This is a a short briefing from the Fraser of Allander Institute on how much revenue would be raised by some of the proposals for an additional band of Scottish Income Tax between the higher (42p in the pound) and top (47p in the pound) rates. There are two separate proposals in the public domain:

• One from the Scottish Trades Union Congress (STUC), which would levy a 44p rate on earnings between £75,000 and £125,140; and
• One from IPPR Scotland, which would levy a 45p rate on earnings between £58,285 and £125,140.

Estimates from the respective organisations are that these would raise £200m and £257m a year, respectively. But all these estimates are static, that is, they assume that taxpayers do not change their behaviour in response to higher tax rates. So what happens when you do allow for behavioural responses?

Our estimates show that about a third of the tax yield is likely to be lost through behaviour

Our briefing goes into detail about how we have modelled behaviour – but our approach is very similar to that used by the Scottish Fiscal Commission when it comes to including policy costings in their forecast.

We quantify two main behaviours:

• The ‘intensive margin’ effect, which quantifies how much declared income changes by looking at the marginal rate that people face, on the assumption that they continue to have the same income streams. This is called the marginal effective tax rate (METR) effect in the literature, and is generally the largest behavioural effect.
• And the ‘extensive margin’ effect, that is, to what extent people chose whether or not to participate altogether in an activity given their new average liabilities. For example, people may choose to not work anymore, or may no longer find it worthwhile to rent out a property. This is called the average effective tax rate (AETR) effect in the literature, and tends to be significantly smaller than the METR effect.

The charts below show our estimates of revenue raised from the two proposals. Our best estimate is that the STUC proposal would raise £56m in 2024-25 after accounting for behaviour, and would be paid by around 141,000 people (5% of those with any Scottish Income Tax liability). For most of them it would be their marginal rate, but top rate payers’ liabilities would increase.

We assume that the £75,000 threshold remains fixed in cash terms, which would bring more people under the new band. We think that would be as many as 189,000, or 6% of those with Scottish Income Tax liabilities. If the threshold were to be indexed going forward, revenues raised would be lower in later years.

Chart: Revenue raised through the STUC proposal – new band at 44p for earnings between £75,000 and the top rate threshold

In the case of the IPPR Scotland proposal, revenues raised would be larger – both because the band starts at a lower level and because the new rate would be higher. We estimate that it would raise around £161m in 2024-25, and be paid by 234,000 people – roughly 10% of those with Scottish Income Tax liabilities. Under the same assumption of a fixed threshold in cash terms, this would rise to £220m by 2028-29 and the rate would be paid by 372,000 taxpayers – 12% of those with any Scottish Income Tax liabilities.

Chart: Revenue raised through the IPPR Scotland proposal – new band at 45p for earnings between £58,285 and the top rate threshold

In both cases, the importance of modelling behaviour is clearly illustrated. The static costing is much larger than accounting for taxpayers’ responses – but these responses are well documented, and therefore need to be considered when studying the merits of a policy proposal. Using the well-established SFC methodology – which is also very similar to that used by HMRC at UK level – behaviour reduces the revenue raised through these measures by around a third: 30% in the IPPR Scotland proposal and 36% in the STUC proposal. Most of this is due to the intensive margin effect, which on its own reduces the yield of the measures by around a quarter.

While these are still significant sums of money, they are substantially lower than they would appear by assuming no taxpayer behaviour. It is important that their anticipated consequences are fully considered as they are debated in the public sphere in the run-up to the decisions for the Scottish Budget.

Next steps

You can read our briefing in full here.

Look out for the next edition of our quarterly Economic Commentary next month, where among other things we will preview the coming Autumn Statement and what that might mean for Scotland. And we will publish Scotland’s Budget Report in December in advance of the Deputy First Minister’s statement on the Scottish Budget, where we will look back at the Chancellor’s announcements and assess the Scottish Government’s options given any consequences from UK-wide announcements.