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IFS Raises Concerns Over Scottish Tax Proposals

by Robert Lee,, London

24 December 2014

The Institute for Fiscal Studies (IFS) has raised concerns about the practical implications of plans to devolve additional tax powers to the Scottish Parliament.

In a new Briefing Note, the IFS analyses the potential consequences of the recommendations made by the Smith Commission in November. The Commission was set up by UK Prime Minister David Cameron in the wake of the "no" vote in September's Scottish independence referendum. Chaired by Lord Smith of Kelvin, the Commission was tasked with brokering a cross-party deal on devolution. It recommended that the Scottish Parliament be given control over income tax rates and bands.

The UK Government has said that it will release in January draft legislative clauses to implement the Smith proposals. According to the IFS, finalizing the details of how the taxes and welfare changes are to be introduced will be crucial. The IFS points out that the Commission did not properly tackle the question of how the UK will adjust the block grant given to Scotland when more tax and spending powers are devolved.

The block grant is the portion of revenues provided by the UK Treasury to the devolved administrations in Scotland, Wales, and Northern Ireland each year, to fund Government operations. When a tax is devolved to Scotland, and the Scottish Government keeps the revenues raised, a reduction must be made to the block grant Scotland receives, by the amount of revenue that is being transferred. If extra spending responsibilities are devolved, the block grant should be increased by the amount the UK would have spent on that area in Scotland.

According to the IFS, implementing such changes would be relatively easy in the first year. However, it would be more difficult to determine what should happen to these adjustments in subsequent years. The IFS says that it would not be appropriate to keep the adjustments at a fixed level, because inflation and economic growth indicate that the amount raised from a tax or spent on a particular area would grow over time. The IFS Briefing Note criticizes the Smith Commission for suggesting that these adjustments be "indexed appropriately", a phrase the IFS describes as cryptic.

The IFS notes that one solution would be to index the block grant reduction to what happens to revenues from the equivalent tax in the rest of the UK. This would insulate the Scottish Government's budget from revenue or spending shocks that hit the rest of the UK, but still incentivize the Scottish Government to grow revenues and limit expenditure. On the other hand, any attempt to insulate Scotland from such risks would be complicated and controversial, and would involve isolating the effect of Scottish policy from other factors affecting devolved tax revenues and spending.

The IFS also warns that nearly all policy decisions taken by one Government (UK or Scottish) could have ramifications for the revenues of spending of the other. If the UK Government wanted to spend more money in a particular area, or intended to increase taxes, these decisions would impact on the whole of the UK, although they would not technically be classed as "spending in Scotland." The IFS says that it would be absurd to suggest that the UK Government could not use an increase in income tax to fund policy changes, but if it did use income tax as part of its response to UK-wide issues, then the amount of grant transferred to the Scottish Government could have to be adjusted in response.

The Briefing Note concludes: "No system will be perfect. There is an inherent trade-off between providing incentives to the Scottish Government, and the degree of risk-sharing between Scotland and the rest of the UK. And, it will not be practical to devise a system where the UK and the Scottish Governments compensate each other for all the knock on effects of their policies as the Smith Commission recommends. That being said, it is possible to avoid some of the biggest pitfalls – and important too."

TAGS: tax | budget | United Kingdom | tax thresholds | ministry of finance | tax authority | tax rates | tax reform | trade | inflation | individual income tax | Scotland

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