Fiscal implications of constitutional change

This is the first of a two part post summarising my presentation to the Red Paper conference in Glasgow on the fiscal implications of constitutional change.


Lets 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 I 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.


I would argue that this vision has major shortcomings. Handing over monetary policy to rUK also limits the scope of fiscal policy. As Bell and Elliot have said:
“monetary union would also entail co-ordination, if not integration of fiscal policy”, then “the burden of any adjustment that would be required to restore competitiveness in the traded sector would fall on nominal wages”.


We only have to look at the Eurozone crisis debate to see the link between monetary and fiscal policy. For an SNP government to support regulation from London, which will very much be in the interests of those institutions, is bizarre. Of course all of this depends on rUK allowing an independent Scotland to pick and choose bits it wants to keep. If the key economic levers in hands of another country, then there is less influence on monetary, and fiscal, policy than under devolution.


However, my 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 already low. The evidence that tax cuts pay for themselves (Laffer curve) is simply not there. 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, as the Stephen Boyd and others have pointed out is actually higher taxation to fund investment in people, plant, infrastructure and research.


The Laffer curve theorists that promote this view would also apply it to personal taxation. In particular they oppose progressive taxation and promote the flat tax approach as Laffer set out himself in an interview on Radio 4 this week. Again as the table below shows there is no link between different levels of taxation and economic growth. While I am not aware of SNP spokespersons advocating this approach, it would be consistent with the policy of business taxes and needs to be clarified in the White Paper.

So what about the extended devolution options?

Firstly, we have 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 by Andrew Hughes Hallett and Drew Scott. What is less clear is the economic benefit. As Arthur Midwinter states:

“there is no clear pattern from comparative analysis that winning or 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 proposal argues 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 for the purpose of creating a more equal society and investment in our people. They ignore issues of class and class power.

In part 2, I will set out some possible different fiscal approaches.