Taxes 'will rise under Calman reforms'

Independent economists Jim and Margaret Cuthbert have warned that Scotland could be caught in a "deflationary trap" by the Calman Commission proposals for giving greater tax powers to Scotland.

In a hard-hitting analysis of the Calman tax power proposal, the couple said Scotland could have to act in a way that could jeopardise its economic growth just to raise enough revenue.

"A devolved Scottish Government operating under the Calman income tax proposal could find itself in a deflationary trap; where it was forced, by its need, to raise revenue, to increase the Scottish rate of income tax – but at the expense of the Scottish economy," the Cuthberts said.

"An independent government, faced with an overall tax yield curve with similar characteristics, would not be in this trap. Such a government could cut its tax rate, increasing both its revenues and overall economic activity."

The Calman Commission, chaired by Sir Kenneth Calman, was set up by the three main unionist parties to review the powers of the Scottish Parliament.

Scotland currently receives an annual grant of 33 billion, using the Barnett formula. The Calman proposal would make Scotland raise part of its own revenue in exchange for a reduction in the block grant.

The critique by two of Scotland's most respected economists – Mrs Cuthbert is an expert in Scottish public expenditure, while Mr Cuthbert was chief statistician at the Scottish Office – who were equally scathing of the SNP's use of the Private Finance Initiative, will be worrying for supporters of the Calman proposals.

The couple recently exposed a series of errors in the calculation of the Government Expenditure and Revenue in Scotland (GERS), which led to a 1.5bn overestimate of Scotland's deficit.

Their analysis of the Calman tax proposals is at odds with Prime Minister Gordon Brown, who has backed the commission's formula for tax-varying powers.

But the Cuthberts warn that under Calman – set up by Labour, the Conservatives and the Liberal Democrats – growth in Scotland's economy could also disproportionately benefit the Treasury, rather than the Scottish Government, because Holyrood would get to keep only 10p out of every tax band.

For every 1p cut in income tax, Scotland would need to raise an extra 5 per cent income from the basic tax payer, an extra 7.5 per cent from those in the 40p bracket and an additional 8 per cent from those in the top 50p bracket, which will be brought in next year.

The pair warned that the Calman proposals would lead to "fiscal drag" and could ultimately depress the Scottish economy, as the Scottish Government could be forced to raise taxes just to get the same amount of revenue.

"We should not be playing with fire inherent in this system," Mrs Cuthbert told The Scotsman.

Mr Cuthbert said the danger of the proposal was that higher taxes could push Scotland into a deflationary cycle, which would lead to higher unemployment.

"We are moving into the unknown. Just because you have a bigger pie, does not mean that Scotland would get a larger slice of it," he added.

In an open letter to the commission, entitled Technical Failings in the Calman Proposals on Income Tax, the pair also warned of the Scottish Government being left to the mercy of "deliberate tax-band manipulation" by the Treasury.

If the UK government changed tax bands, the pair said: "at the very least this would open the Scottish Government to the danger of unpredictable and unplanned changes in its tax revenues. At its worst this situation could be manipulated deliberately by a UK government if it wished to trim the resources going to Scotland.

"Either way, the Scottish Government would be placed in an unsupportable position."

Mr Cuthbert also said that there was no way of knowing how much money would be raised from each tax band, but the Scottish Government would get to keep only 10p from each bracket.

"If the Scottish Government received a lower proportion of high-rate tax revenues than basic-rate tax revenues, the overall effect would be to reduce the share of tax revenues going to the Scottish Government."

Even if the Scottish Government raised tax to increase revenue, it would have short-lived benefits.

Businesses and high-earners would be repelled, leading to a decline in overall tax revenue, which would lead to a drop in income for the Scottish Government.

If the Scottish Government wanted to cut tax to stimulate the economy, this would also lead to a reduction in revenue, although the revenue to the Treasury would increase.

The Cuthberts have argued that the Calman Commission should, instead, follow more closely the Canadian taxation model, to allow Scotland to get a fixed percentage of revenue from its workers, with the rest coming from the Treasury.

"It would be dangerous to apply the Calman proposals as currently structured," the pair said. "In the design of any new funding arrangements for the Scottish Government, much greater attention has to be paid to the danger of creating perverse incentive effects."

The SNP seized on the research, saying it proved that only full fiscal autonomy would work in Scotland's favour.

SNP MSP and finance committee member Linda Fabiani said: "Short of independence, the only sensible way to improve Scotland's fiscal accountability is with full fiscal powers transferred to the Scottish Government and Parliament, and Scotland securing full fiscal autonomy."

She added that the Calman proposals seemed to be "deliberately designed to catch Scottish finances in a fiscal trap". She said: "The only beneficiary appears to be the Treasury – no matter what steps a future Scottish Government would take."

However, a Whitehall source said that the economists' argument was "slightly ludicrous", as it emphasised the obvious.

The source said: "What they are arguing for is protection from the consequences of varying tax powers. It is in Alice in Wonderland economics, in that they want tax-cutting to have only an upside."

A spokesman for the Scotland Office defended the Calman proposals. He said: "It's right for the Scottish Parliament to have increased tax powers hand in hand with increased responsibility. That is what Calman has proposed. A system that gave a tax guarantee to the Scottish Government would not increase accountability."

CALMAN AND ITS IDEAS

THE Calman Commission was the body set up to review devolution, a decade on, and recommend ways forward for the constitutional arrangement with Scotland.

It was set up in 2007 and this June came up with 24 recommendations. Among them were ideas on:

INCOME TAX: The Treasury would cut 10p off every tax band in Scotland, and it would also trim the block grant by the same amount. The Scottish Government would then have to make up the rest through varying tax rates.

OTHER TAXES: The Scottish Parliament would also be handed powers on landfill tax, air passenger duty and aggregates levy. However, transferring fuel duty and VAT was ruled out.

BORROWING: Scotland would have its currently restricted borrowing allowance increased. The Scottish Government could borrow to fund capital investment, such as public infrastructure.

OTHER POWERS: Holyrood would gain control over airgun legislation, drink-driving and speed limits, as well as running Scottish elections.