House of Commons - The Implementation of the Smith Agreement

The Implementation of the Smith Agreement - Scottish Affairs Contents

2 More control over taxation and spending

7. Since its creation in 1999, the Scottish Parliament has been responsible for more than 60% of public expenditure in Scotland but has not been responsible for raising the vast majority of the revenue to fund this expenditure. Only Council Tax and Business Rates—approximately 7.5% of total revenues—have been within the control of the Scottish Parliament.[15] The Scotland Act 2012 slightly reduces this imbalance. The Act made provision for the devolution of responsibility for two additional taxes, Landfill Tax and Stamp Duty Land Tax, and control over a proportion of Income Tax.[16] Together, these taxes are forecast to increase Scottish Parliament control to approximately 16% of revenues. No further spending powers were devolved as part of the Scotland Act 2012.

8. The Smith Agreement seeks to increase the powers of the Scottish Parliament on both the spending side and, in particular, the revenue side. In doing so, the Smith Agreement claims "there will be a corresponding increase in the Parliament's accountability and responsibility for the effects of its decisions and their resulting benefits or costs".[17] For the first time there will be a direct relationship between the taxes levied in Scotland and public expenditure in Scotland. Under the Smith Agreement the Scottish Government will receive all Income Tax paid by Scottish taxpayers on their non-savings and non-dividend income, the first ten percentage points of VAT raised in Scotland (half of VAT revenues at the current rate), and Air Passenger Duty (APD) and the Aggregates Levy will be fully devolved. Together these new powers will mean that the majority of money spent by the Scottish Parliament, will come directly from revenues raised in Scotland.[18] On the spending side the Scottish Parliament will control an additional £2.5 billion of benefits and will be given "new powers to create benefits in areas of devolved responsibility", "new powers to make discretionary payments in any area of welfare without the need to obtain prior permission from DWP" and the ability to vary the housing cost elements of Universal Credit.[19]

9. In terms of revenue and spending powers, the Smith Agreement clearly represents a significant transfer of power to the devolved Government in Scotland. Professor David Bell and David Eiser note that relative to sub-central governments in OECD countries, "implementing Smith will mean that, in terms of fiscal federalism, Scotland will be closer to Canadian provinces and Swiss cantons, which are at the extreme end of the spectrum of devolved fiscal powers among OECD countries".[20]

10. It is disappointing therefore that on the day the Smith Agreement was published, rather than embrace the new powers that will make the Scottish Parliament the third most powerful devolved legislature in the world,[21] the Scottish Government chose instead to deride what had been agreed by the five parties at the negotiating table. The First Minister, Nicola Sturgeon, commented that "it is not so much the home rule that was promised, in so many respects it is continued Westminster rule."[22]

11. In our view, the Smith Agreement successfully achieves two things: it respects the views of the majority of the people of Scotland-that Scotland should continue to enjoy the benefits of pooled resources and shared risk that comes with being part of the United Kingdom-and it delivers recommendations that will create a more powerful, and more accountable, Scottish Parliament. Such an achievement should not be readily dismissed. We look forward to the Scottish Government setting out how it expects to use these new powers to the benefit of the people of Scotland.

Draft clauses

The requirement to consult

12. On 22 January 2015, the UK Government published draft legislative clauses for consultation. Opinion on the draft clauses ranged from them being viewed by Danny Alexander MP, Chief Secretary to the Treasury, as "the faithful fulfilment of the Smith Commission"[23] to claims from the First Minister, Nicola Sturgeon MSP, that they represented "a significant watering down" of the Smith Agreement, "imposed restrictions on the recommended devolved powers and would hand a veto to UK Ministers in key areas".[24] John Swinney MSP, Deputy First Minister, set out the areas where the Scottish Government believed there to be "vetoes":

There are a total of 12 instances across key areas such as welfare, Universal Credit and fuel poverty, where we will have to consult UK Ministers before acting and in eight of these 'permission' from the Secretary of State must be sought: a veto.

13. Given the concerns voiced by the First Minister and Deputy First Minister we asked Rt Hon Alistair Carmichael MP, Secretary of State for Scotland, whether the Scottish Government had been consulted as the draft clauses were being prepared. The Secretary of State explained that the clauses were shared with the Scottish Government once they had been approved by Parliamentary Counsel, and after officials from both governments had reached a shared understanding of the Smith Agreement:

14. We are surprised that the Scottish Government did not raise its concerns when it was initially consulted over the draft text of the clauses but instead waited until after publication to air them. Lord Smith called for both Governments "to work together to create a more productive, robust, visible and transparent relationship". Of course the timetable was tight but on this occasion the working relationship between the UK and Scottish Governments fell markedly short of Lord Smith's aspiration.[27]

15. It would clearly be against the spirit of the Smith Agreement if the UK Government were able to veto the Scottish Government's use of any of the powers conferred by the Agreement. We pressed the Secretary of State on whether any of the draft clauses, if enacted in their current form, would allow the UK Government to impose restrictions or veto decisions made by the Scottish Government. He was adamant: "There are no such vetoes".[28]

16. The Secretary of State suggested that the Scottish Government had confused the need for consultation between governments, a basic requirement for good governance within a framework of devolved and central government, with the idea that the UK Government could impose restrictions.[29] In the words of the Secretary of State, "they have sought to invent vetoes where, candidly, none exist".[30] Where the agreement of the UK Government is required, for example, within the clause on Universal Credit, it is in regard to the start date from which Scottish Ministers can exercise that particular function, not whether they can exercise the function itself and the date of commencement "cannot be unreasonably withheld". The Secretary of State explained that the date needed to be agreed for practical reasons such as changes to computer systems and that the requirement to consult went in both directions. He told us that:

In a number of places, there are areas where consultation must take place; for example, on any action relating to Universal Credit there is a duty to consult that goes in both directions. Therefore, any changes envisaged by the Scottish Government must be the subject of consultation with the UK Government, but the same works in the opposite direction. Any changes anticipated by the UK Government must be the subject of consultation with the Scottish Government.[31]

17. On the Scottish Government's particular claims that "under the current proposals we will not have the independence to take action to abolish the bedroom tax",[32] the Secretary of State was clear:

18. The idea that the draft clauses contain "twelve vetoes" is a ludicrous one and it is disappointing that the UK Government failed adequately to rebut such claims. We hope that a good working relationship between the two Governments will mean that consultation will be routine, agreement a formality, and that dispute will not arise. On such a basis some might question why requirements to consult are included in the draft clauses at all; in the interests of good governance and good legislation it is right that they are there, but we remain of the view that the UK Government should have been better able to explain the clauses and to have avoided the unnecessary conflict and confusion which was used to detract from the real substance of this legislative package.

WELFARE POWERS: A NARROW INTERPRETATION?

19. The referendum result demonstrated that the majority of people in Scotland want to continue to enjoy the benefits of being part of the United Kingdom. One of those benefits and, as Lord Smith told us, a key part of the union, is a shared welfare system.[34] The Smith Commission concluded that the majority of welfare, such as pensions, child benefit and the bulk of Universal Credit, should remain reserved as a key feature which preserved the integrity of the UK state. However, the Smith Agreement also recommended the devolution of powers over £2.5 billion of benefits including those associated with long-term disability and sickness,[35] benefits which comprise the Regulated Social Fund[36] and the Work Programme. Given that social care policy is already devolved to the Scottish Government, devolving those benefits associated with the provision of care and which support people with a disability will mean that the Scottish Government has the opportunity to develop integrated policies to serve them better.

20. The Scottish Government will also gain the ability to vary the housing costs of Universal Credit, including the ability to vary the bedroom tax, local housing allowance, eligible rent and deductions for non-dependents.[37] One of the most controversial areas during the period of the referendum campaign was a question on the Scottish Government's ability to abolish the bedroom tax. The Command Paper accompanying the draft clauses confirms that the Scottish Government will have the power to abolish it in Scotland:

This clause [clause 20], in addition to giving powers to determine when direct payments may be made to landlords, will enable Scottish Ministers to vary the housing costs covered by Universal Credit for people in rented accommodation, including varying or removing the under-occupancy charge, and deductions for non-dependents.[38]

21. Perhaps the most significant of the Smith Agreement recommendations on the spending side are the powers to create new benefits and top-up reserved benefits. The Smith Agreement states:

The recommendations on welfare confer broad powers that would allow the Scottish Government to increase any benefit and create new benefits in devolved areas. In effect, the only powers the Scottish Government will not have over welfare are the powers to cut or completely redesign benefits in reserved areas; this presents the Scottish Government with substantial powers to shape the welfare system in Scotland.

22. Since the publication of the Smith Agreement there has been some debate on what "discretionary" means in the context of the Agreement. Discretionary payments are usually lump sum payments used to alleviate hardship in individual cases, but recently they have used been used more widely in Scotland to offset the impact of the bedroom tax for all those affected by it. It is our understanding that it was this more general use of discretionary payments that was being conferred by the Smith Agreement. We are concerned that it is not clear that the clauses as drafted would allow the Scottish Government to top up a reserved benefit for everyone who received it without first assessing the circumstances of each individual. The Command Paper accompanying the draft clauses states:

These payments can be made in any area of welfare, though the Smith Commission Agreement is clear that they must be discretionary. For this reason, the clause [18] provides for a power to make a payment to meet a short term need to avoid risk to the well-being of an individual. This means that the Scottish Government will be able to make payments to individuals on a case-by-case basis, but will not have the power to create permanent entitlement to any new payments beyond the scope of the devolved benefits described earlier.[40]

23. The Smith Agreement does not define what a discretionary payment is and we are not persuaded of the need for the UK Government to do so in clause 18. We sought clarification from the Secretary of State on what is meant by "short term"; he told us:

We also questioned the Secretary of State on whether the application of discretionary payments would allow the Scottish Government to top up a reserved benefit for everyone who received it:

Mr Carmichael:

Chair: So that we can be clear for our report, every single benefit in Scotland under the proposals coming forward from yourself could be doubled or tripled if the Scottish Government wanted to do so.

Mr Carmichael:

24. The UK Government accepts on the one hand that the Scottish Government should be able to increase any reserved benefit yet, on the other, states that the Scottish Government may have to be 'creative' to achieve such an outcome, for example by using the winter fuel payment as a means of providing additional support to pensioners rather than via a discretionary payment on top of the pension itself.[43] Not only should such complexity be avoided, but it appears unnecessary, particularly if the UK Government is relaxed about the final outcome-that of the Scottish Government increasing a particular benefit. The Smith Agreement clearly states that the Scottish Government will have the power to make discretionary payments in any area of welfare so long as it is able to fund them. If the discretionary payments are to come out of the Scottish Government's budget then it should be for the Scottish Government, not the UK Government, to set the terms and conditions under which those payments can be made. We recommend that draft clause 18 be amended to give the Scottish Government broader powers over the application of discretionary payments. Such a change will make it clear to the people of Scotland that they have the benefit of the security of the UK welfare state while, at the same time, the Scottish Government has the capacity to provide more generous welfare support should it wish to do so.

25. We acknowledge that there is a risk that if certain reserved benefits such as Job Seekers' Allowance were higher in Scotland then people might choose to claim them for longer. This would not only increase the cost to the Scottish Government - who would be funding the top up - but also to the UK Exchequer who would continue to fund the basic payment. However, the Smith Commission puts forward a solution to this problem in the form of a principle of no detriment, underpinned by a system of compensatory payments. In this scenario, the Scottish Government could be required to compensate the UK Government if the policy led to a higher welfare bill for the UK Exchequer. Such a system would mitigate some of the risk associated with giving the Scottish Government greater autonomy within the area of welfare. We discuss the Smith Commission's recommendations on a revised financial framework between Scotland and the UK, including the principle of no detriment, in the next section.

A revised fiscal framework

The transfer of powers

26. Arguably the most complex parts of the Smith Agreement to deliver are those that do not require legislative change, namely the fiscal rules that will govern the operation of borrowing powers, adjustments to the block grant, and the principle of no detriment. Michael Keating, Professor of Politics at the University of Aberdeen, observes that there are two aspects to the no detriment rule:

The first concerns the initial transfers of powers and adjustment of the block grant so that nobody loses out in the process. It is straightforward in principle but requires some very difficult calculations and predictions in practice.

27. According to David Phillips of the Institute for Fiscal Studies, adjusting the block grant to take account of the transfer of power should be "relatively easy" in the first year:

28. The implementation of the Scotland Act 2012 demonstrates that both Governments are able to work together and agree a mechanism to govern the relationship between devolution and the block grant. This gives us reason to be optimistic that a revised fiscal framework governing the first part of the no detriment principle is achievable. For devolution to work the initial deduction and subsequent indexation must be fair. If this fails to be the case, as has been suggested regarding the devolution of business rates, then the financial consequences might be huge and any agreement may end up unwinding.[50]

29. As we will come on to discuss, the second part of the principle of no detriment is potentially much more complex. However, it is worth noting that once the Smith Agreement is fully implemented, the block grant will only provide 35% of Scotland's funding, a reduction of two-thirds from the current situation.[51] While still significant, the scale of the block grant's importance will be markedly reduced.

COMPENSATORY PAYMENTS

30. As well as "no detriment as a result of the decision to devolve further powers", the Smith Agreement also states that there should be "no detriment as a result of UK Government or Scottish Government decisions post-devolution".[52] According to the Smith Agreement such a principle will be underpinned by a system of compensatory payments:

31. The majority of discussion around compensatory payments is likely to focus on the interaction between the tax and welfare systems, the relationship between income tax and Universal Credit being one example. Entitlement to Universal Credit is based on net income so if the Scottish Government were to cut income tax rates or increase the personal allowance (by introducing a higher zero rate) then claimants would be entitled to less universal credit. The Scottish Government would be reducing its own tax take but the UK Government would benefit financially via reduced public spending on welfare. Calculating the benefit to the Treasury might be reasonably straightforward in this example, but there are any number of instances where the policy decision of one Government may affect the other, as David Phillips explained:

32. Further complications include scenarios where the UK Government might increase income tax to pay for UK-wide concerns such as defence, deficit reduction or pensions. Under these circumstances Scotland would benefit from the policy decision but the rest of the UK would pay for it. The Secretary of State for Scotland explained to us that the Treasury does not hypothecate taxes and that they all go into the Consolidated Fund, so that it would not be possible to make such a direct link between tax and spending.[55] The examples of business rates being notionally incorporated into the Communities and Local Government departmental budget to fund local government and the link between National Insurance payments and welfare suggests that there might be exceptions to this rule. The updated fiscal framework should account for circumstances where there might be a direct link between a particular tax and specific public spending. It would not be fair for Scotland to benefit from public spending in reserved areas that was directly based on revenues raised in the rest of the UK. We note, however, the recommendation of the Smith Commission that the UK Government has the power to levy a UK-wide tax if it is in the national interest to do so.

33. That one government should not suffer detriment as a result of a policy decision of the other might sound sensible in principle but, in Professor Michael Keating's opinion, determining what should count as detriment will be "politically contentious and technically complex".[56] David Phillips told us that implementing such a system would be fraught with practical difficulties meaning that compensating transfers will only be practical in a few simple cases otherwise the system could quickly become unworkable.[57]

34. We agree that it would be impossible to design a system that could capture every knock on effect and calculate accurately any detriment caused. For the "post-devolution" principle of no detriment to work, both Governments must agree areas where sizeable knock on effects are likely and focus the system of compensatory payments on these.[58] They should accept that in other areas there will be circumstances where Scotland loses or gains and others where the UK Exchequer loses or gains, these are likely to balance each other over time. Such a system could be revisited periodically if there are clear examples of large effects not being captured.

35. The potential for grievance over the operation of the no detriment principle is enormous. If the Smith Agreement is to be an enduring settlement both Governments must work together in good faith and agree a mechanism to administer a policy of no detriment that is proportionate, fair and based on independently verified data.

FISCAL FRAMEWORK

36. A fiscal framework is the set of rules and institutions that are used to set and coordinate sustainable fiscal policy. The rules can include short-term and medium-term targets for debt and for borrowing, as well as rules restricting borrowing or encouraging saving. In the context of the Smith Agreement they are also likely to include provisions governing issues of detriment.

37. How the administration of the revised devolution settlement will work remains to be set out, but what is certain, as frequent arguments over "Barnett consequentials" illustrate,[59] is that there will be disagreements between the two Governments along the way. It is therefore crucial that there is a clearly agreed framework of fiscal rules within which disputes can be settled, and independently verified evidence on which decisions can be based. Indeed, the Smith Agreement recommends that the Scottish Government "expand and strengthen the independent scrutiny of Scotland's finances", something with which the Chancellor agrees, as he told the Treasury Committee:

A very important part of the arrangements we are going to have to come up with […] is a robust, independent fiscal analysis of the public finances in Scotland. We have the OBR here for the UK and, although the Scottish Government have created their fiscal commission, I think that it could be more independent and more robust. Again, my view is that that will be part of the solution.[60]

38. The fiscal framework needs not only to deal with the question of no detriment and adjustments to the block grant but also with the broader issues of increased Scottish borrowing powers to insulate against volatility in the Scottish public finances and the health of its economy in general. Robust fiscal rules will be required to ensure the Scottish Government runs a broadly balanced budget and to prevent it from over-borrowing. When questioned on whether the UK would allow Scotland to go bust the Chancellor was clear:

It is equally important that the Scottish Government and Parliament should bear the consequences of, and be accountable, for their decisions. If those decisions result in a positive yield on the devolved taxes then the benefit must stay in Scotland, but the fiscal rules must also allow the reverse to be true.

We look forward to the next UK Government delivering a revised fiscal framework to govern the relationship between a more powerful Scottish Parliament and Government and the United Kingdom Government. Sir Nicholas Macpherson suggests "it is going to be an interesting question whether you seek to make this work through a series of bilateral deals between the Scottish Government and the Treasury or whether you develop some sort of wider independent commission."[62] Whatever the mechanism decided upon, the new fiscal framework must have the support of both Governments and deliver a robust set of fiscal rules that are fair, transparent and which allow the Scottish Government the power to exercise its new responsibilities while bearing the consequences of its actions.

15 Government expenditure and revenue Scotland 2012-13, March 2014, p28. Total revenues are taken to include a geographical share of North Sea revenue, in 2012-13 this was £53.1 bn. Back

16 For further discussion of the Scotland Bill see the Scottish Affairs Committee Eighth Report of Session 2010-12, The Scotland Bill, HC 775 Back

17 The Smith Agreement, p4 Back

18 HM Government, Scotland in the United Kingdom: an enduring settlement, Cm 8990, 22 January 2015, Preface. In 2012-13, the revenues that will be devolved to the Scottish Parliament post-implementation of the Smith Agreement totalled approximately £20 billion (See Professor David Bell and David Eiser's post, 'The Scottish budget under the Smith Proposals') while the Scottish Government's Total Managed Expenditure for that year stood at £33,862 billion (See the Scottish Government's Draft Budget 2012-13, p46). Devolution under the Smith Agreement of a further £2.5 billion in welfare powers would increase Scottish Government spending to around £36.5 billion. Back

19 The Smith Agreement, para 54 Back

20 Professor David Bell and David Eiser's post, 'The Scottish budget under the Smith Proposals', published on www.futureukand Scotland.ac.uk Back

21 Q437 Back

22 BBC News Online, Scotland should set own income tax, says Smith commission, 27 November 2014 Back

23 The Press and Journal, Danny Alexander: 'We will deliver on vow we made to the people of Scotland', 22 January 2015 Back

24 The Guardian, Nicola Sturgeon: draft bill 'waters down' Smith commission promises, 22 January 2015 Back

25 Scottish Government Press Release, Demand for urgent re-think of twelve vetoes, 25 January 2015 Back

26 Qq397-8 Back