Tackling poverty and improving public services means higher taxes for most – John McLaren

Increasing all income tax rates by a penny would raise more than £500 million

The Scottish Government’s latest Programme for Government (PfG) left a gaping hole in terms of how it was to be paid for. This, in turn, puts a question mark over the degree of investment to be made in each of the priority areas. How then should the money best be found?

The PfG’s commitments come on top of the government’s medium-term financial strategy, which identified a potential funding gap of £1 billion by 2024-25. It’s important to be clear how this £1 billion shortfall has come about. A general budget tightness is the consequence of decisions by the UK Government on overall funding levels.

However, once this has been decided, the Scottish Government then makes its own spending decisions. Of late, decisions to increase social security spending in Scotland above those seen in England will lead to additional funding of almost £1 billion by 2024-25, according to the Scottish Fiscal Commission.

This is neither the right nor the wrong decision, it is simply a choice made by a democratically elected government. But the increased fiscal burden that results has to be dealt with. There are two basic choices – either make cuts in other budgets or increase tax revenues. Thus far we have seen a bit of a fudge – some budget tightening, some tax rises and maxing out on borrowing powers, but we are coming to a point where a decisive choice has to be made.

Looking at spending first, the increase in welfare payments is largely a policy put in place to reduce poverty, particularly child poverty. To introduce further budget tightening elsewhere would risk implementing cuts that could offset such poverty-reducing actions, whether it be in health, education or care. This strongly suggests that the best option is to raise taxes further, but which ones?

Last year’s Scottish Trades Union Congress (STUC) paper on this issue, which the First Minister is seen as being sympathetic to, outlined a number of options. The big revenue-raising ones were: introducing a wealth tax; extending income tax bands at upper levels; and replacing council tax with a proportional property tax. Given that any locally run wealth tax would not be available before 2027-28 and radical reforms to council tax are up there with sightings of unicorns, I shall concentrate on the ‘easiest’ revenue raiser: income taxes.

The STUC income tax revisions are stated as bringing in just short of an additional £900 million a year. However, it is unclear whether or not these calculations took on board the changes made by Chancellor of the Exchequer in last year’s autumn statement. If not, then the fiscal drag already introduced will have reduced this number.

Regardless, pretty much all the extra tax revenue is coming from those in the current higher and top rates (ie, earning above £40,000). There are two problems with this, in terms of generating revenue. First, there are not that many taxpayers at these upper rate levels, and second, they are more likely to change their behaviour in order to reduce their tax bills.

An alternative approach would be to increase the income tax rate at all levels. An increase of one pence would raise just over £500 million and two pence would produce over £1 billion. Of course, this is a more regressive change than what the STUC proposes. However, if the tax raised is spent in a way that targets those worst off, or living in poverty, then the overall impact is progressive.

The political barrier to such an approach appears to be the claim that many Scots pay lower taxes than in the rest of the UK and the SNP-led government wouldn’t want to give up this political ‘slogan’. But if the goal really is to spend enough to impact deeply on poverty, as well as to maintain real funding levels for key services, then an admission that higher taxes across the board will be needed is more honest.

Such a less progressive approach is commonplace across many European social welfare countries. The Institute for Fiscal Studies (IFS) finds that “the UK has one of the more progressive income tax and social security contributions systems among European countries in the sense that average rates are higher at the top relative to the median (average)”. The IFS found that while the average tax rate for top earners and for median earners is lower in the UK than across a selection of European countries, the differential was higher for median earners than for higher earners. In other words, to better mimic such higher tax countries, middle earners will have to pay more as well as higher earners. (There is also potentially a role for higher employer social security contributions, but that is not an area currently devolved.)

Furthermore, by concentrating on all income tax rates, then behavioural impacts will be minimised, as a few pence difference, offset by better services, should have little net impact on where average households reside.

If the Scottish Government is serious about meeting its key PfG objectives, it needs to bite the bullet on taxation and accept that you can’t greatly reduce poverty and improve the quality of public services without middle earners paying higher taxes. That is the lesson to be learnt from the experience of countries further down the road than us on this journey.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks