Scotland’s Fiscal Framework: A principled agreement?

After months of protracted negotiation, the UK and Scottish governments have finally found something they can agree on, says David Eiser - that two plus two equals five. 
 
So, after months of negotiation, a deal has finally been agreed on how the Scottish Government’s block grant will be adjusted to reflect its new powers over taxation and welfare.
 
John Swinney has effectively got the deal he wanted, at least until 2022. And Nicola Sturgeon has said the deal provides ‘not a penny of detriment’ to the Scottish budget.
 
But it’s important to remember what no detriment means in this context. Under the agreed deal, the Scottish budget will be no worse off (and no better off) than it would have been without the devolved powers, providing that Scottish per capita revenues from devolved taxes grow at the same rate as those taxes in the rest of the UK (rUK).
 
If Scottish per capita revenues grow more slowly than in rUK, the Scottish budget will be worse off than it would have been without devolution. And if Scottish revenues grow more quickly, the Scottish budget will be better off.
 
Since 1999, Scottish per capita revenues have tended to grow more quickly than those in rUK. So, had this deal been in place since the Parliament’s formation, the Scottish budget would be in a slightly stronger position than it currently is.
 
But can we count on this trend continuing? On the one hand, Scottish income tax revenues per capita are still around 11% lower than those in rUK (having been around 19% lower in 1999), and there is no reason to believe that further convergence to the rUK level should not be possible. On the other hand, if Scottish revenue growth falters in the face of headwinds from declining offshore activity, whilst revenues in rUK are buoyed by a booming London economy, it’s possible that Scottish per capita revenues relative to those of rUK might decline. 
 
This is the nature of fiscal risks that the Scottish budget is now exposed to. In five years’ time, the Scottish budget could be better or worse off than it would have been without the new powers. I wouldn’t like to bet one way or the other.
 
With the fiscal framework now effectively agreed, it paves the way for the full devolution of income tax to the Scottish Parliament as early as 2017. Devolution of Air Passenger Duty could follow in 2018, with the ‘assignment’ of VAT revenues to the Scottish Parliament taking place in 2019. Devolution of welfare powers (mainly in relation to disability benefits) is likely to take longer, given the administrative complexities involved. 
 
Why was the deal on the block grant so hard to reach? The key point to remember is that there was more than one ‘no detriment’ principle up for negotiation. For a long time the UK Government objected to John Swinney’s proposal because it would breach the Smith Commission’s ‘taxpayer fairness’ principle. Scotland’s lower revenues per capita and slower population growth mean that the Scottish Government’s proposed method for calculating the block grant would result in the transfer of some revenues from rUK taxpayers to Scotland for taxes that are in theory devolved to Scotland. The mechanism proposed by the UK Government for adjusting Scotland’s grant would not have resulted in any revenue transfer from rUK taxpayers to Scottish taxpayers. But it did not meet the Scottish Government’s interpretation of ‘no detriment’. 
 
By ultimately signing up to Swinney’s preferred option, the UK Government has reneged on its commitment to the taxpayer fairness principle. 
 
But the wording of the agreement is quite bizarre. Until 2022, Scotland’s grant will be calculated using the UK Government’s preferred method, but then adjusted so that it gives the result that the Scottish Government’s preferred method would have produced. 
 
This is like saying ‘we will add two and two together and agree that the answer is five’. Swinney’s motivation for agreeing to the wording is that he gets the result he wants (five), at least until 2022. The UK Government’s rationale for agreeing to the wording is presumably that, come 2022, they can highlight the difference between the result their method would have given each year (four) and the result that the Scottish Government has got (five); and use this difference as the basis of a renegotiation.
 
And yes, in five years’ time we can look forward to going through this negotiation all over again. Of course, economic and political circumstances could be very different then, and it is quite possible that one or both governments may have changed their minds about which is their preferred approach. Perhaps ‘block grant adjustment mechanisms’ should be introduced to the school curriculum.
 

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post by David Eiser
Fraser of Allander Institute
25th February 2016
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