Frantisek Brocek[1] and David Eiser
Under Scotland’s fiscal framework, Scotland’s budget will be better off (than it would have been without tax devolution) if income tax revenues per capita grow more quickly than they do in the rest of the UK (rUK).
Some have argued that demographic projections for Scotland mean that the Scottish budget will almost inevitably lose out from this arrangement.
This is because Scotland’s old age dependency ratio (the ratio of those above working age to those of working age) is projected to grow more rapidly than rUK’s over the period to 2050. Seeing as those above working age pay less income tax per capita, a more rapid growth in this group will act to slow the growth of total income tax revenues per capita, relative to rUK.
But in this blog we show that the issue is more nuanced than this. This is because, as well as there being a difference between the average revenues per capita for those of working age compared to those above working age, there is also significant variation in income tax revenues per capita by age group within the working age population.
When demographic projections by age group are taken into account on a more granular basis, it turns out that the operation of the fiscal framework might actually work in Scotland’s favour. Although Scotland’s old age population is projected to grow relatively more rapidly, its population of children and young adults (who pay little tax) is also projected to decline more rapidly. This more than offsets the impact of a faster growing older population in reducing the growth of income tax revenues per capita.
Chart 1 shows the representative tax profile across different age groups. The young and the old pay relatively less income tax per capita than those of prime working age, from 35-64. (The profile of tax receipts by age is similar in rUK, albeit with somewhat higher revenues per capita).
Chart 1: Average annual income tax revenues per capita by age group in Scotland 2015-16 (Source: HMRC Survey of Personal Incomes, FAI calculations)
What are the prospects for per capita tax revenues in Scotland and rUK in the future?
To estimate how demographic projections alone might influence future income tax revenues we multiplied the representative profiles of tax revenues by age by the projected number of people in each age group in each year to 2060. In other words, we applied the projected demographic structure in each year by the income tax profile by age in 2015/16.
Subsequently we divided the overall income tax revenue by total population in the given year to obtain estimates of per capita income tax in Scotland and rUK.
This calculation assumes that the representative tax profile by age group remains constant over time. This assumption might not be entirely realistic, but it enables us to consider the likely impact of demographic trends in themselves in influencing Scotland’s budget position under the fiscal framework.
Chart 2 shows that demographic trends in themselves would result in income tax revenues per capita declining over time, in both Scotland and rUK (essentially this is because the share of the prime age population that pays relatively more tax is declining).
However, the rate of decline is relatively slower in Scotland. By 2060 rUK per capita tax revenue would 4% based on demographics alone in comparison to only a 1.6% decrease in Scotland.
The consequence of this is that, if the only thing that differed between Scotland and rUK was demographic structure (i.e. if incomes and employment grew at the same rate), then over time Scottish tax revenues would exceed the income tax block grant adjustment (Chart 3). This difference would peak at around £500m in 2050.
Chart 3: Forecast per capita tax revenues in Scotland and rUK (Source: HMRC Survey of Personal Incomes, ONS 2018-based Population Projections, FAI calculations)
Chart 3: Difference between forecast Scottish income tax revenues and the block grant (Source: HMRC Survey of Personal Incomes, ONS 2018-based Population Projections, FAI calculations)
What are the demographic factors that drive this result? As shown in Chart 4, over the period to 2050 Scotland’s share of younger age groups is expected to decline relatively more rapidly than rUK’s, and this more than offsets Scotland’s relatively more rapid growth of population aged 75+. Indeed, Scotland’s share of higher income ‘prime aged’ individuals is projected to increase relatively more rapidly than rUK’s.
Chart 4: Change in the share of population by age group in Scotland and rUK between 2018 and 2050 (Source: ONS 2018-based Population Projections, FAI calculations)
In summary, whilst Scotland’s population is projected to ‘age’ more rapidly than rUK’s, this is not the only demographic factor that determines the relative growth if income tax revenues per capita.
On the basis of demographic projections, it is certainly not a given that the Scottish budget will be made worse off by the fiscal framework – at least when it comes to the revenue side of things. (The spending side is different of course, with spending on health and social care, and the majority of the social security payments being devolved to Scotland increasing by age).
[1] Fraser of Allander Institute and University of Edinburgh
Authors
The Fraser of Allander Institute (FAI) is a leading economy research institute based in the Department of Economics at the University of Strathclyde, Glasgow.