A guide to the Fiscal Powers Debate. Outlining the problems with the current situation and detailing the three choices that are on the table to solve the problems.
Problems with the current devolution settlement
- lack of financial accountability: the Scottish Parliament is dependent on Westminster for 87% of Scottish Budget (only Council Tax and Business Rates devolved) which means that:
- the political debate in Scotland is about spending money rather than raising it;
- there is no incentive for Scottish politicians to deliver improved economic performance since the Scottish Budget does not depend on how much tax is raised and, in any case, any increase generated would accrue to the Treasury;
- there is little incentive to improve the efficiency of public services in Scotland (since savings would not result in tax savings to Scottish voters) or to find innovative models to deliver services;
- in recent times the debate about debt and the public sector deficit has mainly been at Westminster – where the debate has taken place in Scotland it has mainly been about which politicians might be in the best position to limit the scale of cuts in Scotland, rather than finding solutions to the problems;
- lack of transparency: the current Barnett formula for deciding the Scottish Budget is not transparent and is unpopular on both sides of the border;
- limits to devolved powers: in areas that are already devolved, there are limits to powers due to lack of fiscal levers (for example, health policies on alcohol cannot be addressed by increasing alcohol taxes);
- lack of borrowing powers: the Scottish Government has no powers to borrow either to stimulate the economy or to fund capital investment.
Proposals to solve the current problems
Calman Commission recommendations on “Strengthening Accountability in Finance”
- cutting basic and higher rates of income tax levied by the UK Government in Scotland by 10 pence in the pound, with a corresponding reduction in the block grant;
- replacing the Scottish Variable Rate of income tax with a new Scottish income tax rate, applying to basic and higher rates of tax and collected as now; a 10 pence rate would replace the reduction in block grant;
- devolving Stamp Duty Land Tax, the Aggregates Levy, Landfill Tax and Air Passenger Duty to the Scottish Parliament, again with a corresponding block grant reduction;
- giving Scottish Ministers additional borrowing powers.
Problems with Calman proposals
- lack of financial accountability: the Scottish Parliament would still be dependent on Westminster for two-thirds of the Scottish Budget and so it can not reasonably be argued that financial accountability would be achieved – you either have financial accountability or you don’t, you can’t have a degree of financial accountability;
- no change in political culture: with more than two-thirds of the Scottish Budget still coming as a grant from Westminster, it is unlikely to deliver a change in political culture – it will still be about campaigning against cuts rather than how best to deal with the structural deficit (by, for example, increasing growth or reforming public services);
- limited incentives for growth: the limited tax base devolved to Scotland would not incentivise fiscal policies that promoted growth since only a fraction of fiscal benefits would come to the Scottish Parliament – for example, if income tax rates were cut only a proportion of any increased income tax paid associated with greater growth would come to Scotland, with the rest accruing to the Treasury;
- over-dependence on one tax base: the Scottish Budget would be vulnerable to the volatility in income tax receipts and would have to make immediate cuts in response to any unexpected falls in receipts;
- Con:Lib Government income tax proposals: the new UK Government’s proposals to increase income tax allowances to £10,000 would reduce revenue to the Scottish Parliament by an estimated £250 million (if this is funded by Lib Dem proposals to increase National Insurance – retained at Westminster); this is an example of a long term risk to the Scottish Budget from changes to the UK tax system;
- technical problems: there are a range of technical implementation issues that will be difficult to solve, not least the problem of predicting income tax receipts next year based on economic forecasts based on two year old data;
- borrowing powers limited: no short term borrowing to deal with fluctuations in income are allowed and borrowing to fund capital projects is undermined by requirement to raise Scottish income tax immediately to fund repayments;
- economic challenges: the proposed powers are too limited to allow for any significant policy responses in Scotland to address the severe challenges faced by the Scottish economy.
Options that have been proposed – to address current problems and problems with Calman proposals
- Reform Scotland model
- In principle, governments at all levels should be responsible for raising the bulk of the money they spend;
- Scottish Government should be responsible for raising the Scottish Budget (currently c.£30bn) while the UK Government should be responsible for raising UK spending in and on behalf of Scotland (currently c.£20bn);
- Several alternative models are possible for a starting point – preferred model is: UK Government – National Insurance, 40% of Income Tax, 40% of Scotland’s geographical share of North Sea oil revenues; 40% of VAT & additional income from TV licences, passport fees and the National Lottery tax & Scottish Government – all other taxes;
- Need a body to represent English interests so that “UK spending” is identified as distinct from English spending;
- Set up Scottish Exchequer which merges functions of HM Treasury and HM Revenue & Customs in Scotland;
- Use new fiscal powers to simplify the tax system and lower the overall tax burden in Scotland, over time, to deliver improved economic performance.
- Hughes-Hallett & Scott
- Fiscal Autonomy or Fiscal Responsibility;
- Control over all taxes, other than VAT, devolved to Scotland;
- Scottish Government makes payments to UK Government to pay for UK services, where costs are not covered by Scottish VAT receipts – establish a new UK Grants Commission to determine payment level;
- Social welfare and labour market policies also devolved to Scottish Parliament;
- Scottish Government has full borrowing powers, subject to agreed rules (including requirement to balance budget over the economic cycle);
- Scotland assumes responsibility for servicing and repaying a share of UK debt;
- Co-ordination between Scottish and UK Governments on fiscal policy;
- Establish Scottish Treasury and tax collection agency.
- Steel Commission
- Fiscal federalism proposed – the financial underpinning of a move to a federal UK;
- Objective of greater transparency and political accountability;
- Scottish Government should raise as much as practical of its own spending;
- Scottish Government should have substantial authority over levers of power which most affect the Scottish economy and which increase its ability to meet key policy objectives such as protecting the environment or improving health;
- Scottish Government should have borrowing powers and fiscal responsibility which fit into an agreed UK system;
- A needs based system should determine an equitable distribution of resources between different parts of the country;
- Scottish Parliament should be given responsibility for all taxes except for those reserved to the UK
- Scottish Parliament should have the power to vary rates and tax base for each devolved tax or to abolish devolved taxesand introduce new taxes;
- Scottish Parliament should have ability to borrow.
- Independence/ Full Fiscal Autonomy
- Scottish Government and Parliament becomes responsible for all taxation and fiscal policy in Scotland;
- Under independence, Scotland has responsibility for all areas currently retained at Westminster, including foreign affairs, defence, social security and national debt;
- Under full fiscal autonomy, Scotland makes payments to the Treasury to pay the Scottish share of UK services (including social security and national debt servicing);
- Option under full fiscal autonomy model to transfer additional powers to Scotland (e.g. social security) with a corresponding reduction in payments made to the Treasury.
June 2010