland.Those two effects work in different directions. The shared tax base would tend to make us want to raise the rate of income tax above 10p. Other things being equal, if having a different tax rate from the rest of the UK generated more economic activity in Scotland, we might want to cut the tax rate.As David Bell said in his evidence, we know very little about that second effect—how responsive the tax base would be to the possibility of the tax rate in Scotland being different from that in the rest of the UK. However, that could be a really important issue to understand.11:45 There are another couple of effects of having a different tax rate in Scotland than in the rest of the UK. It is important to think about the possibility that, if Scotland had a different tax rate from the rest of the UK, that could open up scope for tax avoidance. Tax avoidance tends to operate when economic activities are taxed at different rates in different locations. That gives rise to all sorts of opportunities for people to find artificial means of channelling their income through different countries to exploit the lower tax rate in one country vis-à-vis another. Whether the tax rate was higher or lower in Scotland, those opportunities for tax avoidance could arise and affect the size of the tax base.I am not suggesting that that is an enormous factor that should make us cautious about setting a different rate in Scotland from the rest of the UK, but tax avoidance is driven not only by the behaviour of taxpayers but by the fact that tax systems set different tax rates on essentially the same activity in different places or on different individuals. Individuals and companies will exploit those opportunities whenever they see them arising.