Tax
Welcome! In this section, we'll dive into the world of taxation. This is how the government raises money, mainly from individuals, consumers, and businesses. The revenue collected is fundamental for financing government spending.The SQA Higher Specification for this section:
‣
These summary slides are best viewed fullscreen on a computer. If you are on a mobile device, click here.
Direct & Indirect Taxes
Let's break down the two main types of taxes: direct and indirect taxes.
Direct tax: This is a tax that is paid directly by a person or business to the government from incomes or profits.
- Income Tax and Corporation Tax are common examples.
- Did you know that Scotland and the UK have Income Tax systems where higher earners contribute a greater proportion of their earnings in taxes than lower earners? This is called progressive taxation.
/w=3840,quality=90,fit=scale-down)
An indirect tax is applied to a good or service at the point of sale.
- One example is Value Added Tax (VAT).
- Individuals do not pay indirect taxes directly to the government. Instead, the tax is included in the price that consumers pay for a good or service. The seller of the good or service deducts the VAT from the transaction and pays the tax to the government.
/w=3840,quality=90,fit=scale-down)
Do indirect taxes contribute to income inequality?
Yes, they do. In the financial year ending 2022, indirect taxes increased income inequality by 3.5 percentage points (ONS).
- This is because indirect taxes tend to be more regressive than direct taxes. This means that the rate of indirect taxes are the same for everyone irrespective of income, which can be a problem because poorer people spend a greater proportion of their income on indirect taxes than richer people.
The Office for National Statistics divided the population into 5 equal groups - called 'quintiles' - to compare the impact the impact of indirect taxes on disposable income. In this graph it is important to remember that the poorest quintile refers to the poorest 20% of the population, and the richest quintile refers to the richest 20%. You can download the dataset used for this graph below:
ONS Indirect Taxation.xls26.5KB
‣
Knowledge checkpoint: Describe the distinctions between direct and indirect taxation
Tax Revenues and Economic Shocks
Total government revenue fell during the 2020 Covid-19 Pandemic. To understand why, let’s explore what happens to tax revenues during economic shocks.
/w=3840,quality=90,fit=scale-down)
By ordering firms to close and households to stay at home, the lockdown caused spending on goods and services to decrease.
- Decreased sales of goods and services mean that firms earn less.
- This means less VAT receipts sent to the government.
- Decreased profits mean firms send less corporation tax to the government.
- Without government support during lockdown in the form of the Job Retention Scheme, the government would receive less income tax as a result of growing unemployment.
The Job Retention Scheme (JRS): During the lockdowns imposed due to the Covid-19 pandemic, the UK government implemented the JRS and paid 80% of wages. This ensured that the country avoided significant unemployment, and ensured that the government would still receive a similar level of income tax, and tax revenue would not decrease substantially.
As the economy expands, tax revenues tend to rise. As the economy contracts, tax revenues tend to fall. This is because automatic fiscal stabilisers mean that when the economy is under pressure, tax revenue falls and spending increases, avoiding significant reductions in demand.
The majority of tax revenues are cyclical! Tax revenue rise when the economy is in a positive state, while tax revenues decrease when the economy is in a negative state or a recession.
Scotland’s Total Revenues
Total revenues in Scotland are collected by the Scottish Government, Local Government and by the UK Government to pay for spending in each government. Learn more about devolution and revenues here.
The annual Government Expenditure and Revenue Scotland (GERS) report allows us to understand this mix of spending in Scotland. The Fraser of Allander Institute has a helpful guide on understanding the report:
You can also download the Government Expenditure and Revenue Scotland (GERS) 2021-22 report and database below:
government-expenditure-revenue-scotland-2021-22.pdf905.3KB
tables-charts.xlsx418.9KB
Use the interactive revenue tracker below to explore the composition of Scotland’s revenue streams over time.
Task: Select ‘Value added tax’ and ‘Income Tax’ on the search panel. Which two time periods saw a big fall in revenue from these taxes? Why did they drop so significantly?
‣
Scottish Tax Revenue Composition: Over half of the revenues generated in Scotland are accounted for by the top 3 taxes in Scotland. Income Tax, National Insurance, and VAT account for the majority of tax revenues in Scotland, displaying their importance.
The below graph follows Scotland’s total revenue over time. GERS uses 3 different measures for this: the blue line reflects the Non-North Sea Revenues (shown previously), while the yellow and orange lines include offshore revenues from oil and gas production.
The orange line ‘including geographic share of North Sea revenue’ forecasts a scenario in which Scotland’s share of UK offshore revenues is equal to its geographical share of UK oil and gas resources. The yellow line ‘including population share of North Sea revenue’ forecasts a scenario in which Scotland’s share of UK offshore revenue is equal to its UK population share.
‣
Knowledge Checkpoint: Explain the distinctions between progressive and regressive taxation
Income Tax: Scotland and the UK
Taxation in Scotland has changed significantly in recent years. Since 2017, the Scottish Parliament have had new income tax powers devolved.
- By 2019, the Scottish Government had moved to a new five-band Income Tax system which was estimated to raise £500m for Scotland’s public finances (compared to if the UK Government policy were applied).
- The additional revenue was raised by subjecting taxpayers in the top half of the income distribution to larger tax rates than they would face in rUK. (FAI)
Income Band | Band name | Tax Rate |
Up to £12,570 | Personal Allowance | 0% |
£12,571 - £14,732 | Starter Rate | 19% |
£14,733 - £25,688 | Scottish Basic Rate | 20% |
£25,689 - £43,662 | Intermediate Rate | 21% |
£43,663 - £125,140 | Higher Rate | 42% |
Over £125,140 | Top Rate | 47% |
(Refers to annual income earned in financial year 2023-2024)
Rest of UK Income Tax Bands
Income Band | Band Name | Tax rate |
Up to £12,570 | Personal Allowance | 0% |
£12,571 to £50,270 | Basic rate | 20% |
£50,271 to £125,140 | Higher rate | 40% |
over £125,140 | Additional rate | 45% |
(Refers to annual income earned in financial year 2023-2024)
The Personal Tax Allowance means that individuals earning less than £12,571 in Scotland and the rUK pay no income tax.
How exactly do tax bands work? A common misunderstanding is that in Scotland, a taxpayer earning £45,000 will pay the higher rate of 42% on all of their income. However, the rate of 42% is only paid on income ABOVE £43,663.
Scotland vs United Kingdom: To further understanding of the difference between tax bands between Scotland and the UK, use the UK government tax calculator to compare after-tax incomes if you were to live in Scotland or England!
The table below shows that the amount of tax that someone earning £45,000 p/year will pay differs if they live in Scotland or the United Kingdom!
United Kingdom | Scotland | |
Taxable Pay | £45,000 | £45,000 |
Income Tax | £6,484.20 | £6,934.70 |
National Insurance | £3,891.60 | £3,891.60 |
Total Tax to Pay | £10,375.80 | £10,826.30 |
Scottish Income Tax in 2023
In December 2022, the Scottish Government announced that income tax rates for higher earners would increase from 41% to 42%. This was announced in response to the cost-of-living crisis and their need to generate tax revenue to improve public services in Scotland. These policy changes meant that those earning higher incomes in the UK would pay more tax than they previously would.
The Fraser of Allander Institute explore in detail the income tax rate increase in Scotland, and assess the potential impacts it may have. Read more here:
Download the data used in this chart here:
Income Tax Liability Comparison - Scotland and rUK.xlsx9.7KB
How many Scots fall into these marginal rates?
Are Scots better or worse off under the Scottish or UK income tax bands?
To answer this, we need to compare the Total Income Tax Liability (the amount of tax owed for a certain income) between Scotland and the UK. In other words, for a given level of income, would you pay more income tax under the Scottish system or the UK system?
How to interpret this graph?
On the x-axis we have ‘annual taxable income’, which refers to total income before tax. On the y-axis we compare the total income tax liability (rUK minus Scotland), at each of those levels of income, under Scotland’s income tax system and the rUK Income Tax system.
Download the dataset used in this graph below:
Income Tax Liability Comparison - Scotland and rUK.xlsx9.7KB
The progressive Scottish income tax system means that 52% of total Scottish taxpayers will pay slightly less Income Tax in 2023-24 than they would elsewhere in the UK while higher-earners will pay significantly more (Scottish Government).
- Try it for yourself! Use this calculator to compare tax liability for different income levels in Scotland vs. rUK.
‣
Knowledge Checkpoint: Discuss the reasons why the UK government might change the levels of direct and indirect taxation, and the effect of this alteration on individuals and firms
Tax Flashcards
Check your knowledge of this section by viewing the flashcards below.