GROWING numbers of Scots are paying an effective marginal tax rate of 54p in the pound because of cross-border tax differences, the Holyrood budget watchdog has said.
The Scottish Fiscal Commission said a “quirk” meant Scottish taxpayers would pay 22p more in the pound on earnings between £43,662 and £50,270 next year than their peers in England.
The phenomenon is not new, but the SFC highlighted it as it held its annual briefing on the Scottish budget.
Deputy First Minister John Swinney yesterday broke an SNP manifesto pledge to freeze income tax rates and bands in this parliament by adding 1p to the higher and top rates of income tax in 2023/24.
Citing world events such as the war in Ukraine, the energy crisis and soaring inflation, he said the situation was very different to when the pledge was made at the 2021 Holyrood election.
The changes mean Scottish taxpayers earning more than the higher rate threshold of £43,662 will pay a 42p rate of income tax, while, after a threshold cut mirroring one in the rest of the UK, Scots earning over £125,140 will pay a top rate of 47p.
However there is a mismatch between tax rates set at Holyrood and national insurance contributions (NICs) set in Westminster.
South of the border, those paying the basic 20p rate of tax pay NICs at 12p, but the NICs rate drops to 2p if they earn over £50,270 and start paying the UK 40p higher rate of tax.
In Scotland, there is no compensating reduction in NICs when the higher rate of tax starts, so people can pay both the 42p rate of tax and the 12p rate of NICs on some income.
The SFC said that number of people affected by this “wrinkle” was growing, as more and more Scots were being drawn into the higher rate of tax by rising wages and the Scottish Government’s decision to keep the higher rate threshold frozen.
Since 2016/17, the number of higher rate taxpayers has grown by 23% in Scotland, but fallen by 10% in the rest of the UK.
SFC director Professor Graeme Roy said: “We're bringing more people in Scotland into paying what is now the 42p tax rate, than there are in England.
“So somebody earning £45,000, for example, in Scotland, might now pay a marginal income tax rate of 42%. That same person in England would be paying a marginal tax rate of 20%.
“There's an additional wrinkle, which is the interaction between income tax and National Insurance.
“You've got this quirk in the system, that a certain group of higher rate taxpayers in Scotland, people [earning] between roughly £43,500 and £50,000 pay 42% marginal tax on income, but then still pay the 12% tax on National Insurance giving a marginal tax rate of 54%.
“Whereas somebody in England over that period is only paying 20% plus the 12% and only paying a marginal tax rate of 32%.
“So somebody in Scotland faces essentially, for every additional pound that they earn, 54p of that being taken by a combination of the Scottish Government and the UK Government.
“That's an interesting quirk of the fiscal framework, but it's something which is worth keeping an eye on and I’m sure the government are considering the potential implications of that as well.”
The fiscal framework, the deal between Edinburgh and London that governs Holyrood's budget, is currently under review.
Sean Cockburn, of the Chartered Institute of Taxation added: “Increasing the higher rate to 42p means that those with earnings that fall between the Scottish and UK higher rate tax thresholds of £43,662 and £50,270 will be taxed at a marginal rate of 54% on that slice of income, compared with 32% in the rest of the UK.
“That is because National Insurance rates are tied to the UK, not Scottish, higher rate.”
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