Scottish Budget: end of the age of innocence

Given his first chance to change the rate of income tax in Scotland, John Swinney took the opportunity to do nothing.

Taxpayers on both sides of the border will continue to pay the same rate next financial year. But make no mistake: things have changed and will never be the same again.

The non-move enables the Finance Secretary to escape the dilemma of either imposing an unpopular tax rise and risking punishment at the polls next May, or cutting spending even more than he is now doing, damaging the SNP’s anti-austerity credibility. Not that he explained it in those terms.

Without the ability to vary rates between tax bands, or change the thresholds (powers he may get if/when the new Scotland Bill is agreed next year) he could not, he claimed, ensure fairness: any increase would fall disproportionately on lower earners; any reduction would disproportionately benefit the better off. This is in itself is questionable, but he did not apply the same principal to other fiscal measures.

He continued the council tax freeze into its ninth year, a measure which he said was worth £1,500 to the average household. Perhaps so, but that average conceals the fact that the biggest benefits have gone to those living in the biggest homes, while those in social housing get a smaller handout. He also announced the continuation of no tuition fees for higher education, which not only benefits the middle classes most, but has been partly paid for by reducing grants to poorer students and forcing them to take loans instead.

There were a few eye-catching announcements – more for digital infrastructure, more for hip replacements and cataract operations, more nursery provision and more for “innovation” – but this was a Finance Secretary with very little room for manoeuvre. He is committed to protecting spending on health, education in school and the police, accounting for more than half the total, has been handed a real-terms cut by Westminster and, although he will raise a little more on landfill tax, second homes and business rates, has rejected the opportunity to increase income tax.

Conspicuous by its absence was any attempt to look ahead, and in particular to give some indication about how income tax may change under the new post-Smith Commission regime. He promised this before the end of the current parliamentary session in late March, blaming the late Autumn Statement from Chancellor George Osborne. But a line has been crossed.

Unlike the old power to vary the standard rate of tax by 3p in the £ (never used and allowed to lapse), the new tax power is mandatory, not optional. The Scottish block grant will be reduced next year by the equivalent of 10p come what may. By imposing a 10p Scottish Rate of Income Tax (SRIT has now entered the political lexicon), Mr Swinney can make up the difference.

So far so easy. The agreed estimate for how much 10p will raise in 2016-17 is £4.9 billion – around a sixth of the total Scottish Government budget. But what about in future years? Tax yields are not static – wages and working hours rise or fall, people join the workforce or retire, economic activity waxes and wanes. How do we calculate how much a 10p SRIT will be worth in future years?

That is the nub of the “fiscal framework,” over which John Swinney and UK Treasury Minister Greg Hands have been arm wrestling for months and was discussed by First Minister Nicola Sturgeon and Prime Minister David Cameron at their recent meeting. There is no agreement yet and the SNP has indicated that it could reject the new Smith powers altogether unless it gets a satisfactory outcome.

The simplest way to resolve the issue would be to index the reduction in the block grant. But index it to what? And how to calculate the index? There are three main contending formulae and even economists cannot agree on which one is best. See for example Glasgow’s  Professor Anton Muscatelli’s take on it, or that of Stirling’s Professor David Bell and David Eiser.

A solution will not be easy and will have to satisfy both the Scottish and the UK parliaments, but in future it could mean that if the Scottish and the UK economies diverge Scotland will get much less support from Westminster. If that happens Mr Swinney or his successors will have to come off the fence, set a different tax rate to the rest of the UK and take the political consequences.

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