David Bell looks at whether there exists a more stable fiscal settlement between Smith and Full Fiscal Autonomy. Following on from Monday's Part 1.
So if FFA is off the agenda, what stable solution might exist to the vexed issue of Scotland’s fiscal powers? There may be no solution to this question, in which independence is the only likely outcome, but there are a number of points worth making.
First, the Smith Commission process was unsatisfactory in many respects. Its timetable was too short and its democratic legitimacy questionable. Its recommendations were not derived from any coherent set of principles. In particular, its “no detriment” principle will be impossible to operationalise. Finally, the general election interrupted any constructive debate of its findings.
Any new set of proposals must emerge from a more coherent and inclusive process. And while there is a need for a more considered timetable, there is a danger that continuing uncertainty over taxation will have a corrosive influence on investment and employment in Scotland.
Nevertheless the next few months will provide an opportunity to reassess the Smith proposals with some more considered assessment. Any new process will need to clarify some issues that were ignored by the Smith Commission. The list might at least include exploring the following issues:
- Who sets the macroeconomic stance for the UK and what role, if any, is there for the devolved regions to be consulted on this stance? Clearly the issue of austerity played an important role in the election campaign. The outcome clearly provides support for the strategy of balancing the UK budget during the new Parliament (i.e. continuing austerity). A sub-national government normally has no role in setting the macroeconomic stance. Macroeconomic management (the setting of fiscal and monetary policy) is almost a defining characteristic of what it is to be a central government. But in some countries, sub-national governments have a role, usually consultative, in the establishment of medium and long-term fiscal objectives (Cottarelli and Guergill 2014, p 137). Examples include Australia, Germany, Spain and Austria.
- Which risks are to be pooled across the UK and which are to be handled by Scotland and possibly other sub-national governments? For example, should unemployment insurance be handled locally or at a UK level? The obvious risk to a local solution is that the costs of a sudden economic downturn have to be met locally rather than being spread across a wide economic base.
- How will borrowing powers be assigned to the Scottish Parliament? This question is linked to both previous issues. The UK government will not wish the Scottish Government to undermine its fiscal stance through excessive borrowing. This problem is described as “deficit bias” in the fiscal decentralisation literature which describes many of its historical occurrences. On the other hand, borrowing will be necessary to cover the risks that are no longer covered by pooling. The UK will not wish to agree a “soft budget constraint” (SBC) that might encourage excessive borrowing by Scotland, which would lead markets to overvalue Scottish debt and undervalue UK. However, the construction of hard budget constraints by national or supra-national authorities is extremely difficult, as witnessed through the recent experiences of Greece and the UK’s commercial banks in 2009. The issue of borrowing needs a much more considered and informed debate than that afforded by the Smith Commission.
- What form of equalisation mechanism might be used to ensure equity in public spending capacity across the UK? As implied above, the Barnett Formula does not fulfil this role. There is now an opportunity to revisit this mechanism, which is widely acknowledged to be deficient.
- How broad is the population base that might be affected by devolved fiscal powers? One valid criticism of the Smith proposals was that it would have minimal effect on those with lower incomes. Their impact on working age benefits is negligible. Similarly, while the assignment of 50 per cent of VAT revenues to Scotland has negligible incentive effects for the Scottish economy, powers to change National Insurance would be much more salient to the working poor.
There are many other issues that need to be considered in any revisitation of Smith. If FFA is off the SNP’s immediate agenda, there is an opportunity to take a more considered view of whether there exists a more stable fiscal settlement between Smith and FFA.
Cottarelli, C., & Guerguil, M. (2014). Designing a European Fiscal Union. Taylor & Francis.