Fiscal Policy and Tax, UK Budget

National Insurance Contributions or income tax cuts – how would either affect Scotland?

The Westminster lobby is in a frenzied state of speculation, with reports in the media that Chancellor Jeremy Hunt will tomorrow announce a cut to the primary rate of class 1 NICs from 10% to 8% (and maybe to class 4 as well). This is after weeks of speculation on whether cuts would be to NICs or income tax, and whether they would be of 1p or 2p in the pound like in the Autumn.

Income tax and NICs are similar taxes, but income tax is much broader: all activity inside the scope of national insurance contributions is also subject to income tax, but the reverse is not true. NICs are formally compulsory social security contributions, but are really a tax on earned income – class 1 is due on employment income; class 4 on self-employment income. Income tax, on the other hand, is due not only on earned income, but also on savings, rental income, dividends, among others.

NICs are also only paid by those below State Pension age, and there are rules on the required contributory record of NICs is necessary to claim State Pension. On the other hand, income tax applies to all adults.

Why would the Chancellor choose NICs instead of income tax?

NICs are not as intuitive to understand as income tax to the average taxpayer – partly because their name feels like it directly pays for one’s pension, which is not true – but they are a significant source of revenue for the UK Exchequer, and for most people they are just another income tax.

Of course, the fact that they don’t cover as many people or as many types of income means that their tax base is smaller. According to the HMRC ready reckoner, taking 1p off the primary rate of class 1 NICs would cost the Treasury £4.6bn a year. If we assume that the same would apply to class 4 NICs for the self-employed (on the basis of what Jeremy Hunt did in the Autumn Statement), there would be an additional c.£350m cost in each, bringing the annual cost of a 1p reduction in workers’ NICs to £5bn.

A 2p reduction in the primary rates of class 1 and 4 NICs would cost around £10bn a year. This is a significant amount of money (over 0.3% of GDP), but considerably less than a similar reduction in the UK basic rate of income tax. Bringing it to 19p would cost around £7bn a year, and it would be over £14bn to bring it to down to 18p.

With rumours abounding that the OBR’s forecast reduced the headroom against the Chancellor breaking his self-imposed fiscal rules, it wouldn’t be surprising if Jeremy Hunt opted for NICs for his ‘big-ticket’ tax cut. 2p off NICs and freezing fuel duty would put together cost less than 2p off income tax.

A NICs cut would apply to Scotland; an income tax cut (mostly) wouldn’t

Income tax is partially devolved, with the Scottish Government able to set rates and bands above the personal allowance on non-savings, non-dividends income. So for most people in Scotland (especially given the savings income allowances) any announcement by the Chancellor on income tax would make no difference.

Instead, the Scottish Government would see its spending power increased – but because of the timing, not immediately. Tax devolution is complicated, and so it’s worth dwelling on this to explain!

As part of the devolution of income tax, the Scottish Government gets to keep the revenue raised from (non-savings, non-dividend) income tax in Scotland. On the other hand, the Scottish Government’s Block Grant from Whitehall gets deducted by an amount to (broadly) take into account how much revenue would have been in the absence of tax devolution. (As with all things devolution, it’s a bit more complicated! But not in an important way for this purpose.)

If rates set by the UK Government are reduced, then revenues would have been lower in the absence of devolution, and therefore the block grant adjustment (BGA) becomes smaller – thereby increasing the Scottish Government’s net revenues. Our estimate is that a 1p reduction in the UK basic rate would reduce the BGA by around £375m in 2024-25 and around £450m in subsequent years; a 2p cut would reduce the BGA by around £750m in 2024-25 and around £900m in the following years.

But because the Scottish Budget has now been passed, the BGA for 2024-25 is now final for the purposes of setting what the Scottish Government can spend in the coming financial year. So the SG would only be able to spend the additional funds from 2025-26 onward. The BGA change for 2024-25 would instead come through a smaller reconciliation in 2026-27, when HMRC has finally totted up how much revenue was collected and the Scottish Fiscal Commission can assess what the difference between forecast and actual receipts in Scotland and the rest of the UK (rUK) comparator (England and Northern Ireland – again, for complicated reasons we don’t need to go into).

No such complications would be incurred by a change in NIC rates – they apply to Scottish taxpayers automatically, as NICs are not devolved, but would also bring no additional spending power to the Scottish Government.

How would this affect differentials in taxes on income between Scotland and the rest of the UK?

If the Chancellor goes for a NICs cut, then there would be no change to tax differentials between Scotland and rUK.

If income tax were to be the Chancellor’s choice, however, it would have potentially big consequences for Scotland – especially given (a) the likely choice of the UK basic rate and (b) the Scottish Government’s policy of making tax lower in Scotland than it would be at rUK rates for those below median earnings.

The reduction in tax paid by earners below the median in Scotland is achieved through the 19p starter rate on income below £14,876. If the Chancellor brought the UK basic rate down to 19p in the pound, all those earning £14,877 or more in Scotland would pay more income tax than they would on the same income in the rest of the UK. And if the UK basic rate were dropped by 2p, then anyone with an income tax liability would pay more in Scotland. It would then be for the Scottish Government to decide how to use the additional funding from 2025-26 – either to reduce income tax in Scotland or to spend on public services.

Chart: Potential differential in income tax between Scotland and the rest of the UK in 2024-25 under different UK Government policy options


João is Deputy Director and Senior Knowledge Exchange Fellow at the Fraser of Allander Institute. Previously, he was a Senior Fiscal Analyst at the Office for Budget Responsibility, where he led on analysis of long-term sustainability of the UK's public finances and on the effect of economic developments and fiscal policy on the UK's medium-term outlook.

Calum is an Associate Economist at the Fraser of Allander Institute (FAI) and a Researcher at the Centre for Inclusive Trade Policy (CITP). He specialises in economic modelling and trade, and holds an MSc in Economics from the University of Edinburgh.