Evaluating new tax powers in the event of a no vote

Peter McGregor discusses tax powers for Scotland in the event of a no vote.

A “no” vote  in the forthcoming referendum on Scottish Independence would immediately lay to rest one of the most controversial issues that has characterised the economic debate so far, namely the currency issue.  Scotland would remain in a monetary union with the rest-of –the UK (RUK), which implies that the Scottish Parliament will have no greater influence on UK monetary policy than it does currently.

What about fiscal policy, which relates to Government expenditure and taxation? Under all of the pro-union plans that are in the public domain, the Scottish Parliament would have comparatively limited influence on the overall fiscal policy stance:  the difference between government revenues and expenditures (although limited borrowing powers are part of some proposals, and indeed will be a reality once the Scotland Act comes into force).  The recent experience of the Eurozone mitigates against much relaxation on this front.

If both the overall monetary and fiscal policy stances are effectively given to the Scottish Government (subject to the qualification of modest borrowing powers whose purpose is constrained), does anything interesting remain?

The answer is an emphatic “yes”:  there is the issue of the level at which both taxes and expenditures are set:  restrictions on the overall fiscal policy stance effectively mean that taxes  and expenditures have to move together.  If the Scottish Government want to increase government expenditure, they also have to increase taxes to finance the change. Similarly, a reduction in taxes would have to be matched by a reduction in government expenditure.

Of course, the extent to which such variation is possible differs among the proposals, as does the group of taxes over which the Scottish Parliament would have control. However, while the differences among pro-union bodies proposals for further devolution are undoubtedly  interesting,  it is also useful to focus on what the proposals have in common and to explore what this could mean for Scotland.

All of the pro-union proposals (that are so far in the public domain) envisage significant additional influence (relative to the Scotland Act) over the levels at which government expenditure and income tax rates are set. Indeed even the most limited of the pro-union proposals on tax – namely the Labour Party’s  plans -  would give the Scottish Government the ability to change tax income tax rates by 15 percentage points on all rates across the board. (There would also be the ability to raise the higher rate to increase the degree of progressivity of the Scottish tax system.)

These powers, if used to their full extent - of course, a big “if” - would result in tax rates of:

  • A35% basic rate, a 55% higher rate and 60% highest rate. So even the most modest proposal could be used to move Scotland significantly  in the direction of Scandinavian countries, characterised by a high tax/ high spend combination.
  • Alternatively - though it seems less likely – the Government  could opt to move in the direction of the low tax/ low spend Baltic countries, and establish a 5% basic rate, with a 25% higher rate and 30% highest rate.
  • This would imply accounting for roughly 40% of the Parliament’s total budget according to the Labour Party.

While the scale of the contribution of taxes to total expenditures has been challenged (as being less than 40%) – see Charlie Jeffery’s blog - there is no doubting the significance of the power. Clearly this is not a simple technical economic choice that is at stake here, but the kind of society in which we live.

Of course, other  pro-union bodies’ proposals involve control of more taxes and up to 66% of spending in Scotland. They would allow an even more radical transformation of the Scottish tax system.

Of course, no Scottish Party has yet signed up  to use the new powers that they propose to effect radical change. And presumably any Scottish Government would have to take account of the anticipated impact of variations in taxes and expenditures on the Scottish economy, which will remain a small, open, regional economy irrespective of the extent of constitutional change.

Our research in this area suggests that public attitudes towards Government expenditure matter a great deal. If Scottish people genuinely want higher government expenditure – and, crucially, are prepared to pay for it through higher income taxes (and  lower disposable incomes) – then it seems that the kind of “balanced budget” expansion of government expenditure and taxes together is likely to have a beneficial impact on the economy as a whole.

However, if, on the other hand, the Scottish workforce seeks to compensate for the higher taxes (used to finance the higher government expenditures) through higher wages, then adverse competitiveness effects would likely predominate to generate a contraction in Scottish economic activity.

Public attitudes matter, but may not be easily impacted by policy – though the Government can: appeal to the idea of a social wage (so that workers value government expenditure not just private consumption); target expenditures on areas where public willingness to pay may be greatest (e.g. health, education, childcare).

Even the most modest of the pro-union bodies’ proposals would allow fairly radical change, and the impact of such changes would, not surprisingly, depend on public attitudes towards taxation.

Futhermore, all of the pro-union proposals for further tax devolution seem likely to add to the strains on the Barnett formula, which almost certainly currently operates in a way that favours Scotland.

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Peter McGregor's picture
post by Peter McGregor
University of Strathclyde
8th May 2014
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