Economy Q&A: Do you think the Scottish Government’s tax proposals will grow or shrink the economy?
Holyrood asked five economists for their views on key questions about the Scottish economy
Professor Charles Nolan, Professor Julia Darby, Professor Ronald MacDonald, Professor Jeremy Peat, Professor Catia Montagna - Image credit: Holyrood
Professor Charles Nolan, Bonar McFie Chair of Economics, University of Glasgow:
The changes in income taxes that are being proposed are probably not transformative: it is hard to see how they could substantially affect the economy’s growth rate, positively or negatively. I think that is the case principally because they are not that large. That said, I also think a degree of caution is wise as we just do not know with any great degree of confidence how changing income taxes in Scotland relative to the UK will turn out.
The idea behind the tax rise, I think, is that it will be a net addition to aggregate demand: tax those who would not spend enough of each additional pound of their income (or would spend it on things the Scottish Government thinks less appropriate) and spend it more effectively. In that way, income may be redistributed and demand is both increased and directed at growth-enhancing measures.
On the other hand, it may be that the increase in income tax merely substitutes one group’s spending for another’s with little net impact on aggregate demand. And if it discourages labour market participation then it could even have a net negative effect on demand.
As I said, the changes proposed are small and so I suspect the effects will end up being small in either direction. If these changes are by way of a first instalment, then these issues become more significant. More research on the question of income (and other) tax changes from a Scottish perspective seems important before more decisive policy divergence is pursued.
Professor Julia Darby, Head of Department of Economics and Fraser of Allander Institute, Strathclyde Business School:
There is little conclusive academic evidence that marginal changes in tax rates – particularly of the scale proposed by the Scottish Government – will have any significant impact, positive or negative, on the economy in the short run.
On the one hand, a higher tax rate will reduce household disposable income for some, which will act to weaken consumer spending. But on the other hand, this will be offset by higher government spending, so the net effect is likely to be minimal.
However, perception is important. If investors, both within the UK and elsewhere, believe that a slightly higher tax rate in Scotland is a signal that the country is a less attractive place to do business, this may have a more significant impact on the economy in the long term.
Of course, if the government uses the additional revenue to support improved education levels, better infrastructure and more effective enterprise and innovation policies, the net impact of the increase in taxation could be positive. But such effects are not guaranteed and the government will have to work hard to ensure that Scotland remains competitive.
Professor Jeremy Peat, Visiting Professor, University of Strathclyde International Public Policy Institute:
As so often in economics nothing is clear cut – so here comes an ‘on the one hand this, but on the other that’ answer.
Positively, there will be an increase in revenue resulting from the income tax changes – estimated by the Scottish Fiscal Commission at £164m in 2018/19, rising to nearly £200m five years later. That will allow higher spending and, at the margin, stimulate the economy. The scale of this stimulation and the extent to which it is sustained will depend upon how and where the net additional funds are spent. But note that the sum involved is relatively small – some 0.6 per cent of the total resource budget for the next financial year.
Further, as stressed by the Scottish Fiscal Commission, higher direct taxes will result in some highly paid individuals relocating elsewhere within the UK. The Scottish Fiscal Commission estimates, on the basis of heroic assumptions, that some £50-£65m of potential tax revenue will be lost each year as a result of such ‘behavioural’ effects. (This is already netted off the revenue estimate given above.)
In the medium term there could be disincentives from a regime appearing tough on the successful, which could lower business investment and activity and hence result in a lower growth rate. In sum, the impact is small and unpredictable, but the longer-term effects of what could in due course become an income tax regime increasingly different from that of the UK could be far more significant.
Professor Catia Montagna, Chair in Economics, University of Aberdeen:
A major part of the proposals concerns the income tax structure, with the introduction of a ‘starter’ and an ‘intermediate’ rate (19 per cent and 21 per cent, respectively) and a one per cent increase in both ‘higher’ and ‘top’ rates.
By signalling a readiness to use Scotland’s new fiscal powers to differentiate income tax from the rest of the UK, this has symbolic value. It is doubtful, however, that the scale of these changes will be sufficient to have a substantial impact on the economy.
Behavioural responses are likely to be small due to a limited effect on the disposable income of either low or high income earners, and the tax differentials with respect to the rest of the UK are unlikely to be sufficient to affect the tax base via in or out migration.
A significant increase in government’s tax revenue, and hence a greater ability to boost aggregate demand via public expenditure, is also not to be expected. The Scottish Fiscal Commission estimates an extra income tax revenue of about £165m; however, this will be partly offset by cuts in business taxation (which may not stimulate greater investment if firms’ outlook continues to be poor) and by the smaller ‘adjusted’ block grant Scotland receives via the Barnett formula as a result of the new fiscal framework.
Professor Ronald MacDonald, Research Professor of Macroeconomics and International Finance, University of Glasgow:
I think on balance the proposed increased taxes are likely to shrink the Scottish economy because Scotland will become a less attractive location for skilled people and for FDI [foreign direct investment] and other forms of investment.
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