Finance and Constitution Committee

Meeting date: Wednesday, November 30, 2016

Official Report 657KB pdf

---

Taxation Inquiry

Item 3 is evidence for our taxation inquiry. We will hear from Yvonne Evans, who is on the tax law sub-committee at the Law Society of Scotland; Alan Barr, who is a partner at Brodies LLP and an honorary fellow at the University of Edinburgh, although today he is speaking mainly in a personal capacity; and Professor David Bell, who is a fellow of the Royal Society of Edinburgh. I warmly welcome our witnesses. Committee members have received papers from each of them, for which we are grateful.

If a question is directed at one particular witness, the others should not feel constricted by that. If you want to contribute, let us know. We will try to make the discussion as free flowing as possible. Nobody wants to make an opening statement, so we will get straight into questions, beginning with one from Adam Tomkins.

I should say that I am also a fellow of the Royal Society of Edinburgh, but I am not a member of the working group that David Bell has been part of.

There is a very strong suggestion in the evidence from Alan Barr, the RSE and others that so far the use of devolved fiscal powers has been a bit disappointing and lacking in imagination. Do you all agree with that? If you do, does it reflect a failure of political imagination on ministers’ part or is it, perhaps more disturbingly, a reflection of a lack of capacity on the Scottish Government’s part?

It is a combination of the two. In the end, it is a matter of practicality. In relation to the devolved taxes there was a need to get legislation on to the statute book and to start collecting tax. That is a long and difficult process, so the understandable main route was to work on the UK taxation model that was there. In other words, the prime revenue-raising tax that is wholly devolved—land and buildings transaction tax—was based entirely on a stamp duty land tax model, and it was understandable that it was based pretty much on the UK model. I would not necessarily have started from there, but ministers did, and I understand the necessity of doing so.

Doing it differently would have required a much greater preparatory effort in terms of the economics of what the tax would raise and whether it would be attached to transactions at all, or even whether it should have been approached from an entirely different angle. That would have been harder and would have taken more time, so I understand why it was done in that way. Was it possible to do it differently? Yes, of course, but I fully understand why that did not happen.

A principle of a well-functioning tax system should be transparency. We should not expect things to change rapidly. If we move away from the current Westminster model of changing taxation at relatively short notice without having wide and informed consultation before that happens, we run the risk that the tax system will lose some credibility. I have not been particularly concerned that a small change has been made in the structure of LBTT, but we are certainly of the view that, as far as the approach to taxation is concerned, a transparent structure would involve wide consultation, and you cannot expect that to result in rapid changes in tax structure.

I agree with that. We do not want change for change’s sake. If there is going to be change, we want it to be considered and carefully thought out. Perhaps slow change is easier to manage, because certainty is a very important principle in tax. It is perhaps more manageable to start small.

There is a power on the statute book—section 80B of the Scotland Act 1998—that is not a Smith commission power but a Calman commission power. The provision, which was introduced by the Scotland Act 2012 and has been in force since 1 July 2012, gives the Parliament the power to create new taxes, but it has never been used and nobody ever talks about it. Should it be used? Should we talk about it? Would that be a way of having a more imaginative discussion about fiscal devolution?

Certainly, the easiest way to get more imaginative solutions would be to start from a new taxation base. Then you would not be trammelled by the Westminster model, either in the form of legislation or what it was attempting to tax.

There is a slight danger of taxation for taxation’s sake—the idea that we have a new toy in the box, so we are going to use it. That seems equally dangerous, but it would be possible if there was a policy or an economic desire to tax a particular thing. The policy of simply raising money might not be enough—tax is much used as an economic lever, so it could be done for both those reasons. However, I can understand why it is not being done: it is hard—these things are difficult.

I agree that we should be opening up the debate. We have had the opportunity for some time to discuss the structure of taxation in Scotland. We cannot do that without recognising that we are part of an existing UK structure that is incredibly complex. Finding a way through that to determine a different path for Scotland is in itself not something that can be done quickly or lightly.

We do not discuss charges very much, either. Taxation and charging for services should not be viewed as completely distinct. For example, local authorities charge a lot for long-term care. There are taxation alternatives to the charging route, but these issues seem not to have been all that high profile in the public discourse in Scotland over the past few years.

I would support all those comments on new taxes or the amendment of existing taxes. We can point to plenty of problems with existing individual taxes that the Scottish Parliament would have an absolute opportunity to reform for the better if it got hold of them.

On the whole tax system, however, it absolutely adds complexity if we have extra or different taxes for taxpayers in Scotland.

It is a policy thing to start with. You have to decide whether taxes are to be used as a means of discouraging or preventing people from doing things by making them more expensive. Alternatively, there is an opportunity. Governments need money, and there is a source of money that can be raised—that will be a reason for a new tax. Sometimes those things happily coincide, but they are separate considerations.

I have one more question. You should feel free to disagree with one other where you want to.

On opening, general principles, so far as I can see, nobody has mentioned the great constitutional principle that there should be no taxation without representation. Is that not a principle of Scottish taxation that we should adhere to? If it is, one question is what the justification is for business tax when businesses do not vote. Another question is whether we are confident that we have got right the relationship between the tax base—and the definition of “Scottish taxpayer”—and effective representation in Scotland.

I do not think that I agree with you on the point that businesses do not vote. The owners of businesses vote. The shareholders, the employees and all the people who economically derive benefit from businesses have votes. It is hard to see how you would give entities a kind of supervote for their representation in any working form of democracy. On that constitutional question, we are as good as we can get. Entities do not have separate votes, and they therefore do not have direct representation.

The question about the Scottish taxpayer base is a difficult one. In a mobile situation without hard borders it is extremely hard to tie it down. The one thing that surprises me—and it is not possible to deal with this in the current devolution settlement—is that rental of land in Scotland will be taxed according to the location of the taxpayer, not the land. That strikes me as somewhat anomalous, given other policy initiatives in relation to land in Scotland. Otherwise, the tax is tied to the person, rather than the place, although the person must be tied to the place by some method or another.

My difficulty with how that is being done is that for a pretty small number of people the situation is uncertain. For most people it is very certain: they have one home location, which will define them as Scottish taxpayers or otherwise. However, for a very small number of people—ironically, it is probably those who have the most to gain or lose from flexibility—there is some uncertainty. The definition that has been adopted is the slightly woolly description of home for a Scottish taxpayer, which has also been carried over into an element of the LBTT legislation. I find that somewhat strange, because it is such a vague definition—it is basically centred on where your home might be. That taxpayer base may change in due course.

I agree with that. The definition of “home” is inconsistent across different capital taxes, including LBTT, and charges. It would be helpful for you to think about that carefully and consider what you are trying to achieve and whether the tax is achieving that.

I have a supplementary question. I am glad that Adam Tomkins has given us all permission to disagree with him—I will bank that for future use.

I thought that he had effectively confirmed that he was supporting votes at 16.

I was surprised at the idea of giving votes to businesses—that sounded more like a 2 am Donald Trump tweet than something from the usually calm and intelligent professor. [Laughter.]

However, Adam Tomkins was right to say that there are pre-existing tax powers that have never been used. This goes back to 1999: the Scottish Parliament has always had the ability to levy a wide range of taxes on any tax base that it wants to use, as long as that tax is being raised for local services.

There has been a reluctance to go beyond the consensus that the council tax is a bit rubbish and a bit of a broken system, and take action. Is it worth suggesting that underlying everything that we say publicly is an unspoken principle, which is that we take the path of least resistance and do what is politically easiest? I know that we will go on to discuss what the principles should be, but is there an unspoken principle that is preventing us from taking political action, even when everyone privately agrees that it is necessary to do so?

I am inclined to agree with you. The conclusions of the Burt review, for which I did the analytical work, were dismissed almost before they hit the press. Subsequent events in relation to council tax have suggested that a very small c conservative approach has been taken to its reform. It is a political problem, rather than an economic one, but it seems to me that Scotland has not been all that radical in its tax approach, particularly in relation to the taxation of property.

There is a danger that any new tax is simply grafted on to the current system. To be truly radical and get acceptance would require a starting point that asks, “What are we going to get rid of before we come up with something new?” It is really difficult to do that, because one has to calculate exactly what the current approach raises, consider whether more or less is needed from what will replace it, and, in political terms, think about which geese will squawk loudest because more feathers will be taken from them than was the case under the previous system.

11:00  

All that is difficult stuff. If one has tax powers, including the power to introduce new taxes, the temptation is simply to say, “Let’s put a new tax on peanuts, or fizzy drinks”—or something else that has its political reasons. That creates a layer of additional complexity in what is the most ridiculously stupid, complex tax system in the world. At the moment, the Scottish element of the system is just another layer of complexity for people who are in Scotland—and if powers were used radically in relation to local authority residents, there might be yet another layer of complexity in a fundamentally stupid tax system. To introduce a Scottish addition to the stupidity just because we can does not seem to be a good way forward.

Well. Silence has followed that.

The suggestion was that Scotland has not been tempted to make changes. You said that there is a temptation to add complexity. When we consider the scope of devolution from 1999 onwards, it seems to me that there has been very little giving in to that temptation—

I agree with you.

In fact, we have retained outdated and dysfunctional systems.

Whether or not they are outdated and dysfunctional, I think that they have been retained because that was the path of least resistance, as you put it. That is understandable, because to make different decisions is hard. It also requires a lot of preliminary work, and this Parliament is not so old as to have done the necessary preliminary work.

It strikes me that there is a tension here in relation to the ability to make radical reforms. Income tax will be our biggest area of tax take for the foreseeable future. In the submissions, everyone talked about procedural fairness, transparency, keeping compliance costs low and so on. How feasible is it radically to reform income tax, when HM Revenue and Customs will continue to administer the process and radical reform would require the Scottish Government to put up significant money to pay for the change? How radical can we be on income tax, in reality?

There are the administrative costs that you rightly identify. There is also the intermingling with the tax system in the rest of the UK, so there might be a behavioural response if we were to go for radical change in the bands and the rates, and the interaction with national insurance, which is another form of income tax in all but name.

There is also the fact that a lot of radical reform might involve changing the tax base, which Scotland does not have control of. It seems to me that radical change in respect of our largest source of revenue should be thought of as a long-term venture, rather than one on which we can embark relatively quickly without going through the necessary analysis, consultation and so on.

I do not think that it would be that expensive to be radical within the current confines. In other words, there is complete control of rates and thresholds, but there is only complete control of rates and thresholds; some of the other things that are talked about in relation to the tax base, such as aspects of the definition of a Scottish taxpayer, are not devolved matters. It would be relatively cheap to diverge radically from income taxation policy in the rest of the UK, but whether that would be desirable is an entirely different matter.

We are told that the greater the divergence, the more it would cost, but that is probably not true for rates and thresholds. Much more important, in terms of administration, it will be just as expensive to make small changes as to make large changes. In many ways, it might be worse to make small changes, because transparency would be lost. It is possible to be radical on such matters within the devolved powers but, given the mobility of the population, whether that is desirable is a very different matter.

I agree with that. You have very wide powers with rates and you can do what you like with them, but that is only part of the story. Not having control of the rest of the tax—expenses, reliefs and so on—will hold you back in terms of how you can shape and reform the tax more radically.

There was comment in some of the paperwork about people creating corporations in order to avoid income tax. Can you talk us through the dangers of that for us if it were to become a reality?

Yes, people could do that, but it is a constantly moving battlefield. A good example of the interaction in the way that it works is that people can take income from their own company in the form of dividends, which are not liable—and are not capable of being liable under the current rules—for the Scottish rate of income tax, however different that is. The up-front costs of converting businesses from sole trader or partnership status to corporations tend to be significant, so whether it is worth people doing that depends on the amounts involved. That illustrates the tension between the two systems. The taxation of dividends is an RUK matter; the taxation of earned income from the same company, same business or the same underlying economic activity is in the confines of the Scottish Parliament.

How sensible is that?

It is not particularly sensible to have that amount of separation. It is perhaps understandable with fluid borders.

Tipping points that are of interest in relation to the yield of income tax include the incorporation issue. There is also the employment/self-employment border. People might be encouraged to become self-employed even though their behaviour is similar to that of an employee in reality. That is one of the reasons why, as the chancellor acknowledged in the autumn statement, income tax revenues have fallen way below expectations for this fiscal year.

The other borders that are important are the hours border, or people working less as a response to higher income tax rates; the early retiral or withdrawal from the labour market border, which can happen if people respond adversely to higher income tax rates; and, as has been mentioned, people moving to a lower tax jurisdiction. Some might find it advantageous to take that route in order to avoid higher rates of tax.

I absolutely agree. The tax system creates a lot of situations in which taxpayers who seem very similar are taxed quite differently based on things such as employment status. That offends the principle of horizontal equity, as it is known. There is no clear policy reason for that and I have seen no justification that explains why it should be the case. It encourages taxpayers to choose tax motives for behaving in particular ways.

Again, most of what I was going to ask about has already been elucidated. On the question of people being mobile and being able to change their residency, how confident are you that the current arrangements with HMRC are tight enough to identify Scottish taxpayers?

Any tax system has to be used to identify tax connections with the people whom it wishes to tax. There are levels of that already, for example, with UK residency. Whether someone is a UK resident is a preliminary to whether they are a Scottish taxpayer, and HMRC’s ability to police that is reasonable. With regard to identifying whether or not someone is a Scottish taxpayer, I stress that the number of people who have a real choice in the matter is relatively small—

But they are relatively high contributors.

Yes, indeed—they would be.

Other than in a few cases, there is a move away from a very objective count-the-days test, which is way down the list in terms of qualifying or disqualifying someone as a Scottish taxpayer. Those vague notions may cause some difficulties in relation to people who are effectively based in Scotland but are able to create a base elsewhere. The extent to which the situation is policed depends on the resources that are put into it, and on how soon people are prepared to challenge the position and get tax cases on the board so that people know that, if they do a particular thing, they will not be a Scottish taxpayer, and if they do not do it, they will be.

If someone was caught as a Scottish taxpayer, the gain could be quite short term. If they knew that they qualified as a Scottish taxpayer, they could just counteract that by changing their practices to spend much more time in London or to address whatever element they had fallen down on in the test.

Murdo Fraser has a supplementary on this area.

The discussion on tax distortions and tax competition is interesting. There is quite a lot in the Royal Society of Edinburgh’s submission about the interrelationship between taxes in Scotland and taxes in the UK, given that we are in a single market and given the fluidity issues that we have discussed. How much evidence is there on the impact of differential tax rates in a jurisdiction such as the one that we are moving into? How much do we know about likely changes in behaviour?

We know a little bit—we know more at the international level than at the sub-national level. Some countries and localities that are right beside each other seem to manage quite successfully with different rates of income tax; Denmark is an example of that.

There are differences in countries such as Switzerland. I would need to go back and check this, but I think that the evidence is less clear as to the potentially negative effects of people taking actions for tax motives in that jurisdiction. There is a mixture of evidence, and my feeling is that one has to be pretty wary about applying international lessons from other jurisdictions to the UK and indeed to Scotland. That is partly because the UK has one of the most fluid labour markets in the world, as evidenced to some extent by the huge increase in employment over the past few years. A lot of the countries from which one might draw evidence do not have that level of fluidity, and that is very important in relation to income taxation.

I can offer only anecdotal professional evidence that what people do in response to tax rates is, I think, surprisingly limited at the edges. If a tax rate is regarded as penal, they will take action if it is possible to avoid it. A differential of 1p in the income tax rate might have very little effect, whereas a differential of 5p or 10p—again, ironically, disproportionately very few people would be affected by that—is much more likely to have that kind of effect.

My evidence would come from capital gains tax, where people who end up paying a rate of 10 per cent because of rules allowing them to do so are much more willing to say, “We’re not going to change our lives. We’re not going to move abroad for the necessary period in order to make that disposal.” They will not uproot themselves at that kind of level, whereas, if the tax was higher, they would do—and have done—exactly that.

11:15  

I agree with those comments.

Alan Barr talked about the potential for a much more radical departure in tax policy in Scotland compared to the rest of the UK. In reality, how much freedom of operation would any Scottish Government have, given the issue that we have just talked about?

That assumes that the taxation is always tied to the person rather than to other things, such as consumption, land and things that are less easy to uproot. The person is only one connecting factor. It is the most important, but there are other connecting factors, such as location of business enterprises or companies. Some of them are silly, in a way, such as the nameplate effect on low taxes. With others, though, you could make a much stronger connecting factor than the person, if you wanted to do that radically. I just say “could”; I am not saying “should”.

We are covering some quite interesting areas here, but the purpose of the session is to discuss the principles and the high-level issues. Let us try to get back into that if we can.

A number of the submissions mentioned the concept of simplicity. The Royal Society of Edinburgh’s submission said that the UK tax code is one of the most complex in the world, and Alan Barr has just referred to that, too. I believe that the UK tax system runs to thousands and thousands of pages and, unfortunately, is riddled with loopholes, which allow people to use the tax system to benefit themselves. I do not think that anybody would seek to replicate that in Scotland, but that is the context in which we are situated.

We recently took evidence from Revenue Scotland, which has just had its first year of operation. Many people who gave evidence on that said that they felt that the system is quite simple and easy to use and that there are good lines of communication. When you talk about simplicity, do you mean the tax code itself or the operational side? Will you explain a bit further?

All of those things are important for simplicity. It is not just about making the tax code shorter, although that can be helpful. The way that the legislation is written can also be helpful in reducing the need to change the legislation to close off loopholes. Alan Barr’s submission has quite a bit on how to frame legislation in a way that almost future proofs it and prevents it from becoming even longer further down the line.

When we talk about simplicity, we also mean administration. That is very important. Efficiency comes into it, too. That is the ideal. Should taxpayers have to go to a tax lawyer or an accountant to understand tax? That is a big issue in Scotland. Taxpayers just do not understand tax, and something that I am quite evangelical about is that it should be more transparent and readily accessible to them.

Let me give you an example. Revenue Scotland is absolutely right. Sticking to LBTT, for the vast majority of transactions, the system has worked well and is tolerably simple. We then had the introduction of the additional dwelling supplement, which is now creating a range of uncertainties. There are things that people—including, I suspect, the people who enacted the legislation—do not realise that it catches and that it should not catch. Therefore, people will do things to stop it catching those things.

That is a classic example. You start with a tax that taxes the purchase of a home—I am talking only about the residential side. That is straightforward, simple and extremely hard to avoid, so it ticks all the boxes. You then put a layer on top and it becomes complex and more difficult to deal with. We have absolute evidence of that with the additional dwelling supplement now, even in our comparatively baby tax system.

The other side of that basic notion of purchasing property and paying tax is when we move to more complex transactions that involve multiple or lease transactions or that kind of thing in the commercial world. As we discussed earlier, those tend to be the ones that can, or should, produce large amounts of tax, which is where the complexity comes in.

There are almost two distinct levels. The basic is fine and can be kept simple. It is when it gets more complex that you create problems, and the complexity sometimes comes from policy decisions. That is what has led to the situation in which, if I had brought the entire UK tax code, you would not be able to see me if it was arrayed in front of you—it is seven fat volumes of very closely printed pages.

Alan Barr gives an example of where the tax base has been extended to an extent. Our submission argues for wide tax bases that are easily understood, where tax rates can be kept lower and are therefore less distorting in terms of behaviour.

An example in the Mirrlees review concerns confectionery and where to draw the line, as far as confectionery is concerned, as to what does and does not attract VAT. I recall that the eye decoration of a figure made in chocolate had something to do with the definition of whether or not it attracted VAT. That is the kind of area where, eventually, people end up going to law, because commercial interests are involved. Dare I say it, with two lawyers beside me, but the whole thing then becomes slow moving and liable to—well, it requires clarity in the legislation, which is a point that has already been made.

You almost got out of that, David. [Laughter.]

You missed out expensive, as well. Maybe you did not wish to go there.

I see a conflict there, though. We are situated in an extremely complex system, so if we bring in a replacement tax or a different tax, we are already adding to the complexity, even if the new tax is simple and easy to use. There is a tension there, is there not?

There is absolutely a tension there, but sometimes the complexity comes from the policy. Again, I will give a UK example that was well covered in the press, which relates to film investment and film partnerships. We have all seen the tales of people—usually celebrities—investing in that and getting caught out by it. That started from an understandable drive to encourage actual investment in actual UK films. However, people—my profession is on the line in relation to this—saw that they could exploit it differently because of the lack of simplicity and were able to construct things that were no longer in line with the simple policy. That led to people investing who were not really investing completely in the films, which was the original, laudable intention. Therefore, it is a question of where the policy starts from. Is it simply to raise money or is to do other things? Those are very different policy aims.

I am sure that a lot of the exemptions and reliefs in the system—there are over 1,000—were well meaning at the time. It has just become so clunky, with so many of them. Of course, once we have put in place a relief, an exemption or an extension to something, it is politically very hard to claw that back.

Ivan McKee has a supplementary question before I come to James Kelly.

One of the benefits of talking about a subject like this is that it gives us a bit of space out of the day to day to look at the bigger picture, if you like. I suppose that the whole concept of principle is that it withstands the test of time. We were talking about Adam Smith’s principles and they have obviously been around for a wee while. If we look over the medium term, we have a moving feast in relation to what is devolved and what is not. That has changed at least twice in the last three or four years and I have no doubt that it will continue to change. That is even before we start talking about the constitutional question.

I would like to leave all of that to one side and go back to the principles. Do you think that the four principles are the right ones? Are there any that should not be there? Are there some that should be there that are not?

As a starter for 10, we have talked about simplicity, which has a huge bearing on at least three: certainty, convenience and efficiency are all impacted by simplicity. The other one that I would like to throw on the table for your thoughts is behavioural change. We often talk about that in a negative sense when we talk about how are people going to be mobile, and so on. Clearly, it is positive to use behavioural change for consumption taxes, for things that would otherwise cost the health service, to drive low carbon behaviour or capital investment, or to encourage people to employ others. The tax system can be used to drive a whole bunch of positive behaviours.

What are your reflections on whether the principles are the right ones?

There is certainly a case to be made for taxes that tax bads rather than goods. There is a question about whether we all agree about what the bads are and whether the state should be trying to influence our behaviour or what we consume or do not consume. I am not saying that I am on any particular side, but the argument has to be made.

The UK Government has taken fairly strong action on taxing the use of carbon, although it might have rolled back on that a bit recently. In general, I do not have a problem, although there has to be clear consensus around the tax, which would require consultation and transparency and involve many stakeholders in the design of the tax policy rather than just a small number of people in the Treasury or finance ministry.

The general principle is acceptable; inevitably there will be a push-back from whatever commercial interests might be harmed. It might also add to innovation. You might force airlines to adopt more fuel efficient planes or, as we have seen today, tobacco companies to adopt less toxic cigarettes. There might be a behavioural response as a result of taxing so-called bads, which is perhaps a good thing.

I do not think that behavioural effects come in to the principles as proposed. Whether driving good behaviour or stopping bad behaviour should be another principle is something to argue about. It would be additional.

To answer your original question on whether the principles are reasonable, I think that they are. They might be limited and affected by other things, but proportionality, certainty, convenience and efficiency, which are pretty wide words, are good principles.

Behavioural effects do not interact with those particularly well. If you want behavioural effects—stop doing bad, start doing good—that would have to be another principle, and large numbers might differ on what are the goods and what are the bads, and what effective ways of stopping or encouraging them fall within the other principles. I do not think that behavioural effects fit very well into a principled notion of taxation.

We should have such principles, and those are as good as any. Their long life and quotation over hundreds of years indicate that they caught something well. They are not complete, as Mr McKee has just demonstrated, but they are a good start.

11:30  

Mr Barr, is there anything that you would add?

I am not sure that I would, because that gets away from one of the principles and the terms of simplicity and certainty. Four is enough. Could we get to three?

Simplicity is not one of them—that is the point.

Yes, but there is no question that simplicity flows through quite a lot of them.

The Law Society does not have a particular view on taxing bads. One criticism is that it can be quite regressive, particularly when taxing things such as sugary drinks. That can be quite a regressive policy.

On the principles generally, as Alan Barr says, if you define them widely, particularly the ability to pay, and if you consider that in the round, they cover what you would want in an ideal tax system.

In your submissions you have emphasised the themes of certainty and efficiency in the tax system. There has bee a lot of commentary today among the press and in the committee about our new income tax powers. How does the system of allocation of income tax revenues to the Scottish budget fit with the principles, bearing in mind that, initially, it is based on forecast numbers? They feed into the block grant adjustment, and it is 18 months before we get the actual figures. Then, it is into the next financial year when the reconciliation is completed and the numbers are actually allocated. There is a time lag. There is much hype about the new powers today, but there will be a time lag of at least two years between the raising of tax revenues and the allocation of the precise figures to the Scottish budget. How does that fit with those principles of efficiency and certainty?

Those principles are based on the perspective of society as a whole. The issue that you are raising is to do with the Government’s budget process and how it is made more difficult as a result of those time lags, which are inevitable, given the structure of income tax, which is the main power that is being devolved.

There is a question about whether forecasting is accurate. Recently, we have seen that the OBR has been very optimistic about income tax revenues in particular. Therefore, my feeling is that the Scottish Fiscal Commission will have to consider carefully whether similarly optimistic forecasts for Scotland would make sense in the future.

There are borrowing powers to deal with the issue of forecasts that go somewhat awry—and it is possible for them to go awry in either direction, of course. Part of the implication of getting tax powers is that you have to take on additional risk. Things could go better or worse, but we have to accept that, with our new tax powers, the Scottish Government’s budget must face more risk than it has done in the past.

In direct answer to your question, I do not think that the process that you have described fits with the principles at all, but nor can it be expected to. The principles are to do with the relationship between the taxpayer and the tax-raising authority, whatever that authority is. The process of allocation comes after that stage has been reached. The goose has been plucked. What are you going to do with the feathers? It is a matter of extending the analogy between the various pluckers and that is not something that Adam Smith’s principles can properly address. Whether the process should be simpler and swifter is, of course, a matter of great concern and importance, and it probably should be, but if it cannot be, it cannot be. I do not know whether it can be or not.

I will press David Bell a wee bit further. It is not just a question of the numbers that end up in the budget. It is pounds and pence and it affects peoples lives. We can take it down to the level of a council having to decide on a budget that might impact on jobs and services. I accept that it is a complicated process—it is not straightforward. How could the process be speeded up to allow accurate figures to be allocated to the budget more quickly?

The issue here is to do with tax receipts and HMRC, and it is partly to do with people who submit tax returns after the year end and might not actually pay until 12 months after the year end, effectively. That inevitably introduces a delay before the full accounts can be drawn up. Whether that process can be speeded up I do not know, but HMRC probably could not do it just for Scotland. It would have to be a change affecting the UK as a whole, and I suspect that many interest groups would like the process to be as long as possible—principally those that may have to pay up.

Within the current constraints under which HMRC is operating, there does not seem to be an obvious way to speed up the process. There might be ways to introduce more evidence as the period progresses. For example, could HMRC make all the PAYE returns, or their value, available to the Scottish Government so that it would at least have that part of income tax information available to it? It could do that almost immediately, I think.

I am not sure how it can be done, but there may be tweaks that might improve the system. A borrowing facility has been put out there, and it is meant to cover errors that could ultimately be derived from the forecasts.

I understand what you are saying about HMRC. As I understand it, once it completes its stage of the process, a reconciliation takes place around the 18-month mark. Is there value in considering how that could be carried out quickly in order for the allocations to take place in that financial year, instead of waiting until the next financial year—say, by means of the autumn budget revision?

There might be. There might be ways of collecting survey evidence on people’s income tax payments. There are almost in-year calculations that could be done. We referred to problems concerning survey evidence in relation to VAT. There might be a way of collecting survey evidence in relation to income tax and VAT.

HMRC has an ambitious—some say too ambitious—programme called “making tax digital”. It is directed at those uncertainties and the delayed payment of tax to some significant extent. It will take a while to bed in. As I say, quite a lot of people think that HMRC was a little bit ambitious in demanding that information up front. To the extent that the programme comes into effect, it will have the effect of knowledge being conveyed and perhaps payment being made much more quickly than would be the case with the kind of delay that David Bell was talking about.

Once that programme has bedded in, the information at least should be available from that source. That might then have a knock-on effect—or knock-back effect, if I can call it that—on timescales because of the necessity to wait for the year end, and a time after the year end, because the information will be available earlier.

We have about 20 minutes left for members to ask questions.

I hope to complicate things even more by talking about corporation tax, which Professor Bell’s submission mentioned. As you know, the UK was—and may still be—planning to give Northern Ireland a reduced corporation tax rate. Then Brexit happened and the UK suggested that it might lower the UK rate, which must have delighted our friends in Northern Ireland. Is there a case for a variable corporation tax system in the UK, so that Scotland is not at a differential disadvantage to Northern Ireland if Northern Ireland gets a reduced corporation tax rate?

We have mentioned the possibility of people doing things for tax motives, which we try to avoid if possible, because it moves economic activity from where it may be most efficiently located to somewhere else. The Republic of Ireland has had a significant advantage economically in recent decades because it has managed to get people to move there for tax motives, which has left the UK in a somewhat difficult position. If the UK reduces its rate to 15 per cent against Ireland’s 12 per cent, the band between the two will become fairly narrow. Whether it will become sufficiently narrow to make moving location not worth while—there are costs to moving—remains to be seen.

I suspect that most countries think that corporation tax is not ideal to drop down to the sub-national level, particularly for the reason that I have given, although that happens in the States and elsewhere. I am not sure where Scotland could advantageously locate itself in the space between 12 and 15 per cent.

I think that the UK has said that it will not go below 17 per cent, which would be quite a differential advantage for Northern Ireland, particularly with Brexit happening. Scotland would be at a further disadvantage to Northern Ireland if Northern Ireland had something like a 12.5 per cent rate, comparable to that in the Republic of Ireland, and we were stuck at 17 per cent.

We have lived with such a disadvantage for some time. While there is some evidence that companies are willing to move to Ireland, I am not sure whether the evidence suggests that Scotland would be similarly affected if it managed to have a similar rate to Northern Ireland. It is possible that that could happen.

Corporation tax is a difficult issue, because a company’s location is not necessarily the end of the story about the rate of corporation tax that is paid—hence the huge press coverage of Google, Facebook and other entities whose economic activity happens in different places from where the company is resident in any legal sense. Without an extension of powers to cover that, exactly what would be taxed in Scotland would, ironically, be open to the same kind of—what is perceived as—abuse, when profits are directed to a place where the rate might be lower, if that is possible to do.

Defining corporation tax by the residence of the corporation is only part of the story, and it may be the smaller part of the story if the differential between rates is greater.

11:45  

Northern Ireland thinks that it will benefit by—

Sorry—we have done quite a bit on that. Yvonne Evans wants to come in.

The Law Society does not tend to comment on particular rates, but we generally agree with the points that have been made. On tax competition, you do not want to trigger a race to the bottom because then everyone loses—that is one point to consider.

On you go, Willie.

From what I have read, it seems that Northern Ireland thinks that it will benefit by £4 billion a year and 32,000 jobs if it reduces the corporation tax rate to help it to compete with the Republic of Ireland. Is there no advantage for Scotland in having a similar model? Otherwise, the reverse effect could happen, as we would be in direct competition with Northern Ireland.

I am not sure where those numbers come from. As has been said, economic activity is not necessarily associated with the location of the payment of corporation tax. I am not sure whether, at present, those figures can be treated as a credible set of statistics.

On another occasion, there will be time to challenge the assumption that ever-lower corporation tax is of benefit, given that decades of continual cuts to corporation tax have driven the level of inequality that we see in society. Sadly, that will not be discussed today.

On the principle of proportionality, I will ask about one comment in the RSE paper. The Scottish Government uses the phrase

“proportionality to the ability to pay”,

but the RSE’s submission—along with submissions from others, including the Poverty Alliance—uses the term “distributional fairness” instead. I see what the intention is, but I wonder whether the use of the word “fairness” is open to criticism for not being sufficiently specific, given that quite a lot of very wealthy people think that it is fair for them to dodge tax through every loophole that they can use to do so.

We were a bit dubious about using the term “proportionality” because the concern was that it might be taken to imply a strictly proportional tax, which is not a progressive tax. In terms of equity, the ability to pay is a concept that is quite difficult to define, partly because most people take it to relate directly to income. That definition ignores wealth, which is an important component that people may have that affects their ability to access goods and services.

Increasingly so.

There is then the question about how we assess equity. The Scottish budget includes an equality impact assessment, for example. We think about equalities mostly in terms of the effect on individuals or households, but there is a case for looking—as the equality impact assessment does—at certain groups by gender or age, although the Scottish Government has not in the past done all that much on the latter aspect.

We were a little concerned about a strict definition of the term “proportionality” and we wanted to think about distributional equity in the round.

Would one way of framing the principle be that the tax system should seek to reduce or limit wealth and income inequality?

That could be one objective—a distributional motive for the tax system is certainly there and it could be argued that it is a key purpose of the tax system. However, there are other objectives that tax systems typically try to invoke, one of which is stabilisation, which means using the tax system to keep the economy on an even keel. The tax system might also be used to support growth.

Some of that applies to the other principles; I was just asking about a way of framing the question about proportionality.

Yvonne Evans mentioned horizontal equity, which I had not heard of before. Will you tell us more about what lies behind that? It is slightly different from other things that we have heard about.

Let us say that we have two taxpayers who have similar incomes, but one is self-employed and the other is employed. Under perfect horizontal equity, those people would expect to be taxed in exactly the same way, but that is very much not the reality in our tax system when we look at how those two taxpayers would be treated for income tax and national insurance. We also have vertical equity, which is to do with progressivity in the system.

Ivan McKee raised the issue of other policy objectives, such as behavioural change, being driven by taxation systems, which Alan Barr discussed. As I understand it, the efficiency principle relates to the idea that the system should minimise negative effects on welfare and economic efficiency. Rather than adding a principle, which I think was Alan Barr’s concern, surely the way to capture that is to seek to maximise social, environmental and economic benefits from the operation of the tax system. Would that capture what is being sought without adding complexity?

That sounds to me more like a policy than a principle, in that the tax system may be a lever to do those things, but whether we want to do them in a principled way is determined by policy. What you said about wealth inequality struck me more as policy driven than principle driven. The policy may well be to reduce wealth inequality—that is a perfectly reasonable policy—but the principle on which that should be done is much more likely to involve actual proportionality, for example, as a principle of doing so rather than an absolute—

Surely if the principle is proportionality to the ability to pay, that hangs on a policy assumption that that is a good thing.

It does, but that does not necessarily reduce wealth inequality. The fact that the richer, or those with the greater income, can pay a great deal more and should, under that principle, pay a great deal more, does not mean that that will necessarily reduce inequality in any absolute sense.

David Bell’s paper gives an example of other objectives, too, and mentions the carrier bag charge. Few people would disagree with the claim that the approach of successive Governments to the taxation of cigarettes has been socially beneficial and that it has been intended to achieve a change in behaviour and not necessarily an increase in revenue. There seems to be a question about the principle of the operation of the tax system that is implicit here rather than explicit, and the question is simply whether we should make it explicit.

The issue relates to generality in the tax system rather than raising a tax specifically from people who gain a benefit from a particular public service. Some people make the case for such hypothecation, but others say that it is important to the cohesive nature of society that tax tends to be general rather than specific. Is it important to get those principles stated rather than having them hanging around in an unstated way?

That is a good point. In considering the behavioural effects of the taxes that one might apply, it is important to keep bearing in mind acceptability.

Hypothecation is an interesting issue with regard to the political acceptability of changes that can be made to the tax system. Increasingly, politicians think that such changes will be acceptable only if we hypothecate for a specific public spending objective, whatever extra revenue is raised.

The UK Treasury has always tended to avoid hypothecation and has argued that it ties the Treasury’s hands. There are serious dangers in having a large chunk of the tax system specifically hypothecated for particular purposes, because—who knows?—public priorities might change through time and people might wish to do other things.

In the short run, hypothecation probably helps with the acceptability of changes to taxation. For example, we can see clearly that the additional revenue from the increase for some council tax bands will be hypothecated to the education budget. That raises all kinds of questions that I do not have time to go into, but it is clear that such hypothecation carries a political risk as well as a potential gain.

I acknowledge that.

Does Alan Barr want to respond?

We sometimes understate the pure revenue-raising effects of some behaviourally driven taxes. If they were entirely behaviourally driven, they would be set at a prohibitive level and aimed at stopping people doing things or restricting those things to a very low level. However, the revenue raising of the sin taxes, if I can call them that—those on fuel, gambling and that kind of thing—is extremely important in a mixed tax system. That might be a slightly cynical suggestion, but that revenue raising is an important part of what the taxes do. If the taxes were truly behavioural because something should be banned, it should be banned.

Patrick Harvie can come back in quickly; I must get Dean Lockhart in.

I have one final question—I know that we are tight for time. It is on the principle of transparency. It seems to me that there should be transparency around not just how the system works but what it is for. The only communication that I, as a taxpayer, have had from any level of government about what my taxes are used for is a flyer from the council that comes with my annual council tax bill; it usually has a picture of a bin being emptied. If we want people to have confidence in the new Scottish approach to taxation, should not the Scottish Government spend some time thinking about how it communicates to individual taxpayers what it is trying to achieve through taxation and, more particularly, why it is doing that—for example, by showing how taxation relates to the challenges that we face collectively as a society?

I tend to agree with that point. I alluded earlier to the way that the UK has done things for the last goodness-knows-how-long, which I do not think is a very good way of defining or setting our tax system. Some time ago, Neil Warren from the University of New South Wales gave evidence to the committee, and I was particularly struck by his reporting of the system that is used in New Zealand, which seems to be much more encompassing. Changing the tax system there involves various stages: strategic, tactical and operational. At the strategic level, large numbers of stakeholders are involved in the process so that they can better understand not only the gains but the potential costs that are associated with significant changes to the system.

I agree, as long as one does not get too hung up on the tax system or devote very large resources to operating it, and it does not get used as a political football. If it goes slightly wrong, that should not be the end of the world. That kind of transparency is extremely important and will be helpful in encouraging people to accept the taxes. In the end, a tax system must be acceptable to those who pay the taxes.

12:00  

I will be boring—I agree with Alan Barr and David Bell. Every year, HMRC sends out a statement, which contains a pie chart, that tells the taxpayer broadly where their tax has been spent. That has been criticised because it covers only income tax and national insurance and does not really explain where all the tax is going. There has been some attempt in that respect, but we would welcome more transparency.

My question relates more to technical aspects than to principles of taxation—it is on the correlation between GDP growth and tax take by the Scottish Government. Professor Bell, at paragraph 22 of your submission you state:

“The make-up of the tax base for Income Tax in Scotland is noticeably different from that of”

the rest of the UK. You go on to note that

“In Scotland just 0.7% of taxpayers ... pay the Additional Rate of Income Tax compared to 1.1% in the UK as a whole.”

Does that mean that the same level of GDP growth in Scotland might result in lower tax take in Scotland in comparison with the rest of the UK? The reason why I ask is that, under the new fiscal framework, relative tax take in Scotland versus the rest of the UK will, in part, determine the level of public spending.

That relates to the block grant adjustment and the per capita indexed mechanism. Of itself, the fact that we have a lower proportion of additional-rate taxpayers does not necessarily mean that, with a given rate of GDP growth, income tax revenues in Scotland will grow less quickly. It all depends on where that growth is coming from. I am a bit concerned about income tax revenues not at that end of the income spectrum but at the lower end. A lot of the increase in employment since the great recession has been relatively low waged—I am talking about the kind of people who are employed at levels of income that are below the income tax threshold. We could see a pretty significant increase in Scottish GDP—and a large growth in employment—without necessarily seeing any significant increase in income tax revenues. That is considerably important. It is difficult to predict based on the distribution of taxpayers at different levels, but the additional-rate taxpayers are very important and Scotland could not afford to lose a significant number of them; there is no question but that that is the case. Recently, I ran a survey of personal incomes to look at the most up-to-date data. The top 1 per cent of taxpayers, going beyond additional-rate taxpayers in Scotland, contribute 23 per cent of the total income tax revenues. That group is critical to the overall tax take, and the issues around how those taxpayers account for their income become very important.

This is not my field, but I agree: I do not think that there is a direct correlation. Those two elements—the number or proportion of additional-rate taxpayers and GDP growth—are not likely to fit particularly well together as parallel indicators.

I agree with that.

I thank the witnesses very much for coming along today to begin our discussion of tax principles. This is our first session on that area, which is a bit more complicated than I had anticipated at the beginning of the process. We will be having important discussions as the months go on. At the start of the meeting, we agreed to take the next agenda items in private, so I close the public part of the meeting.

12:04 Meeting continued in private until 12:28.