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Fiscal Trap

Responsibility without Power: the Mark of the Mug through the Ages

Fiscal Trap

Jim Cuthbert – 23 June 2022

The Scottish Spending Review, which Finance Secretary Kate Forbes released in May, cast a sombre light on the Scottish Government’s spending prospects over the next four years. While priority would be given to health, social care, and social security, the projected budget for other services will be flat in cash terms. Given the current high levels of inflation, this of course implies significant real cuts in these services. The Institute of Fiscal Studies, in their assessment of the implications of the Spending Review, estimated that there would be real cuts of 8% over the next four years in areas like local government, police, prisons, universities, and rural affairs: and of 16% in areas like enterprise, tourism and trade promotion. The IFS also noted that the Scottish Government is implicitly assuming a further rise in income tax rates relative to the rest of the UK: and, that, once the effects of these rises are stripped out, the underlying tax base growth in Scotland is forecast to be slow.

The mainstream press, of course, made predictable hay about the “black hole” in the Scottish Government’s finances, with the unionist majority laying the blame on the SNP’s supposed profligacy. But it was a letter on June 7 in the London Times from a former director of communications of the Scottish Conservatives which perhaps came closest to revealing what is actually going on. What this letter did was to claim credit for the Conservatives for imposing upon Scotland the financial arrangements we now have. And it virtually exulted that, because the Scottish Government had not chosen to adopt a policy of lowering income tax rates relative to the rest of the UK, but to raise income tax, this was leading to the financial stringency Scotland was now experiencing. As the letter said, “in reducing revenues by raising tax rates, it [that is, the Scottish Government’s tax policy] has provided a perfect case study for economics students for years to come.” And later on that “extending Holyrood’s tax-raising powers was a properly considered Conservative policy, with Conservative principles at heart.”

The Times letter is far from being just an after the event rationalisation of how the unionists expected the fiscal settlement to work. There was clear evidence even before the settlement agreement was reached in February 2016 that this is precisely what the unionists intentions were. But before we look at that, it is first of all necessary to give a little background on the design of the fiscal settlement.

Under the post-referendum fiscal settlement, there is a deduction, or “abatement”, each year from the block grant as calculated by the old Barnett formula, to allow for revenues which the Scottish Government would be raising by its own taxes. The abatement for income tax, (the dominant element), is indexed by the percentage growth in corresponding income tax receipts in England, adjusted for the relative growth rates of population in Scotland and England. This means that if Scotland grows its per capita income tax receipts at the same rate as England, then Scotland will receive the same funding as it would have done under the old Barnett formula. Scotland will do better if it achieves a higher growth rate. But if the rate of growth of per capita tax receipts lags behind England, Scotland is penalised. Effectively, the fiscal settlement thrusts Scotland into a fiscal race with England, where, if it wants to do as well as it would have done under Barnett, it has to grow its per capita tax receipts as fast as England. 

The problem is: this is an unequal race. First of all, the range of powers available in Scotland is actually very limited. The only really major tax which is largely under Scottish control is that on non-savings, non-dividend income. And it is also true that the non-tax levers available to the Scottish policy maker are also very limited: in particular, the areas of employment, and trade and industry, crucial to growing the economy, are largely reserved. Further, if Scotland lags in the growth of devolved tax receipts, we will be progressively penalised under the abatement mechanism. Moreover, Scotland is likely to be intrinsically weak in this income tax race. For example, even before devolution of income tax to Scotland in 2016/17, per capita receipts in Scotland of that element of income tax which was going to be devolved were just over 80 percent of the level of corresponding receipts per head in the rest of the UK.

The unionist side in the fiscal settlement negotiations clearly intended to use the system as a means of forcing the Scottish Government to adopt a neo-liberal, low tax fiscal policy. This became obvious at a seminar to discuss the emerging fiscal settlement, which was held at Nuffield College, Oxford, in December 2015: this was before the deal was actually signed, but when the key features of what was being proposed were already clear. At that seminar, I had pointed out the downside risks for Scotland that attached to the proposed deal because the Scottish Government did not have sufficient powers: and the danger that Scotland would then slide into a self-perpetuating cycle of relative economic decline and progressive penalisation under the abatement mechanism. Not so, replied a very senior Treasury official: Scotland did have enough powers to make the system work. What Scotland would need to do, he said, would be to reduce taxes on income, and out-compete the rest of the UK as an attractive destination, particularly for high earners: that was the way for Scotland to win the fiscal race with the rest of the UK.

In other words: once it agreed to the fiscal settlement, the Scottish Government found itself locked into the position of trying to make a system work, where that system was specifically designed to operate under a set of hard line, neo-liberal, low tax beliefs which are the direct opposite of the Scottish Government’s own belief set. This fatal inconsistency, together with the limited powers the Scottish Government has, and the poor design of the system itself, makes it well-nigh impossible for a Scottish government to develop a successful fiscal policy under devolution.

The Scottish Government was represented at the Nuffield seminar, and so had direct knowledge, from the horse’s mouth, of the Treasury view that operating a neo-liberal low tax policy was the only way the new fiscal policy could be made to work successfully. In addition, (and fully conscious that “told you so” is never a good read), before the deal was signed I myself pointed out its inherent risks: both in discussion with senior Scottish personnel, (both political and official), involved in the negotiations: in a technical paper on modelling the new settlement published in the Fraser of Allander Commentary: in evidence to a House of Lords Committee scrutinising the arrangements: and in a number of more popular articles. My own clearly stated position was that the risks involved were so great that the Scottish Government should refuse to sign up to the deal on the table.

While the future is, of course, intrinsically unknowable, there are very worrying indications that Scotland is already being gripped by the cycle of progressive penalisation through the abatement system whose danger was predicted. Consider, for example, the report produced in August 2021 by the Scottish Parliament Information Centre, (SPICE), on the Scottish Government’s use of its income tax powers. What the SPICE report found was that over the three years 2017/18 to 2019/20, Scottish tax revenues were £900 million larger than they would have been, because of the increases which the Scottish Government had implemented in income tax rates, relative to tax rates in the rest of the UK. However, once the effects of the block grant abatement system were added in, this extra revenue was largely cancelled out: the overall benefit to the Scottish budget was only £170 million, because the increased revenue from the Scottish tax rises were largely offset by a slower underlying growth than the rest of the UK in per capita income tax. 

In effect, the Scottish Government has walked into the fiscal settlement trap set by the Treasury, and the jaws of that trap are now closing. The big mistake was in walking into a clearly visible trap in the first place, by signing up to the settlement. Now we are in this position, the damage will be serious, and is likely to occur in four main ways, as follows.

First, will be the direct damage to Scottish public services, and Scottish society, from the progressive squeeze on public expenditure which is in prospect.

Second, since the SNP took responsibility for making the system work, by agreeing to the settlement in the first place, it is the SNP who will incur the political damage of being blamed for its failure. This can already be seen in the general press reaction to the recent spending review. This will not merely damage the SNP, but the whole cause of independence.

Third, from a unionist perspective, the fiscal settlement is being a brilliant success. It is working exactly as predicted, and will seriously damage the cause of independence. So, in the review of the fiscal settlement which is now overdue, we can expect the unionist side to be emboldened, and to press for even harsher neo-liberal medicine for Scotland.

And finally, there will be a harmful effect on the way in which the SNP government exercises those powers which it does have. Budgetary pressure, and lack of adequate powers, are likely to force the SNP down the road of increasing reliance on market based measures like public private partnerships, and even privatisation. This is already happening. Faced by the financial constraints of devolution, the Scottish and Welsh governments are proceeding with the development of the flawed, PFI type, Mutual Investment Model for delivering public sector infrastructure: whereas the UK government, which does not face the same constraints, has abandoned this type of approach. And there are worrying indications that the Scottish Government may also be eyeing up privatisation options in areas like the provision of ferry services.

The famous quotation, “power without responsibility, the prerogative of the harlot throughout the ages”, was used by the Conservative prime minister Stanley Baldwin, with reference to over-weaning press barons. The modified version given in the heading of this note better describes the position the Scottish Government finds itself in, having walked into the trap of taking responsibility for operating the current devolution fiscal settlement without adequate powers. How, and whether, they can extricate themselves from this trap is unclear: but given their propensity for government by wishful thinking, one should not be too optimistic.

9 thoughts on “Responsibility without Power: the Mark of the Mug through the Ages”

    1. MIchael Smith

      From the article it seems that Scots are paying an extra £900m a year in income taxes, but are only seeing and an extra £170m available to the Scottish Government as the UK government nets off the other £730m against the Barnet formula.

      I am thoroughly in favour of reforming how land is taxed in Scotland, so would welcome proposals such as a Land Value Tax or Annual Ground Rent. However all discussions I have seen on these have been on a revenue neutral basis – i.e. they would distribute the tax burden in a more progressive and equitable manner.

      At present the combination of Council Tax and Non-Domestic Rates bring in £5,312m, so to make up the £730m ‘shortfall’ any LVT or AGR to replace Council Tax and NDR would need to bring in 14% more tax income, instead of being revenue neutral. And that is just to stand still, without considering the effects that inflation is having on necessary expenditure.

  1. Ivan Carnegie

    Hillary
    Sounds an option worth looking at – always a mistake to believe that the Tories will fight fair

  2. Ian Davidson

    Jim
    Your explanation of the tax revenue abatement is the first time I have fully understood the “trap” on the income side of the equation. You have every right to “I told you so”. As a former welfare rights officer, I initially welcomed the part devolution of Social Security powers. However it now represents the spending side of the trap. Social Security Spending, once the entitlement rules are set, depends on demand/uptake; forecasts are subject to a large margin of error. Not such a problem when you control the whole national Budget, have extensive borrowing powers etc but a big deal for Scotland’s budget, especially with limited economic growth and high inflation. Then we have “the programme” (policy design) set-up costs and the actual costs of delivery via Social Security Scotland. With the exception of the new Scottish Child Payment, most of the Scottish benefits are more or less structured/paid the same as the DWP ones they are replacing; a big disappointment for disability campaigners. We are going to be spending much cash to design, implement and deliver one third of existing DWP benefits; the key income replacement benefits such as Universal Credit remain UK. A poor deal for Scotland which has been over-hyped from the outset. Sadly, the incompetence of the Scottish “inner circle” will rebound not only on them, but will have real consequences for real people in the future and damage the credibility of any indy campaign. Devolution is “bust” so we have to get indy/full control of the Scottish economy or we are in the soup bowl, beside the cheese/mouse trap?

  3. An in depth analysis of a Westminster policy suggesting Holyrood was ‘caught out’ by smarter Tory policy wonks is commendable , but only if you are studying this subject at university!
    Otherwise this is just another grant cut affecting all of us here in Scotland and should be viewed as such because the above analysis will quite simply bore folk to death.

  4. Good to highlight this again, and if I recall correctly Iain MacWhirter picked up on your comments and put them in his columns at the time. On that basis there’s no excuse for the SNP leadership not having been aware of the trap.

    It was always dumb to take responsibility for income taxes when the levers to improve tax take were outside of Scotland’s control.

    Separately, in the long term the Barnett Formula was always going to be replaced. It is a stick that the Unionists in Scotland will use to beat the independence movement repeatedly. However any replacement would require scrutiny of the true picture of where wealth is generated as well as needs, so it seems unlikely that the UK govt would change.

  5. Bill Hamilton

    I have been aware of the fiscal trap since 2019 when I read an article by Jim Cuthbert in which he referred to it, rather dramatically, as “Fiscal Flodden”. Unfortunately I have not heard any SNP politicians talk about this problem. Is it because they are reluctant to admit they fell into the trap?

  6. florian albert

    This article blames the SNP for falling into an elephant trap. Yet responsibility must be more direct. Almost every profile of Nicola Sturgeon mentions her indifference to matters of economics. That being so, the likelihood is that either John Swinney or Derek Mackay was directly responsible – possibly along with senior civil service officials.

  7. Ian Davidson

    If you go to the Scot Gov news page for 27.6.22 you will see that Scot Gov and HM Treasury have agreed to some research on the fiscal settlement pending a formal review by both governments later in the year!

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