So far this year, we’ve already seen a new government formed in Scotland, albeit under the same leader, and yet another new Prime Minister move into 10 Downing Street.

They may represent different parties, but both men are dealing with very similar challenges when it comes to the sustainability of public finances.

Scotland has a projected fiscal gap of £4.8bn by 2029/2030. Meanwhile, between now and 28 October there will be all manner of speculation about what will appear in the first Budget of Andy Burnham’s government. How will Chancellor John Healey raise more money for investment in public services, but also deliver on a promise to substantially increase defence funding? And will that mean reassessing the rates of tax paid by the better-off?

The question of tax divergence has come into focus this summer as the two governments currently have different policies on income tax, with Scotland’s top rate set 3% higher than in the rest of the UK at 48%, and an ‘advanced rate’ of 45% on earnings above £75,000 but below the top-rate threshold.

A study carried out by Dan Neidle’s Tax Policy Associates, published in late July, says, “Scotland’s increases in the top rate of income tax, culminating in the rise to 48% in April 2024, may now be costing Scotland around £22m of lost tax in its first year.”

While we could debate whether the true figure is £22m, or higher or lower, from an ICAS perspective we have long argued that the UK tax system is overly complex and that simplification is essential to improving compliance, reducing administrative burdens and supporting business confidence.

Simples

In this issue, we speak to Xero’s UK MD, Kate Hayward CA, whose customer base is overwhelmingly made up of small businesses. She says that a major issue for those customers is that the current system is too complicated. Tax divergence, of course, adds to that complexity.

We have been warning for several years that Scotland could be approaching a tipping point, where growing tax divergence from the rest of the UK begins to influence decisions about where people choose to live, work and invest. Potential behavioural changes include opting against promotion, reducing working hours, increasing pension contributions or even relocating to other parts of the UK.

Analysis suggesting the 48p top rate may have raised less revenue than expected underlines why that warning matters. Scotland simply cannot afford to treat tax competitiveness as a secondary issue if it wants to protect its tax base and support economic growth.

Tax policy can’t therefore be viewed solely as a means of closing short-term budget gaps. It must form part of a long-term strategy that supports economic growth, strengthens competitiveness and ensures Scotland remains an attractive place for talent and business.

“Proposals should be assessed not only on the revenue they are expected to generate, but also on their potential impact on taxpayer behaviour”

The Scottish government should look carefully at the evidence and assess the cumulative impact of tax divergence across all income levels – not just among higher earners.

As ministers consider future tax measures, they must balance revenue-raising objectives with the need to attract and retain talent, encourage investment and grow the economy over the long term. Any proposals should be assessed not only on the revenue they are expected to generate, but also on their potential impact on taxpayer behaviour.

Moreover, achieving financial sustainability needs a combined effort to address the scale of the challenge. It is not just about savings, taxation or reform. It is also about a sustained long-term approach to set the policy direction, and agree choices about where to spend less and how to deliver the planned outcomes most effectively.

ICAS believes that the ambition for a strong, sustainable and effective Scottish public sector needs to be articulated and supported by a coherent long-term ‘whole of government’ strategy which integrates economic growth, tax, fiscal sustainability, public sector reform and public service strategies to present a coherent and consistent direction. It would also support prevention-based plans which require sustained multi-year investment, whole-system thinking and outcome measurement across sectors.

This needs to be done quickly to achieve consensus and enable people to understand how they can support the vision, to see what reform looks like and the level of support needed, and for this thinking to be reflected in public sector strategy.

It’s a finely balanced judgement. But if we’re to do what’s best for Scotland – and the rest of the UK – we need to start seeing around corners, not just looking for short-term solutions.

Read ICAS Director of Tax Katie Close CA: “What is wealth tax? The Scottish perspective”