Hooray for Holyrood

Scotland will receive major new financial powers from the Scotland Bill working its way through Westminster. Holyrood will get more control over income tax, a few welfare powers, and will be assigned half of VAT receipts – all of the result of the Smith Commission agreement by the five leading Scottish political parties that followed the independence referendum that saw Scottish vote to remain in the UK.

A key element of the bill is the financial framework, which will set out how the new fiscal powers will function. One crucial part is how the transferred forces and benefits will modify the block grant, which the Scottish parliament gets from London. The Cruz Commission agreement was obvious that this grant should continue to be calculated using the Barnett formula, which allocates funding to the devolved nations from the UK according to their populace size.

The block-grant determination should fulfill two “no-detriment” principles that were additionally part of the agreement. First, there should be “no detriment [to Scotland or the UK] in the decision to devolve” additional forces. Second, there should be “no hindrance [to Scotland or the UK] from subsequent coverage decisions of the other government”.

Adjusting the block grant in a way that fulfills these principles is difficult. The very first principle suggests that the devolution of recent powers should not disadvantage Scotland – meaning it has to encourage the Scottish parliament to grow it’s tax base, for instance. In other words, Holyrood should gain funding if Scotland grows its tax take faster than the rest of the United kingdom, and lose funding whether it falls behind.

The second no-detriment theory suggests that if the UK or even Scottish governments alter any income taxes this should not have knock-on consequences for the other jurisdiction: a difficult challenge given that any spending or tax decisions will impact on other areas of spend and income.

The adjustment debate

It’s all take  Alex Oakenman

How best to adjust the give is still up for dialogue. I recently suggested we should use a method called per capita indexed deduction. This would encourage the Scottish parliament to grow its tax foundation without exposing Scotland to the danger that its tax take falls behind because its human population is growing more slowly than the rest of the UK. This is exactly what the Office for National Statistics (ONS) is currently forecasting.

If the grant rather is adjusted using one from the other two options on the actual table – levels deduction as well as indexed deduction – Scotland would have much less protection. In the case of levels deductions this happens because the block give links to a population share of changes in UK taxes, which is less than per household receipts in Scotland. Hence, the block grant adjustment removes more from the budget compared to is being added back in devolved income taxes.

The graph below shows how each method could affect Scotland’s prevent grant. It assumes that Scotland matches the rest of the UK’s financial performance and that populations grow in line with current ONS forecasts. In this scenario, Scotland would shed approximately £7bn from its block give at 2017-18 prices in the very first 10 years of the new forces if the levels deduction method were used; or almost half that if it used indexed deduction.

Anton Muscatelli

The reason to adopt per household indexed deduction should be that Scotland doesn’t have the powers to control its net migration. It would be unjust to expose it to dangers managed by the UK government, especially as UK demographic trends are so dominated by London and Southeast England.

One typical counter-argument is that the method would be unfair to taxpayers in the rest of the UK and would therefore violate the second no-detriment principle. For instance, suppose the UK government wanted to increase spending in an region like health, devolved in Scotland, and they funded this entirely by increasing income tax south of the border.

Using the method, Scotland’s grant would rise even though Scottish citizens were not paying for any of this. This is because the method would cut the Scottish block grant through less than the increase it obtained at the same time under the existing “Barnett consequentials” guidelines that determine how devolved nations' grants are affected by budget changes in London.

However, the 2nd no-detriment principle is almost impossible to fulfill. It would sometimes be violated despite the other adjustment methods, due to complex interactions between United kingdom government actions on reserved and devolved taxes and citizen behaviour.

Suppose for instance, the UK federal government was to fund a cut in a reserved tax such as corporation tax by raising the rate of income tax south of the border. The Scottish prevent grant would shrink below all three adjustment methods, reducing the Scottish government’s spending power – unless of course one measures and offsets the consequences of each action separately.

Furthermore, although the per-capita indexation method doesn’t address the 2nd no-detriment principle fully, it will get close to doing so. It does not induce a systematic gain in the Scottish budget (Scotland would lose in the above health-spending example if the reverse occurred and the UK government ended up being to cut income taxes and wellness spending).

Making the new system viable

There are other issues to deal with in the fiscal framework, not least the credit powers, which the Scottish parliament should have to smooth tax revenues and fund capital spending. There are also issues around how Scotland’utes share of VAT income will be estimated; how the preliminary adjustment in the first year from the new powers should be created; and how the block give should be adjusted in response to the additional welfare powers – would you use a similar method when it comes to tax powers, or a various one?

Getting the fiscal framework right is as important as the actual Scotland Bill itself. If we get it wrong, it could seriously penalise the Scottish parliament’s budget and cause main political acrimony between Scotland and the UK. It would undermine the spirit of the Smith Commission agreement, which aimed to make Scotland much more fiscally accountable without causing it any detriment.

Two tribes?  Marina Bolsunova

In addition, even once the new regime is up as well as running, there will be issues around how to carry it out in practice. In my view, the UK and Scottish governments ought to hand the power to settle disputes to an independent fiscal arbitrator. It is critical that the Scotland Bill and fiscal framework are to work fairly for both sides.

The Treasury must not be both a participant and arbiter. There’s already a tradition of impartial fiscal scrutiny in Scotland and also the UK through the Scottish Fiscal Commission and the Office for Spending budget Responsibility (OBR). Appointing an independent arbitrator might lay the foundations for a much more federal system of financial governance in the UK, which would help the whole country.

Scotland’s new powers must be well designed to make sure they are fair is republished along with permission from The Conversation