Fiscal Implications of Constitutional Change

Dave Watson

In this section we look at the fiscal implications of independence and extended devolution before suggesting a different fiscal approach as the basis for further discussion.

Let’s start by recognising, that whatever the criticism, the Scotland Act 2012 does give the Scottish Parliament significant new fiscal powers: a Scottish income tax to replace part of the UK income tax; the devolution of stamp duty land tax and landfill tax; the power to create or devolve other taxes to the Scottish Parliament; new borrowing powers (although only a consultation on bonds); and a Scottish cash reserve to manage fluctuations in devolved tax receipts. In addition we already have the Council Tax and business rates. There remains the thorny issue of political willingness to creatively use these powers, but we will return to that later.

What about the fiscal implications of independence? Well, we apparently have to wait until December 2013 for anything definitive on that, but we do have John Swinney’s statements. His post independence strategy appears to be to keep the pound within a Sterling zone including financial services (and possibly consumer) regulation. A VAT cut for tourism and construction coupled with a Corporation Tax cut to give Scotland a ‘fiscal edge’. Other business friendly policies include cutting business rates, tax breaks for R&D and renewables, a review of competition policy and the apparently obligatory cutting of red tape.

We would argue that this vision has major shortcomings. Handing over monetary policy to rUK also limits the scope of fiscal policy. We only have to look at the Eurozone crisis debate to see the link between monetary and fiscal policy. If the key economic levers are controlled by another country, then there is less influence on monetary, and fiscal, policy than under devolution.

However, our biggest difficulty is with the concept of a ‘fiscal edge’. It appears that SNP policy is still wedded to Celtic tiger strategy. Even if desirable, you simply cannot replicate 1990’s Ireland. Other small countries like Denmark, Norway, Sweden, Finland all have higher Corporation Tax and better performing economies. The UK business tax rate is already low and there is limited evidence that tax cuts pay for themselves. Any saving goes into profit not investment and many of our companies are sitting on vast cash reserves already. There will certainly be a huge hit on public finances that is unsustainable. A better way, is actually higher taxation to fund investment in people, plant, infrastructure and research.

The Laffer curve theorists that promote this view also support the flat tax approach to personal taxation. Yet, as table 1 shows, there is no link between different levels of taxation and economic growth. The SNP will need to clarify their position on this in the White Paper.

What of Devo-Max, the proposition that all revenues would be raised in Scotland and the cost of reserved services would be paid to London out of these revenues. The mechanisms for this have been set out in some detail, but there is limited evidence that having greater fiscal autonomy policy is beneficial to economic growth.

In addition this model in full is untested anywhere in the world and therefore there must be a real risk of unintended consequences.

Then we have Devo-Plus. This concept proposes that most revenues would be raised in Scotland to pay for devolved services, with VAT and NI retained at UK level to pay for reserved services. Again the mechanisms have been worked out in some detail. What is less clear is the purpose of this devolution. For that we need to look at the authors, Reform Scotland, objectives that are the apparently, “traditional Scottish principles of limited government, diversity and personal responsibility”. Translated this means- small state, privatisation and blame the poor!

In summary, none of the above meet the key test of devolution forpurpose of creating a more equal society and investment in our people. They ignore issues of class and class power.

If we look at other European countries that devolve fiscal powers, taxes on income are the most popular, followed by property and then taxes on consumption. The Scotland Act 2012 already gives Scotland significant powers over income tax and many property taxes are already devolved. Consumption taxes, primarily VAT, are difficult to devolve because EU rules generally don’t allow variations within nation states. Whatever taxes are devolved there has to be some mechanism through grants or borrowing to address volatility in tax revenues.

Table 2 sets out the current estimate of income raised by each tax in Scotland. It can be seen that detailed discussion of many taxes is of only academic interest because the revenue raised in Scotland is small.

At present revenue from devolved taxes in Scotland is one of the lowest in Europe at 13.8%, just over £4bn. After the Scotland Act 2012 is implemented that will rise to 30.8%, just over £9bn.This will put Scotland in the same league as Germany and Sweden, with one of the most devolved tax revenues in Europe. However, because a Scottish Government can’t vary the rate in each band, any increase in income tax is not as progressive as we would wish. This is illustrated in table 3.

Taxation is not the only power we should consider. The Scotland Act 2012 gives the Scottish Government new borrowing powers and there is a consultation on bond issuance. However, again these are very limited, both in method and amount, with the Treasury orthodoxy insisting on central government’s right to control overall state finances. This is a crucial issue for Scotland and it is essential that Scotland gets wider borrowing powers.

The only restriction should be prudential i.e. can Scotland finance the cost of borrowing from revenue. This power already exists for local government therefore it seems absurd that devolved administrations should not have similar powers. With such flexibility we could finally get rid of the huge cost of PPP/PFI schemes by giving prudential borrowing powers to health boards, NDPBs and public corporations, including Scottish Water.

With the focus of debate on independence and extended devolution we should not lose sight of the value of fiscal solidarity across the UK. Allocating resources on the basis of need was the thinking behind the Barnett Formula. It also happens in other European countries using mechanisms like shared taxation, hypothecated spending and equalisation mechanisms. Scotland has benefitted from this approach in the past and may need to do so again. Greater fiscal autonomy must still allow for resource transfer to areas of need across the UK. In particular we need to recognise where real economic power lies on these islands and even under independence, it isn’t here in Scotland.

This is because Scotland operates in a global market dominated by the Washington Consensus. On tax this means promoting falling income tax rates, low corporation tax, higher consumption taxes, low taxes on wealth, tax simplification (including flat tax) and creating tax competition with a race to the bottom for the rich. In the UK over the last 30 years this ideology has resulted in UK top income tax rates falling from 60% to 45%, and Corporation Tax from 52% to 22%. VAT has increased from 12.5% to 20%, tax havens banned to tax havens encouraged with 5.5% tax rate and Inheritance Tax almost gone. We now have the lowest number of HMRC staff ever, creating a tax gap of some £130bn.

For all the debate around fiscal powers we need to return to the question of what we want these powers for. Fiscal policy should support the creation of a more equal society that allocates resources to tackle poverty through progressive taxation and welfare support. The role of business is to pay taxes, provide decent jobs and social sustainability in return for state support, while the state promotes collective ownership and management of the means of production.

In conclusion here are some initial suggestions on how fiscal devolution might support a more radical social and economic strategy.

  • Devolve all property based taxes. They already largely will be after the Scotland Act 2012 is implemented.
  • Income Tax and National Insurance fully devolved.
  • Business taxes should remain at UK level. Tax competition is wrong in principle and in any case is constrained by tightening EU rules in this field.
  • Consumption taxes (primarily VAT) again largely at UK as EU rules don’t allow variable rates in the same state. There is a stronger policy element to fuel duty, tobacco and alcohol taxes, but given the integrated nature of the UK it is hard to see how these could be set differently in Scotland.
  • Full prudential borrowing powers including bond issuance.
  • Any partial devolution of fiscal powers will also require a balancing mechanism using a combination of grant and borrowing.

Many will remain sceptical, based on  experience since devolution, that further fiscal devolution will significantly improve the governance of Scotland. Political will remains more important than mechanisms. However, they will at least force the Scottish Parliament to consider how they might be used to create a better, more equal society.

6 thoughts on “Fiscal Implications of Constitutional Change

  1. Pingback: » Sterling zone implications

  2. Pingback: » Gordon Brown on fiscal implications

  3. Pingback: » Fiscal Commission Report

  4. Pingback: » Tax and spend in an independent Scotland

  5. Pingback: » Currency union and buses

  6. Pingback: » Taxation and independence

Leave a Reply

Your email address will not be published. Required fields are marked *