Gavin McCrone: The devil is found in taxation details

IT IS unfortunate that such a rumpus developed over the evidence given to the committee of the Scottish Parliament by Professors Andrew Hughes Hallett and Drew Scott.

The points they made about the proposals in the Scotland Bill, which followed the recommendations of the Calman Committee, are important and need to be taken seriously. However, they were, I think, a trifle naive if they thought that they could escape close inquiry on their earlier claim - in a paper of last June which was available to the committee - that Scotland's economy would perform better with full fiscal economy.

I was not present at the committee hearing and, therefore, do not know if there was discourtesy in the way the witnesses were treated. If there was, that cannot be excused.

However, from my experience when I was in the Scottish Office, I know that appearing before a parliamentary committee can be a testing experience. Indeed, committees of the House of Commons, especially the public accounts committee, regularly put their witnesses through very tough, even unpleasant and at times hostile, examinations.

The important contribution made by the two professors in their written evidence is to highlight some flaws in the Scotland Bill. The proposal, following Calman, is to devolve to the Scottish Parliament power to raise a share of Scotland's income tax revenue plus a variety of smaller taxes. This is to be done by cutting the UK income tax rate by 10p and allowing the Scottish Parliament to make up the difference, whether to the UK rate or to some other rate that the parliament would decide.

When combined with local government taxes and the other smaller taxes, this would mean that some 35 per cent of the expenditure for which the Scottish Parliament was responsible would be covered by taxes raised in Scotland. This was an attempt to meet, or partly meet, the widely-held and valid criticism that the present system that gives parliament responsibility for a large part of public expenditure but only minimal powers to raise revenue involves a serious lack of accountability.

The two professors point out that if the UK government decides, as the coalition has done, to increase tax allowances and shift part of the burden to another tax, or to alter the structure of the tax, this would automatically reduce the funding for the Scottish Parliament.They point out that the actual revenue the Scottish Parliament will receive would depend heavily on Treasury forecasts of the proceeds of income tax and that if income tax revenues rose more slowly than expenditure, as they did in the UK in recent years, Scotland would be worse off than under the present system. They also argue, rightly in my view, that the proposed borrowing powers are inadequate to cope with unexpected changes in tax revenue or economic shocks. Clearly, these points are important and account needs to be taken of them.

They seem to me, however, to be on much less secure ground in arguing in their earlier paper for full fiscal autonomy. They suggested that a 1 per cent increase in devolution of such powers might raise Scottish gross domestic product by 1.3 per cent over five years and a larger increase in devolution would result in a commensurate increase. This was apparently based largely on international research not on studies that relate to the UK or to Scotland. It is understandable that this will appeal to those who favour Scottish independence, and it has been seized on by the Scottish Government. However, the professors are not proposing independence; they argue for this in circumstances where Scotland remains part of the UK.

They claim that ministers would do more to improve Scotland's economic performance if the results gave them a dividend in the form of higher tax revenue. That may be so, although I think that Scottish ministers have always been concerned about the need to improve Scotland's economic growth. the only example they give relates to spending on education, which is already the responsibility of the Scottish Government.

If Scotland were to become independent, it would, of course have fiscal autonomy, although even then it would have to take account of constraints arising from the reactions of neighbouring countries and from membership of the European Union (assuming that continued). But as part of the UK, it is accepted that under EU rules Scotland could not have a separate rate of VAT.

Some of those who argue for fiscal autonomy have in mind a reduction in corporation tax to stimulate growth, but this, too, raises serious problems. Unless Scotland could show that the reduced rate of corporation tax was not paid for by a transfer from the rest of the UK, it would fall foul of EU rules on state aid.

So it would have to be seen to be paid for by an increase in other taxes.

Here the facts begin to obtrude. Scotland, along with Northern Ireland, Wales, the northern and north western regions of England and London all have a level of public expenditure per head which is above the UK average. In Scotland's case, it is 16 per cent above, according to the latest figures. More for Northern Ireland and less for Wales and the two northern regions (see chart). However, taxation revenue per head for Scotland without North Sea oil, is slightly less than the UK average.If Scotland's geographical share of North Sea oil tax revenue is included, the remaining deficit is quite small. but the revenues from North Sea oil have proved extremely volatile, fluctuating between 1 billion and 12bn a year. If they had accrued to Scotland, they would have produced a huge budget surplus in the early 1980s but in most other years a deficit of varying amounts would have remained.

There is however a wider point. As part of the UK, Scotland has been part of a system where no attempt has been made to balance public expenditure and revenue region-by-region or country-by-country. Some parts of the UK contribute more in revenue than they receive in expenditure, others less. It is under this system that the infrastructure for North Sea oil and gas was paid for by the UK (rather than the Scottish or English) taxpayer and the revenues have, therefore, been treated as accruing to no single region or country but as a resource for the UK as a whole. If it were proposed now to hypothecate a geographical share to Scotland, and especially if this were then used to reduce another major tax such as corporation tax, this would not go without protest from other parts of the UK. A reduced rate of corporation tax in particular would cause distortions within the single UK market. Sensitivity to this would be especially strong in the north of England and demands for some sort of retaliatory action could be expected.

It is important that we find a system of financing Scottish devolution that improves accountability and is regarded as fair, not only in Scotland but elsewhere in the UK. The block grant system adjusted by the Barnett formula fails the accountability test and is widely seen in England, and even by Lord Barnett himself, as being unjustifiably generous to Scotland. It cannot be expected to last. but Scotland's needs, with its geographically dispersed population and high incidence of deprivation, especially in parts of the west, are different from those of England. Simply to cut Scotland's public expenditure per head to the English level would, therefore, not be appropriate.

Whatever changes are now made, it is essential that we move to a system that is rational and defensible on both sides of the Border.

• Gavin McCrone was formerly chief economist at the Scottish Office.