The Scottish Government says that income tax policy changes since 2016/17 have been ‘highly redistributive’ and have ‘protected low income earners’. But how much of this affect can be attributed to the Scottish Government’s rates and band changes, and how much to the UK Government’s Personal Allowance changes? And how does the story about the distributional impact of recent policy decisions change if we incorporate other taxes (council tax) or social security spending?
The distributional impacts of income tax changes
Alongside the draft budget, the Scottish Government published some distributional analysis of income tax policy changes between 2016/17 and 2020/21.
This analysis compares the impact on household incomes of the 2020/21 income tax policy, compared to a hypothetical world in which the only changes to income tax policy since 2016/17 had been inflationary increases in the Personal Allowance and Higher Rate Threshold.
The government uses this analysis to argue that ‘the Scottish Government’s decisions on income tax since 2016-17, combined with changes in the UK-wide Personal Allowance, have been highly redistributive and have protected low income earners’.
It is of course possible to separate out the impact of the Scottish Government’s income tax policies (the introduction of the five-band tax structure in 2018/19, combined with a below inflationary freeze in the higher rate threshold) from the impact of the above inflationary increases in the Personal Allowance, which is set by the UK Government.
This is shown in the chart below. The dashed red line shows the distributional effect of the UK Government Personal Allowance changes and Scottish Government changes combined. The changes in combination could be said to be redistributive (although whether they can really be described as ‘highly’ redistributive is more subjective).
The chart separates out this combined effect into a part due to the PA changes and a part due to the Scottish Government rates and band changes.
- The Scottish Government’s rates and band changes amount to a progressive increase in taxation (half of Scottish taxpayers do experience a tax cut, but the cut is so small that it doesn’t even register on the chart).
- In contrast the PA increase represents a tax cut to all (apart from the highest earning 1%), the benefits of which are fairly evenly spread across the distribution.
We can conclude by saying that the combination of UK and Scottish Government income tax changes since 2016/17 have been progressive and have protected low earners – with the Scottish Government’s tax changes providing the progressive element and the UK Government Personal Allowance changes doing the ‘protecting low earners’ bit (at the same time as benefitting middle and high earners).
Of course the lowest earners – those earning less than the Personal Allowance – do not get any ‘protection’ from this policy at all. Its worth remembering that charts showing the distributional impact show average effects by decile – but within any decile there will be households affected proportionately more (or less) than this average.
What about council tax?
Income tax isn’t the only tax controlled or partially controlled in Scotland which can have direct consequences for household incomes. Council tax changes have distributional consequences too.
In 2017/18, the Scottish Government changed the ratio between council tax bands in Scotland, increasing the tax liabilities of higher-valued homes in bands E-H relative to those in bands A-D. But since 2016/17, councils have also been able to increase council tax rates more quickly than inflation.
These policies both constitute tax increases, but are likely to have different distributional impacts.
- We might anticipate the former policy to be slightly progressive with respect to household income (only ‘slightly progressive’ because the correlation between household income and council tax band is not particularly strong).
- We might anticipate the latter policy to be somewhat regressive, as the fairly flat structure of council tax means that council tax forms a larger proportion of poorer households’ bills than of richer households’ bills.
This is indeed what we find when we model these council tax policies (see chart below). The net effect of both council tax policies in combination is fairly flat across the distribution. The impact of the above inflation increases is regressive (notwithstanding some protection for households towards the lower end of the distribution through council tax reduction); whilst the E-H changes are slightly progressive.
Chart 3 combines the distributional impacts of the income tax changes with those of the council tax changes. Across most of the distribution the income gain from real terms increases to the Personal Allowance is approximately offset by above inflationary increases in council tax. The overall picture is one of a progressive but modest increase in taxation.
The extent to which decisions on income tax and council tax are coordinated with each other is open to debate. Council tax is formally a tax for which local government has responsibility, although the maximum annual increases and the overall banding structure are set by the Scottish Government in consultation with local authorities.
The Scottish Government is gaining significant new responsibilities for social security spending. Over time, these powers will provide the government with additional levers with which to directly impact the income distribution.
In 2020/21, the main social security policy in spending terms is the Carer’s Allowance Supplement, an annual uplift for recipients of the Carer’s Allowance of around £460.
Recipients of Carer’s Allowance are found throughout the income distribution, although they are more likely to be found in the lower half. The Supplement therefore has a largely progressive impact (see chart below).
It is important to remember however that whilst the average effects of the Carer’s Allowance Supplement by decile look small in percentage terms, this reflects the fact that only a minority of households in each decile are in receipt of Carer’s Allowance. For households in receipt of Carer’s Allowance, the Supplement will be significant.
For example, the median recipient of Carer’s Allowance ranked by income is found in the fourth decile of net household income. The Carer’s Allowance Supplement would boost the net equivalised income of such a household by more than 2%.
In conclusion, the government’s analysis of the distributional impact of income tax policy was a useful addition to this year’s budget documentation. We hope that the government extends this analysis to cover its broader range of distributional impacts in future years, perhaps as part of the Equality and Fairer Scotland Budget Statement.