The Debate on Fiscal Decentralisation in Scotland. di D.G. Bianchi

The United Kingdom has been absorbed in an extraordinary constitutional debate since the election of the secessionist Scottish National Party (SNP) as a minority government in Scotland in May 2007. The SNP’s election victory prompted renewed debate among those opposed to independence about how best to accommodate Scotland’s distinctiveness within the UK. It also emboldened the SNP in its pursuit of Scottish independence. When the SNP won an absolute majority in the 2011 Scottish election it committed to hold a referendum on Scottish independence which is scheduled for 18 September 2014. The prospect of the referendum has again spurred on thinking on the anti-independence (or unionist) side of Scotland’s constitutional debate. One of the central themes of this debate has been fiscal decentralisation. This contribution begins by setting out the current system of fiscal decentralisation in the UK, as applied to Scotland. It then moves to discuss the three main approaches to the reform of fiscal decentralisation in Scotland that have emerged in the debate since 2007. Finally it explores the resonance of these approaches in public opinion as a basis for assessing what reforms might emerge in the coming years.

The Current System

The uk’s fiscal decentralisation arrangements are unique. They link the financial allocations to the Scottish Government (and to the devolved institutions in Northern Ireland and Wales) to decisions the UK Parliament makes on public spending in England. They also have an important historical component. This mix of England and history is explained below.

The bulk of Scottish revenues are allocated by a uk government block grant. This grant has two features: a baseline and an annual increment. The baseline was derived initially from the total amount of annual spending that was allocated to Scotland-specific policy programs by the late 1970s. (Scotland had distinctive policy arrangements, often known as administrative devolution, long before the Scottish Parliament was established.) From 1979 that spending total was established as a baseline subject to annual incremental change. Annual increments were – and remain – determined by what has become known as the ‘Barnett Formula,’ named after the then deputy finance minister, Joel, now Lord, Barnett. Increments are calculated by totalling any changes in uk Parliament spending decisions on programs in England which are comparable to programs dealt with through Scotland-specific spending (that is, those that now fall under the responsibility of the Scottish Parliament), and applying a population factor. Scotland currently has 10.08 per cent of the population of England, so the Scottish Parliament gets 10.08 per cent of any changes (up or down) in spending on comparable programs in England. Any one year’s change is added to or subtracted from the baseline taken forward into the next year, which then becomes the new baseline subject to further incremental change.

In the 2013-14 Scottish Government budget this combination of baseline and increment allocates around £28.5 billion to the Scottish Government. A further £5 billion was generated by local taxation decisions (on residential and business property) that fall under the responsibility of the Scottish Parliament. In addition, the Scottish Parliament has at its disposal the so-called ‘tartan tax,’ the possibility of varying uk standard rate personal income tax by ±3 per cent. Though strongly endorsed in the 1997 referendum that led to the establishment of the Scottish Parliament, no Scottish government has yet used its tartan tax powers. Its probable yield would have been a maximum of around £1 billion in 2009.

The result is (also in the absence hitherto of significant borrowing powers) that the great bulk of the revenue available to the Scottish Parliament is allocated to it by the uk government and is not the consequence of devolved decision-making. The uk government does not attach strings to this allocation. The Scottish Government has almost complete spending discretion (the only significant exception being ‘additionality’ contributions to European Union structural funding programs which are hypothecated within the uk government grant to particular spending purposes). That discretion has increasingly been put to distinct purposes, including a number of high profile (and high cost) divergences from policies in England, notably in the fields of care for the elderly, undergraduate university tuition fees, and National Health Service prescriptions.

This almost complete spending discretion has an additional nuance. For historical reasons (mainly a perceived need to counter the growth of Scottish nationalism), the baseline grant in Scotland supports per capita public spending in Scotland that is higher than per capita spending in England. In 2008–2009, per capita spending in Scotland was at 115 per cent of the uk average. Wales and Northern Ireland also had spending premiums (at 111 and 123 per cent respectively). England’s per capita spending by contrast was at 97 per cent of the uk average (Trench 2013).

This territorial pattern of public spending does not reflect differential spending needs in any direct way, beyond population weighting. Official uk Treasury needs assessments in both 1979 and 1993 suggested that Scotland received funding substantially higher than its ‘needs’ suggested. More recent attempts to assess relative need across the uk concur (Independent Commission on Funding and Finance for Wales 2009a; House of Lords 2009). Scotland appears consistently to have been overfunded relative to need. Unsurprisingly the combination of higher per capita funding for Scotland, alongside significant spending on public services not available in England, has prompted controversy. In particular, right wing media outlets and Conservative MPs in England have frequently argued that funding arrangements for Scotland are unfair to people in England. Such views have resonance in public opinion in England. The 2012 Future of England Survey found that over 50 per cent of respondents in England felt that Scotland got more than its fair share of public spending, while 40 per cent felt that England got less than its fair share (Table One).

 
Table One: English Views on Public Spending in England and Scotland

Source: Wyn Jones et al 2013.
 

An alternative perspective on the question of fairness emerges in a closer analysis of revenues by UK territory. The UK government does not collect (or, at least, does not publish) data on tax revenues generated in the different parts of the UK. However, annual estimates of government spending and revenues in Scotland (that is spent and raised by both the UK and the Scottish Governments in Scotland) have been made since 1990. Now published by the Scottish Government these estimates suggest that while Scotland may enjoy higher public spending per head than England, it also generates higher tax revenues per head than England, assuming that revenues from North Sea oil and gas extracted in Scottish waters are attributed to Scotland. For example, the latest, 2011-2012 estimates suggest that while Scotland had 9.3 per cent of UK public spending, public sector revenues accounted for 9.9 per cent of the UK total, if revenues from North Sea oil and gas are included. Unsurprisingly these analyses have been used by the SNP since 2007 to dismiss claims from England that Scotland has unfair advantages through the current arrangements for fiscal decentralisation.

The focus on revenues as well as spending has also had a further effect: to draw attention to the limited extent to which, under current arrangements, the Scottish Government is responsible for generating the money it spends through its own fiscal policy decisions and the large extent to which it remains dependent on transfers from the UK Government. The Scottish Government currently covers less than twenty per cent of its spending through its own taxation decisions, with the rest coming from the UK Government.

These initial remarks establish the parameters in which the reform debate about fiscal decentralisation in Scotland has been conducted. The limited tax-raising capacities of the Scottish Government raise questions about the accountability of its decision-making on public spending. For others those limits act as a constraint on the ability of the Scottish Government to manage the Scottish economy effectively. In addition there are different views on the level of access the Scottish Government should have to the tax base in Scotland, notably around North Sea oil and gas. Finally, Scotland’s fiscal arrangements have obvious cross-border sensitivities within the UK.

The Reform Debate

There are three broad views in the reform debate. The first has been described in the phrase ‘pocket money parliament’. In this view a Scottish Parliament mainly dependent on ‘pocket money’ awarded by the UK Government needs greater revenue-raising powers in order to establish a better relationship of accountability with voters. To invert the slogan that helped fire the drive for American independence, there should be no representation without taxation. This is a view shared by the Scottish public. The Scottish Social Attitudes survey of 2012 found (as had earlier surveys in 2009 and 2010) that over 55 per cent of Scots felt that the Scottish Parliament ‘ought to make most of the important decisions for Scotland about the level of taxes’ (Scottish Social Attitudes 2013a). A neo-liberal variant of this view – held by prominent figures in the Conservative Party in Scotland – is that greater fiscal accountability is desirable as it would likely have the effect of restraining public spending and reducing (or at least limiting) the size of the public sector in Scotland.

A second view has focused on the additional policy levers that enhanced fiscal powers might bring, both in terms of economic management (for example by reducing corporation tax in order to attract private sector investment) and perhaps also for changing environmental behaviour.

A third view is that Scotland should have fuller fiscal powers because Scotland should have control over its own destiny. These views are not mutually exclusive, but serve rather as a menu of options. From that menu three kinds of reform proposal have been constructed.

The Scotland Act 2012

The Scotland Act 2012 is the end-product of the initial unionist reactions to the SNP’s first electoral victory in 2007. A Commission on Scottish Devolution (CSD) was set up by a decision of the Scottish Parliament (with the support of Labour, the Conservatives, and the Liberal Democrats and against the opposition of the then snp minority Scottish Government) and supported by the then Labour uk government and the Conservatives and Liberal Democrats at Westminster). This unusual cross-party and cross-border body sat from April 2008 and reported in June 2009 (csd 2009). Its recommendations fell in three main areas:

1. a number of minor adjustments to the Scottish Parliament’s policy responsibilities;
2. a strengthening of the institutional relations between the Scottish and uk governments; and
3. a significant extension of the Scottish Parliament’s fiscal autonomy.

The Commission’s recommendations were by far the most radical in the latter area and were intended to bring a much strengthened sense of fiscal accountability to devolution in Scotland. They proposed a significant extension of the currently very limited borrowing powers of the Scottish Parliament, with UK Government loans to enable the cost of major infrastructure projects to be spread over years rather than incurred as a one-off expense in revenue budgets. They also proposed full devolution of tax powers in a number of fields with modest tax yields: aggregates levy, landfill tax, air passenger duty, and stamp duty land tax. More significant was the csd’s recommendation on income tax. The csd held the view that the tartan tax had never been used because there was no penalty for not using it; the Scottish Parliament’s block grant remained at the same level in the absence of an active tartan tax decision. The csd instead proposed that Parliament should be required to take a tax decision. The mechanism it proposed was one recommended to it by the Canadian public finance specialist François Vaillancourt (csd 2009), which was to set a ‘default’ rate of income tax in Scotland at ten percentage points less than in the rest of the uk (with the reduction applying at all income tax bands, currently 20, 40, and 45 per cent). The block grant would be commensurately reduced. It would then be a decision for the Scottish Parliament whether to replicate the uk rate or set income tax below or above it. This decision would be subject to considerable public debate and would therefore require the Parliament actively to account for that decision. The commission did not recommend any scope for progressivity (or regressivity) across the three tax bands; the Scottish Parliament could decide to levy tax, for example, at 18, 38, and 43 per cent, but not at 15, 40, and 50 per cent.

Together with existing powers on local taxation, the csd estimated that these changes would leave the Parliament responsible for raising around 35 per cent of its expenditures (see Table Two), around twice the current level. Finally, the csd recommended a modest extension of the scope for the Parliament to borrow, both to even out short-term revenue fluctuations and to enhance its capital budget through additional borrowing facilities with the uk Treasury (csd 2009).

 
Table Two  Recommendations of the Commission on Scottish Devolution

Source: csd (2009).

The csd’s recommendations on finance were almost all endorsed in the then uk Labour Government’s White Paper published in November 2009 (Scotland Office 2009). The only exception was the removal of air passenger duty from the list of devolved tax powers. Its recommendations were also supported by the Liberal Democrats. The Conservatives at Westminster were broadly supportive but unwilling to endorse the recommendations on finance, though they did commit to revisiting the issue were they to win the UK election in 2010. In the end, following the formation of a Conservative-Liberal Democrat coalition following that election in May 2010, a Scotland Bill was introduced to the uk Parliament in November 2010 (and considered also by the Scottish Parliament both before and after the Scottish election in May 2011). This bill took forward most of the White Paper’s recommendations, including the main provisions on income tax (though now with the aggregates levy removed from the list of Scottish taxes, and the level of borrowing available through the uk Treasury extended beyond that foreseen either by the Calman Commission or in the White Paper). The bill was enacted as the Scotland Act 2012 in May of that year, though its fiscal policy provisions will not come into force until 2016.

Devolution-Max/Plus/More

There is already a strong sense, though, that the new Scotland Act has already been overtaken by events, not least since the SNP won its absolute majority in the 2011 Scottish election. The SNP Government had been dismissive of the Commission on Scottish Devolution from the outset and refused to take part in it, launching instead a ‘National Conversation’ focused on independence (see further below) but also open to the option of maximal devolution within the UK, or what became known as devolution-max.

Devolution-max would involve devolution of legislative powers in most fields with the main exception of defence and foreign policy, and full fiscal devolution. This would include borrowing powers for purposes of counter-cyclical economic management, not just to even out revenue fluctuations and enhance capital spending. These powers would be carried out through borrowing direct from capital markets rather than accessing (and requiring the approval of) the uk Treasury (Scottish Government 2009a). Devolution-max would also involve the devolution of all taxation powers to the Scottish Parliament (within the limits of EU law, which would exclude the devolution of value added tax). The Scottish Parliament would be ‘responsible for raising, collecting and administering all (or the vast majority of) revenues in Scotland and the vast majority of spending for Scotland’ (Scottish Government 2009a). Any uk government services delivered in Scotland, like defence, would be compensated by a payment from Edinburgh to London. The model was broadly that of the Basque Country, and recognized – as in the Basque Country – that fiscal autonomy ‘max’ would be hedged by eu rules, agreements on a ‘degree of harmonization’ reached with the uk government, and the wide role of the uk government in regulating the uk economy

            After it won an absolute majority in 2011 the SNP invited interested parties to develop detailed proposals for devolution-max (and hoped for a time that devolution-max could be a further option available to voters in the independence referendum). The invitation was not taken up. But the gravitational pull of the SNP’s advocacy of independence did prompt further unionist thinking which went beyond the Scotland Act 2012. This has since led to the following array of proposals:

• A centre-right think tank, Reform Scotland, produced proposals in May 2012 for ‘devo-plus’ which envisaged additional devolution of legislative powers and proposed that the Scottish Parliament should have own revenues sufficient, as far as possible, to cover its spending, generated through an extension of tax devolution to cover income tax and corporation tax in their entirety, plus full devolution of a range of smaller tax bases. The effect would be to cover around two-thirds of the Scottish Parliament’s spending through the Parliament’s own tax decisions. These proposals, like those of the CSD, were justified as making the Scottish Parliament more accountable for its spending decisions, though the devolution of corporation tax would open up greater scope for using tax policy to influence economic activity (Devo Plus Group 2012).
• The Home Rule and Community Rule Commission of the Scottish Liberal Democrats issued its report Federalism: the best future for Scotland, in October 2012. This built on the recommendations of an earlier Liberal Democrat Commission which reported in 2003 (Steel Commission 2006). It proposed full devolution of income tax and a number of other tax bases to the Scottish Parliament, along with the assignment of a Scottish share of corporation tax revenues to the Parliament (that is, maintaining a common UK corporation tax rate). The 2012 Commission estimated that the combination of devolved and assigned taxes would cover around 55% of Scottish Parliament spending (using 2010-11 estimates). While the report emphasises the impact of such changes on the fiscal accountability of the Scottish Parliament, it also points to the potential to use greater fiscal powers as ‘powerful economic levers’ Home Rule and Community Rule Commission, 2012).
• A centre-left, London-based think tank, the Institute for Public Policy Research, published proposals for ‘Devo-More’ in January 2013. These proposals again envisage full devolution of income tax and other minor tax bases, but reject the devolution (or assignment of Scottish revenues from) corporation tax. Instead they envisage the assignment of ‘ten points’ (that is, half) of Value Added Tax revenues collected in Scotland to the Scottish Parliament. The effect would be (on 2010-11 figures) that devolved and assigned taxes would cover 60% of Scottish Parliament spending. These proposals are justified in terms of ‘fiscal responsibility’ for distinctive policy choices in Scotland (Trench 2013).
• In April 2013 the Scottish Labour Devolution Commission published its ‘interim report’ with view to consultation on its content within and beyond the party. It too holds out the prospect of full devolution of income tax (and other minor taxes), though does not appear open to the assignment or devolution of VAT or corporation tax. Though no detailed figures are presented, this would leave it at the lower end of the various recent proposals in putting a high proportion of tax revenues under the control of the Scottish Parliament, though nonetheless implies a significant move beyond the Scotland Act 2012.
• A working group on devolution was established by the Scottish Conservatives in March 2013, though it is unclear as yet when it will report. In contributions by the Scottish Conservative leader around its launch it is clear that the working group will give considerable attention to fiscal devolution, no doubt underpinned by an ideologically reasoned ambition to use greater fiscal accountability to rein in public spending and reduce the size of the state in Scotland.

Though there are significant differences, it is clear that there is a common direction of thinking among and around the unionist parties. Each (and the think tanks close to them) is positioning itself beyond the level of fiscal devolution proposed in the Scotland Act 2012, which seems to have become more or less redundant within a year of its enactment. Each is likely to refine these proposals individually, and perhaps with some level of collaboration, in the run-up to the independence referendum in September 2014. The Liberal Democrats’ Home Rule and Community Rule Commission was reconvened in February 2014 with the purpose of finding a common denominator to which all the unionist forces might agree (though it remains to be seen whether the other forces will take much notice of the Liberal Democrats!). The unionist aim is to convey a sense that a No vote in the referendum will in fact mean a vote for more powers for the Scottish Parliament, above all in questions of fiscal devolution and the consequently greater fiscal accountability of decision-making in the Scottish Parliament that will result. The intention is to peel off potential supporters of independence by envisaging a more autonomous Scotland within the UK.

Independence

The case for independence is dominated by the SNP (though two fringe parties, the Scottish Greens and the Scottish Socialist Party, also range among the pro-independence forces). The debate about independence entered a new phase with the SNP’s initial election victory, after which it formed a minority government, in 2007. Shortly after taking office the SNP published a White Paper, Choosing Scotland’s Future (Scottish Executive 2007). This set out two broad options – more devolution within the uk and Scottish independence – and launched a consultation process, the ‘National Conversation’ to explore views on those options. It is not surprising that the SNP advocated independence through that ‘conversation’ (Scottish Government 2009b). But it was unable as a minority government to win sufficient support in the Scottish Parliament to put that advocacy to the test in an independence referendum. Its absolute majority in 2011 changed that situation, and in October 2012 the Scottish and the UK Governments agreed the terms under which the referendum would be held, in particular a simple yes-no question without additional options like devolution-max. The referendum will take place on 18 September 2014 with the question: ‘Should Scotland be an independent country? Yes/No’

            Since 2011 the SNP’s arguments for independence have become clearer, as has the form of independence it envisages. Those arguments are fundamentally about self-determination: that it is right and good for Scotland to run its own affairs. But they also have more instrumental dimensions, focused in part on protecting a left-leaning Scotland from the neo-liberal policies pursued especially by the Conservative Party at the UK level, and in part on the perceived economic advantages independence could bring. Those perceived advantages lie in part in the aspiration to invest North Sea oil and gas revenues in a sovereign wealth fund for Scotland, in part in the view that UK economic policy decisions are dominated by the interests of London and the South East of England; independence would bring economic policies better attuned to the needs of Scotland.

            That said, the vision of independence the SNP has is a highly qualified one which envisages a close continuing relationship with the rest of the UK, including the maintenance of ‘shared services’ in some fields and, most significantly, the maintenance of a sterling currency union in which the Bank of England would continue to act as lender of last resort (and also financial services regulator) for the independent Scotland. The SNP recognises that membership of a sterling currency union would require the independent Scotland to agree and adhere to fiscal rules set out in negotiation with the Bank of England and the UK Government. These would likely set limits around the total public debt and the level of annual public deficits allowable. In other words, even under independence, fiscal autonomy would have its limits. Scotland would of course have the autonomy to define and draw revenues from different tax bases (subject to limits in EU law), but there would likely be limits around the overall balance and effects of fiscal policies. To the extent that an independent Scotland would want to maintain a single domestic market with the rest of the UK, other de facto constraints – for example the avoidance of tax competition, or the concern not to impose too high a compliance overhead on firms operating in Scotland and the rest of the UK – would also exist.

What the Public Thinks

There is an interesting juxtaposition here of a vision of independence which sees significant continuing fiscal interdependencies between Scotland and the rest of the UK, and a dynamic of debate among anti-independence forces which is pushing towards a very significant increase in fiscal autonomy. There is a sense that the pro-independence campaign is seeking to project an imagery of continuity around formal independence, while the unionist message is one of significant further change, especially around fuller fiscal autonomy.

One of the reasons for this blurring of the boundaries of independence and union on both sides has likely to do with public opinion. Regular opinion polls show support for independence as a yes/no choice is at about 30% while support for Scotland remaining within the UK is close to 50%, with the remainder undecided. These figures may of course change as the referendum nears. But the No vote lead at the moment does not signify great satisfaction with the status quo. Surveys have shown for some time strong support for the devolution of both welfare policies and tax powers (the former at just over, the latter at just less than 60% approval). And if a more subtle approach to constitutional options than yes/no on independence is taken, a more nuanced picture emerges. Table Three shows responses to a survey question which removes formal constitutional labels and instead asks about the scope of decision-making by Scottish and UK institutions.

Table Three: Who Should Decide What?

%2011
%2012
%2013
%The Scottish Parliament should make all the decisions for Scotland28433531The UK Government should make decisions about defence and foreign affairs; the Scottish Parliament should decide everything else32293232The UK Government should make decisions about taxes, benefits, defence and foreign affairs; the Scottish Parliament should decide everything else27212425The UK Government should make all the decisions for Scotland10568

Source: Scottish Social Attitudes (2014)

The first row in Table Three describes Scottish independence. The second – where the Scottish Parliament ‘should decide everything’ except defence and foreign affairs (but including taxes and welfare benefits) – is an approximation to ‘devo-max’. The third broadly describes the status quo, and the last the situation that existed before devolution.

It is striking that the status quo has such little support and that options beyond the status quo attract the support of around two-thirds of Scots. The status quo is clearly not much of an option for the Scots. However the Scots are split (and, averaging out year on year fluctuations, pretty much evenly split) between the option of more devolution within the UK and that of independence. That is the area in which the SNP and the unionist parties are now competing in developing their various proposals on ‘independence amid continuing interdependence’ and some form of ‘devo-more-than-now’. It would not be at all surprising as the referendum approaches to see a further blurring of the boundaries between these two alternatives for Scotland. In that case it will be a moot point as to how far, once the dust has settled, ‘Yes’ and ‘No’ actually mean things that are much different from one another.

 Davide Gianluca Bianchi
References
 
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