Time for Executive to hand over spending power to the citizen

Under the 1998 Scotland Act, the Executive was granted the right to vary the basic rate of income tax by 3p in the pound, up or down. Put another way, the Executive could cut the basic rate of income tax from 22p in the pound to just 19p. In percentage terms, that is a whopping 13.6 per cent cut.

For a two-income couple, both earning around the national average, that could yield an annual saving in the region of 1000 (although there would also be adjustments in tax credits).

What would be the impact of such a large income tax cut on the Scottish economy?

Contrary to another myth, cutting tax would not actually reduce the amount of cash spent in Scotland; it would only transfer the spending decision from the Executive to the ordinary citizen.

The result is usually a surge in economic growth as incentives are boosted in the private sector to invest or work harder.

Scotland suffers from a very low rate of economic growth (roughly 1.5 per cent) compared to the UK average (around 2.5 per cent). An income tax cut - especially compared to England - would attract skilled workers, keep young Scottish graduates at home, and boost growth overall.

One peculiarity of the Scottish labour market is that it is workers in the very high professional grades who are underpaid compared with those down south. This leads to a drain of the best Scots to London and acts as a barrier to recruiting outside of Scotland. Any income tax cuts would have a disproportionately greater impact on those higher up the pay scale, helping to remove this anomaly.

Paradoxically, the economic growth stimulated by tax cuts ultimately increases overall tax receipts - a phenomenon known as the Laffer Effect after Arthur Laffer, the economist who first measured it.

The Laffer Effect can be seen at work in the American economy. In 2003, President Bush cut US taxes. At first, tax income fell. But this year, tax receipts have skyrocketed on the back of renewed economic growth.

Would public services suffer if the Executive has less tax money? In theory, if the Executive cuts income tax, its revenue from the Treasury is cut. A drop of 3p would reduce the Executive's budget by around 700 million.

However, real spending by the Executive is slated to rise by 4.2 billion per annum over the next three years. A 3p cut only means the planned increase is 3.5 billion - an extra 700 per head on what is being spent now. So a tax aimed for 2007 would not see any physical reduction in public services.

Besides, Scottish public spending per head is already more than 20 per cent higher than in England, with no appreciable difference in quality. One argument for tax cuts is that it would force the Executive to be more efficient with what it has to spend.

What problems might arise in implementing the 3p cut? The first difficulty is that it would cost money to set up the bureaucracy to collect different taxes in Scotland. However, now the Inland Revenue has moved to self-assessment, this is probably a less complicated task than it was six years ago.

There would still be a management cost that the Treasury would charge to the Executive, which suggests any tax change should be big enough to warrant the expense.

Another obvious issue is determining who is a Scottish taxpayer. The Scotland Act glibly says it is someone who "has the closest connection during that year" with Scotland. But many hundreds of thousands of people work simultaneously on both sides of the border. That leaves ample scope for bureaucratic disaster with income tax forms comparable to the recent fiasco with family tax credits.

Such implementation problems are not to be discounted. If there is one thing Gordon Brown dislikes, it is any threat to his Treasury power base.