Tax Reforms for an Independent Scotland: Economic Insights

1. Taxes in an independent Scotland Presentation prepared for conference: Economic aspects of constitutional change, Edinburgh September 19-20 2013 Stuart Adam and Paul Johnson

2. Outline • Tax revenues in Scotland • Principles for tax reform • The Scottish context • Tax raising options

3. Tax revenues • Onshore revenue in 2012 £47.8 bn (in 2013 prices) • £9,000 per resident • 37.1% of onshore GDP • With 8.4% of UK GDP Scotland contributed 8.2% of onshore revenue • In earlier years Scottish tax revenues were a higher proportion of GDP

4. Scottish and UK revenues as % onshore GDP Source: Authors’ calculations using data from GERS 2011–12 and Historical Fiscal Balance Calculations from Scottish National Accounts Project (SNAP).

5. Tax revenues • Onshore revenue in 2012 £47.8 bn (in 2013 prices) • £9,000 per resident • 37.1% of onshore GDP • With 8.4% of UK GDP Scotland contributed 8.2% of onshore revenue • In earlier years Scottish tax revenues were a higher proportion of GDP • Revenue shares are similar • A bit more from CT, VAT, “sin taxes”, environmental taxes • A bit less from IT, CGT, IHT, council tax, SDLT

6. Composition of onshore revenue UK and Scotland 2011/12

7. Tax revenues • Onshore revenue in 2012 £47.8 bn (in 2013 prices) • £9,000 per resident • 37.1% of onshore GDP • With 8.4% of UK GDP Scotland contributed 8.2% of onshore revenue • In earlier years Scottish tax revenues were a higher proportion of GDP • Revenue shares are similar • A bit more from CT, VAT, “sin taxes”, environmental taxes • A bit less from IT, CGT, IHT, council tax, SDLT • Though Scottish tax base is different • Fewer very high incomes • Less capital income

8. Population shares by income tax band

9. North Sea Revenues • Have been hugely important • An make a big difference to overall fiscal balance • But also very volatile

10. North Sea oil revenues

11. Post independence • Scotland would have the opportunity greatly to improve its tax system • Little sign under devolution of whether it would take the opportunity • Freezes in council tax • Reform of SDLT • Some small reforms to Business Rates • No use of power to change income tax rates

12. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes

13. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity

14. What we have • Does not work as a system • Lack of joining up between income tax and NI • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity • Is not well designed where it should deviate from neutrality • A mass of different tax rates on carbon • Failure to price congestion properly

15. What we have • Does not work as a system • Lack of joining up between income tax and NI, • Personal and corporate taxes • Is not neutral where it should be • Inconsistent savings taxes with normal return often taxed • Corporate tax system that favours debt over equity • Is not well designed where it should deviate from neutrality • A mass of different tax rates on carbon • Failure to price congestion properly • Does not achieve progressivity efficiently • VAT zero rating a poor way to redistribute • Tax and benefit system damages work incentives more than need be

16. So lots of change would improve efficiency • Simplify direct tax system, integrate income tax and NI • Much broader VAT base • Reform taxation of savings (and pensions) • Single tax schedule for income from all sources • Consistent carbon price • Council tax levied at proportionate (not regressive) rate on up-to-date values • Abolish stamp duty land tax • Congestion charging replacing much of petrol taxation • Replace business rates with land value tax

17. Personal tax issues for an independent Scotland • More equal income distribution • Fewer with very high incomes reduces role of higher rates in redistribution • Mobility between Scotland and rUK • Taxation of savings • Additional behavioural margin likely to increase taxable income elasticities

18. Corporate tax issues in an independent Scotland • Companies need to allocate profits between Scotland and rUK • Same set of transfer pricing issues we currently face but with new instance • Scope for tax competition with rUK • Proposals to reduce headline rate • Could move (or add) real activity or where profits are reported • Optimal rate for both Scotland and rUK lower with competition • Formula apportionment one option

19. Indirect taxes in an independent Scotland • Cross border trade zero rated for VAT • Increases administration costs • Opportunities for MTIC fraud • Exemptions create incentive for exempt bodies (e.g. financial services companies) to purchase inputs from lower rated country • Different rates could encourage cross-border shopping • 2% of total consumption in Denmark accounted for by crossing border to shop in Germany due to lower VAT rate • Scope for excise duties to be affected • Fuel duties should reflect externalities from driving • These are considerably less in (less crowded) Scotland than (more crowded) England

20. Property taxes in an independent Scotland • Land and property form a particularly suitable tax base for a small open economy • Scottish government already has control • They have frozen council tax since 2007 (and rates rose less quickly before 2007) • Undermining local tax base • And role of a property tax • Reformed SDLT • In a broadly sensible direction to end cliff edges • (note there are proportionately fewer very expensive properties) • Introduced cliff edges to business rates

21. If a Scottish government wanted to raise revenue

22. If a Scottish government wanted to raise revenue

23. Conclusions • Tax per head very similar to UK average • Though some differences between taxes • Narrower income distribution and fewer very rich has effect on tax base • And reduces optimal redistribution • Lots of opportunity to improve the tax system • And if a newly independent country can’t take the chance, who can? • But some constraints