Five things you should know about the ‘Fiscal Framework’ debate


Ben Wray boils down the key issues you need to know in the fiscal framework debate: a complex issue which is increasingly becoming a make or break issue in the devolution of more powers to Scotland

INTERVENTIONS from the STUC’s Dave Moxham and Glasgow University’s Anton Muscatelli have increased the spotlight on the ‘fiscal framework’ debate over the Scotland Bill. The fiscal framework needs to be worked out in negotiations between the Scottish and UK Governments, and the Scottish Parliament retains the right to reject the Scotland Bill if they are unhappy with the resolution of these negotiations. First Minister Nicola Sturgeon has said getting a fiscal framework that does not disadvantage Scotland is a “red line” issue for accepting the Scotland Bill.

The issues around the fiscal framework are complex, but they should be widely understood since so much hinges on it. Common Weal Policy has tried to break it down into the five key things you need to know to understand what the fiscal framework debate is all about.

1. There is no purely technical solution – politics matters

The first thing to understand about this debate is there is no technical answer that can be arrived at through simply taking the current system – the Barnett Formula – and interpreting it in exact form on to the new constitutional settlement.

The reason why is that the Barnett Formula – the means by which the amount Scotland receives in its block grant for public spending from the UK Government is formulated – was designed for tax powers remaining at the UK level. With income tax devolved to Scotland, the Barnett Formula’s means of calculation is susceptible to change from UK policy decisions that neither the Scottish Government nor Scottish MPs would have any control over.

For the first year, this wouldn’t be a problem, as one would simply deduct the Scottish share of income tax receipts – as the Scottish Government would now directly get its revenue from income tax – from the block grant figure.

The problem comes in subsequent years if a non-adjusted Barnett Formula continues to be used. David Bell and David Eiser pose a scenario to explain the inherent ‘unfairness’ of this:

“Consider the following scenario. Imagine that income tax has been wholly devolved to Scotland. What would happen if the UK Government increased the rate of income tax in the rest of the UK [rUK] to raise an additional PS10bn of revenue, and used this PS10bn additional revenue to fund increases in health or education spending in England? Under the existing Barnett Formula, Scotland would receive an increase in its block grant equal to a population share of PS10bn (approximately PS1bn). The fact that Scots had received a funding consequential without facing any of the tax consequences would strike many as being unfair.”

And of course the reverse is also true: a reduction in tax revenue in England of PS10bn, leading to PS10bn less on health and education spending in England, would result in a loss in Scotland’s block grant, based on population share, of PS1bn.

The Barnett Formula as it is, therefore, is a broken formula, but it has already been agreed that it will continue to be used by the UK Government. An adjustment to it therefore has to be agreed but to do so requires making inherently political decisions, as there is no adjustment that is entirely without winners and losers (this will be discussed further below). Hence why the ‘fiscal framework debate’ is a debate.

This is the first and most important aspect of the fiscal framework debate that has to be widely understood – the politics matters as we are entering uncharted territory in the UK and Scotland’s constitutional journey. Uncharted territory doesn’t have to be a problem in and of itself, but because the constitutional arrangement is increasingly convoluted and lop-sided, it means the space for political tension grows greater between both sides.

2.’No detriment’ principle

The political terrain in which this debate takes places already has some clear contours to it. The Smith Agreement (signed by all parties) did not outline a strategy for the fiscal framework, but it did outline a set of principles in which it should be based upon. The most important, and the most debateable, is the principle of ‘no detriment’.

The Smith Agreement states:

“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.

“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.”

As we have discussed in point 1, how to index this block grant adjustment appropriately is the likely source of disagreement in the negotiations over the fiscal framework. The value of the no detriment principle, then, is that it should help narrow down the purpose of those negotiations – to find an adjustment to the Barnett formula which is, all things being equal and as far as feasibly possible, revenue neutral for both the Scottish and UK Governments.

If both sides struggle to find an agreement over the fiscal framework, expect the principle of ‘no detriment’ to be a frequently used soundbite expressing great tension and political jostling.

3. The sums involved are very substantial in fiscal terms

The fiscal framework debate is not an argument over loose change. As Moxham points out, “Scotland could find itself disadvantaged to the tune hundreds of millions in a relatively short space of time if the wrong method is applied and that this figure could reach the billions over a longer time period.”

Given the block grant has already been cut by almost 20 per cent and, according to Fiscal Affairs Scotland , we are only about half way through the UK Government’s austerity measures, losing hundreds of millions or billions is not an option for the Scottish Government.

The Scotland Bill, as Robin McAlpine has outlined , contains very few powers over job creation and economic growth so the ability of the Scottish Government to improve its fiscal position off its own volition is, at best, restricted.

The stakes are therefore extremely high in fiscal terms – so high that Sturgeon’s ‘red line’ statement should not be taken as a bluff.

4. Uneven population growth and lower incomes are key differentials

To understand why different ways of adjusting the Barnett Formula could lead to very different outcomes is highly complex, but if we assume that economic growth is likely to remain similar both sides of the border (quite a big assumption) then the key differentials that make it difficult to come to a fiscal framework based on the principle of no detriment is uneven population growth and lower incomes in Scotland than England.

RUK’s population is growing considerably faster than Scotland’s. The reason for this is largely to do with economic geography; growth in London and the South-East has been far outstripping the rest of the UK due to the bloated financial sector based round the City of London, and migrants are attracted to places where they are likely to get work.

The consequence of this is that even if per person income tax receipts in Scotland kept pace with rUK’s, aggregate income tax receipts in England are set to be increasing faster than Scotland’s.

This is problematic if the fiscal framework is worked out by a method known as Indexed Deduction, where changes to devolved revenue in Scotland are indexed against the comparable revenue in rUK to work out the block grant. As uneven population growth will not be factored in, Scotland would be worse off under this method.

The other problem is that income per capita in Scotland is much lower than in rUK: most of the rich in the UK live in London and the South-East. 8.3 per cent of the UK population live in Scotland, but just 7.3 per cent of total income tax returns come from north of the border.

The problem with this is that if the fiscal framework is based on a method known as Level Deduction, where changes to the block grant are calculated through a Scottish population share of the changes in comparable tax receipts in rUK. This method will not account for the fact that England has a higher income per capita, and Scotland would therefore be worse off.

One response to this could be “tough luck”, but if the principle of ‘no detriment’ is taken at all seriously then this is likely to be inadequate. Furthermore, Scotland has no control over migration policy – a crucial lever in influencing population levels – and restricted control over economic development, which has led to the UK being the most regionally unequal country in Europe with most of the income wealth congregated in London and the South-East. The ability of Scotland to change the variables of lower population growth and lower income per capita are limited.

The STUC has outlined a proposal which at least in part tackles these issues, but for the purpose of this article it is sufficient to understand that these issues are likely to be political battles when it comes to the fiscal framework negotiations, and defining what is meant by ‘no detriment’.

5. Further constitutional instability likely

Points 1-4 should have drawn you towards an inevitable conclusion – whatever fiscal framework is agreed (if one can be agreed at all), it is unlikely to be the end of the matter. The wonky nature of the UK’s constitution post-Scotland Bill will almost certain lead to heightened instability and intensified grievance.

Common Weal warned of this danger in our submission to the Smith Commission , stating:

“When you analyse the importance of the interaction between different policies and different powers, you find a complex network of interdependencies. To tackle issues such as low productivity, low pay and poverty takes a systematic, coordinated effort across multiple policy and regulatory areas. However, if some powers are devolved and some reserved, these interdependencies can cause negative feedback, with certain policies undermining others, and contradictions constantly arising.”

We proposed a “comprehensive” devolution package which ensured Scotland had real control over its economy, and subsequently of its fiscal levers, not a “half-way house or cherry-picking of policy areas for political expediency”. Home rule was our argument; unfortunately a mish-mash of powers is what Smith, and subsequently the Scotland Bill, is delivering. The fiscal framework debate, with all its technical confusion and complexity, is emblematic of that political failure.