Should Scotland be given full income tax powers?

The Centre for Macroeconomics (CFM) – an ESRC-funded research centre including the University of Cambridge, the London School of Economics (LSE), University College London (UCL) and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of its monthly survey. The surveys are designed to inform the public about the views held by leading UK-based macroeconomists on important questions about macroeconomics and public policy.

This month’s survey looks at the devolution of extensive new fiscal powers to Scotland following the independence referendum in September, which showed a majority of Scots preferred Scotland to be within the UK. The Smith Commission is overseeing the process of finding an agreement to ‘strengthen the powers of the Scottish Parliament within the UK’ (emphasis added). We therefore asked our respondents to answer our questions from the perspective of the whole UK, rather than from one constituent nation or another. A full list of written responses from our panel of experts and the background information to the questions can be found here.

Only 14% of our survey respondents agree that the economic benefits of devolving full income tax powers to Scotland and Wales would outweigh the costs. Many respondents suggest that it would lead to economic inefficiencies and require extensive borrowing powers, which will lead to difficulties arising from implicit central government support. Only 33% of respondents think that there is a clear economic case for establishing ‘English votes for English laws’ for the same tax and spending powers as the Scottish Parliament. Many respondents question whether this would be consistent with the functions of the UK Parliament and support for the Union.

Background

The outcome of the Scottish referendum shows that it is the will of the Scottish people to stay in the UK. However, the referendum also revealed considerable dissatisfaction. Two days before the vote, the leaders of the main UK political parties made a vow to deliver ‘extensive new powers’ to the Scottish Parliament. The Smith Commission is overseeing the process to take forward the willingness ‘to strengthen the powers of the Scottish Parliament within the UK’ (emphasis added).

The UK is a highly uneven union of nations. The English make up 84% of the population, the Scots 8% and the Welsh and Northern Irish the other 8%. In 1998, three devolved legislatures were created – the Scottish Parliament, the National Assembly for Wales and the Northern Ireland Assembly – and granted some powers previously held by the UK Parliament.1 Most taxes across the UK are collected by the UK government. Funds are then allocated to the devolved legislatures by block grants based on the UK government’s Spending Review.2 Each legislature then decides how to spend the grant on devolved areas of spending. Devolved spending powers account for between 50% and 70% of total public spending in each nation, higher than the share in most federal countries.3

Under the Scotland Act (2012) and the Wales Bill (currently before Parliament), further tax powers have, and are likely to be, granted to the Scottish Parliament and Welsh Assembly. The most important taxes to be fully devolved are stamp duty, land, council and landfill taxes and a share of income tax revenues. The Scottish Parliament will be allocated 10p (or 10 percentage points) of the UK income tax rate, which it can raise or lower with its block grant reduced accordingly. Income taxes account for 27% of all UK tax revenue – the largest and most visible source of income for the UK government.

Devolving full income tax powers

Many of the Scottish political parties participating in the Smith Commission propose that income taxes are fully devolved to the Scottish Parliament. No OECD federal state currently devolves all income tax powers to sub-central levels of government.4

Criteria for assessing whether a tax ought to be devolved include efficiency, stability and equity. From an efficiency perspective, different income tax rates may lead to greater tax competition. This could be beneficial in terms of disciplining government largesse or it could be counterproductive as resources are allocated on the basis of tax rather than economic efficiency. Tax competition may lead to a Nash equilibrium with a lower overall tax rate, or divergent tax rates may encourage avoidance and lead to greater complexity. In any case, income tax yields are closely tied to the economic cycle and so unless fiscal reserves are accumulated in advance, or much wider borrowing powers are permitted, lower tax yields may require pro-cyclical tax hikes or spending cuts.

While tax revenues are not hypothecated, revenues support the functions of central government including reserved spending (defence, social security, foreign affairs), redistributing resources across the UK, financing debt interest payments and acting as ‘insurer of last resort’ for all constituent nations of the UK.

Q1: Do you agree that the economic benefits of devolving full income tax powers to the Scottish Parliament and Welsh Assembly outweigh the possible costs?

Summary of responses

Leaving aside respondents who neither agree nor disagree, 85% of our panel members disagree or strongly disagree that the economic benefits of devolving full income tax powers outweigh the costs. Some experts, such as Christopher Martin (Bath) consider that ‘devolution of power over income tax would undermine the nation state’. Jonathan Portes (NIESR) observes that Scots would ‘be paying nothing directly from their incomes to finance quintessentially state-level functions’. Sir Christopher Pissarides (LSE) says that the ‘costs of possible (if not likely) tax competition between the component parts of the UK far outweigh [the benefits]’ and the ‘accounting difficulties will be a nightmare’. Similarly, Tim Besley (LSE) comments that it is ‘best to keep income tax, VAT and corporate taxes in the hands of the national [UK] government’.

Other respondents recognise that devolving full income tax powers would require extensive borrowing powers, which raises the question of what would happen in a crisis. Michael Wickens (York) thinks that the build-up of debt might be such that ‘they may well be forced to seek a bail-out from the rest of the UK’. Silvana Tenreyro (LSE) raises the need for a ‘well-thought [out] plan for resolution in a crisis’. And many experts warn that devolving full income tax powers would undermine the UK’s capacity for macroeconomic management: Morten Ravn (UCL) describes this as ‘the loss of a fiscal instrument for macroeconomic stabilisation for the central authority’; and Tony Yates (Bristol) suggests that this would ‘inhibit the ability to conduct countercyclical fiscal policy’.

Several respondents note in their comments the benefits of not raising taxes and spending money at a more central level of government than is necessary. For example, John Driffill (Birkbeck) suggests that the UK ‘badly needs better regional and local government with stable powers and responsibilities’. Of the few respondents who consider that the benefits outweigh the costs, Andrew Mountford (Royal Holloway) cautions that there would need to be safeguards to prevent a ‘race to the bottom competition, which will leave each country worse off’.

English votes for English laws

England does not have a devolved assembly and its affairs are decided in the UK Parliament at Westminster. The eight regional assemblies in England introduced in 1998 were abolished between 2008 and 2010, although Greater London has an elected London Assembly. However, immediately after the Scottish referendum, Prime Minister Cameron linked the devolution of further powers to Scotland to the same powers for England, saying that ‘just as Scotland will vote separately in the Scottish Parliament on their issues of tax, spending and welfare, so too England… should be able to vote on these issues’ and the question of ‘English votes for English laws’ requires a decisive answer.’5

The economic case for devolving power is to provide for different local preferences. Principal-agent arguments suggest that regional representatives may be more accountable to their electorate than in higher levels of government. Also Brennan and Buchanan (1980) argue that the size of central government could be contained through the decentralisation of fiscal powers. However, Oates (1972) states that one of the conditions for regional provision is an absence of spillovers to other regions. There is a high degree of economic integration between the four constituent nations – for example, total trade between Scotland and the rest of the UK is equivalent to 70% of Scotland’s GDP and the population of England is 10 times that of Scotland. Finally, devolving large fiscal powers to all constituent nations would reduce the tax-raising powers of the UK government, which may be inconsistent with the stability of the UK’s monetary union.

Q2: Do you agree that that there is a clear economic case for establishing ‘English votes for English laws’ with the same tax and spending powers as the Scottish Parliament?

Summary of responses

In the survey, 33% agree and 50% disagree that there is a clear economic case for ‘English votes for English laws’, with the rest neither in agreement nor disagreement. Many responses note the practical difficulties of one nation having 84% of the population and that there is no clear economic case for this level of governance within the UK. However, several panel members in their responses argue in favour of devolving more powers within England to regional assemblies. Marco Bassetto (UCL) suggests that ‘further devolution to regions within England could be a valid alternative’, and Tim Besley (LSE) notes that ‘City regions makes little sense unless the core governance is regional parliaments’.

Nicholas Oulton (LSE) notes that ‘there cannot be any argument in equity for giving Scottish and Welsh MPs power over English affairs while denying the same powers to English MPs’. Yet the dominance of England within the UK raises some practical difficulties. Jagjit Chadha (Kent) notes that ‘the impact of England on the rest of the UK is likely to be such that it would seem quite proper to allow the views of representatives from [the other nations]’. David Cobham (Heriot-Watt) suggests that the argument is ‘disingenuous’ as England would dominate and ‘inevitably have large repercussions for other parties’. Others, such as Wouter den Haan (LSE), think that it would be ‘very difficult to figure out what is meant with ‘English laws’ as the UK is such an integrated economy’.

Martin Ellison (Oxford) observes that because 84% of the UK population is in England, then the ‘efficiency loss of non-English input into English laws should be low’. Other respondents raise concerns for what this might mean for the UK overall. Angus Armstrong (NIESR) notes that if the same powers were devolved to an English chamber as proposed for Scotland, then ‘the UK government would lose control over one-third of its tax base’, which would ‘change the value of the claim of gilt holders’. Morten Ravn (UCL) sees the English votes proposal as ‘potentially leading to a fragmented fiscal union, which I do not see as a good outcome’.

References

Brennan, Geoffrey and James Buchanan (1980) The Power to Tax: Analytical foundations of a fiscal constitution, Cambridge University Press.

Oates, Wallace (1972) Fiscal Federalism, Harcourt Brace Jovanovich.

The Smith Commission (2014) https://www.smith-commission.scot/

Footnotes

1 The UK Parliament remains sovereign, and retains the power to amend the Devolution Acts.

2 The powers of the regional assemblies are the complement of powers reserved by the UK government, which include, for example, defence, the constitution, foreign affairs and financial and economic matters. The Scottish Government has the power to introduce an income tax rate of up to 3p, but this has not been used.

3 Spending by regional assemblies as a share of total public spending in each devolved region is 69% in Scotland, 56% in Wales and 53% in Northern Ireland.

4 The Basque Region in Spain has a particular autonomous tax arrangement.

5 See BBC news coverage for quotations, for example: http://www.bbc.co.uk/news/uk-politics-29303827

Published in collaboration with VoxEU

Author: Angus Armstrong is the Director of Macroeconomic Research at the National Institute for Economic and Social Research. Francesco Caselli is the Professor of Economics at the London School of Economics. Jagjit Chadha is the Professor of Economics at the University of Kent. Wouter den Haan is the Professor of Economics and Co-Director of the Centre for Macroeconomics at the London School of Economics and CEPR Research Fellow.

Image: England and Scotland stickers are seen as shoppers queue in a sweet shop in Berwick Upon Tweed in Northumberland August 20, 2013.  REUTERS/Toby Melville.