Barnett after Smith: Not a Good Outlook

brittaniaThis note reports on a paper of mine which has just been published in the Fraser of Allander (FoA) Economic Commentary, modelling how the Barnett formula will operate once it has been modified under the Smith reforms: (“The Barnett formula under the Smith Reforms”, J.R. Cuthbert: FOA EC, vol 39(1). As will be seen, the modelling has some pretty unpalatable implications.

After Smith has been implemented, Scotland will receive revenues from the taxes it will control, (principally income tax), or which are hypothecated to Scotland, (like about half of Scottish VAT receipts). There will be an abatement to the Scottish government’s block grant as calculated by the original Barnett formula, to compensate Westminster for the tax revenues it will have foregone. And this abatement will be increased each year by an appropriate form of indexation. For income tax, this indexation will be on the so-called “Holtham” basis – i.e., in line with the growth in the overall UK income tax base.

What the FoA paper does is to model the operation of the Barnett formula, as modified by these arrangements, and then to consider how relative levels of per capita public expenditure in Scotland and England are likely to evolve. The paper makes a number of simplifying assumptions: but nevertheless, it is of considerable interest, in that it reveals the underlying pressures which are likely to determine how the system evolves.

It turns out that there are three key parameters which will determine how things will change: namely, the rate of growth of public expenditure in England; the relative rate of growth in the tax base between England and Scotland; and the relative rate of population growth between England and Scotland.

The implication of the modelling is that, left to itself, the system could not go on indefinitely with fixed values of these parameters, (other than in a very unlikely special case). Ultimately, ( and possibly quite quickly), the ratio of per capita spending in Scotland relative to England would evolve to politically unacceptable levels: with the likelihood being that this would involve public expenditure per head in Scotland being pushed down well below levels in England. Moreover, it is probable that dynamic effects would set in, with the parameters themselves changing in ways which would make the adverse effects even worse.

In other words, the fiscal system being set up under Smith will be unstable, and will only operate tolerably under continued intervention by government. Moreover, it is unlikely that the powers which the Scottish government will possess, (which, in the economic sphere, are very limited), will be sufficient to enable it to stabilise the system by its actions. The implication is that, if the system is going to work at all satisfactorily, Westminster is going to have to be prepared to intervene actively, and to adjust fiscal transfers between Scotland and England on a regular basis.

This, however, poses a number of problems. On its past record, it is very doubtful if Westminster is equipped to discharge such a role effectively. And the whole thrust of Smith, that Scotland now has increased powers and should get on with it, runs quite counter to the role which Westminster would have to discharge.

It is essential that the inherent flaws in the fiscal system being set up post Smith should be exposed now. Otherwise, once things go badly wrong under Smith, (as they will), the Scots will get the blame: “You can’t even run Smith: what would you be like running an independent Scotland”.

But on the other hand, this puts the SNP in a difficult position. The SNP signed up to Smith: so it might appear to be very difficult for the SNP to come out now and say that the proposals are ill-conceived and potentially disastrous.

Overall, the current situation is an object lesson of the pitfalls of trying to do fundamental constitutional reform in seven weeks, without actually looking at the detailed implications of what is being agreed to. But this points to a way out. The SNP should argue that, while they were willing to sign up to the principles in Smith, this was of course conditional upon satisfactory arrangements being arrived at for implementation. And satisfactory arrangements are far from being arrived at yet. This is true both as regards the adjustments to the Barnett formula, (as demonstrated by the modelling paper): and also in relation to the critically important gearing problem, (which under laid an earlier Bella piece, of 25th January 2015).

Comments (17)

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  1. Sandy McMillan says:

    Everyone assumes the direction of Scottish funding will be driven by tories in London?

    Scottish tories, as per their labour counterparts, are quite happy to follow a sorched earth policy in Scotland to maintain union. They do not care about the Scottish people. It’s as blunt as that, labour struggle to apologise to Scots over Iraq, Tories have never and never will apologise over thatcher.

    I think this is more likely to be driven by davidson rather than mundell. London Don”t care, there”s no votes in it for them and it may save them some money to spend on London and South East England.

    The SNP have to be very clever over this and doubly important is to be completely transparent with the Scottish people so they are seen always to be fighting for our interests!

  2. Bill Ramsay says:

    I look forward to watching Jim’s presentation to the Public Accounts Committee or similar at Westminster in due course.

  3. muttley79 says:

    When the almost inevitable problems occur with the next Scotland Act, I suspect the SNP will argue for more fiscal powers in particular, as a means of achieving a solution. The only reasons I can think of for the SNP signing up to the Smith proposals is because: 1) there was a No vote in the independence referendum, and the SNP/Greens had to respect the democratic outcome of it, and 2) As I mentioned previously, the SNP would probably argue for more powers to correct the faults inherent in the Smith recommendations.

  4. Dan Huil says:

    Didn’t the Smith Report which the SNP signed up to include the “no detriment” clause? That clause has been withdrawn by Westminster so the SNP can simply tell Westminster to stick their Scotland Bill where the … and call, then hold, another referendum, regardless of Westminster’s protestations.

  5. C Rober says:

    Give em enough rope politics , the poisoned chalice.

    You have highlighted something I have always said about the “vow” . engineered destruction , to look like exactly as you noted “if you cant do Smith….”.

    Hell , the SNP even do it to themselves , fail at their own doctrines , then blame others for its failures , are they therefore happy to be the big fish in the little pond until the water runs dry?

    While I still support sharing the bath water with my own kin , as an independence metaphor.

    I would at least like to have a Scottish sited bath , filled with Scottish water , even if it does mean no bubble bath , but not if the water quality and temp is dictated by my neighbor to be to my detriment and they use bath before me.

  6. Mike Fenwick says:

    Extract: “The SNP should argue that, while they were willing to sign up to the principles in Smith, this was of course conditional upon satisfactory arrangements being arrived at for implementation.”

    During David Mundell’s appearance before the Devolution (Further Powers) Committee yesterday, he chose to dismiss any FFA amendments by claiming that they were bad for Scotland, and that he would resist any changes that would be bad for Scotland.

    Once Jim Cuthbert’s analysis is fully understood, one might hope that David Mundell would wish to act in similar manner and place no less importance on resisting what is clearly bad for Scotland, and based on Jim Cuthbert’s analysis one does sincerely hope that the SNP will persuade him to do so.

  7. iain rodgers says:

    The pdf that you link to is blank or missing.

    (http://www.strath.ac.uk/media/departments/economics/fairse/fecvol39no1/The_Barnett_formula_under_the_Smith_Reforms.pdf)

    Unless you show figures to support your argument this whole article is just “blah blah blah”.

    The fact is, according to GERS figures, Scotland will be poorer if Barnett is replaced by FFA. With the oil price falling and whisky sales also declining in some important markets it’s about time some people realised that the Union provides long term stability both politically and economically.

    The economic case has ceased to exist (if it ever did) and the emotionally driven push for independence is not helping Scotland’s image abroad or within the UK. It’s about time the project was abandoned.

    1. Alan Weir says:

      An interesting phrase ‘The fact is, according to GERS figures’. One could read it as: ‘it’s a fact that the GERS methodology implies [Scotland will be poorer under FFA’ or ‘it’s a fact Scotland will be poorer under FFA- see GERS’. Both are false. GERS or IFS calculations tell us nothing about the fiscal position under FFA without assumptions about the fiscal framework. Which framework should be adopted is a matter of political morality, not economics, something determined in part by moral (not legal) liabilities between Scotland and rUK, in both directions. What liabilities there are may be a chiel that winna ding but at any rate it is highly contestable what the ‘facts’ here are.

    2. Andy Dewar says:

      To Iain’s comment about economic stability staying together, well sorry but I do not agree with you. Firstly Whisky is going down in some markets but going up in others so it really is still growing. Oil again lets not focus on the price per barrel the cost to motorists is still very high and 70% is tax, the cost base for oil companies is now around £65-£70 per barrel so with the proper tax base it will continue to make sense to continue pumping it out. As for better together I am comfortable with both that and Indy as I believe we can make it work. The Smith deal, personally I would abandon it, it’s not fit for purpose and yes the Barnett formula will bite our ass, so its Indy for me or we will continue to be second class citizens.

    3. Willie John says:

      I struggle to understand so many commenters fixation with the price of oil. If oil were to be, say, $100 per barrel in the union then the best that Scotland ‘might’ get would be our one tenth share, $10. I wouldn’t care when oil fell to $50 per barrel in an independent or FFA Scotland because that would actually be a whopping great increase in income!

      1. Iain Rodgers says:

        The price of oil matters because there is a cost in extracting it. Tax is raised on the profit. If oil is not profitable it is not extracted. If it costs $50 a barrel to extract and the price is $50 the profit is zero. The tax raised is also zero.
        Oil may go back up in price in time to save the SNP but don’t bet on it.

        1. Willie John says:

          That is not answering the comment. I am asking why the fixation on the price of oil dropping and the damage it would do to an independent Scotland? 100% of $50 (when independent) is greater than 10% of $100 (if still in the union)!

  8. John B Dick says:

    The arithmetic is far beyond my competence. That said, I can see that there are asssumptions that the future level and movement of several key factors will be similar or relative to the recent past.

    It is inescapable that this is so, and it is not a criticism of the paper to say that the predicted outcome is the natural consequence of the assumptions necessarily made.

    The first question which needs to be addressed is whether any critical assumption is likely to change, either as a consequence of the policy of the UK government licexpenditur[ massive reduction in public expenditure and tax] and the second is whether there is a way for the Scottish Government to play the system to their advantage.

  9. thomaspotter2014 says:

    The Smith Commision is and was a crock of shit

    Next up isn’t another referendum it’ll be straight UDI

    Cameron couldn’t be trusted to deliver a pizza FFS

    1. Iain Rodgers says:

      The SNP signed up to Smith. Declaring UDI would cause civil unrest in Scotland because there is no majority support for independence. Is that what you want?

      Who would be on your side? Not the USA because they won’t be happy with your foolish position on Trident which costs their taxpayers. Not the EU because they won’t like the example set to Catalonia etc. Not the rUK because it has bent over backward to give a free and fair referendum already.

      Scotland would be a pariah.

      1. Willie John says:

        Signed up to Smith? Not worth the paper it was written on according to the way it is being rewritten in Westminster. Not the USA? I understand that it has already been stated in America that they would prefer to see the money spent on Trident being spent on conventional defence instead. Not the EU? Catalonia is Spains problem, not the EUs. And if you really think that rUK allowed a “free and fair” referendum you obviously haven’t been paying much attention to Scottish politics!

  10. Mike Fenwick says:

    UDI?

    During David Mundell’s appearance before the Devolution (Further Powers) Committee this week he was pressed more than once over the Committee’s unanimous proposal that a dissolution of the Scottish Parliament be dependent on a referendum, the sovereign will of the Scottish people.

    In response he found it inconceivable that a proposal to dissolve the Scottish Parliament would leave the UK intact, and there was therefore no need for the committee’s proposal on a referendum.

    David Mundell may be 100% correct, but it does beg the question, in the absence of a referendum, of how the break up would occur.

    Perhaps David Mundell is an advocate of UDI?

    He most certainly appears to be ruling out the democratic alternative.

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