On Taxes and the Smith Commission

money-ballRetired civil servant and now lecturer at Nuffield College, Oxford Prof Jim Gallagher gives the opposing view to the Cuthbert’s analysis of the Smith Commission.

My old friends Jim and Margaret Cuthbert are indefatigable in looking for flaws in any scheme of devolution. They criticized the Calman scheme because it only devolved some of income tax; now they criticize the Smith Commission for devolving all of it. I’m beginning to see a pattern here.

The Smith plan is the outcome of a political negotiation. I’ve no particular ownership of it, but just about everything technical Jim and Margaret say to criticize it is wrong. So this note is pretty technical. Sorry.

Power and Responsibilty

They say devolving income tax is responsibility without power, as the devolved government can’t control the economy, and so the income tax yield. No government can control the economy and make the income tax base grow, as the unhappy Mr. Osborne is finding out just now. And actually most of the long-run tools for economic growth in Scotland are already devolved: and even the SNP don’t propose separate macroeconomic management for Scotland.

Indeed on this argument you would devolve no taxes at all, as they all depend on the economy. Try selling that one.

Income tax as a Devolved Tax

Then there’s the interaction of devolved taxes with the block grant. This is indeed quite complicated, but the Cuthberts seem to have read Smith but not seen its significance properly.

When income tax is devolved in Scotland, it becomes effectively devolved in the rest of the UK as well. Just as changes in income tax in Scotland will not affect public spending in England, changes in income tax in England cannot be allowed to affect public spending for Scotland, up or down. Smith makes that explicit, in the passage quoted. Barnett will be adjusted to remove the effects of English income tax changes.

[For anoraks of the public finances, this is already the position with non domestic rates, though the Treasury made a mistake in way of doing the sums, which is benefited Scotland by about £600m or so.]

So if a right of centre government in rUK cuts income tax, it will feed through into rUK public services (and only those). A penny off the rUK income tax will cut English health, education or the like by £5bn or do. Scotland need not follow that: if it does, it will cut Scottish health education etc by £500m – proportionality a smaller cut, as it happens, as we spend nearly 30% ahead more on these services. So the “gearing” problem Jim and Margaret see does not exist

How the block grant should be changed to reflect the income from devolved taxes is indeed quite complicated, and you can always raise the fear that the wicked UK Treasury will screw us some way or another. But basically this already sorted in preparation for the Scotland Act 2012 – and agreed with the Scottish government.

The easiest way to understand it is to ask which of the risks to the Scottish Parliament’s income is the responsibility of which government. So the Scottish government takes the risk of changing the tax rates, or the thresholds. The United Kingdom government will pay the price of changing the personal allowance, or other changes to the tax base, like pensions tax relief. Because income tax is devolved, the Scottish government will take the benefit, or pay the penalty, if Scottish incomes grow more or less than the UK as a whole.

That has to be right, and it is perverse for nationalists to argue that Scotland shouldn’t take on this risk, or opportunity, when they want to take on much bigger ones. It’s exactly what happens in every other country with decentralized taxes. A sub state government [say, a German Land or US state] gets some central support, but depends on its own economy for some of its funding. That’s the sort of responsibility that comes with power.

The Smith scheme transfers more risk than the Scotland Act, as only 40% of the budget controlled by the Scottish Parliament will now be supported by a share of UK taxes. Maybe further than I would have gone, as a cautious bureaucrat, but that’s what the politicians round the table argued for, and it’s the same as very decentralised federal states like the US or Switzerland.

Historically, Scottish economic growth per capita has been a just a bit above UK levels for the last 50 years or so. But the population of the rest of the UK has grown more. The population trend seems to be reversing recently, so there is reason to assume that with competent policies in Edinburgh, Scotland could do reasonably well out of this scheme.

Jim and Margaret are a National Treasure: but because they look at every issue through what I think is the wrong end of the telescope, they quite often focus on the wrong end of the stick.



Categories: Economics

Tags: , , ,

25 replies

  1. During the referendum the better together campaign told us that Scotland had a demographic problem, its working age population is predicted to grow much more slowly than rUK. This means our income tax revenue will grow much more slowly too.

    Since the smith powers don’t allow Scotland to have the powers to tackle that effectively, that means the relatively low growth of income tax is locked in as part of the deal of remaining in the UK.

    So Jim’s wrong, we know the direction of travel, we know we can’t properly mitigate it, and we know the new deal will cut Scotland’s income tax revenue in the medium to long term.

  2. I can’t see how this refutes the gearing problem identified by the Cuthberts.

    If England lowers income tax, then the yield from it to the Treasury will be lower, so that’s got to effect public spending in England, which in turn is bound to effect the Barnett formula based block grant, which will be adjusted by the Barnett formula as a % of English spending, minus the tax yield of income tax in Scotland.

    Of course English public spending could still remain the same, or even increase, despite lowering income tax. Revenues could still be found from other taxes, an increase in VAT, for instance. Expenditure could also be supported by increased public borrowing. But all of that’s unlikely. The simple fact is that if English public spending decreases, because income tax has been lowered by a right wing government then so will the Barnett formula based block grant.

    The critical issue as I see it is whether Scotland will be able to gather our income tax directly, will Scotland have the administrative systems to collect income tax and deliver it directly to a Treasury office in Scotland? That’s going to be difficult as NI isn’t devolved. So I’m assuming that’s not going to happen.

    The other issue is how do we calculate Scottish income tax? Who decides whether an employee is Scottish or British as regards the final destination of their income tax? The Armed Forces for instance? Who pursues for non-payment or tax evasion?

    Finally, since tax yields vary from year to year, and since I cannot see any great dedication being made on the part of English tax collectors for the pursuit of Scottish income tax payers when it is not going to affect England, what happens to the Barnett formula if tax yields fluctuate?

  3. “Retired civil servant” hardly does him justice!

    “He was educated at St Aloysius College, Glasgow and then at Glasgow and Edinburgh universities and joined the Scottish Office in 1976 to work in the Home and Development departments as well as in several other posts. He was the Private Secretary to the Minister for Home Affairs in 1979-80, and to both Malcolm Rifkind and Ian Lang in their capacity as Secretary of State for Scotland from 1989 to 1991. From 1991 to 1996 he was a Director of the Scottish Prison Service.

    “He was appointed to the UK Cabinet Secretariat and then to the Prime Minister in 1999–2000 before being made Head of the Scottish Executive’s Justice Department in September 2000.

    “Professor Gallagher was Director General for Devolution in the United Kingdom Government’s Ministry of Justice, from 2007 to 2010, and was responsible for devolution to Scotland and Wales.”

    http://en.m.wikipedia.org/wiki/Jim_Gallagher_(civil_servant)

  4. I trust that the vast majority of contributers to this site hold the Cuthberts in the highest regard, as you say as National Treasures. Nevertheless, I remember when I first read the green paper for the Scotland Act and realised that the Scottish Government’s Block Grant was tied to rUK’s expenditure and would not grow with the Scottish economy. If the Scottish Government could double the economy in Scotland there would be no change to the Block Grant! It pains me to see so many contributers lacking confidence in the Scottish economy to grow and to grow Tax Receipts in Scotland.

  5. Professor Gallacher argues that no government can “control the economy”. This is true but trite. It begs the question (petitito principii – a logical fallacy). Managing an economy that it does not control is a principal object of democratic government. This issue is therefore about the real world, managing the economy, so let us stay in the real world. Managing a business in an economy it does not control is what businesses do, if they cannot form a cartel and rig prices. As an aside, we have actually seen attempted price-rigging in certain financial markets in Britain; I wonder why that could happen in Better Together Britain? Incidentally in Britain, managing such things as “economic shocks” [Smith, para., 95(8)] is something British Governments have done notably badly; as demonstrated by the Credit Crunch and the long, long, endless saga of boom-and-bust.

    Gallacher claims that Smith is actually devolving income tax to rUK (although there is no rUK parliament, a curious suggestion): “Smith makes that explicit, in the passage quoted. Barnett will be adjusted to remove the effects of English income tax change.” Again Gallacher begs the question, because he does not acknowledge that new rules are required in Barnett to make the changes, still less how these rules will work, or their intended or unintended consequences. The effects are not ‘automatic’. What Smith says ‘explicitly’ is:

    “New rules to define how [Barnett/block Grant] will be adjusted at the point when powers are transferred and thereafter will be agreed by the Scottish and UK Governments and put in place prior to the powers coming into force. These rules will ensure that neither the Scottish nor UK Governments will lose or gain financially from the act of transferring a power.” (Foreword, p.4)

    What Smith may be trying to do is neither here nor there; it is what will happen that alone matters. We do not know what will happen because nobody – not Smith, not Gallacher here, has bothered to provide us with the answers, still less an adequate explanation of the methodology. Let me be clear: if the Smith proposition is iron-clad in its rigour and mathematical precision, then, Professor Gallacher, give us the equations; if it is not, then give us the explanation. Bland generalisations of the kind now offered by Smith, and apparently now supported by you, will not do.

    Gallacher acknowledges that Barnett is “complicated” but makes no effort to explain the complexity. Allow me to be “explicit”: Professor Gallacher, embrace the complexity. Do the work. How does Barnett work now, in detail (on an actual case-by-case basis), how will it work post-Smith, and how can the changes be made to produce different results that somehow fulfil all the requirements of Smith, and at the same time – make a difference in Scotland?

    I am happy to provide arguments (including evidence supplied by Westminster Select Committees) that, rather suggests Barnett’s “Formula” is woolly, systematically manipulated, and has long been subject to ad-hoc exceptions to the rules. Barnett does not work; nobody believes it is even sound or sustainable – in Westminster; except Smith! At the heart of Smith is a formula for funding Scotland that is wholly discredited; save by Smith, and now by Professor Gallacher.

    • I think it’s an issue, how do you define who is a Scottish income tax payer and who is not? Who decides? How is the income tax to be collected? Who and where will it be collected? How will it be disaggregated from NI? Who or what will pursue Scottish income tax evaders?

      • A part of income tax without capital gains tax, or inheritance tax will be very easily avoidable.

        Having that small part of taxation administered by HMRC is a recipe for Scotland losing money due to the charge that will be levied. The latter being the main reason no Scottish Government has used the existing 3p variation.

  6. Without heading into the tax bun-fight let me just say the the Prof’s already nailed his colours to the establishment mast and was head honcho for the BT campaign – so no surprises here with his critique of the Cuthberts and this is what seriously disappoints me.

    Without an rUK view put on what an independent Scotland can produce, earn, resource and develop – it should be a no-brainer for the likes of Prof Gallagher to attest to as being the actuality, so why is it proper for him to make such aspersions, but only from within a UK mindset? The very cradle which spawned Project Fear.

    What if rUK unbolted from Scotland – would Scotland survive and to what extent survive – would Scotland prosper? Should Prof Gallagher answer that, I’ll be a tad happier, until then be knowing, I do not rate his comments from a UK only standpoint.

  7. Prof Jim Gallagher says no government can control the economy or make the tax base grow. What no government should do is allow the economy to be butchered and allow those with the ability to pay reasonable rates of tax off the hook and extract more in direct and hidden taxes from those who have the least. What the Scottish government should be doing – any government – is protecting the people not leaving them open to exploitation and hardship. The tax base will grow when the people have the ability and opportunity to work and earn. Despite what the Professor writes – and I believe him to be sincere – I still think that the Smith recommendations on income tax are a fiscal trap and that the Cuthberts are right to warn us of it. The more we discuss it the more we educate ourselves and Prof Jim’s contribution is to be welcomed.

  8. The elephant in the room with all this talk of taxation and funding is,of course,the block “grant”.
    The block grant is a political mechanism which is designed to leave London firmly in control of our affairs.
    True devolution would allow for discussions amongst the family of nations to decide which services are shared and pooled and which are not and suitable contributions to be made through taxation.
    At present,all decisions about what is shared and what is not are made by,often unelected, politicians in London e.g. we have to contribute to London sewer renewals which most of us do not share (apart from certain unionist political parties!).
    Until we rid ourselves of this antiquated funding model for devolved government,there is always going to be disagreements and muddle.
    Naively,I thought that Smith was going to sort this out but all we got was another guddle designed to leave London in control of our affairs,both social and economic.
    What we need is a Salmond commission to look at things from a Scottish view point and who knows….maybe after May.

  9. A preliminary comment. “….even the SNP don’t propose separate macroeconomic management for Scotland.” Yes they do. It’s called Independence.

  10. Derick Fae Yell raises some interesting points about how do we define ‘income tax’. If you inherit money, isn’t that still ‘income’? And what about income from savings? Are capital gains, ‘income’?

    Unearned income is still income for taxation purposes.

    So disaggregating income tax when these other taxes on unearned income are not devolved is going to be a bun-fight. And you can bet we will lose out.

  11. And actually most of the long-run tools for economic growth in Scotland are already devolved: and even the SNP don’t propose separate macroeconomic management for Scotland.

    I am afraid to say I agree with Gordon Brown when he said devolving income tax in its entirety (minus the important personal allowance etc) was a trap. The statement above by Jim Gallagher does not make sense to me. The SG will not be able to have a substantial tax base at their disposal, and they will not have important taxation powers, such as North Sea revenues, National Insurance, Corporation tax, fuel duties etc, capital gains tax. The Scottish Parliament really needs to have control of these kind of powers. As far as I can make out the Smith Commission is basically the block grant redesigned to include income tax and some VAT revenues.

  12. We in Scotland couldn’t possibly run the country as well as all our genius BT RABBLE!
    Too wee,too poor,too stupid?
    Do me a favour.
    Don’t trust a word this ‘Professor’says.
    End off.

  13. For an ‘academic’ Gallagher’s contribution has limited rigour. Reads more like civil service spiel.

    ‘Visiting Professor to Glasgow University’? I wonder, at which university is his chair?

    PS to Rifkind and Lang? I would be tempted to keep that quiet.

    Sounds just like the kind of character who might help set a unionist trap.

  14. CraigB and Darien: For myself, I’m still struggling to understand the detail of the arguments involved. In the meantime is it too much to hope that you should address the message rather than trying to shoot the messenger?

    • John below offers the solution. Everything else is just a recipe for conflict. Unlike real home rule elsewhere (e.g. Greenland/Denmark) there is never mutual respect with devo-nano – one side will always try to out-do the other. Gallagher is just another McCrone; an ex senior Scottish civil servant with a British allegiance/loyalty first. Some Scots have a passion for Scotland; unionists and 80-min patriots do not. There is no need to struggle to understand anything.

  15. Basically we need to be an independent country. End of story.

  16. This little piece about Smith and taxation would have been better without Prof Jim Gallagher’s patronising comments about the Cuthberts.

    But perhaps the good lecturer at Nuffield College, or someone else, can enlighten me about the basic effects of the tax proposals on the Barnett grant.

    Q. If the Scottish economy grows faster or slower than rUK and income from the tax base increases or decreases in Scotland, would Barnett grant be reduced or increased to compensate for those scenarios?

    • I can do no better than quote from Smith; para., 95(3a) at least appears to me to be the closest to addressing your issue directly:

      95(3). “No detriment as a result of the decision to devolve further power: the Scottish and UK Governments’ budgets should be no larger or smaller simply as a result of the initial transfer of tax and/or spending powers, before considering how these are used.

      (a) This means that the initial devolution and assignment of tax receipts should be accompanied by a reduction in the block grant equivalent to the revenue forgone by the UK Government, and that future growth in the reduction to the block grant should be indexed appropriately.” (Smith, p.25)

      Now you tell me. I think the reference to “revenue foregone by the UK government” and “indexed appropriately” (to what?) may prove telling; however, I would be very interested to hear informed comments on 95(3) in this context; not least from Professor Gallacher.

      • Thank you.

        Paras 95(3) and (a) emphasise (is that the right word) “initial”. Which suggests to me that afterwards in broad terms Sc and En can go their own way and keep or lose gains and losses in economic activity while revised Barnett (or a replacement) remains the same. And that seems to be the interpretation that Gallacher is making. Is that correct?

        We really do need other WELL INFORMED AND UNBIASED VIEWS ON THIS

  17. I do not believe the implications of 95(3a) are either as clear or certain as you hope. At the same time Barnett will require new rules, but it will not be replaced; in spite of the fact that it is profoundly flawed, its rules are not transparent and it is long discredited (not least by Barnett). Smith simply ignores the flaws in Barnett. I would greatly appreciate if supporters of Smith would clarify these matters and set our minds at rest by contributing to the debate.

  18. Sorry to be personal, and slightly out of topic, but I am wondering if this is the same Professor Gallagher who claimed during the referendum campaign that Pope Francis had opposed Scottish independence. If I remember rightly, the Pope had been asked a question about independence movements, to which he had replied that each case had to be studied on its merits. The question had been posed and answered in general terms, although circumstances made it likely that what the questioner had in mind was Catalonia. As far as I am aware, despite Professor Gallagher’s claims at the time, Francis never said anything at all about the Scottish case, and never specifically mentioned Scotland. Professor though he may be, the inability of Mr. Gallagher to report what the Pope said accurately and objectively, and the ease with which he twisted it to make it suit his own political preferences, makes it difficult to believe in the objectivety of his comments on other subjects. I have no expertise on economic matters, but if I want an informed opinion to guide me in that area, I will be looking elsewhere. I am also no expert in the Catholic Church’s teaching on social and political matters, but I do know that such a thing exists. Now that the referendum is history, a study of which of the two campaigns – Yes or No – came closer to that teaching might make interesting reading. A Professor who makes the Pope say things he never said might not be the best person for the job. The possibility – it might even be a very strong likelihood – that the Yes campaign was closer to the social ideals in question, not least in regard to nuclear weapons and many issues of social justice, should not be discounted in advance.

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