Peter Jones: Problems with Tories’ income tax plan

Cameron fought for Union so should think carefully about complete income tax devolution. Picture: Getty

Scottish Nationalists are preparing plans for more devolution that amount to a ticking time-bomb for independence, according to Willie Rennie, the Scottish Liberal Democrat leader. Maybe so. But are the Conservatives unwittingly doing the same thing?

The speed with which additional devolved-powers packages are being cobbled together plus the pursuit of short-term party advantage is blinding political players to how what should be their long-term goal – strengthening the Union while allowing greater political diversity within it – may well end up being fatally undermined.

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Let’s recall that the sovereign will of the Scottish people expressed on 18 September was to be part of the United Kingdom of Great Britain and Northern Ireland. The political and fiscal architecture of this Union, however, is going to be changed. But these changed structures need to have the word “United” as their central motif. That is what Scots voted for and, since there is no indication to the contrary, also what the other nations in the kingdom want.

If that premise is accepted as a basic principle, then several other principles follow. The new constitutional structures should be durable. Only those who want to break up the UK would want to keep on revisiting the issue.

They should also be stable. They should not create any imbalance, either economic or political, which would cause the edifice to fall apart.

Finally, the new structures ought to be shock-proof. The travails of the euro exemplify the risks of designing a new institution without reinforcing it against external shocks. The penalty for ignoring economists’ warnings of structural inadequacies, dismissed by some as scaremongering at the outset of the euro, took a decade to arrive. When they did, the cost was enormous and is still being felt.

There could be a similar time-bomb in the Tory plan to devolve control of all of income tax to Scotland, except for tax on unearned income (interest and dividends), and the power to set the earned income threshold at which tax becomes payable.

On its own, as a devolved Scottish tax, it is an attractive proposition, meeting objectives of making MSPs more accountable to taxpaying voters. But when coupled with the “English votes for English laws” (Evel) concept, it is potentially disastrous.

David Cameron says he wants to introduce Evel to fix another imbalance in the present constitutional settlement – that while the Scots, Welsh, and Northern Irish have their own decision-making power over health, education, etc, the English do not, as MPs from the other home nations also vote on these English matters.

Giving the nine English regions parliaments to match Scotland’s legislature to create a federal Britain like, say, Germany or Canada, would solve the problem, but there is no English appetite for that. And an English parliament on a par with Scotland’s doesn’t work either. It would represent about 85 per cent of the UK population, making it so dominant a part of the federation as to neutralise the autonomy of the other parts.

Instead, the Tories seem to envisage Westminster operating as a hybrid parliament. All UK MPs would be fully engaged on matters affecting the whole of the UK, but only English MPs would vote on English matters. Sounds good, but if there is to be an English income tax, that’s a big problem.

The difficulty arises, of course, if there is a UK government with a majority of UK seats at Westminster but which is a minority in England. This is mainly thought to affect Labour, because it historically wins most seats in Scotland. In fact, Labour has depended on Scotland for a UK majority only between 1964 and 1966 and between February 1974 and October 1974.

But it can also affect the Tories. In 2010, Mr Cameron was 38 seats short of an overall UK majority, necessitating coalition with the Liberal Democrats. But without Scotland, he would have had a rest-of-UK Tory majority of 18, and in England, there was a Conservative majority of 51.

All sorts of scenarios can be put forward for how a UK government of one complexion might be thwarted in its budget planning if it had ceded control of income tax to the devolved legislatures (if Scotland can get control of income tax, why not Wales and Northern Ireland too?) and to English MPs who, as a group, might be of a different political complexion.

But the important point is to do with macro-economic management. Income tax in 2012-13 raised £148 billion, a quarter of all UK tax revenues of £580bn. Just over a fifth of those revenues came from tax on English incomes. In a crisis such as the one we, along with the rest of the world, have just been through, taxes might well have to be raised. It is easy to imagine a UK government such as the present one, under Lib Dem pressure, doing exactly that, only for English Tory MPs using their English majority to cut income tax and nullifying whatever tax increases the UK government had introduced.

What then? More UK borrowing paid for by all UK taxpayers? Or welfare budget cuts also affecting all UK benefit recipients?

Moreover, potential lenders to the UK would realise that the government had lost control of a quarter of its tax-raising capacity, increasing the risk of debt defaults, and so would demand more in interest payments to compensate for the increased risk. Again, that would hit all UK taxpayers.

Attractive though it looks, complete devolution of income tax only makes macro-economic sense in a federal settlement where the parts of a federation are of roughly the same size. But that is most unlikely to be offered.

In the more likely proposed settlement, income tax can only be a shared tax on the model which is due to come into force in the Calman-inspired 2012 Scotland Act. While the proportions allocated to the different levels of government can be debated, even that is not without some macro-economic risk in a hybrid Westminster operating with Evel principles.

The Conservatives see obvious short-term party advantage in what they have proposed. But if they are the party of the Union they claim to be, they should also think carefully about the longer-term risks they will expose the Union to if they persist with complete income tax devolution.