Peter Jones: The stuff of economic nightmares

Bruce Crawford MSP, convener of the devolution and further powers committee, attacked the Scotland Bill. Picture: Andrew Cowan

Tomorrow, Chancellor George Osborne’s autumn financial statement will set out his plans for public spending over the next three years. There’s a vast amount of incredibly important material in this – how he will re-shape the cuts he wants to make to tax credits, for example – but another aspect is particularly important to Scotland.

This is politicians’ and commentators’ favourite game of Barnett consequentials – working out the effects that the spending plans will have on the Scottish Government’s budget. The Barnett Formula arithmetic is fairly simple in principle, and is done for us by the Treasury. The sums are hardly ever disputed, implying that Barnett is generally uncontroversial apart from the usually brief-lived political hoo-hah about whether Scotland is being generously or miserably treated by the Treasury.

This won’t be the case, however, if the significant tax-raising powers of the Scotland Act 2015 come into force. They throw not just one but several spanners into the works to the point that the system for determining half of the Scottish Government’s budget will either become unworkable or be so incomprehensible that it promotes another push for independence or both.

The Barnett Formula has the merit of being relatively simple. It is based on a doctrine first set out by the Treasury in 1978 – that all UK citizens should have access to the same level of public services regardless of where they live. This justified higher per capita public spending in Scotland because, being relatively sparsely populated, services cost more to deliver north of the Border.

On that basis, it was agreed that changes to Scottish spending should match changes to English spending. So it was decreed that for every £1 per head change to spending on devolved services such as health and education south of the Border, there would be a matching £1 per head allocated to Scotland. Scotland’s share of UK population became the basis for the Barnett Formula, and the money this produces is known as Barnett consequentials.

The equality of service doctrine, if it ever existed in reality, has been blown apart by devolution. You could argue it is still there in terms of the quantum of spending money regionally allocated by the Treasury; it is just that the devolved administrations have decided on different priorities.

But many people, I suspect, would reckon that the patchy provision of some high-profile services – free prescriptions in Scotland and Wales but not in England, free personal care for the elderly in Scotland but not England and Wales; tuition fees demanded of students in England and Wales but not in Scotland – proves only that some parts of Britain get more public spending than other parts.

Now that this view has seeped into political debate, it has become another factor eroding belief in Britain as an equitable union in which all citizens, regardless of where they live, share equally in the risks and rewards. And if that is part of the perceived injustice which has driven the surge for independence, the Smith Commission tax package now being transformed into the Scotland Act 2015 is liable to inflame grievance even further.

Policy-makers are aware of this, which is why there is currently an intense debate between the Scottish government and the Treasury on the practical mechanics that have to accompany introduction of the new tax powers.

Unfortunately this discussion is secret and what we do know of it comes framed in inscrutable terminology such as “fiscal framework”, “indexation”, and “no detriment” – hardly the stuff of lively public debate. Worse, what these concepts actually might mean in pounds and pence of public spending will, I assure you, fry your brain even if wet towels are wrapped around your head.

So I won’t trouble you with the detail; suffice it to say that every idea I have seen for a practical fiscal framework involving indexation and which aims to ensure that the new powers create no detriment to taxpayers on either side of the Border seems to have a flaw in it which, in certain circumstances, will cause detriment, i.e. levy an unfair cost on one set of taxpayers.

The problem stems from the crass stupidity of the Smith Commission adopting the cretinous idea of the Conservative Strathclyde Commission that power over all earned income tax, apart from setting the threshold at which tax becomes payable, should be devolved to Scotland.

This was a wheeze, which must have looked politically brilliant to the originators, to solve the Tories’ problem in Scotland – that in a parliament which only decides how to spend money, there is no room for a party which trades mainly from a tax-cutting agenda. So give it sweeping income tax power and all of a sudden the Tories have a real role. Fantastic.

But economically, it is idiotic and in the long-term it could be politically suicidal for the Union. One small example – suppose the UK government raises income tax in order to pay for some UK purpose, say extra defence spending or paying down national debt.

This tax increase would not apply in Scotland, but Scots would benefit without having to pay for it. That is detrimental to the rest of UK taxpayers. To prevent that detriment, the solution would be to cut Scotland’s Treasury block grant by an amount equivalent to what the tax increase would raise in Scotland.

The Scottish Government would then have to decide to meet the spending shortfall by either raising income tax or simply cutting spending. Fair enough some might think, but what if it was to pay for cost overruns on Trident? How acceptable would that be? The political implications are obvious.

This is why the Lords economic affairs committee last week sought a halt to the Scotland Act 2015 legislative process, arguing that until a clear practical framework for implementing the proposals is established, MPs are passing it into law with no clear idea of how it will actually work.

I’d go further. No other government in the world has such a tax scheme for a very good reason. It causes so many problems that it doesn’t work.

The Smith Commission should be reconvened and told to come up with an alternative tax package that will work.