Peter Jones: Time to get serious on how fiscal powers would cope with debt

Published on Tuesday 13 July 2010 16:54

CAN we please get serious about this debate about how to finance devolved government in Scotland?

I make the plea because it has become increasingly difficult to distinguish between what is political posturing and what is rational argument. Myself, I prefer conclusions based on evidence rather than ideological preference.

I say that because in a recent response to an article I wrote on the problems caused for devolved fiscal management by Britain's ballooning debt (30 June), Andrew Hughes Hallett, professor of economics at St Andrews and George Mason universities and a leading advocate of as much financial devolution as possible, asked where I stood on the issue.

Let me clearly state that I am, in principle, all for "fiscal responsibility" — the vogue term for the case that Scotland should be responsible for levying, varying and collecting most taxes raised within Scotland, and remitting a sum to the Treasury to pay for common UK services such as defence and foreign policy.

But I am concerned that the argument for it is presented as though there are no downsides. This is clearly impossible. No tax change comes without both benefits and costs. You can raise taxes on businesses to pay for things that business wants, such as more motorways and air route subsidies, but those business benefits are liable to be cancelled out by having fewer companies (because they have been taxed out of business) able to make use of them. The same principle applies to changing the nature of the tax system.

The ideology I apply to any such proposal is terribly old-fashioned — utilitarianism. That is, I ask whether it works. Does it have more benefits than costs, or vice versa? And where there are costs and disbenefits that are being swept under the carpet, I'll regard it as my job to haul them out for inspection.

Other points raised by Prof Hughes Hallett are, however, puzzling. In summary, my argument was that so huge is Britain's current national debt (forecast to be 62 per cent of GDP, or 912 billion, by March 2011) and such is the worry about repayment amongst the people who lend this money, that a fiscally responsible Scottish government shouldering a share of this debt would find itself so tied up in rules to prevent default (however unlikely that may be) that it would have no financial freedom at all.

Prof Hughes Hallett argued that this exposed "one more flaw in the Calman plan for tax devolution. Not only is the devolution element tiny; but tying the Scottish income tax component to the cuts in the underlying funding formula that these taxes are supposed to replace means that no Scottish government could ever have the tax revenues free to pay off its share of UK borrowing or past debt."

I confess I don't follow this. The Calman plan envisages the Scottish Government becoming responsible for setting and being able to vary 10p of each income tax band and collecting the revenue from it, plus gaining power over four minor taxes. That revenue is for the Scottish Government to spend on health, education, etc, as it sees fit. Not one penny is for paying off UK debt. So where is the flaw?

Prof Hughes Hallett also contends that it was wrong of me to strip out oil revenues from calculations of whether Scotland's tax revenues are enough to pay for all public spending. I did so in order to point out that in 2008-9, Scotland's non-oil deficit got a lot worse, rising by a third to 10.5bn. It is only offset by a similar rise in Scotland's likely share of oil revenues to 11.8bn.

He contends that you might as well strip out income tax receipts or any other tax "each of which has proved just as volatile as North Sea revenues". This is just not the case. In the five-year period 2004-9, Scotland's likely oil revenues have varied (in nominal terms) between 4.53bn and 11.77bn, a low-to-high variation of 160 per cent.

Looking at the four big revenue raisers over the same period, income tax receipts have varied by 28 per cent, corporation tax by 39 per cent, national insurance contributions by 22 per cent and VAT by 16 per cent.

The point of stripping out oil revenues is that they are much more volatile than other taxes. Any government reliant on them to finance current expenditure would be in serious trouble if, say, instead of rising by 4.32bn between 2007-8 and 2008-9, they had fallen by that amount. Indeed, between 2008-9 and 2009-10, oil revenues are likely to fall by 6bn, pushing Scotland into the red by about 4.5bn.

Therefore the prudent course of action for any government fortunate enough to have natural resource production to tax is to assume low tax revenues and (perhaps) use them to finance some current spending. Any yield above that should be banked in a special fund to use for rainy recession days, which is what the devolved governments in Alaska and Alberta do, or to help fund future pension liabilities — what the Norwegians do. But if a fiscally responsible or completely independent Scotland was to do that, it would cause a public spending deficit, necessitating cuts or tax rises. I don't say that out of any ideological conviction, it is just the conclusion pointed to by the facts and best practice.

There are still unanswered questions over the share-out and management of UK debt, and how the capital costs of any bank bail-out would be apportioned. In both cases, the GERS statistics on which Prof Hughes Hallett relies for his argument give no useful answers, because they are not compiled with a view to answering these points.

But if Prof Hughes Hallett and I can have a serious discussion, and perhaps even agree that the process of getting towards a fiscally responsible Scotland will involve some painful adjustments, then we might make some progress towards a more complete answer.