Scrap Smith?

 

More Fiscal Autonomy

The limited fiscal autonomy granted by the Smith Agreement appears to make life more difficult for the Scottish Government particularly if their policies are materially different to the Westminster Government.  The SNP address this by demanding more fiscal autonomy or as some refer to it “Devo-Max”.

Failure to satisfy SNP supporters will no doubt increase calls for another Referendum.  But the basic economic deficits haven’t changed – Scotland would have to accept Fiscal Rules set by H M Treasury unless it had its own currency and Central Bank.  Those rules would inter alia include similar if not the same provisions on budget management as the current H M Treasury Policy.  Indeed any form of fiscal autonomy would.

The latest GERS estimates the current on-shore revenues at £49,958bn – of which £3.972bn is a “General Operating Surplus”.  By comparison with the UK totals this is an exceptional item and includes ~£1.1bn of Scottish Water revenues.  It may therefore be safer to discount the total on-shore revenue down to £46bn.

The OBR December forecast for North Sea Revenues averaged at £2.6bn for the next 5 years – their current (March) forecast reduces that to £0.7bn.  Because Scotland claims some 84% of the revenue from North Sea the effect is disproportionate to the rest of the UK who would benefit from lower oil and gas prices.  The IFS use these factors when they forecast that a fully fiscally autonomous Scotland would have a deficit of £7.6bn in 2015-2016 and rising.  Fiscal Affairs Scotland estimate even larger deficits.  The emphasis that has been put on these forecasts in the election campaign whilst not totally gratuitous certainly deserves explanation by both sides.

But it would seem manifest that with full fiscal autonomy without actually being independent – that is possibly everything devolved apart from Defence and Foreign Affairs – Barnett would be reversed where Scotland would have to pay an appropriate population share of non-devolved costs and central government. There would also have to be rules which limited Scotland’s borrowing powers.

Under these circumstances Scotland could be permitted to have controlled levels of debt which did not jeopardise the UK.  The level of debt may be greater or less than the rest of the UK. 

But wait – in those circumstances wouldn’t the UK still exercise ultimate control?  Of course it would.  But the judgement call is whether a “fully fiscally autonomous” Scotland could improve not just the Scottish economy but also the economy of the UK over and above what can be achieved under the Smith Agreement or even the 2012 Act. And, I doubt that it could.

Conclusion

Having considered the circumstances above, I conclude:

The Smith Agreement has unintended consequences (see Appendix) and that it may be wise to postpone its implementation until:

  • The incoming Scottish Government, after May 2016, has a strategy for growth within the UK without further fiscal devolution until decentralisation in the rest of the UK has reached parity with Scotland; and

     

  • the incoming Westminster Government, after May 2015, has addressed constitutional change which decentralises greater fiscal control to all regions/sub-governments on an equal and like basis.

Appendix – The consequences of Smith to the Scottish Taxpayer

The policy for funding Scotland by way of the Barnett Formulae is set out by H M Treasury.  It inter alia makes provision to assist the Scottish Government if they need to exceed the permitted £200m of borrowings to fund resource spending in any one year (to an aggregate maximum of £500m).  There are provisions whereby the Scottish Government could be given additional grants from the Reserve in exceptional circumstances and with stringent requirements as to the timing of repayments.  There is an assumption that repayments will be automatically deducted from future Block Grant entitlements.

Other provisions permit the Scottish Government to “bank” underspends for future years.

It is unlikely that any of the new Smith Agreement measures will be implemented before 1 April 2016 and it is reasonable to assume that the provision for the Scottish Government to replace 10p of Income Tax with a Scottish Rate will not now be used.  When attempting to make a judgement on the impact that the Smith Agreement could have on Scottish Income Tax is it is reasonable to use the Spending Review Block Grant for 2015 as a base line.

Under the H M Treasury policy the Scottish Parliament is therefore not permitted to add to the UK’s Deficit – all devolved DEL Resource and AME spending has to be covered by the Block Grant and the Scottish Taxpayer.

 

£m

2013 Spending Review Block Grant for 2015 -2106

29,648

Each Spending review since 1996 has seen a reduction in Scotland’s population share allocation.  It currently stands at 10.03%.  It is reasonable to estimate that at the time of the 2015 Review it will be reduced to 9.93% causing a reduction on Block Grant of:

 

 

 

 

(296)

The key factor to calculating Scotland’s Block Grant is the UK Government’s Programme.  As well as being factored by an “appropriate” population proportion the formulae also applies a “comparabilty percentage”.  Taken together they should converge the factors which create the need.

 

 

The Block Grant is also subject to adjustment (“consequentials”) arising from changes in UK Programmes during the current spending period.

 

 

Revised Base Line without reductions in UK Programmes and consequentials

 

29,353

Taxes devolved under the Smith Agreement will be deducted

 

16,732

Forecast Base-Line Barnett Block Grant for 2016 – 2017

12,261

 

 

We do not have a Scottish Government Budget we can refer to for 2016 to 2017 but as a base line we can use the 2015 – 2016 Budget for DEL Resource Spending and AME:

 

 

 

34,117

The balance between Spending and the Block Grant would have to be raised through all forms of taxation devolved to the Scottish Parliament.

 

 

 

Total Base Line Scottish Tax Liability would be:

21,496

 

 

The Scottish Parliament will have no control over Personal Allowances which will almost certainly be increased by the Westminster Government.  But the Scottish Government could ameliorate by adjusting the thresholds for higher tax payers.

 

 

200

The SNP have made something of a commitment to reducing APD by 50%

 

125

The SNP appear committed to continuing with the freeze on Council Tax but giving more help on Non-Domestic Rates but they appear to be confident that new rates for APD, Landfill and Aggregates taxes will increase tax revenues.

 

 

 

 

 

The SNP assert that to address austerity they will increase spending by 0.5% in real terms reversing the Tories cuts of 1%.  Funding this would fall onto the shoulders of the Scottish Taxpayer. 

 

 

 

510

The Smith Agreement gives the Scottish Parliament the powers over certain Benefits outside Universal Credits – the costs of which should be part of their overall spending plans

 

 

The Scottish Government in the past have underspent and would be advised to do so to build a Scottish Reserve.   Bearing in mind that there are no definitive figures for where each individual would be domiciled for tax purposes it would seem prudent to allow for a contingency against tax collected. Based on past experience an optimistic contribution to a Reserve Fund would amount to:

 

 

 

 

 

 

500

The SNP Manifesto “Stronger for Scotland” says that they would raise the Top Rate of Tax to 50p and tax Bankers’ Bonuses.  This will affect the 16,000 Top Rate payers in Scotland.  Bearing in mind that they are the most mobile taxpayers and past history of raising Top Rate Tax it is unlikely that these measures will increase tax revenues in Scotland.

 

 

They say they support a Mansion Tax on houses over £2m in value.  No Party has yet put a figure on how much tax this would raise.  Zoopla have assessed that there are 108,500 houses in the UK worth more than £2m – 895 (0.8%) are in Scotland.  To raise the £1.5bn some say the Mansion Tax will raise would require a tax of £1,500/house raising in Scotland:

 

 

 

 

 

1.5

The Manifesto proposes a levy on Tobacco Companies.  Tobacco Duties in Scotland raise £1.25bn from 16.5% of the retail price a fraction of the duty on whisky.  Tobacco companies are the most profitable in the World reportedly making some 18% in profit.  Whilst there is room for increasing duty on tobacco products it isn’t devolved.

 

 

The Manifesto supports clamping down on tax avoidance.   Corporation tax and VAT aren’t devolved.  Reports tell us that evasion amounts to some £70-75bn, avoidance to £20-25bn and late payments to c£25bn.  Of this only £4.3bn arises from misuse of off shore tax havens and c£14bn from fraud and error. Income tax amounts to ~25% of all taxes. By breaking down Scotland’s share it is difficult to see how clamping down on tax evasion/avoidance on Scottish Taxes would be significant  The H M Treasury will more than likely use it to reduce the deficit.

 

 

 

 

 

 

 

 

 

There are 2.1 million basic rate taxpayers in Scotland; 358k pay the higher rate and only 16k pay the additional rate. 

The Basic Taxpayers pay 39% of Income Tax in Scotland; the High Taxpayers pay 45% and the Top Taxpayers pay 16%.

Of the Total Tax Liability in Scotland £9.689bn is non Income Tax.

In Summary:

 

£m

Total Base Line Scottish Tax Liability

21,496

Non Income Tax

(9,689)

Income tax receipts on savings/dividends

(499)

Lost APD

125

Scottish Reserve Fund

500

Scottish Income Tax Liability before Increases/decreases in spending

11,933

Current Income Tax Liability (excluding savings and dividends)

(10,911)

SNP reduction of austerity

510

Shortfall before increases/decreases in spending.

1,532

 

Post April 2016 if the Scottish Government uses their increased powers under the current Smith Agreement in the manner the SNP propose they would face preventing a deficit of ~£1.5bn/annum.

SNP pledges would put Scotland in an uncompetitive position with the rest of the UK it is unlikely that this deficit would be materially reduced by increases in devolved taxes.

But the Scottish Government cannot run a deficit and therefore it must make savings of >£1.5bn/annum until such time as it can generate substantial increases through economic growth.

Some measures the Scottish Government could take

 

Risk

Spread the shortfall over all tax payers increasing the Base Rate to 23p.

 

High
Spread the short fall over High and Top Rate payers by increasing the High Rate to 49p and the Top Rate to 59p.

 

High
Eliminate the shortfall by reduction in spending.

 

High
Any of the above plus a 5% increase in Council Taxes and Non-domestic rates raising £100million

 

High
Any of the above plus a 5% increase in Council Tax raising £50million

 

High
Increase the Base Rate by 1.5p and make spending cuts of £750m

 

Medium