The mysterious case of the missing high-earners

  • There was a £550m gap between forecast of income tax paid in Scotland, and actual outturn.
  • Estimates are based on ropey data, making budgeting more difficult.
  • Strengthened economic growth figures for the past year are unlikely to lead to stronger growth forecasts.
Tax Image copyright Getty Images

There aren't as many higher-earning Scottish taxpayers as we thought. That doesn't mean they've deserted the country, for fear of higher tax bills.

It is more likely to mean that they weren't really there in the first place.

The result is an alarmingly large gap between the forecast for income tax set out by the Scottish Fiscal Commission for the 2016-17 year, and the actual outturn figure.

They said it would be around £11.3bn. It came in at £10.7bn. The £550m gap was 5%, which would have made quite a dent to the Scottish government's budgeting if it had been passed on directly.

To rewind a bit, the Fiscal Commission is in the early days of figuring out how much tax revenue is raised in Scotland. Until now, statisticians have taken a population share of the total for the UK, and adjusted it a bit for lower average earnings. Scotland doesn't have the mega-salaries in London and the south-east, which tend to skew things.

Until now, it hasn't mattered all that much. But with income tax powers now at Holyrood, it matters a lot more that the forecasts and the outturns are more closely aligned.

Image copyright Getty Images

In the case of 2016-17, however, there is a get-out for the Scottish government. It doesn't take the impact of that £550m gap. Under the fiscal framework agreed with the UK Treasury, that is the baseline year on which future grants are to be calculated.

I'm told it ought to be fully compensated by the Treasury in its block grant to Holyrood, while the £10.7bn (reduced) figure is baked in to future forecasts.

A more modest scale of forecasting error was found in non-domestic rates. Having under-estimated the extent of reliefs on these business rates, last year saw it come in £50m below the amount expected, on £2.8bn of receipts.

This comes from the annual review, issued today, by the Scottish Fiscal Commission of how its forecasts have been getting on.

It has had a look at the economic growth forecasts as well. These came as a shock last December, on Scottish budget day. The Scottish Fiscal Commission times its forecasts to coincide with the draft budget. And that day, it said the Scottish economy was growing at only 0.7% per year.

By May of this year, it wasn't much different: 0.7% this year, and 0.8% in 2019.

But since then, the Scottish government published a very substantial review of its figures for growth over several years. It included, among other things, a shift from thinking the construction sector had contracted by 12% to reckoning on 4% growth.

So this meant growth for the last financial year, which had looked like 0.7%, was revised up to 1.3% - in line with UK growth.

So you might think the commission would revise its forecasts to reflect that. It will, but it will also reflect other revisions from 2015 and 2016, which saw even weaker growth figures than reported at the time.

Taken together, the trend growth is even lower - down from an average 1.2% to 1.1% - than before that review took place. So when the commission issues its next forecast in December, it's giving us a very strong hint that we shouldn't expect any dramatic changes.

Next steps

The revolution in Scotland's taxation arrangements moves on next to VAT. Holyrood is to have half of the VAT collected in Scotland, but doesn't have any power over the rates of VAT, or the items on which it is levied.

The Fiscal Commission has today published an outline of how it is going to estimate that assigned share.

It doesn't look easy to figure out the best assumptions about relative growth, exports, tourism, a bit less because it isn't charged on rent, which is a bigger part of spending in England, a bit more paid on alcohol.

The data is a lot more ropey than income tax. To make it less so, the commission has set out its wish list of improved data publication. And because VAT will not be identifiable as Scottish, there will be no way of knowing a precise outturn figure.

The other next step is more for the Scottish government than for the Scottish Fiscal Commission - if there aren't as many higher rate taxpayers as expected, where is it going to find more?

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