The Scotland Bill

Written evidence submitted by Professor Iain McLean FBA

1. I am a Professor of Politics at Oxford University. I was a member of the Independent Expert Group on finance (IEG), Calman Commission. The views I express are my own, and are not intended to represent those of the IEG or the Commission. I have published widely in the Committee’s area of interest including my book The Fiscal Crisis of the United Kingdom (Basingstoke: Palgrave, 2005).

2. Below I comment on the four questions listed in your call for evidence. This is a revised version of my written submission to the Scotland Bill Committee of the Scottish Parliament, where I also gave oral evidence on 11 January 2011 (their Official Report for 11.01.2011 beginning at col 135).

3. Income Tax. The Bill reserves the balance between the standard and higher rates; access to allowances; and definition of the tax base, to the UK Government. It (and the accompanying White Paper) offer what I regard as quite generous "no detriment" guarantees to the Scottish Parliament.

4. In my view the proposals in the Bill are a "sweet spot" for Scotland, offering more security than would either less or more devolution of tax powers.

5. Former Secretary of State Lord Forsyth of Drumlean has called for the rejection of the Bill and announced that he intends to move in the Lords for a referendum on its tax devolution proposals, (Scotsman 28.12.10). However, rejection of this Bill would set the UK Government free to manipulate the non-statutory Barnett arrangements unilaterally.

6. The Holtham Commission (Independent Commission on Finance and Funding for Wales) has called for the Barnett Formula to be replaced by a needs-based assessment for Wales. Should Parliament reject the Scotland Bill, HM Treasury would be entirely free to impose a needs-based successor to Barnett on Scotland. Based on current data for GVA per head (Office of National Statistics, latest) and public expenditure per head (HM Treasury, Public Expenditure Statistical Analysis, latest), I have calculated that this would result in a reduction in block grant to Scotland of 12% beyond the UK-wide cuts that are coming anyhow.

7. My calculations are to be found in an opinion piece in the Scottish Perspectives section of The Scotsman, published on 11 January 2011 and included as an Annex to this evidence. I can explain to your Members, or in a supplementary memorandum, how I calculated the figures.

8. Should there be more devolution of tax powers than proposed in the Bill? Devolving the power to change, for example, allowances against Income Tax or the Income Tax base, has been widely discussed in the Scottish media. But it would have two bad consequences. First, it would increase compliance costs on employers, employees, and payroll providers. Second, it would lead to attempts to present well-off taxpayers’ affairs so as to maximise tax avoidance.

9. I do, however, think that the Scottish Parliament should have the power to vary some other tax bases, and I deal with this below.

10. Income Tax on savings income. This is not now to be assigned, as Calman proposed. I would hope that this issue could be reopened, either via this Bill or via the Joint Ministerial Committee.

11. Borrowing. I think that the Scottish Government should be allowed to issue bonds subject to an upper level to be determined, for the four governments of the UK in aggregate, by HM Treasury and the Debt Management Office. The UK Government’s arguments against this seem weak to me. The Exchequer Secretary of the Treasury told the Holyrood Scotland Bill Committee on December 14 that there would be ‘risks to do with confusion in the gilts market.’ If market players become confused, that is their problem. However, I think that money market professionals are capable of distinguishing between a Scottish local authority, the Scottish Government, and the UK Government.

12. In Canada, the yields and ratings of provincial bond issues provide important signals to all market participants (I provided a table of the then-current rates in my Fiscal Crisis...). The same disciplines would apply to Scotland.

13. Other taxes. I support the devolution of land transaction and landfill taxes. The IEG and the Calman Commission reasoned that the most appropriate taxes to devolve are taxes on bases that don’t move. The shape of (any successor to) Stamp Duty Land Tax interacts with the two disguised land taxes already in the Scottish Parliament’s control, namely Council Tax and business rates. The shape of landfill tax is obviously complementary to that of (any successor to) Aggregates Levy.

14. I am not persuaded by the UK Government’s reasons for rejecting Calman’s other two tax devolution proposals, namely Aggregates Levy and Air Passenger Duty. As Scottish Ministers have correctly pointed out, the litigation which is given as a reason for rejecting the transfer of Aggregates Levy was already in progress when Calman reported. If Scotland is willing to take any revenue risk arising from that litigation, it should be allowed to.

15. Likewise, the fact that the UK government intends to convert air passenger duty into a "per plane" duty argues for, not against, devolving it. The principle of subsidiarity implies that the Scottish Government, not the UK Government, should decide how to tax flights originating at small Highland or island airports. Airports don’t move. They are a very suitable devolved tax base.

16. Tax devolution should have at least two good consequences for the devolved jurisdiction: it should be encouraged to broaden the tax base and to grow the devolved economy so as to increase tax yields. Both of these arguments apply to Council Tax and Business Rates, where successive Scottish Governments have not been notable for their tax effort since devolution. All tax experts believe that these two are bad taxes in almost every respect. The Scottish Parliament should be considering how to reform them, in conjunction with designing a successor to SDLT.

17. It follows that the anomaly whereby Council Tax is devolved, but Council Tax Benefit (CTB) is reserved, needs to be addressed in joint ministerial committees. I understand that the UK Government has already started to devolve CTB.

18. Various commentators have discussed the possible devolution of Corporation Tax. That would be a terrible idea. Experience in Northern Ireland between 1920 and 1972 [1] suggests that such devolution would give rise to massive tax avoidance: nowadays largely through firms’ transfer pricing practices.

19. VAT is unsuitable for devolution, for multiple reasons: including EU state aid rules, and the undesirability of having huge booze-and-cigarette hyperstores at either Gretna or Carlisle.

20. Any proposals for new taxes under the powers proposed in the Bill should consider how immobile the suggested tax base is.

21. Views on alternative proposals. The Scottish Government has declined to put forward specific proposals of its own (see oral evidence from John Swinney MSP, Finance Secretary, to the Scotland Bill Committee on 21.12.2010: their Official Report for that date starting at col. 77). Instead, it has adopted the proposals in a paper by Professors Andrew Hughes Hallett and Drew Scott (hereinafter, with my apologies to them, HHS) that has been extensively discussed, especially since their evidence to the Scotland Bill Committee on 11 January 2011.

22. I am working from a version of their paper Scotland: a New Fiscal Settlement. dated 3 June 2010, Other commentators may have access to different versions. So far as I know, the paper has not been submitted to – or at least, has not been published in – a peer-reviewed journal.

23. In the HHS proposals, all taxes raised in Scotland would be fully devolved (with control of tax bases and allowances, as well as rates, being devolved to the Scottish Parliament), except VAT which cannot be devolved within an EU Member State. Scotland would remit an agreed amount (they propose that it would come out of the share of UK VAT revenue raised in Scotland) to pay for UK-level services. Otherwise, Scotland would be responsible for both taxing and spending. Equalisation would be overseen by a Central Grants Commission modelled on the Australian Commonwealth Grants Commission, although I am not clear what their proposed Commission would have to do.

24. In their model, UK-level services include defence and foreign policy; presumably debt interest repayment; and state pensions. Scotland-level services would include the rest of public spending, including the whole of social protection other than state pensions.

25. As HHS rightly said in their Holyrood evidence on 11 January, they cannot be held responsible for the use the Scottish Government has made of their paper. The First Minister has claimed, in a party speech, that tax devolution, in and of itself, could lead to 1% per annum growth for five years in Scottish GDP per head. If Members wish to query that claim, which is not supported by anything that HHS say, they should interrogate the First Minister, not my professorial colleagues.

26. Their claim is more modest. It is that "a 1% point increase in fiscal devolution ...generates additions of between 0.16% and 0.32% to growth rates... [T]aking a mid-point estimate of 0.25%, this means that a 1% increase in fiscal devolution might be expected [to] raise GSP by 1.3% after five years" (HHS, Scotland: a New Fiscal Settlement ch. 6).

27. I do not understand how this claim is derived. Questioning by members of the Scotland Bill Committee established that none of the sources explicitly cited in HHS’s paper makes it (Holyrood Official Report, 11.01.11, cols 157-60).

28. It has been suggested that the claim derives from a single paper by two Japanese economists: Akai, N. and M. Sakata (2002). ‘Fiscal Decentralization Contributes to Economic Growth: Evidence from State-level Cross Section Data for the United States’, Journal of Urban Economics 52, 93–108.

29. Because the matter remains highly controversial, I have read this paper and make the following comments:

a. It is a cross-sectional study of the degree of autonomy that the 50 US States accord to their local governments, not of the degree of autonomy that the US or other federal governments accord to their states and provinces. This is done for sound methodological reasons, but the situation it discusses is not strictly analogous to that in the Scotland Bill.

b. It tries out numerous multiple regressions to see whether the postulated relationship holds across many different ways of specifying the variables of interest. Only some ways of expressing it give a statistically significant result. This technique is derided by some statisticians as a "fishing expedition".

c. Fishing expeditions are not inherently wrong, but HHS catch only those fish that display statistically significant results. This is a biased selection technique.

d. Nothing in the Akai/Sakata paper warrants the procedure of taking an average annual effect and multiplying it by 5 to get a 5-year estimate.

30. The theoretical literature on fiscal federalism has for decades predicted the effect that HHS postulate. But finding it has turned out to be like hunting the snark (or the Higgs boson). I would not advise your Committee to oppose the Calman proposals on the basis of this evidence.

31. HHS, and Scottish Ministers, have a second criticism of the Calman proposals embodied in the Scotland Bill: that Calman is more risky’ than the full fiscal autonomy that they propose (HHS Executive Summary, second page).

32. I cannot understand these claims. Tax receipts in general depend on economic activity and are therefore highly correlated with one another. The more taxes are devolved, the more Scotland is exposed to fiscal risk.

33. The big-ticket taxes that HHS propose to devolve, apart from Corporation Tax, are National Insurance contributions and natural resources taxes (essentially Scotland’s share of North Sea oil taxation),

34. National Insurance receipts essentially vary with Income Tax receipts. Any volatility that arises from the latter is necessarily magnified if the former are also devolved.

35. The IEG discussed possible devolution of natural resource taxation in its report Natural Resource Taxation and Scottish Devolution, available at http://www.commissiononscottishdevolution.org.uk/uploads/2009-06-06-ieg-natural-resource-taxation-1.pdf.

36. The IEG report concluded at 10.4 that assignment of North Sea Oil revenue to Scotland ‘would expose the Scottish Parliament to significant revenue variations, given the inherent volatility of oil and gas taxation revenues. Oil and gas taxation revenues from the UKCS will also diminish over time given the finite nature of the resource’.

37. HHS do not mention this conclusion. If valid, it is sufficient to contradict their, and Scottish Ministers’, assertion that the regime in the current Bill is ‘more risky’ than the regime they propose.

January 2011