Swinney tax plan's missing £700m

JOHN Swinney, the finance secretary, took the biggest gamble of his political career yesterday – staking the SNP government's fate on a new tax that will hit middle- to high-income earners across Scotland.

Unveiling his plans to replace the council tax with a local income tax (LIT) – to come in just before the next election – Mr Swinney insisted he was not targeting hard-working families.

But the plan immediately ran into opposition from an unlikely alliance of Labour, the Tories, the business community and some unions, as the new tax already has a potential black hole of more than £710 million.

Mr Swinney admitted LIT would not raise as much as the council tax, leaving a shortfall of £280 million a year that the Scottish Government would have to find.

Yesterday, he could not say where that would come from, and conceded that he was relying on getting back £400 million a year from the UK government in council tax benefit – a move Westminster has rejected already – to make his sums add up.

In addition, it will cost at least £30 million a year to collect the tax, and that is if Her Majesty's Revenue and Customs can be persuaded to change its stance of collecting only national taxes.

Mr Swinney said the new tax of 3p in the pound on all earnings above £5,435 would be fairer than the council tax as it would be based on ability to pay.

He said many more Scots, including pensioners and the low-paid, would be better off with LIT and that only the highest earners would pay more.

"The vast majority will be better off and the local income tax will benefit most those earning the least," he said.

The finance secretary claimed that 80 per cent of Scots would either be better off or see no change in their bills, with only 18 per cent worse off. He added: "These proposals represent a reduction in the tax burden on Scotland. That will be welcomed across Scotland and is a key part of our plans to create a wealthier and fairer nation."

The Scottish Government published projections forecasting that only households with earnings of more than £70,000 a year would be worse off.

However, independent research by the accountancy firm PricewaterhouseCoopers (PwC) for The Scotsman revealed last night that there would be many more losers under LIT than the Scottish Government has predicted, and that hundreds of thousands of middle-income earners in all parts of Scotland would be worse off.

PwC broke down the wage levels by individual council tax bands – something Scottish Government projections failed to do – to give a more detailed picture of the winners and losers.

It found that single people in average Band D homes earning more than £35,000 would have to pay more, and that those in more expensive Band G homes would pay more if they earned above £53,000.

It also worked out that couples in Band D homes would start to pay more once their combined income hit £49,000, while couples in the more expensive Band G homes would pay more if their combined income totalled £75,000 or more.

Iain McMillan, director of the Scottish CBI, warned Mr Swinney and Alex Salmond, the First Minister, that their plans would "torpedo" attempts to create an enterprise economy in Scotland.

"Higher levels of income tax in Scotland will send the wrong message to people in England and overseas about Scotland's tax regime, because Scotland's effective basic and higher rates of tax will be the highest in the UK," he said.

Warning of the potentially disastrous effects on the SNP at the next election, Mr McMillan added: "They should be mindful that those who gain will have short memories – those who lose will have long memories, and there will be many of them."

Wendy Alexander, the Scottish Labour leader, described the LIT plan as a "gift to the super rich", because it did not tax unearned income.

She said: "It will make Scots workers the highest taxed in the UK. This 'Scottish jobs tax' will hit the pay packets of every hard-working Scot.

It will also inflate house prices and make it even harder for first-time buyers to get on the property ladder."

And Derek Brownlee, the Scottish Tories' finance spokesman, added: "The really damaging thing is the signal this sends out that we would be the highest-taxed part of the UK.

"That would be disastrous in terms of attracting workers and trying to get Scots to return, particularly when we compete internationally and with the rest of the UK."

"This would be really bad for the financial services industry in Edinburgh, and we don't want to be putting obstacles in its way."

Matt Smith, the Scottish secretary of the trade union Unison, said ministers would either have to set the new tax at 6.5p in the pound, not 3p, to generate the same amount of money as the council tax, or they would have to be prepared for cuts in services.

He said: "The introduction of a further tax on wages will either make many families worse off, or lead to cuts in public services. The government can't have it both ways."

Professor James Mitchell, of the politics department at Strathclyde University, said he found the SNP's move towards LIT perplexing because the Scottish Government had previously done so well in targeting "middle Scotland".

He added: "There will be a section of middle-class Scotland which will lose out and, given that the SNP managed to appeal to people across all classes at the election, they are in danger of alienating a significant body of people at the next election.

"While these people are not likely to be Labour voters, there is every reason to believe they may go back to a revived Conservative Party."

SWINNEY UNABLE TO GLOSS OVER THE CRACKS WITH A LOW-KEY LAUNCH OF POLICY THAT LOOKS SET TO FAIL

WHEN John Swinney handed out copies of his consultation paper on local income tax yesterday, something wasn't quite right.

The 50-page document was stapled together on one corner, there was no glossy cover, no colourful folder – nothing, in fact, to suggest this was a key policy announcement by the Scottish Government.

It was almost as if the finance secretary didn't really believe the policy would ever get approved and was merely going through the motions, politically, of launching an initiative which he knew was destined to fail.

After all, it is now clear that there are so many holes in this policy package that it is the political equivalent of a mosquito net.

The first big one is financial – the quite startling black hole of £700 million – £400 million of which the UK government will not return in council tax benefit and £280 million in the shortfall from existing council tax payments, as well as collection costs.

Then there is the lack of aid from Her Majesty's Revenue and Customs, the opposition of a majority of MSPs and huge questions over the collection of the tax.

Mr Swinney had to introduce this policy because it was in his party's election manifesto and it was in the manifesto because SNP activists voted for it. It may be "fairer" for many voters, but it will damage Scotland's economy, and Mr Swinney knows that.

There is a feeling at Holyrood that the Scottish Government is waiting for this one to fail so everybody else, particularly the UK government, can be blamed. That way, Mr Swinney can keep the party on side, blame the UK government and protect the economy – not that he would ever admit it, of course.

Q & A: TAXING QUESTIONS

Q: What does the SNP mean by a local income tax?

A: A direct replacement for the council tax. Every earner who currently pays income tax would have to pay an extra tax on their earnings. It would be set centrally at 3p on the basic and higher rates of income tax.

Q: How would it be collected?

A: The Scottish Government hopes Her Majesty's Revenue and Customs will collect the tax and hand it over. HMRC has yet to be consulted and has shown no enthusiasm to get involved. If HMRC does not collect the money, the Scottish Government would have to set up a Scottish Collection Agency either as a public body or by inviting private companies to tender for the work. Alternatively, councils could be asked to do the collecting themselves.

Q: How much will this cost?

A: Ministers claim collection costs of £30 million a year if done by HMRC. That would rise significantly if done by a new agency. There are no estimates of that cost.

Q: How much will the income tax raise?

A: The SNP believes the local income tax will raise £1.7 billion, £280 million less than is raised by the council tax at the moment. That gap will have to be filled by the Scottish Government.

Q: Will it be shared out equally among councils?

A: Ministers have not decided whether the money should go to each local authority on the basis of what is raised in each area or divided more equitably among councils or even allocated on the basis of deprivation or need.

Q: Who would have to pay?

A: Anybody who is classed as a "Scottish taxpayer". Broadly, this is someone who lives in the UK for income tax purposes and Scotland is the part of the UK with which they have the closest connection during the year. In practice, it will probably mean people whose main home is in Scotland.

Q: What about companies based in England with employees in Scotland?

A: This is a potential problem as these firms might not co-operate with the new tax in the way Scottish companies will have to. But John Swinney, the finance secretary, said he hoped HMRC would help identify all Scottish taxpayers working for English companies and have their tax adjusted accordingly.

Q: What about unearned income?

A: The local income tax would only affect earned income. People who live off their investments will not be liable to pay the income tax.

Q: Could the 3p rate vary?

A: Yes. One of the options is for councils to be given the ability to set their own rates. This is what the Lib Dems want and the SNP might have to concede this to get the support it needs to get the policy through parliament. Householders in different parts of the country could pay different rates. Although the SNP wants to introduce a 3p flat rate across the country, there is nothing to stop future governments raising this. The 3p rate is not capped, unlike the so-called Tartan Tax, which is capped at 3p in the pound by the Scotland Act.

Q: When will it be introduced?

A: Scottish ministers believe it will be before the elections in 2011. However, this depends on the support of other parties to get it through Holyrood quickly, and the co-operation of Westminster and Whitehall, neither of which appears likely. Experts have warned it could take six years, or more.

Q: What about the money Scottish councils get at present in council tax benefit?

A: A big problem. At the moment, the Treasury provides £400 million in funding to Scottish councils in the form of council tax benefit, covering the costs of those who cannot afford council tax. The Treasury has said it will stop paying this if the Scottish Government scraps council tax. Scottish ministers believe the UK government has a duty to pay this money but, if it loses the £400 million, it will find it hard to balance the books. All calculations have been done on the basis of continuing to receive the £400 million.

Q: What about people with second homes?

A: Ministers intend to tax people with their first and second homes in Scotland in the same way they are taxed now, with full council tax on one and a discounted, up to 90 per cent, rate on the other. Under the new plans, householders would be liable to local income tax for their first home and would be charged a fee for their second home; the rate for this has not been set yet.

People with second homes outwith Scotland, say in England, would be able to choose which home they want classed as their main home. The rich would probably choose English homes for a main residence to avoid paying the local income tax in Scotland.

Winners and losers in local tax plans

Rhona Irving

CRUNCHING the numbers, it would appear most people in Scotland would be better off paying 3p extra in income tax rather than council tax.

However, there are some questions worth asking.

The obvious winners from local income tax would be pensioners. Under the current council tax system, it is often retired people who are affected most as they have low incomes, but are sometimes in large family homes in high council tax bands.

A local income tax system appears to balance this as the 3p provision cannot be used on savings and investments, so pensioners who have invested wisely will come out on top.

The higher earners will be the losers and, within that group, a potentially difficult issue would be people with second homes south of the Border.

A local income tax would be decided for most people according to their principal residence, and the simplest way to decide that would be on the address registered with the employer for tax and National Insurance.

There are a number of high-earners who spend a significant part of their week working in England and come home to Scotland at weekends. There are also people who work in Scotland and spend weekends in England. Many of these people own or rent a property in each place.

There could be a choice for them, depending on interpretation of the legislation, between stating that their main home is in England or Scotland.

Another complication will be the perception of international business looking to invest in Scotland. A regular question asked of tax advisers is whether Scotland has a different tax rate to the rest of the UK and, so far, the answer has been "no". An increase of 3p in the pound could be a disincentive, and it is a complex message to say we have higher income tax but no council tax.

There are several areas which would need to be ironed out through the consultation process. This is not to say a local income tax would not work, or that most people would not be better off, but it is not as simple to set up as it first appears.

• Rhona Irving is head of tax at PricewaterhouseCoopers Scotland.