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Monday, 9 July 2012

Fiscal implications of constitutional change - Part Two

In Part One of this blog I covered the fiscal implications of the constitutional options currently on offer, either through independence or extended devolution. In Part Two, I will set out some of the possible solutions I discussed at the recent Red Paper event in Glasgow.

I should emphasise that all this is consistent with our general Red Paper approach to this issue. We are not a think tank who has disappeared into a dark room to produce a proposal. We want to engage those sympathetic to our aims in Scotland, to develop a left alternative that focuses less on the mechanics of devolution and more on what we can do with additional powers.

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.

The table below 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 I would wish. This is illustrated in the table below.

Taxation is not the only power we should consider. As described in Part One, 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 in my view 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 be able to replicate that authority. 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 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 more on this I would strongly recommend the Tax Justice Network.

For all the debate around fiscal powers we need to return to the question of what we want these powers for. Let me suggest the following broad fiscal policy aims:

  Create a more equal society;

  Allocate resources to tackle poverty;

  Progressive taxation & welfare support;

  Role of business is to pay taxes, provide decent jobs and social sustainability in return for state support;

  Collective ownership and management of the means of production;

  Sustainable development including green taxation.

These aims could drive a UK/Scottish fiscal strategy as follows:

  Progressive taxation playing a pivotal role in addressing inequality;

  Barriers to the effective taxation and distribution of wealth being removed;

  Taxation helping sustain family relationships whilst promoting gender equality;

  Taxation policy facilitating creation of sustainable employment in sustainable businesses (industrial strategy) that have access to long term capital;

  Taxation policy that supports the delivery of sustainable, democratically accountable public services;

  Taxation policy that contributes towards meeting climate change targets;

  Contribute to global approach to corruption, tax evasion, information, capital controls. Race to the top in addressing inequality and poverty.

Finally, I looked at how fiscal devolution might support this strategy. These are my initial suggestions:

·         Devolve all property based taxes. They already largely will be after the Scotland Act 2012 is implemented. I am agnostic on adding Inheritance Tax given the modest amount it raises, but logically this should be included.

·         Income tax fully devolved. Partial devolution doesn’t make a lot of sense. This could include National Insurance as the link with contributory benefits is becoming increasingly weak and it may in any case be merged if the Chancellor gets his way.

·         Business taxes should remain at UK level for the reasons outlined above and in Part One. Tax competition is wrong in principle and in any case will be 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. Unless the aim is to promote the sales of white vans!

·         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.

Will any of this significantly improve the governance of Scotland? Probably not a lot, as I remain sceptical that the political will exists to use these powers to achieve the strategic aims I propose. But they will at least force the Scottish Parliament to consider how they might be used to create a better, more equal society.


  1. I didn't realise how little Inheritance Tax is raised in Scotland or the shift in income and business taxes to consumption taxes. These changes creep up on you until you see trends over a long period as you show.

  2. The bottom line for me is will all of this deliver greater resources for public services. It appears to be fiscally neutral unless there is a political will to use these powers for that purpose. I suppose it stops the excuses, the big boy did it and ran away, but it seems a lot of bother for little return.