Our second item of business is evidence from Professor David Bell and David Eiser from the University of Stirling’s division of economics, on their recently published paper, “Scotland’s Fiscal Future in the UK”.
The paper was circulated to members in advance of today’s meeting, so we will go straight to questions from the committee. As usual, I will start the questioning process.
Before we start, I point out that we have a full agenda today and are likely to be pressed for time. I therefore have to restrict each member’s questioning to no more than 10 minutes. I will also try to adhere to that timescale. I say to John Mason that that means no meandering when it comes to his turn. Either or both of our witnesses may answer questions that are put. It is completely up to them.
On options for further fiscal devolution, the third paragraph of page 5 of the paper says:
“The Labour Party’s proposals are somewhat more modest, amounting to an extension to the Scotland Act, so that the devolved part of income tax increases from 10p at each rate to 15p. The proposals also allow the Scottish Government to vary the progressivity of income tax, albeit in a fairly restrictive way”.
Any variation, of course, would be done so as not to reduce that progressivity. How would those proposals advantage or disadvantage Scotland?
The proposal to increase the take from 10p to 15p really amounts to a kind of extension of the revenue share. It would not give control over progressivity and it would not really give control over tax bands. The question is, what advantage might you seek to gain from having control of tax bands and progressivity? In relation to that, another question would be, can you increase total revenue by, say, having higher bands? That would depend on how taxpayers reacted to changes in the tax rate, which is something that we do not really know all that much about. It would also depend on how the rest of the United Kingdom reacted.
One of the things that we talk about in the paper is that there is a huge size difference between Scotland and the rest of the UK. The rest of the UK might not be too worried if Scotland were to cut its income tax rate from the rate that pertained in the rest of the UK. That would depend on how mobile people were between Scotland and the rest of the UK and on whether people were coming in and out of the labour market because of changes in income tax rates.
Having the tax slab increases the revenue and changes incentives in the following way: it would mean that the block grant adjustment would have to be larger, which would mean that there was more pressure on the Scottish Government to grow the economy as fast as, or faster than, the rest of the UK in order to keep its total public spending in line with what it would have been had the Barnett formula continued.
Playing around with bands and rates induces responses that might be good or bad. Scotland would, to an extent, be constrained by what its larger neighbour was doing, because people would react, at some point.
In his evidence to the committee, Professor McGregor suggested that a higher rate here, which could not be reduced, than in the rest of the UK, could cost Scotland 2 per cent of its gross domestic product and 75,000 jobs. Is that accurate or an exaggeration?
There is certainly one issue with having a higher rate here. Because we have a highly unequal distribution of income in Scotland, a large proportion of our income tax is paid by relatively few people; that is, people who are on the higher rate and, in particular, who are on the additional rate of income tax. There is the potential to cause movement between Scotland and the rest of the UK if the rate in Scotland were to go up massively in, let us say, the additional rate, compared with the rest of the UK.
I would be surprised if we were talking about as much as 2 per cent of GDP. Everything would depend on how much the rates were changed by. There is obviously a penal tax rate, after which increases become self-defeating.
In previous work we looked at how much additional revenue would come to the Scottish Government if 1p were to be placed on each rate of income tax. The research suggests—if we assume that there is no behavioural response—that that would bring in an extra £460 million. When we take into account the likely behavioural responses, which David Bell talked about—the possibility of people deciding to relocate as individuals or to relocate some income—the additional revenue might be more like £370 million. The difference is about £100 million, when we take account of behavioural effects. I am not sure how that aligns with the figures that the convener quoted.
I think the Labour proposal was that it should be possible to increase the progressivity of the income tax that is devolved to Scotland, but not necessarily to decrease it. I am not quite sure why you would want to restrict yourselves in a way that enabled you to move progressivity in one direction but not in another.
The devo more recommendation is that half the VAT revenues that are raised in Scotland should be assigned to the Scottish Parliament. In that situation, would Scotland have a say in setting the rate?
The evidence that we have at the moment is that European Union law precludes different VAT rates in parts of the same territory. On that basis, it seems to be unlikely that the rate of VAT could be devolved to the Scottish Parliament so that it could be different from the rate in the rest of the UK.
I am aware of that, but what is suggested is that maybe half the VAT receipts could be assigned to Scotland. In that case, would we have a role in setting the rate, even though there would not be a different rate in Scotland?
I guess that that is a question about intergovernmental relations and how they play out.
What we are talking about in this context is a tax-sharing arrangement. Most of the proposals that are being put forward are not for tax sharing, although tax sharing is pretty common; it is done in Germany, for example. In effect, it means that people somehow come to an agreement about the tax rate and then divvy up revenue according to a formula.
That would mean that Scotland would not have a different risk from the rest of the UK. All the VAT for the whole of the UK would be pooled and Scotland would get 9 per cent, or whatever, of it. If the rest of the UK was booming and people were all buying high-value items, there would be a lot of VAT revenue south of the border and Scotland would still get a share of that, even if people were not spending so much in Scotland.
Sharing of taxes does not seem very much to be on the table, but it is quite common in other countries. It can give a misleading impression of how much power sub-central Governments—for example, the German Länder—have. You have made exactly the right point, because sub-central Governments do not have a huge say in setting the conditions for the tax.
We will move swiftly on. Your paper states:
“Corporation Tax has been proposed for devolution by DevoPlus on the basis that economic and business development are devolved policy areas, although most proposals recognise the risks inherent in devolving corporation tax, namely the fact that the high mobility of the tax base may trigger tax competition.”
However, surely there is already corporation tax competition right across the world. It almost looks as though you are referring to the issue only within the British Isles, as if somehow the rest of the world is not significant to the discussion.
There certainly is corporation tax competition. The Organisation for Economic Co-operation and Development figures on corporation tax rates show absolutely clearly that rates are converging downwards. The stand-out exception is the United States, which still has corporation tax that is well above 30 per cent. That has been the cause of recent disputes that have emerged on issues such as the Pfizer takeover, which related specifically to that.
Corporation tax rates are converging downwards, but the rates are only part of the story, because the allowances and how the tax is applied can vary even when there is the same headline rate. Aspects other than the rate might be of interest to particular kinds of firms; for example, research and development can be emphasised by giving large research and development allowances that attract companies that are biased towards R and D. The issue is much more complex than just the rate, although the rate is quite important.
How does the USA cope with varying corporation tax rates across the country?
Is this the Rhode Island question?
There is an issue about whether there can be different corporation tax rates in different states. Clearly that is possible. How does the USA ensure that it does not have issues about tax competition such as those that were raised during the referendum campaign and that you touch on in your paper? Obviously, there must be an element of competition, but how does the USA ensure that the system works effectively?
I am afraid that I do not know the details of the corporation tax arrangements in the United States.
You are absolutely right that corporation tax is an international issue. Ideally, we would have a greater level of international agreement on how we set corporation tax rates. However, it is potentially more of an issue in a within-territory situation. Because Scotland and the rest of the UK are similar economies, if a company was deciding whether to locate in Scotland or elsewhere in the UK, different rates of corporation tax might play a stronger role in influencing its decision than would be the case if the business were choosing whether to locate in the UK or another country.
09:45
It is true that in the United States, Rhode Island has the lowest corporation tax rate by quite some distance, so a huge number of companies have their nameplates there. I do not know how that is handled. However, the fact that not all of US industry has moved to Rhode Island suggests that there are other issues. For example, California has quite high tax rates but has other attractions, such as the higher education institutions, the ability to find capital in different ways and a very pleasant environment, which might be the countervailing forces to Rhode Island’s low corporation tax rate.
So corporation tax is an issue, but only if all else is equal.
Yes.
I have already taken up 13 minutes of the committee’s time, so we will move on to my colleagues’ questions.
In your paper, you say that the Scottish rate of income tax will operate in effect as a flat tax, because the Scottish Government cannot vary the rates differently, which
“implicitly leaves income redistribution as a reserved issue for the UK Government.”
You also say that
“this may undermine the extent to which the Scotland Act proposals really meet the desire for greater fiscal policy autonomy.”
Can you explain what you mean by that?
The main incentive that the Scottish rate of income tax gives to the Scottish Government is to match the rate of growth of the tax base in the rest of the UK. Otherwise, the size of the block grant adjustment will start to exceed the amount of revenue that the Scottish Government is raising from the flat tax that Jamie Hepburn described.
That flat tax cannot be used to alter people’s behaviour and it cannot be used to redistribute wealth because the Scottish Government does not control the rates or allowances. However, in another paper on inequality in Scotland, we have shown that even moving income tax rates around quite a lot would not have a huge effect on overall inequality, because what we call the market or pre-redistribution distribution of income is very unequal. There is such an unequal distribution of income before taxes are applied and benefits are given out that there would not be a huge effect even if the Government were to make fairly big changes to tax rates and allowances.
David Eiser has just described how, if we were to move the rates relative to the rest of the UK, there is a danger that the Government would end up with less than it thought it would get because of behavioural responses, such as people or companies moving.
You have touched on the problems that could be associated with asymmetric growth in the tax base, which we have discussed before. You describe it as the Scottish Government bearing the full risks associated with that, but you also say:
“The corollary of this of course is that the Scottish Government is fully incentivised to grow the income tax base.”
Do you agree that control of the Scottish rate of income tax alone will not really give the Scottish Government much power to achieve that aim? The Scottish Government will still not have control over immigration and other matters.
That is a good point. The Scottish Government does not have control over immigration, so blockages due to the inability of Scotland to attract high-productivity individuals might be a negative effect. It is difficult to calibrate that at the moment.
Scotland spends considerably more than the rest of the UK on economic development and comes second to London on attractiveness for inward investment. There are levers, and Scotland seems to have chosen to use the economic development lever quite well in order to enhance the Scottish economy’s growth, which should grow the tax base. It is not the case that tax alone will be responsible for growing the tax base; other supply-side instruments are available to the Scottish Government to help with that.
The Scottish rate of income tax will mean that the Scottish Government captures some of the benefits of economic growth—increased tax receipts—but not all the benefits, such as reduced welfare spending. It gives some incentives but not full incentives. Another issue, which David Bell has talked about, is that the Scottish rate of income tax does not give the Scottish Government the power to address income inequality and the distribution of income.
I made the point in a previous paper that, if growth in income tax revenues was concentrated in bankers’ bonuses and they were taxed at 45p in the pound, Scotland would get only 10p of that 45p. However, if growth related to lower incomes, which are taxed at 20p in the pound, Scotland would get half the increased revenue.
Mr Eiser has provided a useful bridge to my next question. Your paper talks about the reduction in welfare spending and says:
“The UK welfare state is seen as the key element in the risk sharing and resource pooling mechanisms that are seen as a defining characteristic of the Union. Thus the Labour proposals talk of ‘rights enshrined at UK level that should be paid for from UK taxes’, the Liberal Democrats talk of maintaining the UK’s social welfare union. The Conservatives describe this social union as ‘hugely important to what glues us [the UK] together’.
In this context, it is unclear to what extent welfare devolution is compatible with these principles.”
You make it pretty clear that social security is unlikely to be devolved, but we know that the welfare changes are likely to push 100,000 more children in Scotland into poverty by 2020, that 100,000 disabled people are being affected and that 80,000 households have been hit by the bedroom tax. The Tories talk about what glues us together; we will be stuck in the glue if we get no further devolution. Do you not see the devolution of social security to any extent as a serious prospect?
Our point was not that we do not think that welfare devolution is on the table or makes sense; we simply said that the traditional argument for keeping most elements of welfare spending reserved—not just in the UK but in many other countries—is that such functions are appropriate to have at a federal level, if you like, or a national level, which ensures that citizens in all parts of countries receive the same level of welfare services and that risk is shared over the economic cycle. That does not necessarily mean that we must agree with the welfare policy that is in place. The paper simply made the point that that position is the traditional starting point of fiscal federalism literature.
I have just written something, which has not been published yet, on devolving welfare. One approach involves thinking that welfare covers a number of risks. Way back when social insurance was introduced, it was intended to insure people against unemployment, but unemployment benefit—jobseekers allowance—now accounts for a smaller and smaller amount of the total welfare bill.
David Eiser just made the point that one argument for having unemployment insurance on a national, UK basis is that one part of the country may suffer a big shock. For example, the oil industry in Aberdeen might suddenly not be doing so well. In that situation, unemployment benefit will be a subsidy not just to individuals in Aberdeen but to the Aberdeen economy. It will keep the economy more buoyant than it would otherwise have been, so it is a form of insurance.
Most of the risks that are now covered by welfare are not about insurance. They are about things such as disability, a need to care or bereavement. With those things, it is not so obvious that we are fulfilling a function of cross-national subsidy to keep the economy going.
I argue that there is a possibility of deciding on, let us say, how much Scotland currently receives in relation to a particular benefit—attendance allowance is one that the Labour Party has selected—and then somehow indexing that in the way that the block grant adjustment will be indexed and letting Scotland get on with distributing that sum of money to the disabled.
The good thing about that is that we already have a policy of free personal care. It does not look as if the two policies sit all that well together—attendance allowance on the one hand and free personal care on the other—because essentially they are trying to do the same thing. The disadvantage is that although that is a big sum of money, an administrative cost has to be paid to share it out. Even if that is done through the Department for Work and Pensions, it will still be expensive because, as you know, the welfare system is extremely complex. Something not too dissimilar to that is done in US states, and I believe that it is worth thinking about in relation to some aspects of welfare spending.
I reiterate what David Eiser said. This is about the design of welfare. It is not about the current policies and the levels of support that are available. Neither of us is saying anything about that.
From reading the paper, it seems to me that you have dispensed with the idea of the vow, which other political parties have made, that the Barnett formula will remain untouched. Is that correct?
Under the Labour proposal it is pretty clear—because it is just an extension of the Scotland Act 2012—that the Barnett formula will still be there. The block grant will be determined and then it will be adjusted; it will be reduced by an amount that the Scottish Government and the UK Treasury will agree on.
Once we start to increase substantially the amount of money that is taken away from the Barnett allocation, it becomes less easy to defend its continued existence. It is not just about Scotland. I was at a meeting on Monday at which strong arguments were made by a representative from Wales. The Welsh Government feels, perhaps with some justification, that Wales has done badly from the Barnett formula for some time. I would have thought that it might come under more pressure if there is a substantially greater income tax take in Scotland, and I suspect that there will be pressure from outside Scotland because it is unpopular outside Scotland.
10:00
In several parts of your paper you suggest that we are dealt with generously, and that that largesse is more or less because of the oil. However, the reality is that we have contributed far more in oil revenues than has ever come back to us through the Barnett formula.
The allocations to Scotland through the Barnett formula are largely a result of the historical baseline allocation. The Barnett formula gets a lot of criticism, but it is the baseline allocation that means that Scotland is funded relatively generously. I very much doubt that this will happen, but in theory the UK Government could think about retaining the Barnett formula while making a one-off adjustment to reduce Scotland’s block grant, if it wanted to do that.
On your point about oil revenues, I think that a couple of pieces of work have been done since 1980 to compare North Sea revenues from Scotland with the funding that has come back to Scotland through the Barnett formula. Over time, the two things pretty much cancel each other out. In effect, Scotland has received back the North Sea revenues, through the Barnett allocation—not explicitly, but that is the implication.
That is the implication in your paper, but I think that it has been challenged and found wanting—that is my point. You link the relatively generous block grant to oil, but others say that about £150 billion has not come back. We will leave it there.
On reading your paper, I feel that we are a bit hamstrung. We agree that devolution of income tax does not leave Scotland in a better place and that the word “power” might be a bit strong in that regard. Real power would be power over taxation. Should we argue for that?
A number of the proposals are for full devolution of income tax, including the ability to vary rates individually and the ability to vary bands. That would bring a very large revenue source fully into the control of the Scottish Parliament and it would give the Scottish Government the ability to address issues to do with inequality and redistribution. It would not represent the full panoply of tax powers, but relative to other countries around the world it would be a substantial level of tax devolution to a devolved Government.
It is true that even if a devolved Government has pretty much complete tax powers, such as is the case in the Basque Country, it is always still constrained in its ability to set tax rates, because factors of production—labour and capital—will ultimately move in response to differential taxes. We see that happening all the time. In a sense, you could escape the constraints of having rates and bands set at Westminster, but you would not be unconstrained. That would not be the correct way to think about it.
Did you not make the case in your paper that there would be constraints because we would still be tied to an economic approach that is set around the London area, and the financial sector in particular?
Yes—we looked at the existing proposals, which would certainly impose constraints. Any Government will look at its fiscal position and make decisions accordingly. Governments have greater or lesser policies towards different parts of their countries. Arguably, the UK Government does not do that hugely, especially within England. Having tax powers would clearly give a greater degree of autonomy, but it would not be unconstrained.
If you were to write a paper from the perspective of showing the powers that Scotland needs to grow its economy and develop industries, would you say that it needs the power to create taxes and impose them on different aspects of industries in Scotland?
Again, there is the issue that most companies would probably prefer much lower taxes than currently pertain in Scotland. If the aim is to grow business, that would certainly be one way of attracting more business to Scotland. However, what we call the supply side of the economy, which is about skills, enterprise, infrastructure and so on, has a considerable bearing on the ability to grow the economy.
With devolved income tax, it would be clear that we should develop the financial sector, because it provides the highest income from tax revenues. Is that right?
It is less true now, but it was certainly true towards the middle of the previous decade that bankers’ bonuses provided a very substantial share of total income tax revenues. As I mentioned, under current proposals, Scotland would not actually get a huge share of that. It would get 10p out of 45p—it was 50p for a while—so it would not benefit to the extent that the UK Government would from that type of income.
Your paper refers to the UK as though it is a really well-functioning monetary union and suggests that somehow there is an advantage to being tied to it. Is that really what you think?
The US is a good example of a well-functioning monetary union, and I think that the UK is a well-functioning monetary union. The eurozone is not a well-functioning monetary union, partly because it lacks the ability to do the kind of fiscal transfers that support parts of the state when they get into trouble. An example that Paul Krugman gave recently, although perhaps rather crudely, was that Florida and Greece were in some ways equivalent in the kind of shock that they experienced during the great recession. However, Florida, through the kind of transfers that I talked about, has largely weathered the storm and not suffered greatly, whereas Greece, which has not received significant fiscal transfers because of the policies of the European Central Bank and the European Union, still has a 60 per cent youth unemployment rate.
We have to move on, Jean.
Okay—thank you.
When the convener opened the questioning, he mentioned the Labour Party’s policy on having the ability to increase taxation but not reduce it. Mr Eiser appeared to doubt the validity of that, which the convener agreed with. They then discussed the Scottish Government’s pledge to reduce corporation tax by a certain amount regardless of the level that is set by the UK Government. The issue of tax competition as a race to the bottom relates to both income tax and corporation tax.
What are your concerns about a position in which there is a policy that allows income tax to be raised in order to increase the amount of money that is available for public spending, and a policy that prevents a reduction in income tax to avoid a race to the bottom, given that you had concerns about allowing a race to the bottom on corporation tax?
That is a fair question. If you look at what has happened to income tax rates and corporation tax rates across countries over time, you will see that the pattern is different. Corporation tax rates have been going down in all countries and income tax rates have stayed much more constant across countries. The idea that horizontal tax competition always results in lower tax rates is not quite right. It depends on the type of tax and on how mobile the tax base that it is applied to is. With income tax, there is evidence that people think not in terms of tax competition but more in terms of fiscal competition.
If people can see that they are receiving the benefits of income tax through locally provided services, they are generally more willing to accept those higher tax rates. That visibility of income tax is a key part of the reason why income tax is often perceived as a good tax to devolve, whereas corporation tax is not, because the link between the tax and locally provided services is not there and the tax base is mobile, so you can get a race to the bottom.
Horizontal tax competition affects different taxes differently, but my earlier point about income tax was really about why you would want to constrain a Parliament for ever more to be able to operate a tax in only one way. That is slightly different from a policy position of saying, “We will cut the tax if we have it.”
The mobility of the tax base is an important issue, and capital is more mobile than labour. That is why corporation tax rates round the world have been coming down, because companies are able to move relatively easily nowadays. Overall, although it has not become as extreme as corporation tax, it has become more difficult to raise huge sums through income tax, partly because we now have a lot of relatively poor people who do not pay a lot of income tax and we have a lot of relatively rich people who are quite good at finding ways of avoiding income tax.
The net result, which is bad for the poor, is that countries have increasingly focused not on direct taxes but on indirect taxes, so what happened at the start of the current UK Parliament was an increase in VAT rather than an increase in income tax. The increase in VAT is partly explained by the fact that the tax authorities know that they will get their money when they increase VAT by a couple of pence. It does not make a huge difference to people’s behaviour patterns.
Thank you for clarifying that.
The question that I wanted to ask at the outset was about VAT and the assignation of the tax generated in Scotland. We know that Scotland and England cannot have different rates under EU rules, so VAT is a good example of how the amount of tax raised in a geographic area can be identified and the money assigned via the block grant. Are there other areas in which that could be done? Are there other ways in which it could be done outwith the block grant?
10:15
That is a slightly different approach from the approach that I described earlier, which is taking all the VAT revenues raised in the UK and giving Scotland its population share of those revenues.
You are interested in trying to figure out how much VAT is actually raised in Scotland and then assigning that to Scotland. You could do that with a number of things. I have forgotten the exact figure, but the amount of revenue that is raised in Scotland in relation to alcohol duty is something like 10 per cent a head more than is raised in the rest of the UK, so we would get more revenue if we had our proper share of total alcohol duty.
Such things can be done—the difficulty is that the incentives that are created are perhaps not the best incentives. [Laughter.] You have to be quite careful. It is not that unusual to do such things and, at a political level, it might increase the feeling that the money that we spend is money that is raised in Scotland. However, you need to be careful about the incentives that you end up with.
Jim Johnston, the committee clerk, has just pointed out that the figure in your paper is 16 per cent a head more, not 10 per cent.
Sorry.
What do we need to do in Scotland to build up our capacity for analysing and ultimately dealing with the concept of behavioural response to taxes?
That is quite a difficult question. The UK experts—indeed, they are possibly the world experts—are in the Institute for Fiscal Studies in London. Economists get quite nerdy about the issue. It is about trying to construct a situation that, on the one hand, is like real life but, on the other hand, involves one group of people being confronted with a certain tax rate and another group of similar people being confronted with a different tax rate, and then seeing how the groups respond. Quite a lot of work has been done at the UK level and in other countries, and you need to ask how useful the comparison between Scotland and those other countries is.
If I was to make a general finding from the current literature, it would be that the people who react quite a lot to changes in the tax regime are those who are just about to retire and who might base their decision on such changes, whereas people in mid-career are less responsive. Sometimes, married women are more responsive to such changes, but things such as how much child support is available matter, too.
Although I do not think that there is a huge amount of evidence yet, it is already clear that things such as tax credits affect people’s willingness to supply labour—to work—for longer, because once someone exhausts their tax credits, they can suddenly be facing not a tax rate of 40 per cent but a tax rate of 70 per cent, and they will think, “What is the point of doing that extra hour of work?”
It seems to me that there is a need for a body to bring that all together in Scotland because, whatever powers Scotland gets at the end of the process, it is important to educate not only the people who are involved in policy making but the Scottish public more generally, so that they do not assume that you simply raise the tax and get X, and that is the end of the story.
Who do you envisage doing that? One of the risks with any devolution of tax is that if we get the behavioural response element wrong, we could end up getting not £460 million but a hugely lower figure or, indeed, a hugely higher figure, depending on what happens. Obviously, with experience, we would get better and make fewer mistakes, but my slight concern is that we have to go through all the pain first before we get the hang of it. How could we set things up so that we make as few mistakes as possible early on?
The Office for Budget Responsibility is part of the UK structure although, in fact, it does not do this stuff. It looks at taxes and, I think, largely refers to Institute for Fiscal Studies research. One can think of different models, but you have to have a model that has a very good pipeline to research. I do not just mean IFS research; we have looked at work that has been done in Denmark, other European countries and the United States. You have to have such international linkage, so that you are up to date with the latest thinking on these issues. The field is called microeconometrics, if you want to know the correct term.
He will use it in his speech.
We really need people who are up to speed with the latest thinking.
That is helpful. Thank you.
I refer to figure 2 on page 10 of your paper, which is headed “Decentralisation ratios in OECD countries (2010)”. Can either of you talk me through what is going on in that chart?
I will try. The chart looks at the share of expenditure and the share of revenue that sub-national Governments in different countries have. I refer to the UK (Scotland) point. Looking at the X axis, we can see that, of all the public spending that takes place in Scotland, the Scottish Government is responsible for about 50 per cent, but we see from the Y axis that, of all the taxes raised in Scotland, the Scottish Government is responsible for less than 10 per cent.
The graph plots other OECD countries according to their sub-national Governments’ expenditure share and revenue share. In some of those countries, the sub-national Governments are local authorities. In some of the Nordic countries, for example, local authorities have the ability to vary tax rates and so on. The other sub-national Governments include US states, cantons in Switzerland and regions in Spain.
We have tried to show where Scotland would be on the chart if we implemented the proposals of Scottish Labour, the Scottish Conservatives, devo more and devo plus.
The UK (Scotland) point is plotted at about 50 per cent on the X axis and at about 8 per cent on the Y axis. The Scotland Act point is straight up from the UK (Scotland) point because the Scotland Act 2012 is really about raising taxes. The Labour proposals would increase taxes, and would increase spending a little bit—there has been discussion about powers over attendance allowance and housing benefit. The Scottish Labour point is slightly to the north-east of the Scotland Act point. The Scottish Conservatives’ proposal—which is for some spending powers but more tax-raising powers—is plotted vertically above Scottish Labour’s proposal. That is how the chart works out. Eventually, at the top of the chart, is the devo plus case, with a large proportion of both spending and revenue raising.
For the sake of completeness, where would the Scottish Lib Dem proposals appear on figure 2?
I am not sure why they are not there. They would be somewhere around the devo more and devo plus area.
Also for the sake of completeness, I note that the figures are from 2010—they are probably the most recent figures that you were able to get. Has anything major changed in any of the countries that would make the graph look markedly different?
No.
Will you briefly talk us through what figure 3, on “Tax power of sub-central governments in OECD countries”, tells us?
Yes. If you go back to figure 2 and look at Germany, you will see that the Länder appear to have a relatively high share of the revenues that are raised in Germany, at about 30 per cent. However, a lot of the taxes that are devolved to the German Länder are in the form of taxes that are assigned, meaning that the Länder do not have the ability to vary those tax rates or thresholds. We talked about that earlier.
Figure 3 looks at how the taxes on the Y axis in figure 2 break down in terms of the level of power, if you like, that the sub-national Governments have over each tax. It is not necessarily the case that because a sub-national Government has a relatively high revenue share it has full autonomy to vary the tax rate.
It might be suggested that the sub-national Government has a lot of control over revenue, but its power is more limited, because it is sharing rather than setting the rates and base.
Okay. The German position, in particular, might seem a little artificial, because a huge proportion is tax sharing only.
Yes.
Figure 3 shows bars for a number of OECD countries on the left, and bars for the UK and various proposals for Scotland on the right. The proposals from the Scottish Conservatives and from the Scottish Lib Dems are absent from the graph. Where would they feature?
Let us start by looking at the bar for the Scotland Act 2012 proposals. We have interpreted the Scottish rate of income tax here as being more like a shared tax than a full-control tax, so that is reflected in the Scotland Act and Scottish Labour proposals—[Interruption.] Sorry, the Scotland Act and Scottish Labour proposals are that the Scottish Government varies the rate only, not the base.
The devo more proposals would give full control over income tax—the Scottish Government would have control over the rate and the base of income tax. Devo more also brings in the idea of tax sharing of VAT. Under the devo plus proposals, the Scottish Government would have the power to vary the rate and the base in relation to all the taxes that are proposed for devolution.
Off the top of my head, I cannot remember exactly where the Conservative and Liberal Democrat proposals would go; I think that they would come in at somewhere below the devo plus level but around the devo more level.
Yes, I think that they would be between the Labour proposals and the devo more proposals. If you like, we can come back to you with a graph that includes them, for completeness. The share of central Government-determined rate and base would be higher for the Scottish Conservative and the Scottish Liberal proposals, but I cannot tell you the height of each bar.
10:30
Sure. I am not asking you to give a verbal description of what that chart would look like. Would it be easy enough for you to provide that? I would certainly find that useful.
Yes. One of the issues might be that, for some of the taxes, it was not entirely clear to what extent the proposal would give power over a base as opposed to a rate. That might be why we did not include bars for those proposals, but we can certainly consider doing that.
I would be grateful if you did.
You talked about the devolution of some aspects of welfare. If the whole of welfare were devolved, which some people have argued for, what would that do to what you describe as the vertical fiscal imbalance?
The vertical fiscal imbalance is the difference between the spending that the Scottish Government has control over and the taxes for which it has responsibility. At the moment, as you know, the Scottish Government has a particularly high vertical fiscal imbalance—in other words, it has responsibility for a lot of spending but not much tax revenue raising. A key concern of many of the proposals is to address the vertical fiscal imbalance by devolving tax powers to the Scottish Government. There are good reasons why you might want to devolve some aspects of welfare spending, but doing that would increase the vertical fiscal imbalance even more. Therefore, the implication is that, if you want to narrow the vertical fiscal imbalance, you would have to match welfare spending devolution with even more tax devolution.
You are talking about a figure of £15 billion—it is of that order. In other words, it is something like income tax plus half of VAT.
Can I ask one last, quick question?
If it is a small one.
What are the pros and cons of the devolution of capital gains tax?
I thought it was going to be a small one. [Laughter.]
He asked it quickly.
Among the cons are the fact that, potentially, the tax base could be fairly mobile. That would be the big risk.
If there are already ways to avoid capital gains tax, the devolution of the tax would probably magnify those possibilities.
Like Gavin Brown, I quite like tables and figures. I started with table 1 on page 7. The proposals that jumped out at me were the ones that relate to taxes on which the position of Scotland is quite different. That was my starting point. If Scotland is in a different position on those taxes, are they not the obvious ones to let us have control over? The first one is North Sea revenue. That would be an easy one to give us control over—we could be given control over 50 per cent or 75 per cent of that. Is volatility the main argument against that?
Not really; I do not think so. It is quite common in other states—Canada, for example—that a share of resource revenues is allocated locally.
During the referendum, the UK side tended to argue that oil revenues would not be very good in the future, and our side tended to argue that they would be. If the UK Government let us have the North Sea revenues, that would give us a chance to test that. We could see what we could do with them.
That is true. I guess that if you were to make a block grant adjustment for that—maybe I am coming to a conclusion too quickly—there would certainly be a volatility issue, because North Sea revenue is even less predictable than income tax is. Given that there are borrowing powers associated with forecast errors for the income tax revenues as things stand, if you were to go down that route, it would be necessary to have increased borrowing powers to cover the uncertainty associated with devolving North Sea oil revenues to Scotland.
I presume that we could do it by taking borrowing powers or we could build in the assumption that, for the first few years, we would save and build up a fund that would cover us in the future.
Yes, but there would have to be a quid pro quo in relation to the block grant, because the UK would lose that source of revenue to its revenue account.
It would have to be a bargaining point.
Whether the revenue could be put into a savings account might be debatable.
The risks around volatility are the big ones. The other thing about North Sea tax is that it would not give any incentive to the Scottish Government to grow the economy. It would not give any powers over income distribution or anything like that. It is just a source of revenue, albeit a very volatile one.
It would help with the problem of vertical fiscal imbalance.
It would help solve that problem, but it would do that quite differently from one year to the next. How you dealt with that would be a challenge.
The next three things in table 1 are quite different for Scotland. Alcohol is one that has been mentioned. Tobacco duties in Scotland are 41 per cent per head higher than in the UK, and betting and gaming are 17 per cent higher. Health policy comes into those things. I spoke to a group yesterday who said that the number 1 thing that they would like to see Scotland control is gambling. Could we tie in the revenue side of these issues with other policy?
It is possible but, again, the issue of response comes up, as it does with corporation tax and income tax.
I am not convinced that rates of smoking are that much higher in Scotland. I suspect that part of the reason why tobacco duties are much higher is that there may be less smuggling of cigarettes in Scotland, because there is less easy access to—
That would mean that Scots are paying a lot more tax because a lot of English people are buying illegal tobacco.
That might be true, but the question then is how far you can press that to get the health benefits that you might want. That is not a question to which I know the answer.
The argument for devolving alcohol and tobacco duties is a strong one, as you have mentioned, given the links to devolved spending policy. However, there are a couple of practical difficulties in devolving the taxes. The primary one is that the taxes are levied on production and importation to the UK, not consumption.
Would that be difficult to change?
I do not know how difficult that would be to change, but it would be a major change in how the tax is collected.
You would have to charge the outlets, which I suspect might be quite expensive, but it would not be impossible.
The other question that we do not know the answer to is whether EU laws preclude Scotland having different VAT rates. I am not sure to what extent the possibility of having different rates of some of these excise duties in different parts of the country has been tested. I do not know the answer to that.
The Scottish Government is exploring having a minimum alcohol price and we will see how that progresses.
I will take my thinking a step further. Instead of starting where we are and adding more powers, we could start at the far end—with all the powers—and take things off. The term “home rule” has been mentioned. It is slightly old-fashioned, but I think that I know what it means, whereas I do not know what devo max means. If, like Jersey, we did not do foreign affairs or defence, but at the end of the year we wrote a cheque to Westminster for those functions and we did everything else, would that be financially feasible?
In effect, that is what the Basque Country does, but a place must be in a strong fiscal position to do that. The UK is not in a strong fiscal position and neither would Scotland be, even if it raised all the revenues in Scotland. If Scotland made payments for debt interest, defence and foreign affairs, it might also want to have some say in how those moneys were used. The Basque Country is more affluent than Spain, so it can go down that line. At the moment, Scotland would experience difficulties in doing that because of its fiscal position.
I have a practical point about something that I did not quite understand. You say on page 3 that, after the Scotland Act 2012’s measures,
“the Scottish Government will be responsible for taxes equivalent to around 27% of its spending”,
but page 9 says:
“The Scotland Act proposals result in the Scottish Government’s revenue share increasing to 17%”.
Will you clarify that?
The difference might relate to council tax not being part of the Scottish Government’s revenue. The 27 per cent includes council tax, business rates, the landfill tax, stamp duty land tax and income tax, but those cannot quite all be described as Scottish Government taxes.
So the 17 per cent excludes council tax and maybe other elements.
I think so.
What was the second page that John Mason mentioned?
I referred to pages 3 and 9, and I quoted the second-bottom line on page 9.
I think that we are talking about two slightly different things—one is the percentage of all Government spending in Scotland and the other is the proportion of existing Scottish Government spending—but I would have to read the references in a bit more detail to remind myself of that.
Can you get back to us to clarify the position?
Yes.
I was a bit confused about whether I was comparing like with like.
The word “federal” appears in the fourth paragraph of page 9 and is used quite widely in your paper. Am I right in thinking that federalism does not define the amount of power that is down at the individual state level and is more about how the structure works? Germany has a federal system, but there is not much power at the state level. Federalism does not tell us about the amount of devolution; it just tells us about the set-up.
That is true. We call this well-known area of economics “fiscal federalism”; the OECD has a website that is associated with it. We often use the term “federal”, which covers a multitude of arrangements in different countries.
We have probably fallen into a trap, as economists sometimes use the word “federal” in a slightly different way from political scientists. To an economist, fiscal federalism is the study of which taxation and spending levers should be allocated to which level of government; the term does not necessarily say anything more than that. Perhaps we have sometimes mixed the economic and political notions of the word.
That was helpful—thank you.
That concludes questions from committee members, but I have another couple of questions. You say on page 19:
“if tax devolution is accompanied by reform of the mechanism for determining Scotland’s block grant—either as part of a quid pro quo for more powers, or in order to operationalise tax devolution in Wales—the Scottish Government’s budget may face a decline in its spending power relative to rUK.”
One of the concerns that we have is that powers may be devolved but not necessarily the budgets. For example, when the council tax benefit was devolved a few years ago, only 90 per cent of the budget was devolved with it, so we ended up with a £40 million shortfall that the Scottish Government and local authorities had to make up. Is that an issue of concern?
10:45
We have to separate powers that are being devolved from the overall macroeconomic fiscal stance. One of the defining characteristics of a union is that the union determines the macroeconomic fiscal stance; powers can be devolved, but if the fiscal stance is that there must be cuts to the overall deficit, there could be the situation where the Scottish Government suddenly gets new powers but also a reduced budget to deal with them. In a sense, they are separate issues but, if we are still part of a union, the question is who controls what. The argument would be that, mostly, the central state gets to determine the overall macroeconomic stance. In other countries, other governmental organisations get to debate that issue, so it is a fair question to raise, but in the UK it is traditionally the Treasury that controls the overall stance.
So we should expect policy control but not fiscal control.
I could not possibly comment on that.
I would like your comment on a point that you make on page 18:
“There is perhaps a danger that Unionist parties are raising expectations beyond what is feasible for political reasons.”
What proposals are being made that are not feasible?
My worry is that the powers over taxation are not the be-all and end-all as far as economic growth is concerned. I have gone into that issue recently. Those powers will increase the accountability of the Scottish Government and the Parliament and will create certain incentives for the Scottish Government to ensure that the Scottish economy grows as fast as possible. However, the tax powers in and of themselves are not necessarily the key to seeing substantially faster growth in the Scottish economy than in the rest of the UK.
The point that you quoted from our paper was not necessarily confined to tax powers, convener. We have not talked quite so much today about the various proposals for welfare devolution, some of which propose devolving bits of tax credits or employment programmes. There are potentially many practical political difficulties around that as well, which our comment was alluding to.
I would like clarification on the point that both Michael McMahon and I raised in relation to corporation and income tax. Is it not the case that the devolution of corporation tax would allow that tax to be raised or lowered as the Government wished, whereas the Labour Party’s proposal for income tax would allow it to be raised to a certain level, without the power to reduce it?
The Scottish Government could raise corporation tax and potentially redesign it. As both David Eiser and I have said, it is true that, over the past 20 or 30 years, the tendency has been for corporation tax rates internationally to lean towards the Irish rate, which is the minimum rate of 12.5 per cent. Most countries have some way to go to get there, but it is absolutely clear that corporation tax rates have been coming down.
Thank you for responding to all our questions.
10:49 Meeting suspended.