The Scottish Budget under the Smith Proposals

David Bell and David Eiser

The Smith Commission proposals seek to increase the powers of the Scottish Parliament and to secure a corresponding increase in the Parliament’s accountability and responsibility for the effects of its decisions and their resulting benefits or costs.

How has this ambition been translated into concrete proposals for fiscal responsibility? On the spending side, the Scottish Parliament will control benefits associated with long-term disability and sickness, along with some relatively small benefits for older people, and the Work Programme – the UK Government’s key programme for supporting people into work. In total, this will transfer benefits worth around £2.5bn to the Scottish Parliament (in addition the Scottish Parliament would gain some limited ability to vary the housing cost elements of Universal Credit, and top-up other benefits).

On the revenue side, the Scottish Parliament will gain the ability to vary income tax rates and thresholds (but not the personal allowance). Half of VAT revenues raised in Scotland will be assigned to the Scottish Parliament (the VAT rate and exemptions cannot be varied). And Air Passenger Duty (APD) and the Aggregates Levy will be fully devolved.

Table 1 sets out what these proposals would have meant for the 2012/13 budget. The increase in spending responsibility from £34bn to £36bn is relatively insubstantial compared to the increase in revenue raising responsibility. Revenues under the control of the Scottish Parliament are currently just £4bn (council tax and business rates). This figure is already due to increase to almost £9bn under the Scotland Act.  The Smith proposals will increase this figure to around £20bn.

How should these proposals be assessed? The key objective of the Commission was to raise the financial accountability of the Scottish Parliament. Accountability in this sense includes:

• Having a direct stake in the performance of the Scottish economy and facing the fiscal consequences of policy decisions
• Being able to control the overall size of its budget and being forced to consider the marginal benefit of an additional pound of taxation
• Being able to use fiscal policy as a policy instrument to pursue distinct policy objectives

The Smith Commission proposals do increase the stake of the SG in the performance of the Scottish economy, as its revenues will be more closely linked to this performance (and on the spending side, depending how the allocation for benefits from DWP are constructed,  the Scottish Government may have an incentive to reduce the incidence of disability). The proposals also give the Scottish Parliament the ability to vary its budget at the margin and to do this somewhat more subtly than under the Scotland Act.

However, the extent to which the proposed transfer of welfare powers provide the Scottish Government with the ability to pursue substantially distinctive policy objectives may be questioned. It could decide whether or not to make Winter Fuel Payments means-tested, alter the payment structure of the Work Programme, and make some additional, discretionary benefit payments.

On the tax side, the proposed powers are perhaps not focussed on the concerns around poverty and social justice that were raised during the referendum campaign. By keeping the personal allowance reserved at UK level, and with tax credits, National Insurance, employment legislation (including the minimum wage) and working age benefits remaining reserved, the Scottish Government has not gained any new powers to influence the incomes of the almost one fifth of workers who earn less than the personal allowance.

Arguably, the proposals are tantamount to devolving redistributive policy in the upper half of the income distribution, but leaving it reserved in the lower half of the distribution. And ironically, the Scottish Government could see its level of revenues from income tax decline if the UK Government continues to raise the personal allowance in real terms (although the Scottish Government has hinted that raising the personal allowance is a policy which they are likely to follow in any case, ostensibly to reduce poverty, although the actual effect would be to reduce taxes on all those earning more than the personal allowance).

Achieving consensus on devolved powers within the timescale available was always going to be challenging for the Commission, and there was a risk that the resulting proposals would be riddled with inconsistency. To an extent, the proposals that have emerged should not come as too much of a surprise. Faced with the challenge of increasing the level of revenues under the control of the Scottish Parliament, income tax was always the most obvious candidate. Some fears have been expressed about the implications of this for the rest of the UK, several of which are exaggerated. On the benefits side, devolving Attendance Allowance made sense given that social care policy is devolved and has evolved differently in Scotland. Having transferred Attendance Allowance, it makes sense to devolve the closely related Disability Living Allowance. The key challenge was always going to be how to devolve any of the main working age benefits, given their close interlinkage, and the Commission has avoided this issue by leaving the majority of these at Westminster.

A critical unanswered question is how the Scottish Government’s remaining block grant will be determined. Although a commitment to the Barnett Formula has been made, the specific way in which the Barnett-determined grant is adjusted over time has the potential to influence the risks and incentives faced by the Scottish Government, and how its budget evolves over time. This is particularly true when devolving something such as the Work Programme, where Scottish Government success (or failure) in managing this will impose benefits (or costs) on reserved elements of the UK Government welfare budget. A similar issue will arise if the Scottish Government were to ‘top-up’ a particular benefit in such a way that the incentives to enter employment differed significantly between Scotland and rUK. The issue of grant determination remains critical to assessing the impact of the Smith proposals in aggregate.

There are many other details that will require to be worked-out, such as who will be responsible for calculating Scottish shares of tax, the administrative arrangements for collecting income tax in Scotland, and a set of issues around the scope of Scottish Government borrowing powers. Further work is also required to understand the broader implications for UK macroeconomic policy.

To finish, the figure below shows the proposals in the context of decentralisation ratios in OECD countries. Relative to sub-central governments in OECD countries, Scotland currently is responsible for around 50% of all public spending in Scotland, but less than 10% of all revenues raised. Implementing Smith will mean that, in terms of fiscal federalism, Scotland will be closer to Canadian provinces and Swiss cantons, which are at the extreme end of the spectrum of devolved fiscal powers among OECD countries.