Heald Slides - Scottish Constitutional Futures Forum

Report
Funding after a NO Vote:
Reform of Barnett and Implementation
of the Scotland Act 2012?
Presentation by David Heald
(University of Aberdeen)
at the Scottish Constitutional Futures Forum
If Scotland Votes NO, 28 January 2014
Financial implications – slide 1 of 12
Context
• Devolution coincided with a period of remarkably rapid public spending
growth, now in considerable reverse
• The Barnett formula is attacked from all sides as ‘unfair’. Every territorial
‘unit’ believes that Barnett is bad for them. Understanding of how this system
works remains low. The 1997-2010 Labour Government consistently closed
down debate but never articulated a defence of the Barnett ‘system’
• England has 84% of UK population (cf Ontario accounts for 35% of the
Canadian population, and no federation is more unbalanced). This has
profound implications for UK devolution financing
• The Scottish Independence Referendum has attracted more attention to
expenditure relatives and to Barnett. The ‘NO’ result has probably weakened
Scotland’s political clout within the United Kingdom. Some will now argue that
Scotland’s bluff has been called. Promises in 1979 of a ‘better devolution deal’
in the event of a No vote turned sour
• Those urging a No vote have been offering Scotland a better devolution
deal. However, this jars with widespread perceptions elsewhere that Scotland
gets too good a deal now. Two members of the Holtham Commission
suggested a Needs Assessment could result in a £4 billion cut in the Scottish
block grant. ‘Reform of Barnett’ is usually code for a worse deal for Scotland
If Scotland Votes NO, 28 January 2014
Financial implications – slide 2 of 12
How identifiable expenditure relatives vary over nations and regions
Index (UK identifiable expenditure = 100)
National Statistics
2007-08
outturn
2008-09
outturn
2009-10
outturn
2010-11
outturn
2011-12
outturn
North East
108
109
108
108
107
North West
105
104
105
105
105
Yorkshire and the Humber
96
98
98
98
98
East Midlands
90
90
90
91
91
West Midlands
97
97
97
97
96
East
86
87
88
89
89
115
113
114
112
110
South East
85
87
86
86
87
South West
90
92
92
92
93
England
97
97
97
97
97
Scotland
118
115
114
114
115
Wales
111
110
109
111
111
Northern Ireland
125
123
120
120
121
London
Notes: (1) Distribution among English regions has nothing to do with the Barnett formula but flows from distribution formulae used
within England.
(2) There are no official estimates of indexes of comparable expenditure covered by the Barnett formula.
(3) On the then definitions, 1987-88 indexes of identifiable expenditure have been reported as: England (95.6), Scotland (121.5), Wales
(109.3) and Northern Ireland (145.8). These numbers were sensitive to data source. See Heald (Public Administration, 1994, p. 158).
(4) There is noise in identifiable expenditure data from regionally-differentiated economic cycles.
Source: Public Expenditure Statistical Analyses 2013, Table 9.2.
If Scotland Votes NO, 28 January 2014
Financial implications – slide 3 of 12
1. General public
services
2. Defence
3. Public order
and safety
4. Economic
affairs
5. Environment
protection
6. Housing and
community
amenities
7. Health
8. Recreation,
culture and
religion
9. Education
10. Social
protection
UK identifiable expenditure on services by function, country and region, per head
indexed, 2011-12
North East
88
99
108
84
84
126
110
104
103
112
107
North West
90
82
106
84
168
86
107
80
102
107
105
Yorkshire and the Humber
76
81
96
82
78
80
100
86
102
100
98
East Midlands
117
98
81
72
74
65
91
69
97
95
91
West Midlands
92
87
93
68
68
68
98
80
100
101
96
East
77
118
73
89
76
43
90
67
94
92
89
London
80
117
155
145
87
154
110
139
114
96
110
South East
87
68
76
68
90
53
89
70
92
89
87
South West
82
89
79
77
109
53
93
78
93
100
93
England
87
92
98
88
95
81
98
87
100
98
97
Scotland
164
159
98
177
147
199
110
183
101
108
115
Wales
185
174
99
141
113
134
103
147
100
112
111
Northern Ireland
163
27
165
165
82
324
111
170
103
112
121
UK identifiable expenditure
100
100
100
100
100
100
100
100
100
100
100
% of Total Expenditure on Services
1%
0%
6%
6%
2%
2%
22%
1%
17%
43%
100%
Total
Expenditure on
Services
Notes: (1) Distribution among English regions has nothing to do with the Barnett formula but flows from distribution formulae used
within England.
(2) Indexes in this Table should be interpreted with care because (a) high indexes may result from only small proportions of
expenditure being treated as Identifiable, and (b) functional spends differ massively in size.
Source: Public Expenditure Statistical Analyses 2013, Tables 9.15 and 9.16.
If Scotland Votes NO, 28 January 2014
Financial implications – slide 4 of 12
Net Fiscal Balance: Scotland and the UK, 2007-08 to 2011-12
2007-08
2008-09
Scotland
2009-10
2010-11
2011-12
(£ million)
Excluding North Sea revenue
-11,110
-15,450
-20,385
-19,743
-18,159
Including North Sea revenue (per capita share)
-10,480
-14,362
-19,839
-19,006
-17,217
-3,998
-3,699
-14,475
-11,700
-7,586
-36,719
-97,539
-158,922
-140,967
-120,963
Including North Sea revenue (geographical
share)
UK
Scotland
(% of GDP)
Excluding North Sea revenue
-9.7%
-13.4%
-18.1%
-16.5%
-14.6%
Including North Sea revenue (per capita share)
-9.0%
-12.1%
-17.2%
-15.6%
-13.5%
Including North Sea revenue (geographical
share)
-2.9%
-2.6%
-10.7%
-8.1%
-5.0%
UK
-2.6%
-6.9%
-11.2%
-9.5%
-7.9%
Source: Government Expenditure and Revenues in Scotland (2013), Table E4
If Scotland Votes NO, 28 January 2014
Financial implications – slide 5 of 12
Origins and Survival of the Barnett Formula
• Long history of the use of formulae in UK territorial management – Goschen formula
used from 1888 until (at least) 1959. Although the Barnett formula is sometimes
presented as a needs-based formula, this is inaccurate. It is an adjustment formula
• In 1978 the Barnett formula was probably seen as temporary and it is not clear how
well its theoretical convergence properties were then understood. But an implicit
assumption of ‘over-funding’, otherwise would not have distributed increments less
generously than the inherited base. After 1979 the Conservative Government
formalised the ‘Scottish block’ and expenditure-switching powers
• Despite widespread attacks, the survival of the Barnett formula is not
accidental:
– automatic adjustment (that limits conflict and saves time) suits the key actors
– expenditure-switching flexibility (that enhanced the budgetary power of originally the Secretary
of State and later the Scottish Executive/Government)
– defence of the Barnett formula became a political objective of Scottish
Office/Executive/Government ministers, whatever they said in public
– Scottish UK Cabinet ministers continuously at the Treasury from 1997-present
– expectation that a Needs Assessment would be technically difficult, costly and politically
explosive
– strong flow of money post-devolution dampened discontents in Wales and Northern Ireland
– the system became ‘Barnett-plus’, with add-ons for Wales and Northern Ireland
– UK protection of health and education since 2010 has protected the devolved blocks and
allowed the Devolved Administrations to soften cuts elsewhere in their programmes
– alternatives are more complicated, more difficult to manage or constrained by EU law
If Scotland Votes NO, 28 January 2014
Financial implications – slide 6 of 12
Fundamental Issues
• UK devolution finance is an expenditure-based system, deeply embedded within UK
public expenditure planning:
o Lack of Transparency: derivation of formula consequentials is not made public and
there is lots of noise (eg accounting changes, control system changes, transfers of
function, reclassifications between Department Expenditure Limits (DEL) and Annually
Managed Expenditure (AME)) (See Heald and McLeod, Regional Studies, 2005). No
publication of comparable expenditure in England. The Treasury can game the baselines
and comparability factors, and it sometimes does so. However, the Barnett system has
provided an anchor since devolution, though misleading representations proliferate in part
due to the lack of sufficient published data
o Disputed concepts of territorial equity: London and the devolved countries have the
highest index of Total Expenditure on Services per head (Slide 4). However, London
argues that it generates much UK tax revenue (12.5% of taxpayers generating 22.2% of
tax revenues) and Scotland argues that its geographical share of North Sea oil revenues is
90-95%. Growing political pressures to ‘keep what you kill’: note also the weakening of
equalisation within English local government
o Revenue is largely irrelevant in an expenditure-based system: assignment of tax
revenues does not confer devolved discretion; assignment of tax bases only confers
discretion if the tax rates can credibly be varied upwards and downwards. The ‘tartan tax’
power atrophied and the Calman income tax might suffer the same fate. Other taxes under
discussion (Airport Passenger Duty and Corporation Tax) are desired only to reduce them
• There is no meaningful fiscal autonomy for the Scottish Parliament if the system were
to entail Scotland receiving the Scottish proceeds of UK tax rates on UK-determined
Scottish tax bases. Accountability gains derive from being able to take credible decisions
at the margin through changes in tax rates (and possibly tax bases). Otherwise, notionally
devolved taxes approximate to assigned revenues, introducing uncontrollable volatility
unless there are complicated smoothing mechanisms
If Scotland Votes NO, 28 January 2014
Financial implications – slide 7 of 12
(1) The Calman Future
• Whether to have a Needs Assessment, which could be (a) broad brush (few
indicators as proposed by the Holtham Commission in 2010) or (b) highly detailed (on
Australian model). Divergent policies (eg university tuition fees, prescription charges, free
personal care, bridge tolls) are complicating factors. Issues of (a) whose policies are
regarded as the baseline, and (b) implications of relative population growth and changes
in demographic structure. It would be hard to maintain the integrity of the Needs
Assessment (against leaks and campaigns) and the losers (widely assumed to be
Scotland and Northern Ireland) would complain bitterly
• Territorial Exchequer Board, independent of the Treasury, to co-ordinate the Needs
Assessment, to provide a data platform, and to verify data (NB the problem of counting
the UK population, let alone measuring needs-weighted population)
• Transitional formula almost certainly needed after a Needs Assessment, and some
form of prior agreement might be a prerequisite of commitment. See Heald and McLeod
(IPPR, 2002) for how this might be done, but that was in the context of strong
expenditure growth
• The tartan tax power, validated by the second question in the 1997 Referendum, was
never used and has now been repealed. Following the Calman Report (2009), a
Canadian-style 10 percentage-points tax transfer from UK to Scotland from 2016-17.
Unlike the tartan tax (restricted to the basic rate, hence limiting maximum loss or gain),
this applies to all taxpayers. Without a ceiling on loss/gain, verifying Scottish residence
becomes critical. Issue of how much priority HMRC will attach to enforcement. In 201011, 40% of UK income tax revenues from Scotland came from 7% of taxpayers (192,000
taxpayers) and 19.6% from 1.29% (35,000). Without a ceiling on loss/gain, behavioural
effects – moving residence or affecting to do so – will be larger
If Scotland Votes NO, 28 January 2014
Financial implications – slide 8 of 12
(1) The Calman Future (continued)
• Tartan tax was estimated in 2011-12 to yield £1,200 million if the full upwards power were to be
used (a Treasury estimate taking no account of behavioural effects). The Scottish Rate of
Income Tax (Calman income tax, now SRIT) is estimated to yield circa £5 billion in 2016-17 if
levied at 10p (ie matching the rate elsewhere in the UK). However, other than administrative
costs to be met by the Scottish Government, at 10p there is no change in ability-to-spend
• Crucial change is that the Scottish Parliament, on a motion from Scottish ministers,
must make a tax decision, otherwise lose the circa £5 billion that will have been deducted
from the block grant. The tartan tax required no action, unless levied
•The Scottish Rate of Income Tax is unusable unless there is a securely-anchored,
verifiable and transparent devolution funding system
• When the Scottish Parliament/Government complains about reductions in the block
grant, the retort from the UK Government will be – “Well, use your tax powers!”
• Unlike tartan tax, 10p reduction applies to all income tax bands from 2016-17, so UK rate
applicable in Scotland would become 10%, 30% and 35%, with the Scottish Rate of Income Tax
on top
• SRIT applies to employment, self-employment and pensions income but not to savings and
investment income which represented 5% of the total income of Scottish taxpayers in 2010-11.
There are practical reasons for exclusion but this will generate arguments about fairness
• Setting SRIT at 10p would replace the circa £5 billion reduction of block grant (to be indexed),
less HMRC administration costs. Estimated set-up costs £40-45 million; annual running costs
£4.2 million. Revenue would be based on Office for Budget Responsibility (OBR) forecast but
then converted to actual yield (revision mechanism supported by temporary borrowing if there
were shortfalls on forecasts and a secure ‘cash reserve’ if revenues higher). Memorandum of
Understanding between Scottish Government and HMRC, under which former will reimburse
HMRC at ‘full economic cost’ and meet additional charges of HMRC’s IT contractors
If Scotland Votes NO, 28 January 2014
Financial implications – slide 9 of 12
(1) The Calman Future (continued)
• From 2013-14, the UK has adopted a statutory residence test as opposed to relying heavily
on accumulated case law. Scottish taxpayers are defined as a subset of UK taxpayers, to be
given an S prefix to their tax code. Non-UK residents cannot be Scottish taxpayers.
Complicated rules in Scotland Act 2012 but straightforward for most taxpayers (main
residence). Cases where there is doubt (and scope for avoidance) are likely to relate to UKresident, high-income taxpayers
• In relation to self-employment (including unincorporated businesses), issue of relationship
between effective tax rate relative to that for incorporated status. With Corporation Tax rates in
decline across OECD countries, incorporated status may give tax savings in relation to:
National Insurance Contributions; the timing of when income is received; and Capital Gains
Tax treatment. However, there are costs to incorporation and to exiting from it
• Interactions of UK social security system and a partially-devolved income tax may cause
difficulties, both administratively and in terms of marginal effective tax rates
• Two out of the four Calman ‘minor’ taxes have been devolved from 1 April 2015. Stamp Duty
Land Tax (to be replaced in Scotland by Land and Buildings Transaction Tax) and Landfill Tax
(to be replaced by Scottish Landfill Tax). ‘Revenue Scotland’ established to administer these
taxes (an embryo SHMRC?). For 2015-16, OBR forecasts SDLT (£491 million) and Landfill
Tax (£104 million). Such taxes are highly sensitive to the state of the economy. Future revenue
risk, upwards and downwards, for the these devolved taxes is transferred, and (indexed)
deductions will be made from the Scottish block
• Not devolved are Aggregates Levy and Airport Passenger Duty (there is limited devolution of
APD to Northern Ireland). Such taxes are vulnerable to ‘a race to the bottom’ and to European
Commission challenges as state aid. Provision to devolve other taxes by mutual agreement
• From 2015-16, Scottish Government can borrow up to 10% of Capital DEL each year, with
statutory maximum of £2.2 billion. Narrower interim borrowing power from 2011-12
If Scotland Votes NO, 28 January 2014
Financial implications – slide 10 of 12
(2) Beyond Calman: ‘Devo Plus’ or ‘Devo Max’
• The Devolved Administrations receiving their ‘national’ proceeds of taxes controlled by the UK
Government is not ‘fiscal autonomy’. It is an illusion that “raising at least half the money they
spend” brings autonomy or accountability if tax base and rate are outside devolved control.
Psychological and presentational benefits may be claimed, but this is ‘assignment of revenues’
without the protections afforded by the constitutionally-based German equalisation system. Are
‘Devo Plus’ and ‘Devo Max’ intended to lead to more spending (protecting services) or less (hard
budget constraint)?
• Evolution since 1999 has been to bring Wales and Northern Ireland closer to the Scottish model, thus
reducing asymmetry across the devolved countries. Scottish developments involving devolved taxes reintroduce asymmetry. Wales has 48% of its population living within 25 ‘crow-fly’ miles of the English
border, extensive cross-border commuting, and average income levels are low, meaning that tax-base
equalisation would be necessary. If adopted in Wales, intention of setting rates lower than in England to
attract ‘rich’ taxpayers across the border?
• Crucial questions as to which tier of government controls the tax base and which controls allowances
and tax rates – some design constraints emanate from membership of the European Union and the
judgments of the Court of First Instance/European Court of Justice (Azores, Basque and Gibraltar
cases). Also practical constraints (avoidance possibilities and fraud) on devolving Corporation Tax or
VAT: credible candidates are income tax (eg transfer of tax points in the Canadian sense) and property
taxes (already devolved and, like England, council tax bands still based on 1991 valuations and tax
rates subjected to centrally-imposed freeze)
• Full devolution of income tax is one possibility, but the issues of (a) usability and (b) interaction with
the UK social security system are obstacles to this. Also, vulnerable to UK switch to less income tax but
more VAT (political risk) and macro-fiscal risks (when have no policy control)
• If have considerable taxation powers, there must be substantive (not just short-term to deal with timing
differences) borrowing powers, and UK Governments may be reluctant to grant these to (what might be)
hostile and/or separatist governments
If Scotland Votes NO, 28 January 2014
Financial implications – slide 11 of 12
Conclusions
• The way that different countries handle internal territorial issues depends heavily on
history and political culture. There is no single or simple solution as to how a devolution
financing system should work. The United Kingdom has its particularities, one of which is
inadequate legitimacy across the nations and regions. Controversy and political conflict are
inherent in territorial public finance. But systems can be made to work if there is the political
will to do so
• The fiscal structure of the United Kingdom points strongly towards the use of an
expenditure-based rather than revenue-based system. The 1921-72 Stormont revenuebased system was quickly subverted. The risk of a supposedly revenue-based system is
that discretion is unusable, for technical reasons (eg lack of administrative capacity or
information-sharing) or for political reasons (Devolved Administrations dare not either
increase or reduce tax rates)
• The Barnett formula may in time be ceremonially abolished, but my expectation is that it
will have an offspring. Per capita convergence on Barnett-controlled expenditure (so-called
‘Barnett squeeze’) has not gone as far as predicted 30 years ago. Expenditure reductions
set this process into reverse. Transparency in the form of ‘full documentation’ is vital
now: NB the 1984 National Archives release about cutting secretly and the Treasury
reporting tartan tax potential yield for 2011-12 under Section 76 (Scotland Act 1998) when
no capacity-to-use
• A key issue now is whether the Calman income tax will atrophy (just match the UK rate),
just as did the tartan tax in very different budgetary circumstances
• Although the inclination of all three Devolved Administrations is to spend more than in
England, most proposals are to tax less (NB a decision on devolved Corporation Tax for
Northern Ireland has been deferred until after the Scottish Independence Referendum)
If Scotland Votes NO, 28 January 2014
Financial implications – slide 12 of 12

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