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Section 1 - How Much Local Income Tax Will People Pay?
1. This section explains our main proposals for how local income tax will be calculated.
2. Local authorities receive funding through a range of sources. The bulk of their funding comes from the Scottish Government in the form of grant. They also collect council tax and Non-Domestic rates (business rates) locally and they receive certain other income from fees and charges. They also receive some funding from the UK Government (such as Council Tax Benefit). Our aim is to replace the council tax by an alternative local income tax.
3. We want a local income tax, that is efficient, easy to understand and that will cut the burden of taxation, benefiting most people in Scotland. The actual amount you may be required to pay will depend on your personal circumstances, though you can get an idea of the amount of tax you will pay by taking a look at Annex A, which explains how you can work out the amount of local income tax you are likely to pay.
Personal Allowance
4. Under the existing UK income tax system each taxpayer has a "personal allowance", which is a tax-free amount of income. People who don't earn more than their personal allowance don't pay income tax. All income above the personal allowance threshold is subject to income tax.
5. The Scottish Government supports the existence of a personal allowance for a local income tax. Having a tax-free amount applied to the first part of income encourages people to work, and helps those on low incomes. It will also mean that many pensioners, students and others working part time or part of the year will not pay any local income tax at all.
6. We see clear administrative advantages to linking the Scottish local income tax personal allowance to the UK income tax personal allowance. This will make it easier to collect by the existing "Pay As You Earn" ( PAYE) and self-assessment systems. Matching the Scottish local income tax to the UK tax structure in this way minimises the administrative burden on employers and government. This should make implementation as quick and easy as possible.
7. Alternatively, the Scottish local income tax personal allowance could be higher or lower than the UK income tax personal allowance. A higher personal allowance could encourage people to work because they would not pay local income tax on more hours. However, it would also mean that fewer people would be paying local income tax. The fewer people there are paying local income tax, the higher the rate would need to be in order to raise enough money to pay for essential public services.
8. A lower personal allowance would result in more people paying local income tax, and would mean that the rate could be slightly lower than 3%. However, a lower personal allowance could lead to financial difficulties for those on the lowest incomes because they would pay local income tax on more hours. On balance we think the Scottish local income tax personal allowance should mirror the UK income tax personal allowance.
The Local Income Tax Rate and Bands
9. We propose that people pay 3% on all their income (except income from savings and investments) over the personal allowance. We think that a flat rate is the best way to raise funds efficiently and fairly without placing a large administrative burden on employers, and without compromising our goals of encouraging economic growth and entrepreneurship. A single rate across Scotland would provide certainty and consistency.
Other Kinds of Local Income Tax
10. A single rate would not be the only way to introduce a local income tax. It would be possible for local authorities to set their own rate for local income tax, and for this to apply to those who live in their area. This is the position of the Scottish Liberal Democrats and we would be interested to hear views on alternative approaches such as this.
11. Councils could be given the power to set any rate of local income tax they choose, or the power to vary the rate within a defined range. This level could be within a range - for example, 3% plus or minus _%. A more limited power to vary the LIT rate, similar to the Liberal Democrat proposal, might be introduced. For example, a rate of 3p could be set and local authorities could be allowed to vary the tax rate BELOW this level, but not ABOVE it. This would allow for a degree of local variation while not breaking our commitment to a LIT rate no higher than 3p
12. A local income tax set by councils could have advantages. In particular, local authorities would have the power to determine the tax paid by their residents and vary the rate they charged to increase or decrease their own financial budget. When residents voted for their local councillors, they would do so knowing that their vote could directly influence how much local income tax they would pay.
13. In our view, however, the advantage outlined above is outweighed by the disadvantages. A locally variable rate would require extensive and expensive bureaucracy. This is because there would need to be a way of collecting up to 32 different variable tax rates from people living in Scotland, according to which local authority area they lived in. This could prove expensive and confusing for employers, councils and taxpayers.
14. There are also many different ways in which the tax could be structured. The tax could be capped for high earners, so that no one pays more than an agreed level. The rate could also be varied for those who are 'higher' rate taxpayers or it could be capped at a certain level, to be set by Scottish Ministers. We believe that the advantages of a simple, easily administered tax outweigh the benefits of any variations.
Income subject to Local Income Tax
15. We propose that earned income of the type currently subject to UK income tax should be subject to local income tax. This is income from employment, pensions and other sources of income. An illustrative list is at Annex B. It excludes income from savings and dividends and other types of unearned income, such as gifts or loans.
Income from Savings and Investments
16. Some people receive income through interest on savings in banks and building societies and other investments (please see Annex B for information). Some may argue for a local income tax on this income, but we are not proposing that this should apply.
17. Our main concern is that the cost of collecting a local income tax on these types of income may be more expensive than the amount of money we will raise, as recently concluded by an independent committee when they examined available evidence. Additionally, we want to encourage people to save for their future and invest in business in Scotland to promote economic growth. A local income tax on these types of income may discourage saving and investment.
Exemptions and Discounts
18. Other than the personal allowances for a local income tax, we do not propose that there should be any exemptions or discounts. We believe that any person earning enough to become liable for a local income tax should make a contribution. A complicated system of exemptions and discounts could lead to appeals and disputes between taxpayers and Her Majesty's Revenue and Customs ( HMRC), adding to the costs and bureaucracy of the new system. Reducing bills for some people in this way could mean that the overall local income tax rate would need to be higher than 3% in order to compensate.
Residency Issues
19. People who have to pay local income tax will be "Scottish taxpayers". We intend to define a Scottish taxpayer using the definition already in the Scotland Act. 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. Someone has their closest connection with Scotland during a year if one or more of the following applies:
a) The number of days they spend in Scotland equals the number spent elsewhere in the UK;
b) They spend a part of the year in Scotland, and their main UK home is in Scotland and used as a residence;
c) They are an MP for a Scottish constituency, an MSP or a member of the European Parliament for a Scottish constituency.
20. In practice this means that where a person's main home is in Scotland, but they spend more than half of the year living outside of Scotland, they may be liable for a local income tax. In addition, where the period of time spent in Scotland in the year is more than the period of time spent in the remainder of the UK, the person would be liable for local income tax.
21. Alternatively, local income tax could be linked to the proportion of the year a person lives in Scotland. In our view, that approach appears to build significant and unnecessary bureaucracy into the system.
Transitional Arrangements for Individuals
22. Most households will pay less under our local income tax proposals than they currently pay under council tax, but a minority will pay more. One way of making this change easier for those who will pay more would be to phase in their higher payments so that they would have more time to adjust. This type of phased approach is known as "transitional arrangements" and has been used elsewhere, such as in the Non-Domestic rates system. Phasing in the increases costs money because those making reduced payments will be paying less tax. This can either be paid for by national government, or by phasing in the changes for people who will pay less over the same time period.
23. We do not intend to introduce transitional arrangements. This is because we think the current council tax system is fundamentally unfair, and transitional arrangements will just continue this unfairness. We believe that transitional arrangements will result in richer people paying a reduced share of the total taxation bill at the expense of poorer taxpayers. We do not think that either government or other taxpayers should subsidise those who should rightly be paying more.
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