Fiscal devolution and reducing inequality

Fiscal devolution is about more than just transferring powers from one parliament to another. It has to be part of a strategy to reduce inequality in Scotland.

That was the key message in my Sunday Times (£) column yesterday. I set out the options for fiscal devolution and my own preferred option as described in the Red Paper on Scotland and UNISON Scotland’s ‘Fairer Scotland – Devolution’ paper. This approach devolves all property-based and income taxes, including the power to vary the rate in each band. Business and consumption taxes are retained at UK level, because business tax competition simply leads to a race to the bottom.

I also took the opportunity to rebut some of the recent criticisms of fiscal devolution, including the impact on the Barnett formula and the risk that further devolution will lead to independence. Both in my view miss the point completely.

However, the main thrust of my column was that powers, including fiscal devolution, have to be for a purpose. That purpose is a fairer and more equal Scotland because more equal societies perform better on every measure.

The Yes campaign and the White Paper makes much of the OECD 2011 paper that appears to show the UK as the fourth most unequal society in the developed world. However, this selective use of the paper only deals with income inequality. The OECD paper actually emphasises the role of public services in reducing inequality. The paper says:

But public services improved their impact on reducing inequality. Social spending in the UK relies more on public services (such as education, health etc.) than on cash transfers: spending on services amounts to over 15.4% of GDP while spending on cash transfers is some 10%. These services reduce inequality more than almost anywhere else, and this impact has increased over the 2000s.”

This is why the strongest argument for fiscal devolution is that Scotland is suffering from the financial consequences of English public service reform as the Tories shrink the state. Having the power to develop our own public service model is weakened if the financial rug is pulled from under it. University privatisation and NHS cuts are two recent examples. The IPPR ‘Devo More’ paper makes a similar point.

The OECD key policy recommendations are also noting:

  • Employment is the most promising way of tackling inequality. The biggest challenge is creating more and better jobs that offer good career prospects and a real chance to people to escape poverty.
  • Investing in human capital is key. This must begin from early childhood and be sustained through compulsory education. Once the transition from school to work has been accomplished, there must be sufficient incentives for workers and employers to invest in skills throughout the working life.
  • Reforming tax and benefit policies is the most direct instrument for increasing redistributive effects. Large and persistent losses in low-income groups following recessions underline the importance of government transfers and well-conceived income-support policies.
  • The growing share of income going to top earners means that this group now has a greater capacity to pay taxes. In this context governments may re-examine the redistributive role of taxation to ensure that wealthier individuals contribute their fair share of the tax burden.
  • The provision of freely accessible and high-quality public services, such as education, health, and family care, is important.

The Yes campaign would of course argue that we could do all of this with independence. There is a certain irony that the SNP’s currency union could actually result in greater financial control from ‘London’ than fiscal devolution. The SNP (Stewart Hosie’s line in the last BBC debate) would still have us believe that Scandinavian levels of public services are possible on current tax rates. Scandamerica is simply not a credible proposition for anyone who is serious about tackling inequality.

All the polls make it clear that the majority of Scots want to see greater devolution short of outright independence. Scottish Labour has to go with that majority by arguing for the fiscal powers that can help deliver a vision of the fairer and more equal society. Anything short of that really would encourage a drift to independence.

The challenges of reducing inequality

One of the Scottish Government’s strategic aims and claims for independence in the White Paper is to reduce inequality. New research from University of Stirling indicates that Scotland faces significant challenges in closing its “inequality gap”.

Scotland and the UK currently have much higher income inequality than comparable Nordic countries such as Norway and Denmark, with Scotland having a gap against these Nordic countries of 4.7 points on the Gini Coefficient – the recognised measure of the equality of a nation’s income distribution.

The research found the Scottish Government’s current fiscal powers – including council tax and the new Scottish Rate of Income Tax – are relatively ineffective at tackling inequality because they cannot be targeted at specific income groups. While an independent Scottish government would have access to the full range of fiscal powers, the research found the impact on inequality of exercising these additional powers would in fact be relatively small.

The authors argue that because the UK will remain highly integrated, any change in tax on income would trigger migration between countries. In addition, the small numbers of top rate tax payers means that tax changes have limited impact. Income support at the bottom is more effective in reducing inequality.

Co-author David Eiser added: “The Nordic countries have lower levels of inequality than Scotland not only because they have more progressive tax and benefit policies, but also because the level of inequality in income before taxes and benefits is much lower than in Scotland.

“Our report shows once the effect of tax rises on migration and labour supply are considered, the revenue raised from a one pence increase in the basic rate of income tax in Scotland could fall from £320 million to £210 million, and the revenue raised from a one pence increase in the upper rate of income tax could fall from £40 million to only £2 million.”

He added: “given the scale of labour mobility between Scotland and the rest of the UK, a fiscal solution to inequality could be detrimental to government finances because raising taxes will increase incentives for high earners to relocate, and likewise raising benefits could harm work incentives. Achieving Nordic levels of inequality in Scotland will likely have to involve some equalisation of incomes before taxes and benefits, rather than a large increase in redistribution.”

I am personally pretty sceptical about claims of tax flight because there are many other constraints on geographic mobility. However, we do have to recognise that the scope for significant redistribution is limited and involves difficult political choices that Scotland’s political parties have been unwilling to make. The research does strengthen the case for pre-distribution policies such as the living wage and tackling low pay generally. That is potentially a better route to reducing inequality.

Social exclusion and constitutional change

The Scotland Institute has published its first report ‘Social Exclusion in Scotland’. Founded in June 2012, the Institute’s mission is to build an economy which is sustainable and competitive, a society where wealth is fairly distributed, and a politics which tackles social exclusion and deprivation as a matter of course.

The report recognises the efforts made since devolution to tackle social exclusion, but concludes that there are four main gaps: services to low income households; low wages; education and health outcomes; and support for workless families.

The report also questions (like the Red Paper) how independence linked to Sterling will address social exclusion: “If Scotland remains tied to UK-wide economic policy, and if that continues to set primarily to meet the needs of the City of London, then the best that can be achieved is a set of policies that will mitigate the worst effects. If, as currently suggested, independence means retaining sterling, then that independence will preclude the ability to create a genuinely different economic model.”

This report is a significant constribution to our understanding of poverty in Scotland and the limitations of the current constitutional settlement in tackling the deep seated causes.