Income tax devolution is set to cost Scottish Government a fortune. So why is no one talking about it? – John McLaren

In four years’ time, it is estimated that the Scottish Government will be receiving £1.5 billion less in revenues as a result of taking partial control of income tax, rather than sticking with the original Barnett formula.

Scotland would have been better off sticking with the original Barnett formula, devised by Labour politician Joel Barnett in 1978 (Picture: PA)

In practice, that doesn’t mean there will be less funding available, rather it means that taxes – mainly on households – will be much higher in Scotland than elsewhere in the UK, but with next to nothing to show for it.

According to Scottish Government ‘ready reckoner’ estimates, £1.5 billion is roughly equivalent to 9p on the basic rate of income tax, or almost 4p on all rates of income tax – from starter rate to top rate.

So rather than the revenue raised from higher taxes being used to increase spending, which might have come in rather useful, instead it’s had to be used to help to make up the shortfall in funding due to slower economic growth in Scotland.

This has, effectively, been the end result of the partial devolution of tax powers since 2017-18. Why so? For three reasons.

First, growth in the economy has been slower than the UK. Second, growth in higher tax band revenues – which is responsible for a disproportionate share of the tax total – has been slower. Third, the population is ageing faster, impacting on the size of the workforce.

Could this have been foreseen? To some extent, no. For example, the decline of North Sea oil and its related high-wage employment was difficult to predict precisely, although the general direction was known. But to a large extent, yes. So why go ahead with the transfer of such powers? Politics, of course, the Scottish Government and Parliament wanted more powers, regardless of the outcome.

It has taken some time for the negative consequences of fiscal devolution to become apparent but now they seem quite clear, if little discussed.

The latest Scottish Fiscal Commission (SFC) report from late last month highlights that “slower Scottish earnings and employment growth have contributed negatively to the net position”, where the “net position” is determined by the degree to which Scottish income tax per head grows faster or slower than in the rest of the UK.

"This is offset by divergence in Scottish and UK income tax policy which has helped keep the net position positive in most years. We estimate that, in the absence of Scottish and UK income tax policy differences, the net position would have been minus £1,004 million [£1bn] in 2022-23. By having relatively higher tax rates in Scotland and lower thresholds for higher rate taxpayers, the income tax net position shifts to an expected minus £157 million in 2022-23,” the SFC report adds.

That negative net position is then expected to rise to over minus £1.5 billion by 2026-27, mainly due to demographic effects.

While the Scottish Government may be worried about rising energy prices, and highlight this as a humanitarian crisis in its latest Programme for Government, there was not a word in this document about the self-inflicted higher tax burden that Scottish households are facing thanks to the transfer of income tax powers.

No doubt the SNP-led government, and possibly others, would argue that the slower economic growth is largely outside their control, as Westminster retains the key powers. That may, to some extent, be true, but then why negotiate for more powers when you believe that the UK Government’s economic policies will end up costing the Scottish Budget big time?

The weird thing about all this is that the ‘higher tax for no benefit’ position Scotland is now in, is not part of the political debate. When the SFC recently came out with the £1.5 billion loss figure there was no political furore, but silence.

While it may be expected that the SNP did not want to discuss the figures, what of the other parties? Surely this is a clear and obvious failing and needs to be given prominence and the government challenged on it.

What providers of analysis we do have – the Fraser of Allander Institute, the Scottish Parliament Information Centre (SPICe) and the SFC itself – have highlighted the emerging problem but to little avail in terms of giving it a higher political profile. What does this say about our government and parliament?

While many may lament the, many, shortcomings of the UK Government, it is at least held to account and challenged in a variety of ways. Whether it be through robust opposition parties, the House of Lords, the Commons’ committee system, think tanks or the media, bad policies are exposed and debated, not least in terms of the economy.

In Scotland, no such wider system of political accountability exists. As a result, the economic debate suffers, as too does the debate around other important areas of public policy like health, education and beyond.

All such omissions have costs, it’s just that in the case of the economy we are seeing these costs explicitly laid out, in terms of a smaller budget that needs to be topped up through higher taxes. On education, the international OECD Pisa results suggest that education suffers too. No doubt health in some ways also.

At present, Scottish politics is in a poor place, with the state of the economy being just one of the casualties. Clearly there is no going back on devolution so the choices are to rejuvenate the Scottish Parliament as it stands or to push on to independence, which would force a change in approach, for good or ill, on economic and other matters.

For now, we remain in an unhealthy position, with a parliament that pontificates at length but effects little change in practice. Meanwhile, as the Scottish Fiscal Commission keeps illustrating, the costs of such disengagement keep rising.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks