Fiscal Framework
1) The STUC has argued, in a view taken during the referendum and prior to the ‘Vow’, Smith
Commission and subsequent Scotland Act, that the Fiscal Framework surrounding the new
powers over tax and spending had the potential to ‘make or break’ the new devolution
settlement.
2) This concern is amplified by the nature of the powers finally agreed for transfer; the transfer
of income tax powers isn’t balanced by a sufficiently wide basket of other tax powers.
3) Key factors include the fact that Scotland’s share of the UK total income tax revenue is
below its population share due to the concentration of high income tax earners in London
and the South East of England; and that the Scottish population is predicted to grow more
slowly than that of the rUK.
4) The ‘no detriment’ principle is very difficult to apply and remains the subject of varying
interpretations.
5) The three key questions are.
a) How will the Scottish block grant be adjusted to take account of additional spending
flowing from the devolution of new powers - primarily welfare?
b) What mechanisms will be put in place to allow the block grant to be adjusted to
reflect specific UK and Scottish Parliament spending decisions where they have a
direct impact on the finances of the other body.
c) Following the initial adjustment of the block grant to compensate for the devolution
of taxes to the Scottish Parliament, what method of will be used for block grant
adjustment in future years. How will this impact in Scotland?
6) This paper deals with the third of these questions and concludes that, if the wrong
adjustment method is adopted, severe reductions in Scottish Parliament revenues can be
predicted which would infringe the ‘no detriment’ principle and call into question whether
the devolution of income tax as laid out in the Scotland should be accepted by the Scottish
Parliament.
7) The year one calculation is reasonably simple. The Block grant will be increased by the
quantum of spending currently attached on the UK responsibilities to be devolved and then
decreased by the amount of revenue the Scottish Parliament would have raised if it already
had the new tax powers – primarily income tax.
8) The calculation for following years is far more complicated and outcomes are very sensitive
to the methods applied.
No detriment and the devolution of powers
The STUC recognises that the Smith Commission’s recommendations on ‘no detriment’ are
subject to variable interpretation and can be applied in different ways. In the STUC’s view, the
application of ‘no detriment’, as it relates to the calculation of the future block grant, are:
a) The initial adjustment to the block grant to reflect changes in tax and spending powers
should be revenue neutral. For the tax revenue component of this, the initial calculation
should be a deduction from the Scottish block grant of the sum that will be derived from
the newly devolved Scottish taxes.
b) The adjustment in subsequent years should allow for different impacts where Scottish
Parliament tax and spending policies differ from that of the UK Parliament. This implies
that if Scottish tax revenue should rise or fall consequent to policy decisions to alter rates
or thresholds; or if there are differing levels of economic growth, the benefit/detriment
should be retained by the Scottish Parliament.
c) The adjustment in subsequent years should employ a method which guarantees (as
closely as is possible) that had there been no changes in policy or variation in relative
growth, the block grant deduction would retain maintain parity with the tax raised in
Scotland through newly devolved taxes. In short, if there is no difference in economic
performance or tax rates between Scotland and the rest of the UK, public spending in
Scotland should be no higher or lower than under the current funding framework.
Thus, the principle of ‘no detriment’ as it applies to the adjustment of the block grant to reflect
the devolution of tax revenue streams is maintained initially and in future years without
impacting on the principle that the effect of differing fiscal policy decisions should impact on the
Parliament which takes such decisions.
Indexing options
Clearly, the revenue derived from taxation will differ year on year. Over a period, revenues can
be expected to increase as a consequence of overall growth. Thus, in most years, the quantum
of both UK and Scottish income tax should increase, leading to an increase in revenue for the
Scottish Parliament from income tax and a larger deduction in the block grant reflecting overall
growth in tax receipts.
The initial adjustment figure is a lump sum, which requires no formula save an agreed figure for
what constitutes the Scottish share of income tax receipts (principle a).
Subsequent adjustments cannot be made using the same method otherwise the calculation
would fail to recognise potential policy variations (principle b) and therefore a formula is required
by which changes in UK tax receipts and Scottish tax receipts can be reconciled with the
appropriate deduction to the block grant.
The STUC has reviewed the currently available literature on methods of adjustment1. There is
more than one way in which this future adjustment can be calculated. Remembering that the
overall figure might vary as a consequence of different growth rates or tax policy, it is still
possible to predict how the various methods for the adjustment would impact on the revenues of
the two parliaments assuming no divergence in policy or growth (principle c).
All of the options for indexation retain the same Year 1 adjustment figure as is consistent with
principle a), but take a different approach to how the increase in the block grant deduction is
calculated.
Option 1 – Level deduction (population share of rUK change in tax receipts is added to
baseline deduction each year)
This option would calculate the additional amount by which the block grant is to be reduced by
each year based on Scotland’s population share of the change in comparable tax receipts in the
rest of the UK (rUK).
This method would create a disparity between the block grant deduction and the increase in
Scottish Parliament income tax receipts. This is because Scottish income tax receipts are lower
per capita than across the UK as a whole (largely driven by the concentration of higher rate taxpayers in London and the South East). Scotland accounts for 8.3% of the UK population but
7.3% of UK income tax receipts, the annual block grant deduction will therefore be greater than
the growth in Scottish income tax receipts – even when income tax receipts are growing at the
same rate in Scotland and the rest of the UK. This indexation method therefore guarantees that
even when Scotland matches the economic performance of the rest of the UK its budget will be
smaller than that provided under the current funding framework.
http://scotfes.com/2014/11/20/how-should-the-barnett-formula-be-adjusted-to-reflect-devolved-taxes-aquestion-of-allocating-risk-wonkish/
http%3a%2f%2fwww.ifs.org.uk%2fuploads%2fpublications%2fconferences%2fpresentations%2fPhillips_
Scottish_Finance_Committee.pdf
http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/economic-affairscommittee/the-devolution-of-public-finances-in-the-united-kingdom/written/21826.pdf
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This breaches the no detriment principle outlined earlier that the effect of the devolution of
income tax should be revenue neutral, assuming comparable growth rates and non-divergent
tax policy.
The effect of using this method would be that, over a period, Scotland’s public spending relative
to the rUK would be significantly damaged.
Option 2 – indexation against relevant UK tax receipts in the rUK
Option 2 would index the annual block grant deduction to the overall increase in comparable tax
revenue in the rUK. However, as rUK population growth is expected to exceed Scotland’s, the
annual block grant deduction will, over time, exceed the growth in Scottish income tax receipts –
even if per person receipts in Scotland and the rest of the UK grow at the same rate.
Scotland does not have key devolved powers such as migration policy, which might enable it to
proactively increase its population relative to rUK. This method of indexation therefore also
conflicts with principle c), that all other factors being equal, Scotland’s relative fiscal position
should not deteriorate.
Option 3 – indexation against relevant UK tax receipts in the rUK adjusted for population
growth
The best, and in the STUC’s view, fairest approach, is to index the initial baseline adjustment to
the growth in relevant rUK tax receipts (Option 2) but to make a subsequent adjustment taking
into account the change in relative population growth between rUK and Scotland. In the case of
income tax, this would mean indexing the initial block grant adjustment to the growth in per
person income tax receipts in the rest of the UK.
This method gets closest to compensating for the disparity in tax base between Scotland and
rUK which is [largely?] a consequence of UK macro-economic and fiscal policy; and the
predicted slower rise in Scotland’s population relative to the rUK, a trend the Scottish
Parliament does not have the powers to substantially influence. It means that if income tax
receipts per person grow at the same rate in Scotland and rUK, and tax rates are the same in
both countries, public spending in Scotland will be exactly the same as it is under the current
funding framework. This therefore achieves the Smith Commission’s no detriment principle
Appendix 1
Level Deduction Worked Example
Year 1
Year 2
Rest of UK Income Tax Receipts2
£145 billion
£167 billion (15% growth)
Scotland – Income Tax Receipts3
£11 billion
£12.7 billion (15% growth)
Block Grant Adjustment (BGA)
£11 billion
£13 billion
£0
-£300 million
Impact on Scottish budget
(Scottish Income Tax – BGA)
Calculation for the BGA in year 2 is as follows
Year 2 BGA = Year 1 BGA + (Scotland’s population share4 of change in rUK receipts))
Year 2 BGA = £11 billion + (9.1%* (£167bn - £145bn))
Indexed Deduction per capita Worked
Example
Year 1
Year 2
Rest of UK Income Tax Receipts
£145 billion
£167 billion (15% growth)
Scotland – Income Tax Receipts
£11 billion
£12.7 billion (15% growth)
Block Grant Adjustment (BGA)
£11 billion
£12.7 billion
£0
£0
Impact on Scottish budget
(Scottish Income Tax – BGA)
Calculation for the BGA in year 2 is as follows
Year 2 BGA = Year 1 BGA * Growth in rUK Income Tax Receipts per capita, multiplied by
Scottish population growth
Year 2 BGA = £11 billion * (1.15/1.06) * 1.06
Notes
For simplicity, the calculations assume that the population grows at the same rate in Scotland
and the rest of the UK (0.6%). In this case, tax receipts per head would also grow at the same
rate in Scotland and the rest of the UK and indexed deduction and indexed deduction per capita
yield the same result.
The above examples illustrate the differences between the level deduction and indexed deduction
methods under the assumption that population growth is similar in Scotland and the rest of the
UK. However, latest population projections indicate that Scotland’s population is expected to
grow less quickly than in the rest of the UK. In this case, if tax receipts per capita grew at the
same rate in Scotland and the rest of the UK, Indexed Deduction (per capita?) would ensure that
Scotland’s budget is no better or worse off following the devolution of income tax whilst Indexed
Deduction would not. This is because even if per person receipts in Scotland grow in line with the
rest of the UK, aggregate receipts may not due to slower population growth.
2GERS,
Table 3.1. Rest of the UK is defined as UK minus Scotland.
ibid.
4ONS2013-14 population estimates for UK and Scotland. Rest of the UK calculated as UK minus Scotland.
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