Smith Fatally Flawed by Inadequate Attention to Feasibility

JS51800599By Jim and Margaret Cuthbert

The Smith Commission report has had a mixed reception in Scotland and in the rest of the UK. There is a widespread view in Scotland that the proposals are far from enough: a view with which we concur. Meanwhile, in England, there is a concentration on Cameron’s response of “English votes for English laws”.

However, one fundamental flaw in the Smith report is its lack of attention to detail: this is despite Smith saying that the proposals were agreed on the basis of top expert advice. This failure to deal adequately with detail is in itself a result of the unsatisfactory and undemocratic nature of the process, in which a small group of politicians were given an inadequate timescale to come up with proposals. The result has been that some significant technical issues have either been glossed over, or entirely ignored. As we will show here, this is likely to prove fatal.

Some of the issues which the Commission has skated over were indeed pointed out to the Commission in submissions made by the public or interested groups. Examples are the problems of exactly how to index the reduction to the Barnetted Block Grant if the Scottish Government is given extended tax raising powers of its own: the problem of likely fluctuations in the tax base if income tax is used as a major source of funding for the Scottish Parliament: and the problems that would arise if the tax base for which the Scottish Parliament was given responsibility intrinsically grew less fast than the corresponding tax base in the rest of the UK. Particularly disappointing, and of major importance, is the failure to give the Scottish Parliament adequate economic powers to grow the tax base on which they will have to rely: Smith signally fails to address the difficulties posed by giving the Scottish Parliament responsibility (for a given tax base), without power (to grow that tax base).

All of the above issues were identified, for example, in the submission which we made to the Smith Commission on behalf of the Jimmy Reid Foundation: and no doubt other submissions among the 407 from civic institutions and 18,381 from members of the public raised similar points.

The specific problem we want to talk about here, which we will call the gearing problem, is not one we have written about ourselves, and as far as we are aware seems to have escaped general notice. Nevertheless, as we will explain, it has the capability of blowing the Smith proposals, and indeed the union itself, apart – particularly in the light of David Cameron’s typically opportunistic response to restrict decisions on income tax rates in the rest of the UK, (rUK), to rUK MPs.

What do we mean by the gearing problem: and why is it potentially so important? We now explain. We do this in terms of Scotland and rUK, leaving out the further complications posed by Welsh and Northern Irish devolution.

Suppose that the Scottish Government was given responsibility for funding devolved spending out of the income tax it raises itself, (as well as out of other smaller taxes for which it has responsibility), and out of the reduced Block Grant determined by an adjusted Barnett formula. Income tax is going to be a major component of the Scottish government’s funding: according to Government Expenditure and Revenues, it amounted to £10.865 billion in 2012-13. Approximately 7.2% of this is income tax levied on savings and dividends. So the total expected income tax receipts from non-savings, non-dividend income tax in Scotland is around £10 billion. Total expenditure within the control of the Scottish government and local authorities is £38.546 billion. Thus if the Scottish government set income tax rates at the current UK levels, then income tax is going to fund about 26% of that public expenditure in Scotland within the control of the Scottish Government.

For the rest of the UK, income tax is one of the revenue streams which contribute to the funding of general public expenditure: that is, not only those services for the rest of the UK like health and education which are devolved in Scotland, but reserved services for the whole of the UK like welfare, defence, and foreign affairs. Rest of UK income tax funds about19% of all of this expenditure.

Also suppose that, under Cameron’s law, it is only rUK MPs that are responsible for setting rUK income tax rates. Suppose, as is very plausible, that a right wing majority of those MPs decide to implement a significant cut in income tax rates, and have a corresponding reduction in public expenditure. Suppose, for example, there is a 5% reduction in rUK income tax receipts as a result, and further suppose that the corresponding reduction in public expenditure is spread evenly over not just domestic “devolved” services in rUK but also over “reserved” services like defence, social security etc. Since, as we have seen, income tax funds 19% of this expenditure, the result would be a 0.05 times 19% cut in this expenditure, that is a fall of 0.95% in expenditure, and hence, specifically in expenditure in devolved services in the rest of the UK.

Now consider Scotland’s position. If the Scottish government does not match the cut in income tax rates by the rest of the UK, then the Scottish economy is likely to be at a chronic disadvantage: ultimately, any Scottish Government would have to follow suit if the rest of the UK were pursuing an aggressive policy of cutting income tax rates. But if the Scottish Government does adopt the same cut in tax rates as the rest of the UK, and if that reduces Scottish income tax receipts by the same 5% as in the rest of the UK, then since income tax accounts, as we have seen, for 26% of the funding of the public expenditure under the control of the Scottish Government, then the cut in Scottish Government public expenditure will be 1.3% – that is, a 37% larger cut than in similar expenditure in the rest of the UK. This is what we mean by the gearing effect.

This kind of arrangement would put Scotland in an intolerable situation. The gearing effect would mean that an income tax cutting policy in the rest of the UK would force upon Scotland either disproportionately higher tax rates or disproportionately greater cuts in public expenditure: there would be no escape. And in the situation where, as the Future of England survey has made abundantly clear, English voters want to punish Scotland for the referendum, the potential for doing precisely this through the gearing effect of income tax cuts, would not be lost on right wing English MPs. In fact, if the public expenditure cuts funding the reductions in rUK income tax rates were loaded disproportionately onto reserved functions such as defence or social security, Scotland could be penalised at little or no cost to rUK devolved services.

The Smith Commission report does not spell out this problem of gearing: but on the other hand, there is evidence to suggest that they are aware of the problem. In particular, paragraph 95.4(b) of the report is relevant here: it states that,
“Changes to taxes in the rest of the UK, for which responsibility in Scotland has been devolved, should only affect public spending in the rest of the UK. Changes to devolved taxes in Scotland should only affect public spending in Scotland.”

The most obvious interpretation of this provision is that a change in rUK income tax rates should not be used to fund, or should not be funded by, changes in UK wide services like defence or social security. If implemented, it would mean that rUK income tax receipts, (or, more specifically, the non-savings/non-dividend element of these receipts), would be hypothecated to funding rUK only services – which effectively, are those services which are devolved to Scotland. The result of implementing this provision would therefore be to solve the gearing problem. So although the Smith Commission did not specifically spell out the implications of the gearing problem, the circumstantial evidence of paragraph 95.4(b) suggests they were aware of it.

Given that the Smith Commission does not specifically identify the gearing problem, the critical importance of paragraph 95.4(b) is not at all obvious to the reader of the report. This means that there is every danger of this clause being overlooked when the Smith Commission findings are being legislated on. It is of fundamental importance for Scotland that this does not happen.

What Smith missed, however, are the difficulties of implementing the provisions of paragraph 95.4(b). In fact, it is very difficult to see how the principle underlying paragraph 95.4(b) could be implemented without putting in place a fully federal system. Let’s follow the chain of logic which points to this conclusion.

If 95.4(b) is to hold in any meaningful sense, then there would have to be a ring-fenced rUK budget for “devolved” services in rUK, which, (leaving items like council tax out of the equation for simplicity), would be funded from two sources – namely, an rUK Block Grant and rUK income tax revenues. This then raises a number of questions. First, who would make the decisions on how this budget is spent? Since one of the major sources of funding for this budget, (namely rUK income tax), would be under the control of rUK MPs: and since the services funded by this budget will be solely rUK devolved services, the only satisfactory answer would be that rUK MPs make the spending decisions.

Second, what would the relationship be between the rUK Block Grant, and the Scottish Block Grant? One possibility that would be consistent with the vow to retain Barnett would be that changes in the Scottish Block Grant would be related to changes in the rUK Block Grant via the Barnett formula. This, however, would operate in a significantly different way from the Barnett formula as envisaged by Smith. Since the relationship is now between rUK Block Grant, that is, (rUK public expenditure minus income tax), and the Scottish Block Grant, there would be no need for the kind of complicated abatement to Barnett envisaged by Smith.

Thirdly, and critically, who would set the rUK Block Grant? This is where the nub issue lies. This could not be a decision that was left to rUK MPs. If this was the case, then Scotland would have no democratic input whatsoever on how the major part of its funding was delivered. So at the very minimum, decisions on the size of the rUK Block Grant would have to be made by the whole UK Parliament. In fact, this would be barely satisfactory from the Scottish viewpoint – given the numerical preponderance of rUK in the union. But leaving this problem aside for the present, what we have as very minimum as a consequence of the paragraph 95.4(b) principle, is a situation where the whole UK Parliament sets the Block Grant for rUK, (and via Barnett for Scotland), while the group of rUK MPs decides on:

a) the rUK rate of income tax, and
b) how the rUK budget for devolved services is spent.

This is, to all intents and purposes, a federal system: and it appears to be the very minimum which is consistent with the principle so glibly enunciated by Smith in paragraph 95.4(b).

In terms of feasibility, this poses major problems. On the one hand, this type of federalism goes far beyond anything envisaged by Smith or the UK parties, and is unlikely to be acceptable to English MPs. But on the other hand, it is unsatisfactory for Scotland. In a federal system, the over-arching federal body has to be sufficiently wise and impartial, or has to be constituted of sufficiently balanced competing interests, that it can be trusted to make fair judgements about the transfers of resources among members, and other key decisions, (e.g., on monetary policy), for which it will be responsible. Given the numerical preponderance of English MPs, Scotland could not trust the Westminster Parliament to fulfil this role.

Overall, therefore, the gearing issue is fatal for Smith: in effect, the bland wording of paragraph 95.4(b) conceals a veritable Catch 22 situation. On the one hand, if a solution to the gearing issue is not found, (by implementing something like 95.4(b)), then giving Scotland control of income tax would put Scotland in a disastrous situation, where hostile rUK MPs could remorselessly drive down public expenditure in Scotland. On the other hand, it is difficult, and we would say impossible, to see how paragraph 95.4(b) could be implemented, without putting in place a genuinely federal structure for the UK as a whole: such a change goes far beyond anything currently considered – and in any event is unlikely to be feasible given the disparity in size between Scotland and rUK. On this basis alone, therefore, the central plank of the Smith Commission recommendations relating to income tax is unworkable.

Although there are many things that are good in the Smith report, inadequate attention to detail fatally undermines the whole edifice. Just as with the Referendum, it is not enough for politicians to dismiss difficulties with airy phrases. They need to make sure that what they propose is feasible before they spout.



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18 replies

  1. Really good to see the Smith report in this deeper way, which lay people would miss otherwise.
    The call is clear, wake up Scots we are being had. Our politicians should be talking and gearing against these proposals NOW!

  2. “This kind of arrangement [the gearing problem] would put Scotland in an intolerable situation.”

    Jim & Margaret, Scotland has been in an intolerable situation for over 300 years, and that has not so far blown the Union apart, as you suggest the Smith proposals could do. I hope you are correct, but one should never underestimate the capacity of the Scottish electorate to swallow shite.

    • “one should never underestimate the capacity of the Scottish electorate to swallow shite.”
      Sad but, true; as the last 30 odd years has clearly demonstrated. However, things ain’t like what they used to be, as song goes. We now have a more switched on electorate, than ever before.

  3. This article seems to suggest burning it wasn’t such a bad idea after all. Still, they all look very happy with themselves.

  4. Excellent article. I have always though the reaction of England to the report is more important, potentially more potent, than the reaction of Scotland. As said above, most people in Scotland want greater powers devolved, while many in England believe Scotland has been given too much and are demanding parity in the shape of EVEL.
    I hope EVEL is implemented; it will be major step towards independence.
    I hope the Smith report is torn apart by Westminster unionists; it will [should!] result in further distrust and disappointment with the union by more and more Scots.

  5. So what was the Lord Smith commission all about then? Did he know that Scotland would be put into an invidious position over this tax scam? Did he write clause 95.4 (b) or was it given to him by the Treasury, or some other UK gov chancer?

    The Cuthbert’s have to be roundly applauded for this forensic work – we really are dealing with spivs and con-men.

  6. The Cuthbert’s analyses are always pertinent and in this case highlights yet another of the weaknesses of this rushed political exercise dressed up as a commission. This fudge, however, highlights the underlying flaw of the whole process which is not so much about economics as about basic principles of democracy.

    In 1707 the Act of Union was passed by a little over 100 votes and around the same number either abstained or voted against. In 2014, despite the biggest turnout of the electorate in generations, the constitutional arrangements are left in the hands of 10 people. If more than half the electorate really do want full economic and welfare power to be invested in Holryood, this charade of democratic process is not going to satisfy that majority.

    The numbers have been counted as far as the referendum goes, but the weight of public opinion and aspiration has not been satisfied. As the process unfolds, we can expect to see the Smith Report exacerbate the constitutional debate rather than anaesthetise it.

  7. This is the telling paragraph:
    “This kind of arrangement would put Scotland in an intolerable situation. The gearing effect would mean that an income tax cutting policy in the rest of the UK would force upon Scotland either disproportionately higher tax rates or disproportionately greater cuts in public expenditure: there would be no escape. And in the situation where, as the Future of England survey has made abundantly clear, English voters want to punish Scotland for the referendum, the potential for doing precisely this through the gearing effect of income tax cuts, would not be lost on right wing English MPs. In fact, if the public expenditure cuts funding the reductions in rUK income tax rates were loaded disproportionately onto reserved functions such as defence or social security, Scotland could be penalised at little or no cost to rUK devolved services.”

    It should be obvious now that, at the very least, we need maximum devolution so that we control ALL our affairs:

    I believe that any new powers should include ALL of the following:

    1. Control of ALL taxation raised in Scotland
    2. Control of oil and gas tax revenues generated in Scottish waters
    3. Control of the benefits and welfare system
    4. Control of ALL areas of government policy, perhaps with the exception of defence and foreign affairs
    5. Control of policies regarding state pensions
    6. Control of broadcasting policy
    7. Guaranteed consultation by the UK Government with the Scottish Government on decisions on the UK’s stance in EU negotiations.

    The Scottish Government must have control of ALL POLICY AREAS which are necessary to build a fairer society in Scotland and build a more prosperous economy for the Scottish people.

    I believe that this can best be done in a situation involving full independence or maximum devolution in the absence of such an event.

  8. I have to admit I had never even considered a gearing effect, and the implications are quite staggering. Especially if left in the hands of a didactic neo-classicist, neo-liberal ideologue like Osbourne.

    Still, if Jim Murphy can raise £250 milion from a mere 5% increase in the income tax of earnings over £150k of just 16,000 people he’ll sort out this egregious instrument of oppression in jig time. Magic Murphy can do anything, you know.

  9. The smith commission took a large number of words, compressed it into the dumbest selection of ideas since Canute thought he could command the tides. This on the back of Osborne’s continued attack on human decency by announcing that all but the rich, must take a bite out of the shit sandwich he has been cooking up these last 5 years. The feeble collection of stocking fillers will be drowned out by the sheer horror that will be belched forth from Osborne’s well fed and paid backside.

    The question now, is how far will UK labour lurch to try and steal the conservative vote. The next question is that given that Scottish labour is so massively swivel eyed at the moment, how long before its collective head explodes from the stress.

    In all seriousness, it is pretty obvious to me that the UK may have won the referendum but lost the peace.

  10. For Smith and his commissio

    You’ve given us a charity-shop of poor power
    A timid tawdry list of hope turned sour
    A potion of powers: enough to let us fail
    A poisoned parritch o taxes and cauld kail.
    Go! Heng as high as yon kirk steeple
    You betrayed the hopes of our working-people!

  11. Never read anything so scary. I thought the Tories, with EVEL, had marched hapless Ed and the Labour party into a giant, sucking trap from which there’s no escape this side of May.

    But the more I look at Smith and read scary analyses like this one, it looks to me like the Tories have played a blinder post-indy and led us all into that trap. The one ray of light for Scotland is from the escape tunnel called 50-SNP-MPs. Jeez, if we don’t build that tunnel then we’re all f****ed.

    • “The one ray of light for Scotland is from the escape tunnel called 50-SNP-MPs.”

      Hold on there a wee minute. A red and blue Tory alliance (plus assorted hangers on) at Westminster would easily neutralise such a voting bloc. What then? As is the case today, there may be very little point in SNP MP’s even taking their seats at Westminster.

      It was always the general understanding at Westminster that if Scotland returned a majority of MP’s who supported independence, then independence could rightfully and democratically be claimed and declared. That is indeed how we lost our nation, by a majority vote of Scots members. That 30+ bloc would need to link arms, walk up Calton Hill and claim their nation back. And the people would need to be right behind them.But that would require courageous politicians, and a courageous people!

  12. It’s actually a double whammy, if Westminster chooses to cut public spending ( as opposed to taxes) in areas where Barnet consequentials have an effect then that reduces tax revenues returned to Scotland leaving Holyrood to choose between increasing income tax or increasing those in employment – only the Scottish government have little, if any, power to influence economic activity that would eventually lead to increased employment to replace the lost revenue. All the while Westminster would still be collecting in excess of £60 billion from Scotland. Just like to thank all No voters for that one.

  13. The point has been well made: we had a referendum and now the future of Scotland has been put in the hands of a ten people, including a rather smug Lord. What Scotland needs is a Constitutional Convention which sits in continual session until a workable proposal on the future governance of Scotland is found. Then that must be put to the people. The limited income tax scheme for Scotland is a Tory trap and that was obvious from September 19th. David Cameron on the morning of the 19th showed us all his Janus face. The population were brow beaten into voting No by Unionists who had nothing concrete to offer except fear and more of the same. More of the same, I fear, will do for us all.

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  1. Deconstructing Smith: or, Gearing-up for Failure |
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