Michael Fry: Time to open window for fiscal change

The Nobel prizes were first awarded in 1901. Between then and 1914, when they were suspended due to the First World War, Scotland won eight of them – more per head than any other nation in the world. It is a sad measure of intellectual decline that, during the entire second half of the 20th century, only two Nobel prizes were awarded to Scots.

One of the them, for medicine, went to Sir James Black, the inventor of beta-blockers, who died a couple of years ago. The other Nobel prizewinner, Sir James Mirrlees, is still with us and full of beans. Since his retiral from full-time academic life he has been, among many other things, an economic adviser to the First Minister of Scotland.

Alex Salmond is known for being no respecter of persons, but he does seem to have a soft spot for both cardinals and Nobel prizewinners. Only people at that level of exaltation in religion or science can, we must assume, strike a little bit of awe into the cheeky chappy in Bute House. Sir James seems to be relishing the acquaintance too.

After leaving Newton Stewart he spent all his life in the ivory tower, working on what his Nobel citation calls “fundamental contributions to the economic theory of incentives under asymmetric information” – in other words, getting people to do things when they do not really see why they should.

It would seem, on the face of it, to be a political rather than a strictly economic task. An example might be persuading those two-thirds of the Scottish people who are not Nationalists to vote for independence on September 18, 2014. And indeed Sir James, who seems delighted to have climbed down from his ivory tower into the political cockpit, is full of bright ideas that might help.

What they are all about is using the fiscal system, the system of taxing and spending, to move the country out of the rut in which it has been stuck since the Scottish Parliament was set up in 1999.

What has changed in that time? Well, certainly far too little. Salmond would argue this is because his government lacks the full powers that independence would bring. But, when you read what he and his colleagues say about change it appears that, even after the changes they do want to make, Scotland would carry on pretty much as before, at the very least with the same monarchy, currency and whatnot. It would all be just that much couthier and nicer.

In which case, we might rationally ask, why bother to go to all the trouble of independence? The English seem to be coming round to the view that they might cough up a bit more than they already do to keep Scotland in the Union. Perhaps the best thing from the Scots’ point of view would be to maintain the whole arrangement in a permanent state of suspense. It might well be more profitable that way than killing the goose which lays the golden egg.

It is to Sir James Mirrlees’s great credit that he has projected on to this conceptually-challenged scene some ideas which might actually excite, though also dismay.

From the heights of Oxford and Cambridge, or now Melbourne and Hong Kong, he appears always to have regarded the irrational British tax system with exasperation: its two forms of income tax, its tax on property based on outdated valuations, its other taxes that just look virtuous rather than actually collecting revenue, its arbitrary and bizarre selection of incentives and disincentives, some useless, some positively damaging. Yet every Chancellor of the Exchequer, including George Osborne last week, adds to them. A prime feature of the system is the abuse and avoidance generated by itself.

So, as soon as Mirrlees had said goodbye to his highly successful career in asymmetrical incentives, he sat down to write a report on taxation for the Institute of Fiscal Studies. This is one of the most venerable of the British think-tanks, founded by a group of economists in horrified reaction to James Callaghan’s last budget as chancellor in the 1960s, the one that led straight on to the devaluation of the pound. By my exacting standards the IFS is not especially right-wing, though most of the criticism it attracts is from the left.

And that is about where the Mirrlees Report stands too. Sir James used at one stage to be an adviser to the Labour party, though you would hardly guess it from what he says nowadays. While he is certainly no Thatcherite dogmatist either, the ideas he seeks to float would cause a sharp intake of breath among most MPs at Westminster. In that case, we can be sure the intake of breath would be even sharper at Holyrood. But that is what radicals are for.

The report is radical in the sense that it takes nothing for granted. It sets out from the point of view of somebody wanting to sweep a lousy system away and start again – not a luxury many people have in the real world, where you only ever chip at the corners of other people’s mistakes.

Yet that is just the luxury that Scotland could have after voting for independence: hence the potential importance of Mirrlees’s appointment as one of Salmond’s economic advisers. If an independent Scotland, or indeed a devolved Scotland that raised all its own taxes, were to follow the proposals, then the following is what would happen.

There would be a simple structure of progressive income tax. There would be a single integrated benefit for those with low incomes or high needs. In principle VAT would be charged on everything (including food) at a uniform rate. Stamp duties would be abolished. A consistent price would be put on carbon emissions. Road congestion would be taxed rather than fuel consumption. There would be no tax on the normal return to savings, with some additional incentive for retirement savings. Income from profits and shares would be taxed at the same rate as other income. Wealth would be taxed at transfer, not death. There would be a land value tax for business and agriculture.

Myself, as a crusty old reactionary, I do not hold with some of these proposals. What I do see here is a simple and consistent system which, compared to the present set-up, is a virtue in itself. On those grounds alone, it would be good for Scotland. It would be an example of Scots doing better for themselves, despite the difficulties, than they can do as part of the UK. It would be something for Scots to aspire to, rather than be scared about.

In that sense, it would greatly raise the at present dismal quality of the campaign for the referendum.

The Mirrlees Tax System Review

The Mirrlees Review, published by the IFS in November 2010, argued that a coherent vision for the tax system was needed, and laid out a comprehensive set of proposals for tax reform.

The key principles that underlie the proposals were that the tax system should:

• Be designed as a whole, in conjunction with the benefits system. The system as a whole needs to be green and to be progressive. But not every tax needs to be green or progressive. Indeed, not all should be. The way taxes (and the benefit system) fit together matters very much.

• Seek neutrality. Tax systems that distort people’s behaviour by treating similar activities differently without very good reason – as the UK system currently does – create inefficiency, complexity and opportunities for avoidance. Exceptions, to deal with the costs of smoking or pollution for example, should be limited and carefully designed.

• Achieve progressivity as efficiently as possible. That means relying on the rate schedule of personal taxes and benefits – rather than inefficiently distorting the tax base – to achieve redistribution. It also means designing that rate schedule carefully to minimise the extent to which the tax system reduces employment and earnings.