Problems with the Fiscal Settlement
And so we have a fiscal settlement. Unfortunately, we have a variant of the Treasury’s originally proposed method for indexing the abatement to the Scottish government’s block grant: a variant which has been designed to be virtually identical to the so-called per capita indexed deduction, or PCID, method, (or so John Swinney claims.) It turns out, therefore, that the outcome predicted in my Bella article of 7 February 2016 (‘Will a disastrous fiscal settlement be the end for John Swinney?‘) has indeed come to pass.
As I argued in that article, this is bad news for Scotland. What it means is that Scotland has to engage in an economic race with the rest of the UK, (rUK) – a race in which, to avoid being penalised, Scotland has to grow its income tax revenues per head as fast as rUK. Given Scotland’s lack of economic powers, and given that income tax is not Scotland’s strong suite, there is every chance of Scotland falling behind in this race. And the penalties if we get into this situation are very severe. Ultimately, if Scotland’s growth rate in income tax revenues per head is consistently lower than the growth rate in rUK, then levels of public expenditure per head in Scotland on devolved services would reduce to about half of the levels in rUK.
I don’t want to repeat here all the arguments in that earlier article: but my conclusions still hold. Unfortunately, John Swinney has let himself be comprehensively outplayed by the Treasury negotiators.
What I want to do here is to examine the likely significance of the re-negotiation arrangements which are part and parcel of the current agreement. It is useful to start by looking at the Treasury’s view of Scotland’s economic powers. During a meeting late last year attended by several Treasury officials, I expressed the view that Scotland would not have adequate economic powers to make it worthwhile to take on the risks inherent in PCID type indexation of the block grant abatement. The response from a very senior Treasury official was that I was wrong, and that Scotland would indeed have adequate powers: in particular, the official said that the primary power Scotland would have would be the ability to lower tax rates in the higher income tax bands relative to the rest of the UK – so making Scotland a haven for the rich, and hence increasing Scotland’s tax base and revenues.
This view of course is nonsense: it runs quite counter to anything that any reasonable Scot would want to do with Scotland’s new powers: (in particular, John Swinney has said he wants to make Scotland’s income tax more progressive – i.e., quite the opposite of the Treasury official’s recommended course of action.) And the Treasury policy is extremely unlikely to work anyway, even if any Scottish government was willing to give it a try.
However, the Treasury’s view does indicate what would happen in any attempt to re-negotiate the fiscal settlement. Suppose that Scotland is failing to keep up in the economic race with the rest of the UK which is implicit in the current settlement. That is, suppose that Scotland’s income tax receipts per head are failing to grow at the same rate as rUK’s, and that, as public expenditure becomes progressively squeezed, Scotland is slipping into a self perpetuating cycle of decline relative to rUK. Then, if Scotland asks for an adjustment to the block grant indexation arrangements at one of the regular reviews, the Treasury response is likely to be: “Have you implemented a policy of cutting the higher rates of income tax to make Scotland a tax haven for the rich? No? Well then, your problems are the result of your mistaken policy choices, and are therefore self inflicted. By the Smith no-detriment principle, we can do nothing for you.”
The implication is that the re-negotiation facility in the recently negotiated deal is actually likely to be worth very little when we really need it – and need it we will, at some stage.