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Fiscal Federalism

By John McLaren

First published in The Scotsman newspaper, 8th July, 2005.

FISCAL federalism. The name alone suggests something that is never going to be political dynamite. Nor should it. The debate around fiscal federalism is only another exercise in avoiding the real problems and difficulties in energising Scotland's youthful parliament; another fumbling attempt at finding Scotland's political G-spot before it has learned how to kiss properly.

The parliament, apparently, lacks a proper sense of financial and economic responsibility and the best way of changing this is to give it greater powers over taxation. Since when did giving a person or an institution that exhibited poor judgement more freedom to exercise that poor judgement result in greater responsibility? It doesn't happen. The debate merely serves to confirm the parliament's lack of maturity. Besides, no research exists that links greater taxation powers at sub-national level to improved economic performance. But still they come, professing the transformative powers of something that nobody understands because the detail of "fiscal federalism" is never explained. Labour backbench MSPs, LibDems, Tory leaders in waiting, the SNP, newspapers and their commentators - all champion the "fiscal federalism" cause but none tell us what it means in practice.

To get to grips with how shallow this debate has been, it is important to descend into the detail for a moment. Fiscal federalism is touted as the obvious replacement for the clapped-out Barnett formula.

This formula is remarkably simple in practice. It can, in essence, be boiled down to Scotland's share of any UK increases in government spending is proportional to its population share. So, if English spending departments get an extra £100 million, then Scotland gets roughly £10 million, as we have a population that is 10 per cent the size of England's. (Please don't write in saying this ignores non-devolved areas. I know, but the preceding catches the essentials).

Fiscal federalism moves away from this simplicity by splitting the taxation powers, as well as the spending powers, between Scotland and the UK.

But what does this actually mean? Which taxes do Scotland control? If it's all of them, then it is effectively independence, which is not what most people want. Do you devolve or assign these taxes? That is, do you simply get the Inland Revenue to give back Scotland's share of UK taxes or do you allow the parliament to set the tax rates and tax bases themselves? Should North Sea oil taxes stay in Scotland, even though they are probably the worst taxes to control because the price fluctuates and North Sea production levels have been declining since 1999?

What about income and corporation taxes? These can impact on personal and company mobility but you can't tell in advance whether government finances or the economy will improve or worsen if you increase or reduce them.

Also, how do you move from the current position, where most commentators argue that Scotland gets too much of the UK budget, to this new position of fiscal federalism?

Do you have a needs assessment to determine the correct starting point?

But, then, what are the criteria on which to base this assessment and what weights to give these criteria? Do you update this needs assessment and, if so, how often and how do you move from one assessment to the next?

If future needs assessments show Scotland lagging behind on what should be spent here to allow for equal provision of essential public services, do you adjust for that or just say: "Well that's part of the deal"?

I could go on... and on, over what are all tricky and politically charged issues. The basic point is that it's all very well asking for fiscal federalism, but it is a meaningless debate until you start to define the concept - and then the real fun starts and the complications, as well as the winners and losers, begin to emerge. By contrast, the Barnett formula has three very big plusses going for it. First, it is extremely simple. Second, it already exists. Third, the public aren't interested. In political terms these advantages are difficult to underestimate.

My guess is that there is only one way that fiscal federalism would really work, that is if it resulted in an economic or budgetary crisis - and it is a reasonable bet that this would happen. While much of the discussion that accompanies fiscal federalism revolves around the ability to reduce corporation taxes in order to make the Scottish economy more competitive, the reality of the Scottish Parliament suggests that taxes or borrowing would rise to pay for increased public spending. This is due to the fact that the majority in all Scottish political parties are pro-spend rather than low-spend.

Ultimately, this behaviour would lead to an economic or fiscal crisis, which, in turn, might finally lead to stronger purse strings being applied. Do we really need to go this far down to come back up? Obviously, the answer is no. What we could do is use the considerable existing powers to improve financial responsibility and show greater rigour in spending and investing the money under the control of the Scottish Parliament.

That simply needs a stronger and more able ministry of finance - a minister and a department with the clout of the Chancellor and the Treasury in Westminster, who would enforce discipline prioritising where the money is to be spent and ensuring the greatest returns possible would be generated from this investment. Since devolution this has been weakly carried out in Scotland.

Rather than discuss hypotheticals that they can't even properly describe, our MSPs should go back to basics and re-examine the powers they have and use them more effectively. Only once that has been achieved could we think about getting greater and more complicated powers to exercise.

We are grateful for permission to republish this article.  The views are those of the author alone, who does not represent the New Party.

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