Peter Jones: More tax powers could leave a devolved nation £126bn in red

Published on Tuesday 13 October 2009 21:42

DEBATE about whether the Scottish Parliament should have more tax powers got a boost this week with the publication of a new book on the subject, The Political Economy Of Financing Scottish Government.

Written by academics, it was, well, a bit academic. All the more so, I suspect, because there is a big shadow over this discussion which nobody seems to want to talk about – the vast and still swelling size of the British national debt.

The size of the debt threatens to crush our Scottish debate about adding some fiscal responsibility to the spending prerogatives of the parliament. This is a great pity because it postpones important decisions about a centrally relevant debate: how to improve the Scottish economy.

The book, by Ronald MacDonald and Paul Hallwood, professors of economics at Glasgow and Connecticut universities, makes a significant contribution to this discussion.

It goes through the flaws in the current system whereby the Scottish Government gets most of what it spends via a block grant from the Treasury, annually adjusted by the Barnett Formula which gives Scotland its population share of spending increases or decreases elsewhere in Britain.

The main problem is that this gives Scottish politicians absolutely no incentive to spend the Scottish Government budget in ways which will create economic growth because the Scottish budget gets no benefit from any increase in tax revenues that might come from such growth policies.

Then the two professors canvass the alternative ways of giving the Scottish Parliament more power to tax, ranging from straightforward devolution of a few taxes all the way through to gaining total control over all taxes through independence.

The most interesting feature is a discussion of international practice. Do regional governments which have more responsibility for raising taxes for their spending programmes also have better performing economies?

Sadly, the answer is unclear. They write: "The empirical evidence on the fiscal devolution-economic growth link produces a rather mixed outcome: some studies find a positive association – more fiscal decentralisation stimulates economic growth – while others in fact find a negative relationship." In other words, some regional governments with lots of tax powers also have lousy economies.

The point is that it all depends what the politicians spend the money on. The classic example is that of Jamaica and Singapore, which in 1960 had broadly the same population numbers and income levels. Singapore's somewhat authoritarian regime spent heavily on education and infrastructure while Jamaica's government did not. And today, of course, Singapore is much richer than Jamaica.

The authors do think, however, that there is a positive link between reducing corporation tax and faster economic growth. This is a bit too simplistic: companies will only benefit from low taxes and grow faster if they have a ready supply of the right labour with the right skills and good access to markets for what they produce.

Nevertheless, the two economists argue quite strongly that a policy of reducing company taxes might be profitably pursued in either a fiscally devolved or an independent Scotland. In normal times, this argument has a lot of attractions. But these are abnormal economic times and, aware of that, I began to feel that their book is a bit too detached from current realities.

For example, they cite in support of the argument the examples of Ireland, Estonia, Hungary, Latvia and Poland as countries which have successfully followed low corporation tax paths. But with the exception of Poland, these countries are also now being clobbered by the worst of the recession afflicting Europe, suggesting that low tax policies may also have a severe downside when the good times stop.

The recession has also caused a big headache for those who want, as do professors MacDonald and Hallwood, to devolve some or all of Britain's tax responsibilities to Scotland. That's because with tax powers, borrowing powers must also come and borrowing means debt.

This brings the existing British national debt into play. Put simply, if you are going to remove some or all of the British government's ability to tax Scotland, you may have to shoulder some of the burden of British debt. This may apply with tax devolution inside the UK, but it certainly applies with independence.

The SNP government accepts this. Its National Conversation document says there would have to be negotiations covering "apportionment of the national debt".

In 2000 I did research on this for the Constitution Unit and concluded that Scotland's share would be about 9 per cent. Britain's debt is now forecast to reach 1,400 billion by 2013-14 and a 9 per cent share would be 126bn. That would be between 80-100 per cent of Scottish GDP, depending on how high the price of oil was then.

Nobody has done the sums, but there may also be smaller shares of debt which have to be taken on as a price for Scotland getting tax and borrowing powers within the Union.

This has not been discussed around, for example, the Calman Commission's proposals for tax devolution, and there is not much economic rationale for it either.

But there may be a political rationale because of one glaring fact: part of the reason for the British government running up such a huge debt was the failure of two big Scottish banks. The electorate south of the Border knows that and thus there may be political demands for the Scots to pay a price for anything given away by Westminster.

This certainly would be the argument with any demand for independence. And 126bn is serious money even in central bankers' language. Moreover the cost of it would be a lot higher to an independent Scotland (which would be an unknown entity to those who lend this sort of money) than it is to the UK government.

Paying the interest and repaying the capital would take a huge chunk out of tax revenues, quite how much is hard to judge. It may even be so large that it quite negates any potential gain from gaining either devolved or independent control of more taxes.

The Political Economy of Financing the Scottish Government: Considering a New Constitutional Settlement for Scotland by Ronald MacDonald and C Paul Hallwood is published by Edward Elgar Publishing, priced 59.95 .