Fiscal federalism needed to implement Smith reforms, says Cuthbert

30 Apr 15

A leading independent economist has warned MSPs that the fiscal reforms proposed by the Smith Commission on further devolution will be unworkable without major parallel changes at UK level to a more federal regime.

In a paper for Holyrood’s finance committee, former Scottish Office chief statistician Dr Jim Cuthbert identified a string of anomalies that he believes will arise from the Smith plans, notably “gearing” – the extent to which tax changes in the rest of the UK (rUK) impact on Scotland after control over income tax is devolved to Holyrood.

‘It matters a lot, because unless they solve the gearing problem, then the arrangements are liable to be intolerable for Scotland,” Cuthbert told Public Finance. ‘It is not delivering what was promised under Smith, which was greater autonomy and the ability to set your own income tax rate.’

Cuthbert’s paper, submitted on behalf of the Jimmy Reid Foundation, argued that changes to rUK tax rates will affect Scotland, not just through the Barnett Formula as it relates to services that are devolved in Scotland, but also when they impact on reserved functions like defence.

If rUK decided to fund income tax cuts by cutting spending, including on reserved areas, and Scotland felt it had to match the tax cuts to avoid economic disadvantage, the resulting spending cuts would fall on Scottish devolved services, Cuthbert says.

Equally, if the rUK government decided to raise spending on, say, the Trident replacement, Scotland would be held to have benefited from additional UK-wide public spending, and its block grant would be reduced accordingly – again hitting devolved budgets.

The Smith proposal included a ‘no detriment’ provision, that where taxes are devolved changes in rates should impact only on the respective parts of the UK where the changes apply.

But Cuthbert argues that the gearing problem undermines this principle: ‘If, every time they change income tax rates down south and it washes into reserved services, we have to make an adjustment to tax or spend on devolved services, then that is going to be regarded as an intolerable betrayal of Smith.’

Cuthbert agreed with a submission from another economist, John McLaren of Fiscal Affairs Scotland, that there could be some circumstances when the gearing anomaly worked to Scotland’s advantage.
‘There would be pluses and minuses, but it’s a question of democracy, and it subverts the principle of Smith if the Scottish Government is going to have to react to decisions which are taken outside Scotland, either by altering its income tax rate or altering what it spends on devolved services.’
He suggested Holyrood should negotiate for greater economic powers, perhaps in return for surrendering Smith’s offer of half Scotland’s VAT receipts: ‘What do we get from VAT? We get much greater exposure to estimation volatility in the receipts, but we have no control over the VAT rate.

‘I think the gearing problem is inevitable unless you move to something like federalism. You have to hypothecate rUK revenues properly to what you might call devolved services down south – those services that are devolved in Scotland. Managing that hypothecation is extraordinarily difficult.’

Any mathematical formula for determining fiscal transfers within the UK would deliver inevitable injustices, he said. Instead, authority should pass to an independent, overarching UK body, but not the UK Treasury or Office for Budget Responsibility: ‘You really need a wise body taking a non-partisan, non-parochial overview adjusting things within the monetary union.’

This, Cuthbert insisted, must be very different from David Cameron’s plans for English Votes for English Laws plan, which would exclude Scottish MPs from rUK budget votes. ‘[Under EVEL] Scotland would be a bit like a puppet, being yanked about – sometimes to the good, sometimes to the bad – by decisions of another body, and that runs quite contrary to the principles of Smith.

‘It’s not just a question of minor adjustments to public expenditure. If you’re doing something like Smith, there has to be an acceptance down south that you can only do this by making fundamental constitutional change for the UK as a whole.’

  • Keith Aitken
    Keith Aitken

    covers Scottish affairs for Public Finance from Edinburgh. He was formerly economics editor and chief leader writer on The Scotsman and now has a busy freelance career as a writer, broadcaster and event chair.

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