A Deal With The Devolved - Part Three

Craig DalzellThanks to an FOI request, I now have evidence that the Scottish Government has applied its devolved Freeport tax cuts without any data saying that they will benefit the Scottish public purse or be offset by other taxes.About a month ago I used Common Weal’s column in The National to return once again to the issue of Scotland’s “Green Freeports” and the Scottish Government’s not just complicity in allowing them to be set up in Scotland but their outright endorsement of them by way of applying their powers of devolved taxation to give them tax cuts in areas like business rates and Land and Buildings Transaction Tax in addition to the Corporation Tax and Employer’s (but not Employee’s) National Insurance cuts that will be controlled by Westminster.The argument for the reserved tax cuts is mostly based on the largely discredited and mostly overly-simplistic idea of the “Laffer Curve”. The idea behind the curve is that we can think about the estimate revenue from a tax based on the rate it is applied at. Logically, if the tax rate is 0% then the government will raise no revenue at all. As the rate is increased, then you start to increase the revenue but as tax rates get higher then people start changing their behaviour. If income tax goes up, people might – so the theory goes – work less, or turn down a pay rise, or they may start avoiding or evading the tax. If the tax rate reaches 100% then there is no incentive at all to do the thing that causes you to pay the tax (why work effectively for free if the government taxes 100% of your salary? Well...ask the volunteer sector, but let's put that to the side for now) and therefore if the tax rate is 100% the government should get no revenue at all, just as if the rate was 0%. This leads to the idea that there must be some tax rate that gives us the maximum possible revenue – if it’s lowered from that point, people are undertaxed and revenue declines; if it’s raised from the optimum rate, people will evade the tax and revenue declines. If we think about Corporation Tax, then if we cut the rate too low then Corporations might move their HQ here, but we don’t get much revenue from them; if too high, then they might leave and go to Ireland.That’s all fairly logical from a textbook economics standpoint but here’s the trick that’s played by politicians. No-one can agree where the “optimum tax rate” actually is and almost everyone who mentions the Laffer Curve will try to convince you that we’re already on the far side of the peak and we should cut taxes. The second part of that is clearly ideological but the former is slightly harder to understand.The problem is that taxes rarely work in isolation. Consider Income Tax again. One of the problems that devolved Scotland has with its control over Income Tax is that we don’t have control over Capital Gains tax which, as Richard Murphy explains well, is charged at a much lower rate. It’s relatively simple for very high earners to switch their recompense from paid income to something like shares and dividends and thus to benefit from the lower rate of Capital Gains tax. Therefore the “Laffer Optimum” level of Income Tax depends on a government’s ability and willingness to prevent that from happening. The maximum possible rate of income tax in Scotland might be higher if Scotland could also adjust Capital Gains tax too (though this might encourage people to take things like shares of land instead of shares in the company... maybe we need a land tax too...and so the chase continues).So that’s the economics lesson. How does this relate to the Freeports and devolved taxes?When I’ve been discussing the roles of the Scottish Government in giving tax cuts to Freeports, one of the arguments for their actions follows a similar path to the Laffer Curve argument as it relates to multiple, interlinked taxes.The argument goes that if we reduce business rates and LBTT, then we encourage businesses to come to Scotland. Those businesses employ people and pay them income, that income is taxed with devolved income tax. If, therefore, the cut to the business rates and LBTT is less then the increase in income tax due to the new jobs, would that not mean that the Scottish Government collects more revenue in the round?It’s a good question and one that could be modelled using various tools available to government statisticians similar to tools like the Input-Output Tables that simulate the impact of government investment in the economy. Not having seen any such modelling for the Freeports in any of the government releases about them, I did the thing that no-one else seems to have done up till now. I asked for the data via a Freedom of Information Request.That FOI came back to me this week (It’ll be recorded as FOI 202400407877 when (if) it’s eventually published on the Government’s own website but just in case it’s not, you can read it here too.It states plainly that the Scottish Government has not done that kind of economic modelling. They do not know if giving the Freeports devolved tax cuts will be offset by increased income tax revenue. They don’t even know how much money the tax cuts themselves will cost. The closest they come is via the comment that they expect the LBTT cuts to “below [their] materiality threshold” and that they have done no formal costing. In other words, they claim – without evidence – that the LBTT tax cut will not matter much at all (we disagreed in our response to the consultation – it’s not just the revenue that’s the problem but the potential for the tax cut to be used in a way that encourages “leakage” of Freeport economic activity into the domestic economy).Taking the Government at its word here, this bring up another problem. If they expect the tax cut to be immaterial, then why give it at all? It seems like they’re doing it just because they want to avoid a fight with Westminster and the best way to do that is to just copy/paste whatever they are doing with Freeports up here without question or examination (as further evidence of that, see how readily the Scottish Government extended the length of the tax cuts from five to ten years after Westminster did). It also seems that if the tax cuts are as immaterial as they claim they’ll be, then doesn’t that cast into doubt the entire business case for the Freeports? If the case being put forward by the companies involved is essentially that it entirely depends on a marginal tax cut and wouldn’t happen without it, then it may say that the case for the business is so shaky that they really shouldn’t have the kind of business leverage that they’re throwing around (the fact that many of the plans for the Freeports – including the other potential sites in Scotland – were often based on regurgitated plans from years or even decades ago also speaks to the lack of actual new innovation in this sector).As Scotland moves into the next chapter of its politics then I’d make a plea to the Government and to all governments that follow them. Can we stop making policy based on textbook economics that don’t stand up under any kind of real-world scrutiny? Can we stop making policy that runs contrary to the data or runs despite the absence of data? And can we stop making policy based on whatever happens to stop a political fight just because it’s easier that way?There’s a real dearth of the science of policy-making in Scotland – Freeports are where that ends up.