Iain McLean: Calman puts good deal on the table

A COMMITTEE of the Scottish Parliament is today set to continue its scrutiny of the Scotland Bill, which would cut income tax payable in Scotland by 10p in the pound and force Holyrood to set a tax rate to make up the difference. The Calman Commission, which proposed this, saw it as a way of making the Scottish Parliament fiscally responsible. At the moment, it spends public money but raises hardly any of what it spends, although it controls council tax and business rates, which are spent by Scottish councils. A fiscally responsible parliament has to make grown-up choices: either to spend another pound and therefore raise another pound in taxes, or to reduce taxes by a pound and therefore cut expenditure by a pound.

The Calman proposals face criticism. Former secretary of state Michael Forsyth recently said they are so bad that Scotland should vote against the idea. SNP ministers in the Scottish Government say they are so bad that Scotland should leap to full fiscal autonomy. Statisticians Jim and Margaret Cuthbert say they are fatally flawed. Are any of them right?

It is not for me, as an expat, to say whether Scotland should become independent, or devolution should be abandoned, or neither. That is for Scottish electors to decide. But I can say that all three arguments against the Calman tax scheme are flawed.

Lord Forsyth wants the current bill to fail. He would like a referendum on the tax powers, which he hopes will be lost. But what would happen then? Lord Forsyth's candour undermines his own case. In The Scotsman on 28 December, he said: "The Treasury has wanted to get to a position where they can replace Barnett and move to a system based on need. As Scottish secretary, we were briefed up to the eyeballs not to ever contemplate moving to a system based on need because it would mean a huge reduction in the Scottish budget."

Yet the Welsh equivalent to the Calman Commission, the Holtham Commission, has called for a system based on need. There is no law to stop the Treasury from unilaterally imposing a needs-based system on Scotland.

If the Scottish Parliament or people reject this bill, then as sure as eggs are eggs the government of the day will say: "OK, if you don't like that, then we will give you and Wales a system based on need." The Treasury has been itching for a chance to say that for a hundred years. To see why a needs-based system would hurt, consider these official statistics which we reproduce on this page.

All the numbers are indexed to a UK average of 100. The first column shows that Scotland is almost an average-income part of the country.The second column shows that it has high public spending per head. The third shows what would happen if a crude "Robin Hood" needs assessment were done - one based on Gross Value Added (GVA), which just takes away from the rich and gives to the poor. Scottish public spending per head would go down from 113.3 to 100 - a cut of 12 per cent over and above the UK-wide cuts that are coming anyhow.

If abandoning the bill would be dangerous, what about going beyond it? Scottish ministers say that devolving just income tax and a couple of small taxes, as in the Scotland Bill, exposes Scotland to revenue risk. They have been coy about unveiling their own proposals, but finance secretary John Swinney recently supported proposals from academics Andrew Hughes Hallett and Drew Scott to devolve every tax - "full fiscal autonomy" as it is called. Under full fiscal autonomy, the Scottish Parliament would decide the rate (how much in the pound) and the base (who pays it) for every tax levied in Scotland. If Scotland is independent, that is the end of the story, apart from any European Union restraints. If a loose Union remains, Scotland pays an agreed sum to Westminster for services provided there.

But there is a simple logical flaw in the argument that the Calman plan is "too risky". The more taxes you devolve, the more revenue risk Scotland faces. If the Scottish economy grows, the income from all taxes will grow together because they are strongly correlated. If it falters, the income from all taxes will falter together. How much risk the Scots want to take is up to them; but, unarguably, current Scottish ministers' plans mean more revenue risk than this bill.

The Cuthberts proudly boast that they belong to no party, but their hearts beat to a nationalist drum. Their arguments fail not because they are nationalists, but because of the implausibility of their set-up.

In some circumstances, they argue, if Scotland cuts the rate of "Calman" income tax, Scotland would get less revenue - but Westminster would get more. There is nothing wrong with their algebra, but everything wrong with the assumption that drives it. Years ago, the American economist Arthur Laffer proposed the "curve" that bears his name. If the tax rate is zero, the proceeds will be zero. If it is 100 per cent, the proceeds will again be zero, because nobody will admit to doing the taxed activity. Therefore there must, logically, be a curve. Up to some optimum rate of tax, the amount raised will go up as the tax rate goes up. Beyond that point, as the tax rate goes up, the yield will go down, as people stop doing the taxed activity, or hide it. Above the optimum tax rate - that is, on the right-hand side of the curve - it follows that politicians can reduce the tax rate and increase the yield from the tax.Since Ronald Reagan, right-wing American governments have continually said the United States is on the right-hand side of the Laffer curve: that cutting tax rates would raise revenue. It never has. The US has one of the world's biggest deficits, because taxes have been repeatedly cut, yet revenue has failed to rise. In the UK, the standard rate of income tax has been cut several times, but there is no known case where the proceeds have actually gone up after the rate cut. The Cuthberts' paradox kicks in only if Scotland is in the same (mythical?) "right-hand" state. They present no evidence to suggest that it is.

Their second argument concerns "fiscal drag": that is, the tendency of inflation or economic growth to bring people into higher tax bands, if the bands are not adjusted for inflation. Under Calman, fiscal drag would lead to Scottish tax receipts suffering as people move into higher tax bands, where the Scottish Parliament gets a lower proportion of the receipts. But fiscal drag also leads to potentially millions of people coming into tax for the first time, in which case the Scottish Parliament gets more (than zero) of the receipts. The Cuthberts present no evidence that the bad effect outweighs the good. In the long run, fiscal drag is not a real problem, because a rational government will always re-index allowances and rates from time to time to keep up with inflation.

In sum, the Calman tax proposals involve less risk to Scotland than either dropping them or moving to full fiscal autonomy. And they would make the Scottish Parliament fiscally responsible for the first time in its history. That might sound like a reasonable deal to the canny men and women who read The Scotsman. Even if they don't drink in Morningside.

• Iain McLean is Professor of Politics at Oxford University and was a member of the independent expert group which advised the Calman Commission.