Conclusions and recommendations
Fiscal institutions
1.Economic forecasts will have a key role in the new fiscal framework. There is a clear consensus that forecasting should be done by a body independent of government. We agree with the conclusions of the Finance Committee of the Scottish Parliament and recommend that an enhanced Scottish Fiscal Commission be made responsible for forecasting in Scotland. (Paragraph 17)
Borrowing powers
2.We welcome the devolution of further powers to Scotland but there is a danger that, while those tax powers being devolved may look substantial, they are not particularly suited to addressing the problems caused by an economic shock. The fiscal framework should ensure that Scotland’s exposure to exogenous shocks is commensurate with the Scottish Government’s ability to take effective action to mitigate them. In the event of a substantial exogenous shock we would expect the Joint Exchequer Committee to be convened to discuss how such costs should be shared. (Paragraph 25)
3.Whichever method of block grant adjustment is chosen, we support the principle that adjustments to the block grant should be indexedto changes to rUK tax yields as this approach will limit Scotland’s exposure to UK-wide fiscal shocks. (Paragraph 27)
4.The UK Government has a commitment to run a balanced budget over the economic cycle and we expect the negotiations over revising Scotland’s fiscal framework to provide a similar level of flexibility to the Scottish Government, subject to clear fiscal targets. An enhanced Scottish Fiscal Commission should monitor and report on the Scottish Government’s performance against those targets. (Paragraph 32)
5.It is our view that borrowing from the markets will instil a degree of market discipline and transparency to the Scottish Government’s borrowing. Such transparency should in itself act as a check on imprudence. If the cost of doing so is similar to that of borrowing via the UK, which it could well be if the UK Government were to be explicit that the debt would be fully underwritten, then this should be the default approach of Scottish Government borrowing. (Paragraph 44)
6.We recommend that a specific limit on current borrowing be set and the criteria on which that limit is based be published. Transparency is vital if the fiscal framework is to be a lasting agreement. A specified limit for current borrowing will help people in Scotland understand the additional risk that Scotland is taking on as a result of the devolution of further powers and make them better able to judge the Scottish Government’s performance in managing that risk. (Paragraph 47)
7.There is merit in both governments exploring whether limits to the Scottish Government’s capital borrowing powers should be based on a measure of affordability rather than a specific set value. Such an approach would better align Scottish Government borrowing powers with the performance of the Scottish economy. The methodology behind whatever debt rules are agreed must be clearly set out in the fiscal framework. This will provide clarity to those holding the Scottish Government to account and certainty to those pricing Scotland’s debt. (Paragraph 48)
8.We have already given our view that transparency will be key to discouraging imprudent borrowing. To that end, we recommend that an enhanced Scottish Fiscal Commission be required to give regular borrowing forecasts to the Scottish Parliament. The Commission should also be required to assess the state of Scotland’s public finances and their sustainability over the longer term. (Paragraph 49)
9.We reiterate our view that the cost of borrowing is likely to be reduced if the criteria on which Scottish borrowing powers are based are seen to have been decided on objective and transparent criteria and that the issue of moral hazard is explicitly addressed in the fiscal framework. (Paragraph 51)
Adjusting the block grant
10.The method of determining the initial adjustment from the block grant must be transparent and fair to both sides. If there is any perception of unfairness over the initial adjustment then the prospect of a stable settlement will be remote. To prevent the initial adjustment capturing the effects of an atypical year in the economic cycle we suggest the forecast be based on an average of outturns over several years. (Paragraph 53)
11.The method of indexing the adjustment to the block grant to account for devolved revenues should not expose Scotland to risks that it lacks the powers to mitigate. We note the UK Government told us that the Scottish Government has the levers to increase Scotland’s population. Furthermore, we consider any method of indexation that requires Scotland to increase its tax revenues at a faster rate, per person or in aggregate, than in rUK in order to maintain existing levels of public spending as breaching the first principle of no detriment. The Per Capita Indexed Deduction method both removes the risk arising from slower population growth and satisfies the Smith principle of ‘no detriment at the point of devolution’. It also exposes the Scottish Government to revenue risks allowing it to bear the costs or reap the benefits of its own policy decisions. (Paragraph 70)
12.However, implemented unchecked the Per Capita Indexed Deduction method would breach the second no detriment principle, that of taxpayer fairness. It would be unfair on the rest of the UK if the method of adjusting the block grant were to exacerbate the existing redistribution of funding from rUK to Scotland. We heard that an additional adjustment could be made to the Per Capita Indexed Deduction approach to ensure that Scotland’s funding per capita does not increase beyond a certain point relative to rUK. We recommend that both governments explore this option to determine whether it provides a suitable compromise between their respective positions. (Paragraph 71)
13.We support the views of the Deputy First Minister and Chief Secretary to the Treasury that the same approach to indexation should be used across the range of devolved and assigned taxes. (Paragraph 72)
Compensatory transfers
14.There is some sense behind the principle of compensatory payments, but we think that it can only work in a small number of cases where the effects are substantial and mechanical rather than behavioural. In those cases, for the principle of compensatory transfers to work without dispute, they must be well-evidenced and either be set out in the fiscal framework in advance or agreed separately by both governments. Although we have heard the case for an independent arbiter, within the current constitutional settlement of the UK we believe such matters are best solved at a political level. (Paragraph 82)
Devolution of welfare powers
15.We intend to examine Scotland’s population trends and their impact on the development of public policy in a future inquiry. As part of that inquiry we will consider the extent to which Scotland, under the devolution settlement, bears the risks associated with an ageing population. (Paragraph 84)
16.We recommend that both Governments explore basing the adjustment to the block grant to take account of the devolution of spending powers on a Per Capita Indexed Addition approach. This is consistent with the mechanism we recommend the Governments explore for indexing tax powers, it also keeps the adjustment process relatively simple and mechanical. Alternative options based on an assessment of need risk adding a substantial degree of complication while blunting incentives for the Scottish Government to reduce welfare spend. (Paragraph 87)
17.There is a clear risk that a system in which some benefits are devolved and some are reserved will create confusion and uncertainty for those who depend on welfare support. Both governments must work together effectively to ensure that claimants are not disadvantaged by the process of transition from one system to another or by the interaction of those separate systems in the future, not least because those claiming multiple benefits are likely to be on the lowest incomes. The needs of those who rely on benefits should be at the heart of the process of devolving spending powers to the Scottish Government. We expect to monitor progress in this area as part of our future work. (Paragraph 91)
VAT
18.We agree with the Deputy First Minister that linking the Scottish Government’s budget to economic activity through the assignment of a share of VAT revenues provides incentives for growth. The fiscal framework should make it clear that if estimates of VAT revenues are exceeded then the Scottish Government retains the benefit of that improved economic performance and consequential improved VAT take. (Paragraph 96)
19.We are concerned at the potential for inaccuracy in the data and forecasts on which VAT assignment and subsequent indexation will be based. Any method that is unreliable may lead to disagreement between governments and it will almost certainly lead to forecast errors. This latter risk must be factored in when the governments are negotiating what the Scottish Government’s enhanced current borrowing powers should look like. (Paragraph 97)
Conclusion
20.The way in which the Scotland Bill and fiscal framework have been progressed has been unsatisfactory. Substantial changes are going to be made to the relationship between Scotland and the rest of the United Kingdom and it is to the detriment of everyone who will be affected that the process will not have been subject to the level of examination it deserves. (Paragraph 99)
21.We recommend that the operation of the fiscal framework be subject to review after four years. Such a period is long enough for it to be determined whether the framework is working but short enough to prevent any perceived unfairness from having a substantial impact. A four year period will also mean that the effectsof at least one spending round are included in the review. (Paragraph 103)
© Parliamentary copyright 2015
Prepared 9 February 2016