If Scotland were to become independent it would gain considerably more control over its tax system than it currently enjoys. This paper considers the consequences of independence for the optimal design of a new Scottish tax system, an analysis which would also be of some relevance for considering the consequences for tax design of independence of other smaller nations.
Scotland is different from the rest of the UK in some ways that are important for tax system design. Incomes are more equally distributed, for example. That is one reason why the progressive income tax currently raises less per head in Scotland than in the rest of the UK. It also suggests that there is less to be gained in terms of redistribution from sharply progressive taxation.
Independence would create additional complexity for individuals and firms working or trading across borders. It could also put downward pressure on tax rates and our analysis suggests that optimal tax rates in an independent Scotland are likely to be lower than optimal rates in the UK as a whole. At the same time, the context of a substantial budget deficit will continue to put upward pressure on tax rates.
Possible consequences of Scottish independence for tax design.
Currently, onshore revenues per head in Scotland are very similar to those in the UK as a whole. The biggest differences relate to one of the important economic differences between Scotland and RUK—the relatively more equal distribution of income and wealth. This results in receipts for income tax and various capital taxes being lower in Scotland than in RUK. It also implies that, all else equal, the benefits from high and strongly progressive tax rates are less in Scotland than in RUK.
Of course the biggest difference between total tax receipts in Scotland and RUK is the very much greater importance of oil and gas revenues in Scotland. While the fact of independence would not obviously change the optimal structure of oil and gas taxation, it would matter a lot for the role of oil and gas revenues in the public finances. Total receipts in Scotland would have been very much more volatile than in the UK as a whole over recent decades because of the volatility of oil and gas revenues and their greater importance in a smaller economy. Going forward it is clear that an independent Scotland could not plan its public finances by treating oil and gas revenues as certain. While we do not consider it in this paper, the combination of higher spending per head in Scotland with similar onshore revenues, uncertainty about offshore revenues and, shared with RUK, more fiscal consolidation required in the short term, means that the pressure for taxes to rise following independence would be considerable.
Of more general application is our analysis of the possible effects of independence on optimal tax policy. The key new challenge is mobility of tax bases given the likely openness of the Scottish economy vis-à-vis RUK. If most of the major tax bases—people and personal income, goods and services, capital and profits—are mobile between Scotland and RUK (as well as wherever else they might already be mobile), then taxes on all of those would be harder to raise. This will create pressure to move towards more reliance on less mobile tax bases (notably property) and less reliance on the most mobile tax bases (notably corporate profits), and in the absence of cooperation in tax rate setting between Scotland and RUK, the optimal long-run level of taxation is likely to be lower than in a unified UK.
The same will also apply to RUK, which will (to a lesser extent) be a more open economy by virtue of having an independent Scotland next door. Tax competition between the two countries (as well as the existing competition vis-à-vis third countries) might lead them to raise less revenue between them than would be best for them collectively. There would therefore be a premium on cooperation and coordination to minimize potentially inefficient tax competition—as well as to minimize compliance costs for firms that trade (or hire etc.) across the border. Such concerns should not be overstated. The Scotland–RUK border is not densely populated and there are many reasons that people would not move between the two countries in a frictionless way to live, work, or shop. But it is a factor that an independent Scottish government would need to take into account.
One focus for an independent Scotland should be to look at how tax policy is made. Setting up institutions in such a way as to facilitate a tax strategy to be coherently formulated and implemented and to promote high-quality debate and scrutiny would increase the chances of good policies being implemented and poor ones being reversed (or, better still, not being introduced in the first place). This should also help to bring about a more stable tax system over the longer term, which in itself would help enable individuals and firms to plan and boost prosperity.