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UK Budget, UK Economy

Weekly Update – Economic news on inflation and growth, and what would have happened if the UK Government had increased income tax instead of national insurance?

We may have entered 2025 but the lagged nature of economic data means we are still getting a better sense of where UK economy was around the end of 2024. This week saw two important data releases- GDP for the month of November as well as Consumer Price Index for the month of December.

On the first front, the British economy finally posted its first monthly growth in November since the month of August. However, the monthly figure of 0.1 per cent growth was below consensus economist forecasts and come after two consecutive monthly declines- underscoring the fact that the overall economic picture remains weak. This fact can be simply illustrated that the UK Economy in November 2024 was still 0.1 per cent smaller than March 2024 – essentially the economy has been flat since the Spring.

The Bank of England itself has reduced its growth forecasts, stating that it expected no growth in the last three months of 2024.

Market participants were also heavily tuned to the December inflation data which was released on Wednesday after a particularly volatile period in the fixed income markets that has seen a general rise in UK government borrowing costs.

The annual inflation for the month of December came in at 2.5%- ahead of Bank of England’s target- but more importantly, lower than month before.

The slowdown in price growth, coupled with weak economic activity has strengthened the case for monetary policy to be loosened at the next Bank of England meeting in February – but wider global factors, including the prospects of higher inflation in the US, may lead to caution from the Monetary Policy Committee. They have tended to be cautious on rate cutting, erring on the side of keeping inflation down.

What would have happened if the UK Government Increased income tax rather than Employer NICS?

Since the start of the year, the First Minister John Swinney has been making the case that instead of increasing employer National insurance contributions, the UK Government had alternatives for raising revenue – for example, they could have followed the Scottish Government’s example to raise income tax. This was couched in his concern that raising employers NICS is a “jobs tax”.

Given the way the fiscal framework operates, this presents an interesting question about what the net impact would be on the Scottish Budget if, indeed, the UK Government had increased income tax instead of employer NICS (with all else being equal).

A quick explainer on the fiscal framework to set out why this matters (let’s just focus on income tax). In order to retain the Barnett-based block grant but also reflect that fact that income tax is devolved to Scotland, and adjustment is made to the Block Grant (which is supposed to represent the revenues the UK government has foregone due to tax devolution).

This block grant adjustment (BGA) is based on the revenues raised (per head) in England and NI (the areas of the UK where income tax is not devolved).

[This mechanism is why although Scottish rates raise £1.7bn more than if UK rates prevailed, the Scottish Budget is only around £800m better off, due to our tax base performing more poorly than in England].

So, if the UK Government increased income tax (all else being equal, including spending), the deduction to the block grant would be larger and the Scottish Budget would be worse off. But by how much, if, for example, the UK system became more similar to the Scottish system?

Table: Income Tax regimes in Scotland and the UK, 2025-26

Scottish Band Taxable income Scottish tax rate UK Band Taxable income UK tax rate
Personal Allowance Up to £12,570 0% Personal Allowance Up to £12,570 0%
Starter rate £12,571 to £15,397 19% Basic Rate £12,571 to £50,270 20%
Basic rate £15,398 to £27,491 20%
Intermediate rate £27,492 to £43,662 21%
Higher rate £43,663 to £75,000 42% Higher Rate £50,271 to £125,140 40%
Advanced rate £75,001 to £125,140 45%
Top rate over £125,140 48% Additional Rate over £125,140 45%

Source: SG, HMRC

We have crunched some numbers using the published ready reckoners produced by HMRC, to estimate how changing the UK income tax system to be more like the Scottish system would impact on UK revenues, and therefore the impact it would have on the Scottish Budget envelope.

Table: Impact of UK income tax increases on the Block Grant Adjustment

£m 2025/25
Measure

 Yield for UK Income Tax

Impact on the Block Grant Adjustment

Increase top rate to 48p

125

-9

Increase higher rate to 42p

1,350

-97

Reduce HRT to £43,662

7,384

-530

Total

8,859

-636

Source: FAI calculations

These are not all the differences between the systems: further measures in Scotland, like the 21p Intermediate rate, and the 45p Advanced rate, are further revenue raising measures and if implemented in the rest of the UK would reduce the Scottish budget envelope still further. These scenarios are not in the published ready reckoner, so it is less straightforward to work these out!

This discussion illustrates the complex and intertwined nature of the tax system in the UK, and the sometimes unexpected consequences of decisions in other parts of the UK: if the UK Government does move the income tax system to be more like Scotland’s, all else equal, the Scottish budget will be smaller.

Of course, the employer NICs decision is also costing the Scottish Government  and wider public sector money, given that it is a major employer. The Scottish Government has estimated that this will cost the core public sector around £580m (our calculations are a bit lower, but still over £500m), and perhaps still more in the cost of provision of services by other providers.

As also covered in our blog, the Treasury have said they will compensate public sector employers. The amount of compensation is, as far as we know, still being discussed – hopefully this will come to a conclusion soon.

Authors

Picture of Mairi Spowage, director of the Fraser of Allander Institute

Mairi is the Director of the Fraser of Allander Institute. Previously, she was the Deputy Chief Executive of the Scottish Fiscal Commission and the Head of National Accounts at the Scottish Government and has over a decade of experience working in different areas of statistics and analysis.

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.

Sanjam Suri is a Knowledge Exchange Fellow at the Fraser of Allander Institute.  Sanjam works closely with internal and external partners specializing in business and economic analysis. Sanjam also lead's the Scottish Business Monitor publication.  Prior to this, Sanjam was the Lead Country Risk Analyst at Export Development Canada in Ottawa. Sanjam has also worked as an Economist and Senior Economist at the Bank of Canada in Ottawa. Sanjam has an undergraduate degree in Mathematical Economics from Trent University (Canada), and a Masters degree in Financial Economics from Western University (Canada).