money-ballRetired civil servant and now lecturer at Nuffield College, Oxford Prof Jim Gallagher gives the opposing view to the Cuthbert’s analysis of the Smith Commission.

My old friends Jim and Margaret Cuthbert are indefatigable in looking for flaws in any scheme of devolution. They criticized the Calman scheme because it only devolved some of income tax; now they criticize the Smith Commission for devolving all of it. I’m beginning to see a pattern here.

The Smith plan is the outcome of a political negotiation. I’ve no particular ownership of it, but just about everything technical Jim and Margaret say to criticize it is wrong. So this note is pretty technical. Sorry.

Power and Responsibilty

They say devolving income tax is responsibility without power, as the devolved government can’t control the economy, and so the income tax yield. No government can control the economy and make the income tax base grow, as the unhappy Mr. Osborne is finding out just now. And actually most of the long-run tools for economic growth in Scotland are already devolved: and even the SNP don’t propose separate macroeconomic management for Scotland.

Indeed on this argument you would devolve no taxes at all, as they all depend on the economy. Try selling that one.

Income tax as a Devolved Tax

Then there’s the interaction of devolved taxes with the block grant. This is indeed quite complicated, but the Cuthberts seem to have read Smith but not seen its significance properly.

When income tax is devolved in Scotland, it becomes effectively devolved in the rest of the UK as well. Just as changes in income tax in Scotland will not affect public spending in England, changes in income tax in England cannot be allowed to affect public spending for Scotland, up or down. Smith makes that explicit, in the passage quoted. Barnett will be adjusted to remove the effects of English income tax changes.

[For anoraks of the public finances, this is already the position with non domestic rates, though the Treasury made a mistake in way of doing the sums, which is benefited Scotland by about £600m or so.]

So if a right of centre government in rUK cuts income tax, it will feed through into rUK public services (and only those). A penny off the rUK income tax will cut English health, education or the like by £5bn or do. Scotland need not follow that: if it does, it will cut Scottish health education etc by £500m – proportionality a smaller cut, as it happens, as we spend nearly 30% ahead more on these services. So the “gearing” problem Jim and Margaret see does not exist

How the block grant should be changed to reflect the income from devolved taxes is indeed quite complicated, and you can always raise the fear that the wicked UK Treasury will screw us some way or another. But basically this already sorted in preparation for the Scotland Act 2012 – and agreed with the Scottish government.

The easiest way to understand it is to ask which of the risks to the Scottish Parliament’s income is the responsibility of which government. So the Scottish government takes the risk of changing the tax rates, or the thresholds. The United Kingdom government will pay the price of changing the personal allowance, or other changes to the tax base, like pensions tax relief. Because income tax is devolved, the Scottish government will take the benefit, or pay the penalty, if Scottish incomes grow more or less than the UK as a whole.

That has to be right, and it is perverse for nationalists to argue that Scotland shouldn’t take on this risk, or opportunity, when they want to take on much bigger ones. It’s exactly what happens in every other country with decentralized taxes. A sub state government [say, a German Land or US state] gets some central support, but depends on its own economy for some of its funding. That’s the sort of responsibility that comes with power.

The Smith scheme transfers more risk than the Scotland Act, as only 40% of the budget controlled by the Scottish Parliament will now be supported by a share of UK taxes. Maybe further than I would have gone, as a cautious bureaucrat, but that’s what the politicians round the table argued for, and it’s the same as very decentralised federal states like the US or Switzerland.

Historically, Scottish economic growth per capita has been a just a bit above UK levels for the last 50 years or so. But the population of the rest of the UK has grown more. The population trend seems to be reversing recently, so there is reason to assume that with competent policies in Edinburgh, Scotland could do reasonably well out of this scheme.

Jim and Margaret are a National Treasure: but because they look at every issue through what I think is the wrong end of the telescope, they quite often focus on the wrong end of the stick.