Alex Salmond wants more tools to fix Scotland's economy – but he could use the Tartan Tax. The question is: should it go up or down?

Published on Saturday 25 April 2009 20:00

A FEW months before the establishment of the Scottish Parliament, Alex Salmond took one of the most audacious political gambles of his life. He challenged voters to pay a "Penny for Scotland". It was a gamble that failed to pay off.

Salmond's suggestion that the so-called Tartan Tax should be levied had a frosty reception at the polls and was blamed for the SNP's relatively poor showing during the first Holyrood elections.

But in the 10 years since the birth of devolution in 1999, the political landscape has changed almost beyond recognition. Labour's stranglehold on Scottish politics has been breached, Salmond sits in charge of an SNP administration in Edinburgh and a Scot resides at 10 Downing Street – at least for the time being. Most significantly and alarmingly, prosperity has been replaced by economic desolation.

Throughout all this change, there has been at least one constant in Scottish political life: the tax-raising powers entrusted to the Scottish Parliament under the devolved settlement have remained firmly under lock and key. Indeed, over the past 10 years it has never really looked likely that Holyrood's most powerful fiscal instrument – backed by the Scottish people in the 1997 referendum – would ever be used. Salmond's unsuccessful flirtation with the Tartan Tax appeared to kill the genie before it had been released from the bottle.

In any case, there hardly seemed a need for it with public spending increasing yearly. And the political will did not exist while Scotland was in the hands of a Labour-led administration that was reluctant to go its separate way from London, where the New Labour orthodoxy was that tax rises were political suicide.

Today, however, things are different. As Scotland faces economic turmoil, there is a growing body of opinion suggesting that the instrument might finally be used. The one thing that such business leaders and economists are unable to agree on is whether Tartan Tax should be raised or lowered.

Sir Tom Hunter today calls on the First Minister to cut taxes to give Scottish business an advantage. But with Salmond determined to make great play of the importance of protecting Scotland's public services from the ravages of the 500m yearly budget cut that he claims Alistair Darling has imposed on the block grant, others are telling him it should be raised.

So is now the time for Salmond to use Scotland's powers to raise tax for the first time? After all, he can always blame tax rises on his miserly foes at Westminster. How easy – or otherwise – would it be to introduce? And could it protect Scotland from the worst of the coming economic chill; a defence for Scotland's beleaguered public services against economic apocalypse?

"It is an option. It is available for them to do. Clearly it would take some money out of the economy, but it would raise money to secure some of the areas where they say they want to improve public services," said Professor Richard Kerley, an expert in public service funding at Queen Margaret University, who drew up an influential report on local government for the Labour-led Scottish Executive in 2000.

"It is curious that a Government which wants more powers hasn't used them. The point is that we already have a tax power available to us. It seems to me to be the essence of responsible government that we should use it. If you want increased powers and responsibility for a devolved legislature, then let's use the powers we have already."

Tellingly, one of the members of Salmond's own council of economic advisers also admitted that the tax could help.

"Obviously, numerically raising the Tartan Tax would make a difference and if they used that as an option it would be possible to partly close the gap," said Andrew Hughes Hallett, Professor of Economics and Public Policy at George Mason University in the US and a visiting Professor of Economics at St Andrews.

"But the money raised would not be enough to satisfy the need completely. It would also be possible to raise taxes from Westminster to close that gap. It would be anomalous to ask the Scots to pay to close their gap, but not ask anyone else to close any gaps in their funding."

As Hughes Hallett hinted, selling tax rises to a Scottish population struggling in the recession would probably prove problematic – despite theories that Scots have been more willing than their counterparts in other parts of the UK to contribute to the public purse for the common good.

The Scotland Act allows a Scottish Government to vary the British level of standard variable rate of income tax by up to 3p in the pound – up or down. Earlier this year it was estimated that implementing a 1p change would yield 400m in a year. As of yesterday, economic decline means that the same move would now only result in a tax take of 350m. Therefore, if implemented in full it would only result in a take of 1,050m compared with 1,200m a few months ago.

"Income tax is driven by the financial services and that is in decline," said David Heald, Professor of Accountancy at Aberdeen University, who has published studies on the Tartan Tax. "More people are now unemployed, therefore there are fewer people paying income tax."

According to Heald, other difficulties would be raised by the practicalities of administering the tax and the cost of introducing it. The Scottish Parliament would pass a resolution to invoke the tax and then the UK-wide HMRC would have the responsibility for collecting it. The most up-to-date estimates suggest that the cost of setting it up would run to at least 200m, while yearly running costs would amount to 50m. There would also be the thorny issue of what constitutes the tax base and which Scottish residents would have to pay.

Officially, the definition for residence is "an individual who is resident in the United Kingdom for income tax purposes and who in any tax year spends at least half of his time in Scotland (when in the UK) or whose principal home is in Scotland". For the record, a Scottish MP with a principal home in Scotland would have to pay. But, according to Heald, there would be marginal cases that would undoubtedly end up in the law courts, adding to the Government's difficulties.

Professor John Kay, another of Salmond's economic advisers, took a cynical view, arguing that the difficulties associated with implementing it far outweighed any potential benefit. He said: "If the Scottish Government were to say that it wanted to use the Tartan Tax, there would be panic as no one knows how it would work, how it would be gathered. My guess is that if they did want to use it, it would take another three or four years before you worked through the detail and the administrative details for implementing it."

Kay went further, suggesting that Holyrood's tax-raising powers were nothing more than a cosmetic device intended to give the impression that the Scottish Parliament had 'teeth'. He claimed: "The powers that the parliament already have were not really intended to be used. They were a sop to give the appearance of more fiscal autonomy."

But the fact that the powers do exist – at least in theory – has meant that the Tartan Tax has been a costly battleground for some politicians. Earlier this year Tavish Scott, the Lib Dem leader, was ridiculed for demanding a 2% Tartan Tax cut to stimulate the economy. Scott's demand sent him scurrying from budget negotiations with Salmond with a flea in his ear. His proposal was unaffordable, said the Nats, claiming it would cost the Scottish economy 800m per year.

Since then, however, some of Scotland's most prominent business leaders have called on Salmond to set a tax-cutting agenda by lowering the Tartan Tax.

"Lowering it has got to be good," billionaire retailer Sir Tom told Scotland on Sunday. "When he was campaigning to get into government, Salmond was saying that he wanted Scotland to be a low-tax economy along the lines of Switzerland, and cutting Tartan Tax would be a step in the right direction."

But just like 1999, when Salmond wanted to use Holyrood's powers to cancel the 1p Budget cut unveiled by then chancellor Gordon Brown, a tax hike seems to be the far more likely option to be explored by the SNP.

With Salmond determined to fight the forthcoming European and Westminster elections on the injustice of Darling's cuts and the threat to 9,000 Scottish jobs, people could be forgiven for wondering why he does not invoke Scotland's tax-raising powers to do something about it.

The political and economic climate now may well be poles apart from a decade ago and old arguments may have been made redundant, but perhaps the most fundamental objection remains: how does Salmond sell a tax rise to the electorate in times of austerity?

"The Tartan Tax is lurking in the background," said Dougie Adams, chief economic adviser to Ernst & Young's Independent Treasury Economic Model (ITEM) Club. "Will somebody do it to try and protect public service levels? We are in uncharted territory in terms of economic policy. Another part of that uncharted territory is whether the public mood is going to put up with higher taxation.

"We are coming out of a period where we've had ever-increasing amounts of spending in the public sector and it has been pretty painless for us. But now we are in trouble. Quite how the public would react to having more pain, I don't know. We've seen howls when it came to council tax, and Scottish finance is perhaps not that far from local authority finance in that regard."

But, according to Heald, it is an option that will have to be explored – if not now, then perhaps some time in the future if Westminster cuts continue to have an effect in Scotland. Such a move would be rich in symbolism, finally allowing the Scottish Parliament to flex muscles that have lain dormant for more than a decade.

Some die-hard Unionists would no doubt lament the breaking-up of the UK's uniform tax rate. But Heald indicates such a drastic step would someday be necessary to deal with an economic outlook forecasting that the UK will remain in debt until February 2032.

Under the Barnett Formula – the complex mechanism that determines how much money Scotland receives – Heald explained it was possible for cuts in English spending to have a "negative consequential" in Scotland – a move that has the potential to play havoc with Scottish public services.

"Quite a lot of cuts could be made to health in England, which would then feed back in terms of cuts to Scotland," Heald said. "Perhaps this is not an issue at the moment, but it is very clear that the next 10 years are going to be difficult in terms of public expenditure. If Scotland wished to increase spending when it was being cut in the south, this is a decision the Scottish Government and the parliament would have to take. After all, the power is there."