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politics, scotland

Let’s hope John Swinney has his wits about him. This is the most important week for public finances since the Barnett Formula was introduced in 1978.

THE discovery of gravitational waves involved decades of effort by some of the greatest scientific minds using mathematics of breathtaking complexity. Perhaps now they have confirmed Einstein’s relativity hypothesis, they could turn their attention to another issue of mind-bending difficulty: the fiscal framework for income tax devolution.

I know: the debate about Scotland’s financial black hole is tedious and your mind is probably wandering to the top 10 plastic surgery disasters or celebrities who have aged badly. But bear with me, because this is probably the most important issue in Scotland right now.  If Scotland gets the wrong deal on the fiscal framework, we could be looking – according to economists like Professor Anton Muscatelli – at a £3 billion tax loss over the next decade – a lot of pennies. And unlike Labour’s penny for Scotland, which brings in £400m at best a year, this would be irreversible.

Make no mistake, this is the most important week for the future finances of the public sector in Scotland since the Barnett Formula was introduced in 1978.

The problem is this: the Scotland Bill has devolved income tax to Scotland. Fine. Let the Scottish Parliament pay for its own spending decisions. But it’s not as easy as that. The Smith Commission said there should be “no detriment” to Scottish spending as a result of the changes and that the Barnett Formula, which broadly equalises spending over the UK, should remain.

Now it is obvious that these two objectives, “Scotland on its own feet” and “Scotland should not lose out”, are incompatible. The Institute for Fiscal Studies has devoted much time and many words to a confirmation of the bleeding obvious.

However, this is politics, and that as we know is the art of the possible. The Scottish Government’s role here is to do its best to stop Scotland being disadvantaged. It doesn’t want to find itself, in a few years, slashing yet more billions from teaching budgets that are already being squeezed by UK spending cuts.

This is not a problem on day one of income tax devolution because you just deduct from the block grant delivered by the Barnett Formula the sum of the income tax that is raised in Scotland. But what happens thereafter? Well, two things and they are not good.

Scotland’s tax base is shrinking, partly because there are proportionately fewer high-earning people here than in England (think of all those bankers in London) and also because the Scottish population is falling relative to England. It is also ageing faster than England’s.

The IFS knows all about this because it is one of the reasons it argued independence would leave a £9.7bn black hole in Scotland’s accounts. Older people cost money in care services. Fewer younger people of working age means an effective cut in tax revenue to pay for that dependent population.

Under Barnett this doesn’t matter too much because Scotland just gets its block grant increased in proportion to the increase in spending on UK departments. It is automatic.

No-one has to think too much about it. Scotland has in the past done well out of Barnett – getting up to 20 per cent more cash per head than in the UK as a whole. This is fair because it costs more to provide things like healthcare in remote areas. Also, Scotland’s relative advantage over the rest of the UK falls gradually over time if population share equalises – hence the Barnett Squeeze.

What John Swinney is trying to do, crudely, is restore Barnett in another name. That’s what the fiscal framework row is all about: preventing Scotland losing revenue because its population is falling relative to England and its tax base is shrinking.

There are many formulas for doing this. Levels deduction, indexed deduction, per capita indexed deduction, and so on. We won’t go into the maths. But the Scottish Affairs Select Committee has said it thinks per capita indexed deduction (PCID) does the best job at compensating Scotland for its falling taxes.

The UK Treasury disagrees. It believes PCID is not fair on the rest of the UK; that Scotland should not demand tax devolution and then seek to bend the rules so it can never fall behind England, and retains the same advantage it has under Barnett.  There was always a punitive undertone to the Scotland Bill rhetoric. Many English Conservatives believe Scotland gets too much from the Barnett Formula and should “live within its means”.

Some Scottish academics agree, including the economist Professor Jim Gallagher, who has advised most of Labour’s inquiries into devolution. He says, essentially, that what John Swinney is trying to do is “unfair to the rest of the UK”, which should not have to guarantee that Scotland should never lose out. Others add that it makes a nonsense of the case for independence. If Scotland had voted Yes, there would be no Barnett Formula safety net to fall back on, would there? No indexation of Scottish taxes.

Well, no there wouldn’t. But under independence Scotland would have the power to increase immigration to increase its tax base (migrants contribute more in tax than they consume in benefits and services). It would also have access to all sources of tax revenue and not just income tax, the toxic tax. It could raise wealth taxes, corporation tax, national insurance, excise duties and so on.

Here’s an example. George Osborne has found another hole in his financial projections because of the recent stock-market turbulence. He is not going to raise income tax to fill it, because it is now illegal – yes illegal – to raise income tax in England. He is reportedly considering raising fuel duties instead. The Scottish Government cannot do that.

Truth be told, there is no way of compensating for this through the fiscal framework. The Scotland Bill was designed to hoist Holyrood on its own petard. As the former Scottish Secretary, Michael Forsyth,recently confirmed, the idea was that “Scotland would have less money and would have to raise taxes to stay where it is”. As welfare is cut, and the responsibility handed to Holyrood, the nationalists will – ha ha – have to raise income tax.

But the fiscal trap can be mitigated and that is what John Swinney is trying to do. It will never compensate entirely for the lack of the full range of tax powers, but the fiscal framework could, by essentially using UK spending as a base line, help to minimise any losses.

Will he succeed? Some suspect he doesn’t want to succeed. That the Scottish Government wants to walk away from the Scotland Bill tax powers and seek a restoration of the Barnett Formula.

This would allow Nicola Sturgeon to continue to blame Westminster for cuts to Scottish spending and relieve her of the problem of explaining why she is not using the Scottish tax system to compensate for those cuts.

I think many in the SNP realise now they should never have signed up to Smith. They should have said: all tax powers or nothing. But that’s water under the bridge now. The SNP accepted the “one club” approach.

Scotland is stuck in a very difficult bind and it involves every one of us. Forget that it is the UK that is slashing welfare spending. From here on, the issue is going to be why, if you have tax powers, do you not use them to compensate?

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About iain2macwhirter

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