21
The Scottish Affairs Committee
Oral evidence: Revising Scotland’s Fiscal Framework, HC 660
Monday 25 January 2016
Ordered by the House of Commons to be published on 25 January 2016.
Members present: Pete Wishart (Chair); Mr David Anderson; Kirsty Blackman; Mr Christopher Chope; Margaret Ferrier; Mr Stephen Hepburn; Chris Law
Questions 65-156
Witnesses: Professor Anton Muscatelli, Principal and Vice Chancellor, University of Glasgow, Professor David Bell, Professor of Economics, University of Stirling, and David Eiser, Research Fellow, University of Stirling, gave evidence.
Q65 Chair: Just before we start, everybody, I am delighted so many people have come along today to witness this evidence session for the Scottish Affairs Committee. I do not think there is any amplification, so we are hoping that you are going to be able to hear evidence. Can everybody hear okay at the back? Given you have made this effort to attend and turn up today, we are keen that you are able to hear. It does not get any more exciting than the fiscal framework, the means and wherewithal about how we are going to resolve the Scotland Bill, so we will try to make it as interesting as possible for you. This is a parliamentary proceeding so there are no interruptions. You will just have to listen to our proceedings and that is the way that things have to happen when it comes to Committees of the House of Commons. I am sure you will appreciate that and hopefully you will be able to hear everything properly and you will be able to hear what our witnesses have to say.
It is 11.30. Can I welcome our three witnesses to the evidence session of the Scottish Affairs Committee on the fiscal framework? This is Burns Day so we are especially delighted to have you along with us this afternoon. It is the first time ever that the Scottish Affairs Committee has met in the fair city of Perth, something I am personally delighted about. I am hopeful we will be back here for a number of our sessions as we go through this parliamentary term. I am grateful to all of you for attending this morning. We will get straight to business, if that is all right. Perhaps just for a record, from left to right—we will start with you, Professor Muscatelli—tell us who you are and if you have any opening statement you wish to give to the Committee.
Professor Muscatelli: Anton Muscatelli, University of Glasgow, speaking in a personal capacity, not in my role as principal of the university but as an economist today. I would be very happy to provide an opening statement around the fiscal framework.
Obviously, there are a number of issues in the fiscal framework. I think a lot of debate has focused on the indexation mechanism for the block grant adjustment, and that is indeed important. Different methodologies have been put forward. One of the things that is important to realise is that, as many have pointed out including my other co-witnesses today, there is not a single formula that suits perfectly the principles that have been set out in the Smith commission report, but I personally have suggested that one of the adjustment mechanisms might be better and indeed might be adopted to produce an even better outcome. There are many other aspects that I think you may want to discuss around the fiscal framework, not least how VAT assignment would work, how borrowing will work, administration costs, and how you would adjust the block grant for welfare payments. It is a very complex and full area.
Q66 Chair: I am grateful, Professor Muscatelli. Could I say to our witnesses we have to press this big button in order to be heard? We are also live streaming this, so it is just to make sure that it is going to be heard in all the other facilities. When you are speaking, just make sure that you do press the button. That goes for my fellow Committee members.
David Eiser: Good morning. I am David Eiser from the Economics Department at the University of Stirling. I have been working on the fiscal framework alongside Professor David Bell and David Phillips of the IFS, looking particularly at different mechanisms for indexing the block grant adjustment following the devolution of tax and welfare powers.
Professor Bell: I am David Bell. I am in Stirling Management School at the University of Stirling. I have been working with David Eiser and David Phillips for some time and for some time before that when I was the adviser to the Finance Committee of the Scottish Parliament, which was the first occasion on which the dreaded block grant adjustment issue came up. I am happy to contribute as I can.
Q67 Chair: I am grateful to all of you. Could I kick off with a few things, mainly general principles? We are getting to the stage now where this is all getting very time critical. Both Governments have suggested that they would like to reach an agreement by the middle of the month and the dates of 14 or 12 February have been mentioned in terms of trying to come to a concluding arrangement. It is proving to be very difficult and we are having the Deputy First Minister in session this afternoon. That will be followed by a session with the Chief Secretary to the Treasury, Greg Hands, the following Wednesday and we will be keen to hear what maybe will be the stumbling blocks and issues that both Governments are looking at in order to come to an arrangement. In your view, is this doable? What do you believe are the critical factors that are getting in the way for a deal to be concluded? I also want you to think when you are answering this that we have the principles of no detriment in the Smith agreement and Smith arrangement. Is it possible that they will be met in any agreement reached? The broad questions are: is this doable, can it match what has been set out in the Smith agreement when it comes to the no detriment principles, and what are your views about the biggest sticking blocks that both Governments have managed to uncover as we go forward in trying to get an agreement? We will start with you, Professor Muscatelli.
Professor Muscatelli: Thank you very much. As has been set out in the discussion, the Smith commission agreement set out a number of principles around which the fiscal framework should be based. Above all, it reiterated the centrality of the Barnett formula and then it set out two no detriment principles, which I think it is fair to say different methodologies for block grant adjustment have found it difficult to meet both of these principles at the same time.
As I said in my opening statement, I have a preference for the per capita index deduction method on two grounds. First, because Barnett was reiterated as the central principle of the Smith commission agreement, anything else is likely to erode Barnett over time because Barnett already exposes Scotland to some demographic risks but anything but the per capita index deduction method would expose Scotland to further demographic risks. I think that is a difficulty—we can go into details—given the relative population projections for Scotland and the rest of the UK, particularly in the south-east of England.
The difficulty with the per capita index deduction method is that it is not seen to meet all the aspects of the second no detriment clause of the Smith commission agreement; in other words that if the rest of the UK were to, say, increase devolved taxes to pay for additional expenditure, then Scotland would get some additional benefit from that, which it otherwise would not get. In my view, there are ways, potentially, of addressing that. The trigger for that could be if the rest of the UK does change devolved tax rates or thresholds as a way of trying to spend more in areas of spend. You could think conceivably of a modification to the per capita method to do that.
Q68 Chair: Can I ask you, as a keen student of the evolving discussion and debate that we are having about the fiscal framework, what do you see as the major stumbling block that has led to this almost impasse between the two Governments? What is your view about where we are and why we are having this difficulty coming to any sort of agreement and arrangement?
Professor Muscatelli: I will be honest, it is very difficult to see that from the outside because, of course, the discussions have taken place obviously in camera. It is difficult for anybody on the outside to see what exactly the stumbling block is. It sounds as though a big stumbling block is around the block grant adjustment but, as I said in my opening statement, there will probably be other issues around the tax, the VAT assignment issue, or indeed around the block grant adjustment for welfare payments. From the outside, it seems as if it is around the block grant adjustment for the additional tax bars and I really do not understand why it should be such a huge stumbling block. One could think of how one could tweak or adjust one of the methods, which as I say I think fits best in terms of the no detriment clauses, in order to address that. It is difficult to know because we do not have the details of what is happening in the Joint Exchequer Committee.
Q69 Mr Hepburn: Just on your comments there, it strikes me that there is a problem with transparency in the process. Why are the likes of yourselves, who are so-called experts in the field, kept in the dark about moving this whole process over?
Professor Muscatelli: As I say, I cannot answer that—
Mr Hepburn: I am not asking you to make political comments. I am just saying: do you not think it is strange?
Professor Muscatelli: Well, I think it certainly will allow for very little time for parliamentary scrutiny both in Holyrood and Westminster. If an agreement is reached by, say, mid-February, it would allow very little time before purdah and the Scottish election. I would agree that it really does allow very little time for discussions.
Q70 Mr Anderson: Similar to what Stephen said, we are trying to make conclusions and we are far from experts. I understand in any negotiation you want to keep some things back, but in general if there is a real sticking point why not get it out there so people like yourselves or people from around the world could say, “Have you looked at this? Have you tried that?” Do you think there should be any problem with that?
Professor Muscatelli: No, I would agree. If there are sticking points, I would be very happy to assist in any way. I am sure my colleagues would, too.
Q71 Chair: Great, thank you. Professor Bell, is this doable? What are the issues and difficulties and why has progress been so hard to secure?
Professor Bell: I agree with Professor Muscatelli around an inherent contradiction in the way that the no detriment clauses sit alongside the Barnett formula and the fact that none of the mechanisms fully address the no detriment principles. One might say that some of this would have been better had the Smith commission—it did not have much time—done a little bit more work on the fiscal framework and then that could have formed part of the Bill, maybe in outline form but a little more than we have. Then there would have been an opportunity for a more open discussion.
I would, however, add that there is not much point in looking for international comparators because there is nothing like the system that we are now constructing. There is nothing like the no detriment principle. There are not very many countries that run anything very similar to the Barnett formula, so that makes it a difficult problem. We have not been, as Professor Muscatelli said, party to the innermost discussions. We know they have been going on over the last few weeks but we do not know much about them.
David Eiser: There are a number of criteria by which you might choose between which of these block grant adjustments you think is appropriate. One way you might look at this is to say which risks should the Scottish Government be exposed to. One potential answer to that is to say it would not be fair for the Scottish budget to be exposed to the risk of differential population growth between Scotland and the rest of the UK. Although you can argue that the Scottish Government do have powers with which they can influence population growth at the margin, such as education policy, health policy, infrastructure and so on, the idea that the Scottish Government have the powers to fundamentally change the relative rates of population growth with respect to the rest of the UK is probably unreasonable. On that basis, you would argue for the per capita index deduction method.
However, the problem with that is that you have to think about how that sits with what we have at the moment, the commitment to the Barnett formula. What the Barnett formula does is effectively rewards Scotland for having relatively slower population growth than the rest of the UK. You might say if the Barnett formula is rewarding Scotland for relatively slower population growth on the spending side, why should the indexation method for the block grant adjustment protect it from that relatively slower population growth on the revenue side? I am not party to the intergovernmental discussions, clearly, but it seems to me that that is one area where there is quite likely to be disagreement. I suppose the question is: should we be choosing the indexation method based on which risks we think it is fair that the Scottish budget should be exposed to or to what extent should we be trying to correct some of the anomalies that are already built into the Barnett formula when we choose which indexation method we adopt?
Q72 Chair: Professor Bell, could you help me with this one? It emerged in the evidence session with Professor Heald and David Phillips. They were talking about the general principle of why we are doing all this and why the fiscal framework was an absolute necessity for the Scotland Bill. What they have said to us is they both noted that more powers do not automatically produce economic growth and even with the Scotland Bill and a fully functioning fiscal framework this does not necessarily equip Scotland with the tools to grow an economy and make its own fiscal decisions. Do you think what we are trying to achieve here is more about giving the Scottish Parliament the tools in order to develop the economy and make its own fiscal decisions or is it more about accountability, about making sure the Scottish Parliament and the Scottish Government are more accountable for money spent?
Professor Bell: I think the latter is probably the stronger argument at the moment in that what we are trying to get here is a settlement that will give Scotland additional revenue-raising powers and, therefore, make it more accountable for a larger proportion of its budget. Whether these powers in themselves can be used to stimulate additional economic growth is maybe questionable. We might think about going to a low tax economy to stimulate growth. That would pose certain difficulties, clearly, and the Scottish Government as they currently stand do have quite a lot of powers that can be used to influence growth around economic development, education, skills development and infrastructure. I probably doubt whether the new taxes add significantly to that.
Q73 Chair: Professor Muscatelli, do these new powers help? Does it give incentives to follow and benefit from a different fiscal policy from the rest of the United Kingdom?
Professor Muscatelli: As David Bell said, I think it is part of the picture. It certainly adds to the set of powers that the Scottish Parliament will have and it could use these to try to incentivise growth of the economy. I would agree that income tax per se will not generate additional growth in the economy. It is likely to be the result of a wide range of policy interventions, some around levers that Scotland still will not have around business taxation, for instance. I would say that it is only partly about that and it is largely about accountability.
However, I do think it is important—and I think all of the block grant adjustment methods do this—to ensure that Scotland is incentivised to think about growing its tax base relative to the rest of the UK, and all three methods allow you to take account of that. But I would totally agree that devolving a certain range of income taxation will not allow you to do that.
I would add one other thing. By also retaining some elements of income taxation—for instance, the personal allowance—and also the complex interaction with national insurance contribution by employees, you are not really giving full scope of personal income taxation anyway. It is still a limited set of powers.
David Eiser: I would reiterate and agree with everything that my co-witnesses have said. I think the argument is mainly one around enhancing accountability. You could question the extent to which these new income tax powers will enable the Scottish Government to significantly enhance rates of economic growth. Of course, one thing that they certainly will be able to do much more effectively than they can do now is think about the distribution of income and the way in which income tax is used to redistribute income across the Scottish population, which is clearly something that they cannot do at the moment.
One other point I would make, though, is that although it is true that under these proposals income tax rates and thresholds are fully devolved, effectively the definition of the tax base is still reserved. That means that quite important questions, for example, around how pension income is treated and taxed, are not devolved.
Q74 Chair: That is very helpful. These are the sorts of issues we want to explore a little bit more with you. Another general question is this idea of exposure to risk, which is at the very root of some of the Smith principles. We are seeing an increase in borrowing power and I think they are talking of up to £500 million for the Scottish Government in terms of all this. It is this question about the whole shock and UK-wide risks and the unanswered questions that we heard from David Phillips about who bears the responsibility and risk of exogenous shocks to Scotland. I think this is still relatively unresolved. Who should bear the risk of exogenous shocks, particularly fiscal shocks specific to Scotland but over which the Scottish Government have no control whatsoever?
Professor Bell: This might perhaps have been a better starting point for the Smith commission to examine these risks and think about which risks ought to be held at a federal government, federal level, national, whatever you want to call it, and what risks should be held at a Scottish level. What we seem to have had is a decision about the taxes and then afterwards people are trying to figure out which risks are being allocated to which level.
The usual thing would be that a central Government controls macroeconomic policy and in those circumstances the central Government deals with shocks that hit the whole of the territory. For example, the financial crisis in 2008 would be thought of as a shock that would primarily be the responsibility of the national Government. Subnational governments will bear a variety of other kinds of risks. Sorry, I should just go back and say that all of the block grant adjustment mechanisms in some way insure Scotland against the overall macro shocks because, on the one hand, if Scotland is getting less spent on it because the UK Government have contracted spending, it will also have less taken away from it through the block grant adjustment mechanism.
What various countries do to differing extents is protect subnational governments from specific shocks. In Germany, although there is a considerable number of devolved taxes, there is not a huge amount of risk sharing. If you take Canada as an alternative case and think about Alberta and its situation currently, which is a bit similar to the situation that Scotland is in, it is a heavily resource-dependent economy and it is going to have to take quite a large hit because that particular risk, the changes in resource price risk, is not covered by the provincial government in Ottawa. The issue of deciding on risk on the welfare side is also important. What kind of risk is it? How much disability is there in the population? What about the risk of unemployment? Normally, central governments cover unemployment risk because that is a consequence of a shock that has hit the economy as a whole. What Scotland has ended up with is a rather interesting group of welfare powers that have a set of risks associated with them. It would have been better if we had decided at the start to talk about the risks first and then decide which welfare benefits.
Chair: I think interesting is one way to put it.
Q75 Mr Anderson: I am finding it quite depressing as we go on. I am worrying about that this is all based on forecasts. If we look at the last three months, to give you an example, we had an autumn statement of the Chancellor. In a few weeks he had found £27 billion and we have seen over the last week markets fall across the world and the oil price has gone through the floor. How confident can we be that whatever is put in place is going to be able to be flexible enough to cushion these impacts or the opposite if things go the other way, with an imbalance that way? I am probably showing my ignorance but it is a real worry in terms of how accurate we can be.
Professor Muscatelli: Absolutely. I think you have identified one of the key issues that if you base it on forecasts, if you take Scotland’s devolved income taxation, which I think is on 2014 figures supposed to yield something like £10.9 billion, that could be out by half a billion or more each way. If you base it on forecasts the question is: do you then readjust it in the light of actual outturns or not? How that will be specified will be absolutely critical and, indeed, when do you start in the economic cycle? If you choose as year zero a year that happens to be atypical then you may have set the initial framework in this way.
I also totally agree with what David Bell was saying. In a sense, it emphasised what was said earlier. The Smith commission deal was a political deal. We started with probably horse trading around which taxes should be kept reserved, which should not, instead of starting from what we might call an economic perspective, which is around risk sharing, which risks should be held centrally, while keeping an open mind as to which taxes may be devolved because of spill-over effects or other interdependencies. But I think your point about estimates is absolutely correct.
Q76 Mr Chope: Can I ask about the basis of all this? I can understand full fiscal responsibility. I can understand the desire of the Scottish people to be masters of their own destiny through their elected Government and, as I understand it, the Scottish Government are in favour of full fiscal responsibility. Why are we wasting so much time messing around with this sort of messy compromise that is neither one nor the other? If the Scottish Government are in favour of full fiscal responsibility and win the upcoming elections with that in its manifesto, then surely that should be the issue on which you are devoting your energies rather than trying to reinterpret a rather flawed and rushed agreement, which is what we are faced with at the moment?
Chair: Answer that one then. I think Mr Eiser is going to venture carefully into that particular frame.
David Eiser: I think if there was unanimity that that was what was wanted then that is presumably what we would be looking at, but I am not sure that it is. It is the Smith commission recommendations that we have and we are trying to think about how we put the fiscal framework around those recommendations. That has been our starting point.
If I could quickly touch on the forecasts issue, clearly forecasts are important because they are what the block grant adjustment will be based on initially but subsequently, once outturn figures become available, the block grant adjustment will be tweaked to reflect the outturn figures. In some ways you could argue that in the long run the forecasts are less important, and that is right, but it does mean that there might be scope for political arguments around how good the forecasts were and the implications for budgetary planning. That is why who does the forecasts is quite an important issue.
Q77 Chair: Could I hold on to Mr Chope’s question because I think it is an interesting one? It was something that did emerge on the Second Reading of the Scotland Bill as it went through the House of Commons. I know there was some support, not just from the Scottish National Party and Scottish Members but from Conservative Members like Mr Chope, who I think raised this as an issue with some of his colleagues. What we heard from Professor Heald and David Phillips was that if we did go down the route of full fiscal autonomy or full fiscal responsibility, as Mr Chope phrases it, it would still be subject to a whole range of intergovernmental issues, which may in effect be worse than what we are trying to negotiate and make our way around in trying to have a fiscal framework that meets the principles of the Smith commission. Do you have any views on that, Professor Bell? Would it simplify matters readily and easily if we went down the whole route of full fiscal autonomy or is that equally as complicated and as difficult to try to find a solution to?
Professor Bell: Effectively, full fiscal autonomy means that you are responsible for your revenues, you are responsible for your expenditure and you make a payment to the central Government for shared services. That sounds quite simple but I do not think it would work out quite as simple as that. Aside from getting to a starting block where everyone was agreed on how to proceed, one of the issues would be around, for example, borrowing if that happened in the short run. One of the issues that a central Government worries about is the extent to which subnational governments are borrowing because there is a question about who provides the backstop if the subnational government is unable to repay its debts. That is a strong argument why, on the one hand, central Governments want to keep control over subnational government borrowing.
There is also the issue that for most international purposes subnational debt is consolidated into the national debt. If you are looking at the UK and it has 80% debt to GDP ratio and you are considering whether to lend to the UK, then the extent of other debt that may be lurking in the background but may come to add to the UK debt in the future would be a considerable concern.
Can I also add in response to Mr Chope that countries around the world have different degrees of, let’s call it, fiscal autonomy. The UK has been a country that has been very centralised. In other words, tax is mainly collected at the centre; revenue is distributed from the centre. It has moved, or at least in respect of Scotland we have moved, past most of the other OECD countries, for example, into a situation where we are comparable, I would say, with Switzerland and Canada in terms of the proportion of revenues that are generated in Scotland that are retained by the Scottish Government and then the proportion of the spending that happens in Scotland that is controlled by the Scottish Government. We have moved; we are close to the edge of that distribution. Most countries set up these arrangements in their constitutions so you know the relationship between the states and the central Government. That makes it much easier to deal with because you can go to a constitutional court rather than this kind of arrangement or process that we are now describing, which I think could only be described as messy.
Q78 Kirsty Blackman: Just a bit of clarity on the position in relation to Switzerland and Canada: are we comparable with them now or will we be comparable with them after the further devolution?
Professor Bell: We will be comparable with them if the Scotland Bill goes through.
Kirsty Blackman: Thank you.
Q79 Mr Chope: You have put forward an explanation as to all of the problems that there might be about full fiscal autonomy, but full fiscal autonomy is the policy of the Scottish Government. I would like you to tell us how it is possible for the Scottish Government to argue on the one hand for full fiscal autonomy while at the same time whinge about the fact that the discussions that are going on at the moment may result in some risks being borne by Scotland. Surely the whole essence of fiscal autonomy is that you take the rewards and the risks. If the Scottish Government want to do that, why are they now baulking at taking some of those risks in the interim?
Professor Muscatelli: Just to reiterate what David Bell said, there is a spectrum around you can either give full fiscal autonomy and full accountability or you can move along the spectrum and have full risk sharing. A number of countries position themselves differently on that spectrum and, as David said, if the Scotland Bill goes through we will be roughly positioned where Canada is in that range. Even federal countries like the US have mechanisms in place around welfare benefits or whatever that cushion the impact of GDP, asymmetric shocks in GDP from one state to the federal state. I think in the US that was measured some time ago at about 45% or 50%, so if a state loses a dollar, it gets 45 cents back through federal mechanisms.
In answer to your question, just to correct one misapprehension. If, as I understand it, the Scottish Government are pushing the per capita index deduction method, I do not think it is suggesting that that is insulating Scotland from all the risks because Scotland would still bear the risks of revenue risk. If Scotland does not grow its income tax revenue as fast as the rest of the UK, it would lose in terms of that block grant adjustment.
The second point I would make is that Scotland is subject to some risks. As we pointed out earlier, it is subject to demographic risk through the Barnett formula. The per capita method simply means that you do not take on additional demographic risk. As I understand it, I do not think the Scottish Government are arguing we must not take any of the risks, not at all. I think there are risks built in within the per capita index deduction method.
Professor Bell: I will add a couple of sentences. It was elucidated in an e‑mail exchange yesterday with our colleague down south that no detriment does not really mean no detriment under any circumstances. There certainly could be detriment to the Scottish economy if its income tax revenues do not grow as fast as those in the rest of the UK. That is independent of the block grant adjustment mechanism.
Q80 Chair: The last question from me is about borrowing. It is something you could help clarify that I did not quite get when we had our previous panel of academics. Currently, the cost of Scottish Government borrowing is borne by the UK and, as no revenues are devolved, then Scotland contributes less to the cost of servicing that UK borrowing as the UK obviously has less revenue to draw upon. As such then, should Scotland contribute to the cost of both UK borrowing and its own borrowing via the UK Government and, if so, how might that contribution be calculated?
Professor Muscatelli: I will have a go. I have to say in the short term I do not think it is a huge issue. We do not know where the borrowing levels are going to be set. Obviously, we know where they were set as a result of the last Scotland Bill, but any scenarios I have seen that allow additional scope for borrowing would still have such an infinitesimal impact on the cost of borrowing for the rest of the UK, especially in the current circumstances, that I think it is something we can probably worry about again in about five to 10 years’ time. I do not want to trivialise it, but what Scotland would borrow in the context of what the UK is borrowing at the moment is absolutely infinitesimal.
Professor Bell: The current UK debt is £1.6 trillion or thereabouts and we are arguing about mere sums like £2.5 billion and £300 million for forecast debt. That is on the Scotland Act 2012. It will be a bit more but it is not going to come anywhere close to £1.6 trillion.
Q81 Chair: Is there a relationship between the UK Government’s desire to see deficit reduction and fiscal consolidation over a period of years and a Scottish Government deciding that they maybe had a different fiscal plan and arrangement that did not seek to secure that in the course of this? Would there be a conflict and would a tension emerge if that was the case?
Professor Muscatelli: I think it was David Bell or David Eiser who mentioned this before. The shared effort is there through the existing mechanism, so if a future UK Government were to decide to embark on further fiscal consolidation, that will feed through to Scotland through the Barnett formula and through any impact it has on tax policies to, say, increase taxes because of the deficit. Scotland is already taking part in that shared effort, so I really do not think having an additional mechanism around sharing out fiscal effort is needed at this point. I do think it is a second order issue.
Q82 Margaret Ferrier: On the point of borrowing for the Scottish Government, do you believe that if the markets believed Scotland’s debt would be underwritten by the UK Government, Scotland would be able to borrow at a similar rate from the markets?
Professor Bell: I guess that would probably be true. To the extent that the debt is underwritten then the borrowing conditions are likely to be the same. Of course, what that means is that the UK Government would be bearing the risk of default should that occur. There has been a big discussion around should the Scottish Government be allowed to borrow on the markets and then what would be the margin that they might have to pay as a result of that. Also, given that local authorities are able to borrow under what is called the prudential regime, should the Scottish Government be allowed to do the same. I return to something I said earlier and that is that it is likely that the UK Government will be seen as the backstop if things go wrong and that means that the markets will price that in but also Scotland’s local authorities, the northern powerhouse, whoever is borrowing, will gain a benefit from that.
Professor Muscatelli: Yes, I would agree. We do not know what mechanism is going to be put in place but if as per the Smith commission agreement it is going to follow prudential arrangements, it would essentially be at the same rate. It should be at the same rate because it would be seen implicitly or explicitly as underwritten by the UK Government so Scotland would borrow essentially at the same rate.
Whatever mechanism will be put in place is likely to be such that it will not probably allow any future Scottish Government or Scottish Parliament to expose Scotland to any additional risks. If we are talking about borrowing under the prudential regime, I think unless something cataclysmic happened it would be very difficult to imagine a situation in which Scotland started having to carry implicitly some default risk. If the borrowing happens through the Debt Management Office, then explicitly there will be a guarantee on the part of the UK Government that will underwrite that debt.
David Eiser: In terms of subnational borrowing, the evidence from other countries is clear that there has to be an expectation of no bailout from the central Government. If there is an expectation of bailout then there is an issue of moral hazard. The borrowing costs of the subnational government are lower than they should be and they may slightly rise for the national Government. In practice, it is quite difficult to convince the market that there is a no bailout clause and that is generally why in federal countries various fiscal rules are imposed by the central Government on the subnational governments. It is to help reinforce that no bailout expectation and alongside that most federal countries have in their equivalent of the fiscal framework rules what would happen if fiscal rules are broken in terms of conditionality and sanction. That also adds to the no bailout expectation that you need if the debt market for the subnational government is to be effective.
Q83 Margaret Ferrier: Thank you. We heard some commentators had suggested that there should be a no bailout rule and several witnesses to the House of Lords Committee questioned whether such a rule would be credible. In fact, we heard Mr Darling had said that he thought a no bailout rule would be unnecessary and downright provocative. He said, “As part of the UK, do not tell me I cannot be bailed out by a country that I happen to be a citizen of”. That was Mr Darling’s comment.
Professor Bell: Could I add a couple of things? On the issue of no bailout, it may be very difficult to credibly establish a no bailout rule because you may be harming yourself. For example, if the UK Government let Scotland go bankrupt and it effectively would have to pay for public services by whatever revenue it got in on a week-to-week basis, that would do a lot of harm to the rest of the UK economy, so you would be to some extent harming yourself.
The other point I would make—this is not a Scottish or a UK point—is governments do like to hide other forms of debt if they possibly can and keep them off balance sheet. We should be aware that that does go on a lot, with things like National Rail debt, public sector pensions and so on. It is something that the Auditor General gets very exercised about. It is important to bear in mind this notion that headline debt is not necessarily the full story.
Q84 Margaret Ferrier: I have one more question on the accountability. At the moment, the Chancellor currently delivers borrowing forecasts twice a year, which are scrutinised by the OBR. If the Scottish Government’s borrowing powers are enhanced, do you think they would need to do something similar?
Professor Muscatelli: One of the things that is quite interesting here is exactly who is going to provide that information in a relatively dispassionate way. It has been suggested that is a function that could fall to the OBR. Of course, Scotland has the Scottish Fiscal Commission that can do that.
One other issue that I raised in front of the Holyrood Committee, the Further Powers Committee, was the fact that there is also an issue here about the whole governance of the fiscal framework, which I think is really important. What happens if in future—it is not difficult to imagine—you have Governments north and south of the border who disagree about how the fiscal framework is going to be implemented? In that sort of circumstance, all the federal countries have put mechanisms in place either to govern the allocation of grants or to deal with disputes. I set out three principles. One was around transparency, one was around stability and the other was around asymmetry of power. One of the issues in the UK is partly because of the centralisation that David Bell was talking about. In a sense, there has always been a bit of an asymmetry of power between the Treasury and spending departments and in some respects devolved budgets have been seen almost like spending departments. That is not the right structure if you are trying to create what is essentially a federal structure. It might be better to have some sort of independent body at least advising the two Governments and saying, “On this particular interpretation of what has happened to tax revenues or the spill-over effects on tax or spending policies, this is what we think is the right judgment”. That would diffuse, hopefully, some of the political tension out of it. That is a suggestion. It may or may not be taken up by the Joint Exchequer Committee.
Professor Bell: To agree with and add to what Anton has just said, I think it is essential that the forecasting is done outside Government, then you will know if they are wrong, which is probably going to be true; they will be honestly wrong rather than dishonestly wrong. The Fiscal Commission has been established in Scotland and I think it should have the ability to construct the forecasts for Scotland. It should do that in consultation with the OBR because you do not want to have completely different views of the prospects for the economy. There has to be some mechanism around how those two are going to—
Q85 Chair: Could I test this a little bit further? We know that the Scottish Parliament is currently putting the Fiscal Commission on to a statutory footing. How would that relationship work with the OBR, which is predominantly a beast of Westminster and services the Chancellor? How would they be able to work together? Would it be a new body that would be created out of both of these organisations or is there some way that a joint—
Professor Bell: Although they are responsible to two different Governments, they are essentially technical organisations. It is technocrats who are running them and I do not know exactly what arrangements you would have to put in place but it does not seem to me to be impossible, if they are both independent, to get them to come to some broadly common view about the prospects for the economy.
Q86 Chair: Just before we leave this alone, the OBR now has become a real feature of the financial arrangements and the consolidation that we have year on year fiscally at Westminster. There are issues to do with politics, as obviously there would be in a political role for the OBR. Would there be any concern that if we were moving the Fiscal Commission on to a statutory footing and having this new role or new power that there would be a conversation or a debate about power reach or having an extended role in the fiscal arrangements of Scotland?
Professor Muscatelli: Ultimately, you can have all the structures you want but it will depend on personalities, in my experience. My own view was you probably might want an independent fiscal arbitrator. It is not having to add a whole new infrastructure. You could probably feed that off the infrastructure of the Scottish Fiscal Commission and the OBR. You could think about their collaboration flowing through to an independent fiscal arbitrator, who would then be answerable to both Parliaments. I think that would give more of that symmetry of power around this fiscal framework, which currently risks simply being a negotiation that has to be repeated several times over between two Governments. Again, that is a personal view.
Professor Bell: Could I add another bit? Anton mentioned an external mechanism with oversight of the central Government and subnational government or Scottish Government. There is a real asymmetry of power around the Treasury and the so-called spending departments that would not occur in a federal country. The Barnett formula has no legislative basis and, therefore, can be changed. Of course, it is central to the Smith commission so it does seem that there would need to be some assurance about the way that it will remain reasonably stable going through the future.
Q87 Chris Law: Going back to borrowing, I know we are focusing on this quite generally but specifically last week we were speaking with Professor David Heald, who said at best new borrowing powers will be able to tinker at the margins. I think David Bell said today that it is infinitesimally small compared with borrowing UK large. My question is: how far can borrowing powers allow the Scottish Government to operate a distinct fiscal policy? That is for the panel.
Professor Bell: I think that if you want to have a completely distinct fiscal policy you basically have to have independence. A key feature of national Governments worldwide is that they control macroeconomic policy and they allow subnational governments to deviate to some extent, but there has to be a limit to that because they are ultimately responsible for the central Government debt.
David Eiser: I would agree entirely with that. If the Scottish Government want to adopt a different stance in respect of spending relative to GDP, they can use their income tax powers to generate more tax but the idea that they will be able to borrow significant amounts to adopt the different fiscal stance I think is wrong. The borrowing is largely going to be about smoothing revenues, smoothing differences between forecasts and outturns and smoothing general year-to-year fluctuations. It is not about enabling very different levels of spending relative to GDP.
Professor Muscatelli: I would endorse that. Fiscal policy in Scotland in terms of the overall fiscal stance is likely on the revenue side for revenue spending to simply be around smoothing and fluctuations. What it may give the Scottish Government, however, if you have a sufficiently permissive borrowing cap on capital, would be, say, a different mix of spend between infrastructure and revenue spend, which might allow you to grow your tax base. If you think, for instance, of Scotland particularly given its geographic location, additional infrastructure spend might allow it to generate additional economic growth if it feels that the UK Government split between public investment and revenue is not right. For instance, in the first Parliament after the recent financial crisis we had particular cuts to capital spending by Westminster. The Scottish Government could have said, “We take a different view of the world. We would rather spend more on capital and less on revenue”. They could have taken that view if the structure was set up properly.
Chair: Thank you. I think we have dealt with borrowing sufficiently and I am very grateful for your contributions to that. We want to move on now to perhaps the key issue, which is the block grant adjustment. I know that several members have questions on this but we will have Kirsty Blackman kick us off on a couple of questions.
Q88 Kirsty Blackman: I want to start on the initial baseline adjustment of the block grant and how that should be done, any views you have on that, and also how to ensure that the way it is done is fair and transparent. It is something that Smith mentioned but it seems to be incredibly complicated to me, particularly transparency.
David Eiser: I will kick off. In some of our reports we have said the deduction in the first year is simple. I think probably the more accurate thing to say would be that it is relatively simple. I suppose there is one argument that says in the year that the taxes are devolved we deduct the level of revenues raised in Scotland from those taxes. The issue that you might have with that is if you think that that first year is an exceptional one for the level of revenues generated in Scotland. If it was a particularly bad year for tax revenues in Scotland, then from the Scottish Government point of view that might be good because that first year is quite important. If that first year deduction is relatively less, then from the Scottish Government perspective that is good. There is a question about whether you average over a number of years and, if so, how many.
Q89 Kirsty Blackman: Do you think enough is being done so that people can access it, so that it is transparent enough? How do you think Governments could improve on how they are doing that?
Professor Bell: What we are dependent on here is HMRC and it is not going to know how much income tax has been raised until the January following—well, not even at the January but mostly by the January following—the end of the tax year in the previous April, so there is going to be quite a considerable lag. How do you make that transparent? That is not an issue that I am all that concerned about. Of course, it is important that the allocation of people to the S code on their income tax forms is accurate, and presumably some effort will be going in at present to make sure that that is the case. One could put someone in from Audit Scotland to make sure that HMRC’s calculations are correct and there might be a case for that. It is not something I am terribly worried about.
Q90 Chair: Just before Professor Muscatelli comes in, I do not know whether it was you, Professor Muscatelli, who said that the way that the initial deduction should be assessed would be over a period of years, three to five on average, instead of taking the risk of one year. Is that something that you would favour as an approach to the initial block grant adjustment?
Professor Bell: I would certainly favour that, absolutely, because of the points that David Eiser made. It avoids taking an odd year as a first year. It means that you are averaging over at least a business cycle, although the last three or four years have hardly been typical either but at least you would put less on one year. We must not forget also about VAT because it is assigned; it is not devolved. At the moment, it is quite difficult to identify how much VAT is raised in Scotland. The Living Costs and Food Survey is limited in scope and that is how it is done. Supposing Scotland is successful in growing its tourism and spending in Scotland. It may not be able to pick up Scottish VAT receipts over time. There are similar problems when you are looking at income taxation, which is devolved, or indeed assigned taxation as well.
Q91 Kirsty Blackman: Yes. Moving on to the fun bit, the indexation of the adjustment of the block grant. You have all mentioned it already. I wanted to mention the spirit of Smith, and one of the things that is said in Smith is that its operation should not require frequent, ongoing negotiation, which is difficult. In terms of what your views are on how the block grant adjustment should be indexed, you have all mentioned it but it would be useful if you could sum it up in a couple of sentences.
Professor Muscatelli: Since I have nailed my colours to the mast at the very beginning, I have suggested the per capita method. If you look at the Smith commission agreement with the Barnett formula and the two no detriment clauses and trying to logically order something that, as has been said earlier, perhaps was not intended to be contradictory but is, to me it says Barnett is here, it is a promise, it is part of the vow, and it stays there, so everything else that follows should not be trying to undermine it. The per capita index deduction method maintains the first no detriment principle, which tracks Barnett, providing Scotland can maintain its tax revenues on a similar par to the rest of the UK and it does not expose it to additional population risk. To me, that seems a sensible way of doing it.
The problem is it then runs into problems with the tax fairness part of the second no detriment principle because, as I said, supposing the rest of the UK were to increase taxes and spend, increase taxes that are devolved, like income taxes, to pay for additional spend, then Scotland would benefit because there is a divergence there between the population share, which is used in Barnett, and the share in tax receipts.
However, it is not beyond the wit of man to have an additional adjustment, which could be mechanistic and automatic, that says, “Every time the UK Government tries to increase spend or, for that matter, decrease spend, because it can work both ways, let’s see whether we can correct the per capita index deduction to take account of those situations”. I think you can make it reasonably automatic and reasonably self-administering. However, the reason I suggested a fiscal arbitrator is because there will be some elements that are probably not predicted that might come into play at some point.
Q92 Chair: Looking at the various evidence that we have seen from the Devolution Committee in the House of Lords and our Committee, there does seem to be an emerging consensus around per capita. Why can we not just have this agreed then, and what is stopping this being adopted as the way forward, given the way that you guys have looked at it, which is obviously very studiously, and most of the evidence that has been presented at the various committees suggests that this sticks to the principles of Smith and no detriment? Why cannot we just get on and accept this?
Professor Muscatelli: I do not know. We were actually speculating about this outside before we came in. We wondered—my colleagues can speak for themselves—whether it was an attempt to say, whether in some quarters of the Treasury or whatever, people do not like the Barnett formula and they think, “I know we agreed to it, but maybe this is a way of trying to erode it a bit over time”. I do not know, but none of us know what exactly is happening in the negotiations so that is entirely speculation on my part.
Q93 Chair: Just on this, because it is quite important, do you think there is a suspicion and a hostility towards Barnett that is maybe driving some of the Treasury’s agenda about this? We are hearing some things about greater convergence when it comes to spending across the UK, and there is the usual hostility that we see in the House of Commons about Barnett and a needs-based formula being required across the UK. Is that perhaps what is holding back the adoption of this and is maybe driving the agenda from Treasury?
Professor Muscatelli: It is possible.
Q94 Kirsty Blackman: What is the preferred method of the block grant adjustment for Professor David Bell and David Eiser?
Professor Bell: I would reiterate that it is adding complication on complication and then a third level. I agree with Professor Muscatelli that you could fix the per capita index deduction method such that there is no redistribution from English taxpayers to Scotland when there is a spending increase down south. It is not a place I would think was ideal if you were starting with a blank sheet, but given the existing constraints around the Barnett formula and what Smith said, I think it is probably the least worst option.
David Eiser: My take on this is that the indexation is trying to say, “What level of revenues has the UK Government forgone in future years from having devolved these taxes to Scotland?” I think the per capita index deduction is the mechanism that captures that or is likely to capture that most accurately. The index deduction mechanism would imply that the population in Scotland is growing just as quickly as it is in the rest of the UK, and we know that population projections are that that is not going to happen. If you take the view that the Scottish Government do not have the powers to reverse that position of relative population growth—Scottish population growth—more quickly than RUK, then it seems to me that per capita index deduction is the best way to go.
The other option, of course, is what we have called the levels method, but what that implies is that Scottish revenues have to grow even faster relative to those in RUK just to keep up.
David Eiser: I think that probably the stumbling block is the fact that the Barnett formula is protecting the Scottish budget from relative population decline on one side, so if you adopt per capita index deduction you are effectively locking in what is really an anomaly, I think you would have to say. There is probably an extent to which those who are arguing for index deduction are doing so because they see it as a way of addressing this anomaly, but if you want to address that anomaly we should do it explicitly and head-on so as to avoid political grievance in the future.
Q95 Mr Anderson: The one guarantee we have to start a row in an English pub is to mention the word “Barnett”. You can have all the discussions with people about the reason why it is there—the geography, the demography, the deprivation, everything—people do not want to know. How can we produce a system in the language of fairness and no detriment to the taxpayer but that can be given credence on both sides of the border? If you had access to the papers or the minutes, whatever, of the Joint Exchequer Committee, would that help people like yourselves to advise people like us on how better this could be handled?
Professor Muscatelli: Perhaps if I can have a go. I do think the per capita index deduction method is fair to both Scotland and to the rest of the UK, and I think it is fair because it starts from the starting point. Whether we like it or not, Smith was a political deal that was done around Barnett and no detriment at the point at which the additional devolved powers were given. Moving forward from that, it does expose Scotland to some additional risk to its revenue base and I think it starts from the point of where we are, which is Barnett. You hinted that there are issues around how Barnett is considered, for instance in some of the regions around England and in terms of level spending per capita, but I don’t think you address that in this particular devolution deal. You address that through how you construct regional devolution in England. One could easily imagine the world in which, if there was additional regional devolved spending in England, you could decouple spending within the rest of the UK, within England, to allow differential spend levels in the north of England, say, relative to the south-east, and I think that would be entirely possible and, in a sense, sits outside this whole debate.
If we were given access to what is happening, yes, I am sure all of us would be very willing to help along the lines as was suggested. How could you formulaically and automatically develop a model that ensures that the per capita method, which I think we seem to all agree on, is the one that fits closest to the Smith commission agreement? Can we fine-tune to ensure that everybody around the UK and Scotland, does not feel as if it has disadvantaged them relative to the initial starting position? I think that would be a good way forward, and obviously that is a matter for the two Governments.
David Eiser: From a technical perspective, I think it would be quite easy to design a system that was not the Barnett formula for distributing resources to Scotland, clearly, but the reasons we still have the Barnett formula are political. All I would say is that every federal country in the world grapples with the issue of how much it should be equalising resources between different constituent parts of its territory. Although from a technocratic point of view you could design a system that was not a Barnett formula, the idea that we could have a system that everyone was permanently always happy with is false because there is not a country in the world where there are not constant wranglings about how various devolved taxes are equalised and redistributed around the territories. That is just the nature of the question.
Q96 Kirsty Blackman: You have all touched on this. What do you think is a reasonable level of risk to be transferred to the Scottish Government, considering the level of levers that we have?
Professor Muscatelli: Just to reiterate, even with the per capita method, Scotland is exposed to additional risk, which is around being able to grow your tax revenues in line with the rest of the UK. It is probably a reasonable level of risk. One of the issues we need to grapple with over time is: how you design the borrowing powers? How do you also deal with exceptional circumstances? Nobody foresaw what happened during the financial crisis. This is why I think we need to predict what might be unforeseeable at this point in time and supposing something dramatic were to happen that might require some risk sharing across the UK. When big things happen there is a shared effort. An example is New Orleans when the major floods happened and you do not expect the state of Louisiana to look after that.
We can design a framework that operates in normal times and I think it is an appropriate level of risk sharing, especially if the per capita method is used for income tax adjustment, but I think we also need to bear in mind what might happen if something exceptional happens in terms of risk sharing around the UK because it can never be predicted.
Chair: I am keen to move on because we have the Deputy First Minister coming in at 1.00 pm and we have a few more questions we would like to deal with.
Q97 Chris Law: It is a bit more about the compensation that was mentioned in the Smith commission if one Government, through either tax or spend, causes financial detriment to the other. Do you think compensation being spent is desirable or necessary and what are your thoughts on that being implemented?
Professor Bell: I do not think it is implementable. I think it is just too complicated. Trying to figure out the knock-on effects of changes in Scotland’s income tax structure on the rest of the UK or changes in Scotland APD on the rest of the UK or tax changes down south that might affect Scotland are too complicated to work out. We should maybe think about this in principle rather than in detail, that we should try to avoid detriment, but to have people spending lots of time trying to research the implications of tax changes would be fruitless because no one would eventually agree on them.
Professor Muscatelli: I would agree with that. My only caveat would be that if there are major changes to the tax structure in the UK, this is again where a fiscal arbitrator may be useful. Supposing that the future UK Government decide to have a major change in pension law or decide to completely change the way in which national insurance is structured, that is bound to have an impact on the Scottish tax base, and vice versa, as David has pointed out, in some cases of things that the Scottish Government might decide. I do think in normal times this would work, and I totally agree that you cannot have a mechanism to decide this, but what is the trigger for something really major—
Q98 Chair: Just to rush you through these things, how detrimental could Scotland, with 8.7% of the population of the UK, be to the rest of the United Kingdom?
Professor Bell: It could be localised. You can think of the north-east of England. The example that is often used is Newcastle Airport if Scotland chose to reduce its air passenger duty. It may not be a big effect but politically it could be quite important.
Professor Muscatelli: I agree with you that it would not be big in terms of overall tax base from Scotland to the rest of the UK, but it could be very big, rest of the UK to Scotland, if national insurance is changed or pension law or capital gains tax is completely reformed. I think we need to look at those possibilities.
Chris Law: Thanks for that. I had three other questions but I think you have answered them; it is a complete waste of time. I think we will move on swiftly.
Q99 Chair: I am quite keen to pursue the no detriment thing. I do recognise the APD issue, and I have two Newcastle colleagues on the Committee here.
Mr Anderson: Sunderland colleagues.
Chair: Sunderland colleagues, sorry. Tyneside colleagues. We know this is mentioned as an issue, but surely the way that no detriment works must mean such a small percentage and part of the UK population. We are more likely to be impacted with a detriment from policy decisions of the UK Government than we could ever have an influence with a detriment to the rest of the United Kingdom. Is it worth the UK Government pursuing this no detriment issue as it applies to them from Scotland?
Professor Bell: Probably not if we are thinking about the cash, but there may be a principle at stake and it might be pursued on the basis of that argument rather than the amount of money involved.
Professor Muscatelli: If I were the Scottish Government, I would certainly look to potential things that could be done at UK level that might impact on our taxpayers as well as to the rest of the UK income taxpayers.
Chair: Thank you. We will hopefully get a couple of questions on the welfare powers.
Q100 Mr Anderson: It pertains to some of the stuff you said about needs assessment. Do we need a needs assessment element because of the different demographic traits? We know that people, for a variety of reasons, die earlier and so on. Should that be built in?
Professor Bell: This was put to me last week in the Further Powers Committee, and you have a number of different welfare benefits being transferred: attendance allowance, disability living allowance, carers allowance and so on. You could try to fine tune a kind of needs assessment for Scotland in relation to each of these running forward so that Scotland is not exposed to additional risk. It would allow Scotland to redesign its welfare system, perhaps, but this is £2.5 billion. We are talking about £16 billion or thereabouts on the tax side. What we are talking about already is going to be quite complex. One alternative is to keep on applying the chosen method, like the per capita index deduction, to the welfare budget as well for the sake of simplicity, because all of this stuff will be contentious. For lack of future antagonism you may say, “Let us just agree that this is a good starting place” and try to stick with it.
Q101 Mr Anderson: Is there a risk that if you did change the needs assessment route, somewhere along the line you would have a clash between giving somebody an additional benefit within Scotland and then we claw it back because it would interact differentially with the UK system?
David Eiser: With the welfare benefits, one thing to recognise is that because these benefits at the moment are distributed according to eligibility criteria that are the same across the UK, what is being spent on those benefits in Scotland now effectively has been subject to a needs assessment. In the first year that the spending on these benefits has transferred, that effectively has been needs-assessed. My take is that in future you should probably use the same indexation method for moving that into the future that you choose for the tax, so if you go for per capita index deduction on tax, it makes sense to go for per capita index addition, I suppose it should be called, on the welfare side. Politically, the idea that we could do a needs assessment in future, when by that point the Scottish Government might have quite a different view on what disability needs are from that of the UK Government, and have an agreement on what needs assessment would look like and how that would work is probably unreasonable.
Chair: We are rushing through it now because we are quite keen to get your responses to a number of the issues, and I know we have spent quite a lot of time talking about borrowing and block grant adjustment. I think a couple of you did mention the issue of VAT and we are keen to explore that a little bit.
Q102 Mr Hepburn: What does Scotland gain by the proposal to get a share of the VAT, and how exactly do you think that share should be determined?
Professor Bell: Well, my contribution first. There is no immediately clear benefit in that Scotland will have effectively what is called an assigned tax, so Scotland will get its share of the 10p worth of spending that is subject to VAT in Scotland and it will not get to change the tax base or the tax rates. I suppose it could look at policies that will encourage people to spend in Scotland but, as we have already mentioned—it is a little bit of a contrast with income tax—it is going to be really difficult to figure out the actual amount of VAT. You have to think about where it is being spent. Is it being spent at source or at the origin? How will things like online shopping be dealt with? It does seem to me to raise a number of difficulties about getting a baseline for this tax.
Professor Muscatelli: I would agree with that, and hence the remarks that I made earlier. I do not think it provides a huge number of incentives, but I think we have to get it right because otherwise, as David Eiser pointed out, if you get these things wrong then it can be a source of political tension where perhaps there should not be on something like that. I think VAT is not an easy tax to devolve because of the issues around the value chain and the points that David has made. What you find is that in most countries where you do devolve elements of retail tax it tends to be sales taxes, for obvious reasons, because then at least it is easier to track. I would say let us get it right in terms of identifying what that share is. Let us make sure that there is a benefit to Scotland, for instance if Scotland were to attract more tourism or spend in Scotland, that is tracked in some way. At the moment it would be difficult to do so. That at least creates some incentive for Scotland to think about its tax base. I think that is the best that can be hoped for, given the structure.
Q103 Chair: Do any other colleagues have questions on VAT? I would like to end the session with a hypothetical question, which will hopefully not come to pass and I think we are all trying to ensure that it will not be the case. What happens if we do not get an agreement on the fiscal framework?
Professor Muscatelli: I suppose I have said publicly that I think the Scottish Government and the Scottish Parliament need to look carefully at pros and cons. As I said, the fiscal framework is as important as the Scotland Bill itself because it defines the base of resources on which these powers are to be exercised. Given the potential losses I think I highlighted on one scenario, if you contrasted the per capita method with the levels deduction method, over 10 years, with current population trends, in real terms the Scottish Parliament could lose £7 billion. That is sufficiently serious in the context of the total spend in Scotland that I do not think it would be wise to accept those powers. We know that until the fiscal framework is in place the Scotland Bill will not progress, but I think it would be unwise, frankly, to rush it and to reach a deal that then will lead to political recrimination and more conflict. I would say it is probably time to take a pause and possibly return to it after the election.
Q104 Chair: Do you think the Scottish Government are right to suggest, as they have done in a series of interventions on this issue, not to proceed unless they did get the right indexation and the right solution and settlement in the fiscal framework?
Professor Muscatelli: Absolutely. As I said publicly, I think you cannot accept additional powers at any price, because you might have those powers but you may have less resources than you should have rightly as part of the Smith agreement. If the Smith agreement is being violated, then I think they are entirely right to decline those additional powers.
David Eiser: I think if there was no agreement, that would be a worrying indictment about intergovernmental relations and how things might go in the future. At essence, some of the things that we are talking about here are really quite simple. Should we have an index deduction or a per capita index deduction, you would hope that there is scope for ultimately some agreement. There would clearly have to be some negotiations and some sort of quid pro quo type of adjustments. One thing that could be looked at, for example, is an agreement to go for per capita index deduction combined with some kind of ceiling on the Barnett consequential so that Scotland’s funding per capita does not increase beyond a certain point relative to RUK. You would hope that some kind of consensus could emerge. If it does not, then I do not know what the answer is.
Q105 Margaret Ferrier: Just a quick one, if the panel agrees or disagrees: to what extent do you think effective intergovernmental relations are key to these latest negotiations? My Committee colleague, Mr Chope, is hoping that there will be an enduring settlement, but we do not want to have to keep revisiting this over the years if we do not get it right.
Professor Bell: I do think it is very important to have these structures in place. For the sake of transparency and for the sake of sustainability, it does not seem to me that the way that current operations progress is necessarily leading to that outcome. Going back to the previous question, if I was being optimistic I would hope that if it does not make it through the parliamentary hurdles at this stage, there is an opportunity to revisit the Bill, include some of the fiscal framework in the Bill and maybe revisit it.
Q106 Chair: Is that possible? There will be a new Queen’s Speech in May. There will be the new legislative programme by UK Government, and it would be incumbent upon UK Government to include this as part of their legislative programme. Given that we have been through this experience and no agreement was reached, is it possible that there may not be a Scotland Bill if there is no agreement on this? We are really dependent on Westminster parliamentary time and the desire of UK Government to look at this again.
Professor Muscatelli: I am not an expert in parliamentary procedure, and of course it is a political judgment. I think it would not go down very well, given the importance of the vow and the Smith commission agreement. I agree with David. I think there would need to be parliamentary time given to it in order to ensure that we have an agreement. Can I stress again that it is because of the potential for future conflict, not just the need to reach a negotiation now, that I think it might be worth looking at the whole notion of an arbitrator in future? It is difficult to predict where issues might arise.
Chair: Great. Unless any other colleagues have any further questions, it is just a matter of thanking you for your attendance today. I think it has been a very helpful session and we have got through most of the issues that we wanted to touch on, even though we had to rush the latter stages of it. I am very grateful to you for attending the Scottish Affairs Committee. As always, with all the guests that we have in this Committee, if there is anything that you feel was not aired properly here, anything further you have to add to our report or inquiry, please give it to the Committee. Other than that, thank you very much for your attendance today.
Examination of Witnesses
Witnesses: John Swinney MSP, Deputy First Minister and Cabinet Secretary for Finance, Constitution and Economy, and Sean Neill, gave evidence.
Q107 Chair: Welcome to the second evidence session of the Scottish Affairs Committee’s fiscal framework inquiry at Perth College UHI. I do not think I have mentioned it but we are eternally grateful to UHI Perth College for allowing us to have this session here today. I think it is an excellent facility and hopefully this will not be our last visit to Perth. It is a great pleasure now to take evidence from the Deputy First Minister, who has been leading the negotiations on behalf of the Scottish Government, and we have Mr Neill also. Mr Swinney, is there anything you want to say to the Committee by way of an opening statement, and if Mr Neill would like to contribute too.
John Swinney: Thank you very much, Chair, and I welcome very much the invitation to provide evidence to this session of the Scottish Affairs Select Committee.
Paragraph 94 of the Smith commission report recommended that the devolution of further tax and spending powers to the Scottish Government should be accompanied by an updated fiscal framework for Scotland. In paragraph 95(9) Smith further recommended that the Scottish and United Kingdom Governments should jointly work together via the Joint Exchequer Committee to agree this revised fiscal and funding framework for Scotland. This is the process in which I am currently engaged with the UK Government, and the Joint Exchequer Committee has met seven times to date. Our overarching aim is to ensure that the new fiscal framework is fair and workable and is in line with the Smith commission report. Crucially, Smith identified that Scotland’s budget should be no larger or smaller simply as a result of the initial transfer of powers. We seek a fiscal framework that gives the Scottish Government the flexibility it needs to create a fair and prosperous Scotland and the ability to use the powers we have in an effective way. This has to be about genuine autonomy and choice. We know this must be done in a responsible and sustainable manner, in the same way that we have used all of our existing fiscal powers.
We need a fiscal framework that will ensure that further devolution provides the right incentives and increases accountability, linking the Scottish Government’s budget to Scottish economic performance. On 7 October I set out to the Scottish Parliament our areas where we need to reach agreement as part of an acceptable fiscal framework: on the block grant adjustment for tax, financial transfers to meet implementation and administration costs in full, and the questions of additional capital and resource borrowing. I have made it clear that I consider index deduction per capita to be the only block grant adjustment mechanism that meets the Smith criteria and that is fairest to Scotland.
There have been useful discussions on the other issues and progress is being made, but I believe we still have some significant distance to travel to resolve these matters. The negotiations need to conclude so that both Parliaments have time to scrutinise the framework and the Scottish Parliament can consider it alongside the Bill and the legislative consent motion, and that effectively has to happen by 12 February. This will require a lot of hard work and good faith to make sure it can be done, and I continue to operate in this manner. The Scottish Government have made it clear that we will not bring a legislative consent motion to the Scottish Parliament without an agreed fiscal framework that is fair to Scotland and that remains the case.
I am very keen to be helpful to the Committee in its inquiry today, but I would add the caveat that I have to respect the confidence of negotiations that remain underway with the United Kingdom Government.
Q108 Chair: I am very grateful to you, Deputy First Minister. Does Mr Neill want to add anything? I know that you will tell this Committee that you cannot provide any commentary on the intergovernmental conversations and discussions and negotiations that are currently ongoing, but is there any way that you could perhaps update the Committee about how far we have come in terms of progress? Is there anything you could say to characterise some of the difficulties that are still to be negotiated and dealt with between both Governments?
John Swinney: Chair, I think all of the issues are out on the table. The issues are presented and they have been well aired within the Joint Exchequer Committee. As well as seven meetings of the Joint Exchequer Committee involving Ministers, there have been a range and very substantial number of official discussions to undertake detailed preparatory work to support those ministerial discussions. I think all of the information and all of the detail is essentially out there. We are in a position where we need to conclude what agreement is possible on these questions and that, for me, is the best way to characterise where we have reached in these discussions.
Q109 Chair: I have noted that in some of the statements that have come from the Scottish Government, and you have said it in your opening statement, that you are not prepared to sign up to any agreement that may be to the detriment of Scotland’s financial and fiscal position. How serious is the Scottish Government about this? Would that, therefore, mean that the Scotland Bill that is currently being progressed through the House of Commons would effectively fall? Is this something that the Scottish Government are serious in doing, that they would knock back the Scotland Bill on the basis of this?
John Swinney: We have said that we would not put the question of legislative consent to the Scottish Parliament without being able at the same time to recommend an acceptable fiscal framework for implementation alongside the Scotland Bill provisions. The answer to your question is yes. The Government will not put forward a legislative consent motion until such time as we have an acceptable fiscal framework in place. It has been a very clearly advertised and communicated position of the Scottish Government. That has not stopped us going into these discussions in good faith, in participating in a whole range of different discussions to try to get to agreement, and it sums up and captures the basis and the approach that we will take for the remaining period available to us.
There has been some commentary about the significance of the date of 12 February, and essentially that is there to signal the last moment at which we can then embark upon effective parliamentary scrutiny of the fiscal framework within the Scottish Parliament as part of the legislative consent process.
Also, to be fair to the process in the United Kingdom Parliament, the existence of the fiscal framework and its requirement to be in place has been a very material part of the discussion within the House of Lords on the consideration of the Scotland Bill, and I think the expectation of the House of Lords would be that a fiscal framework would be in place before the House of Lords moves to consider the Bill at report stage.
Q110 Chair: We will come into some of the deeper issues about the block grant adjustment, but I think it is fair to say—and you can say what you want on this—that a lot of the sticking point does seem to be around this. We know the Scottish Government’s favoured position when it comes to the block grant adjustment and the per capita as a means to approach this. We asked some of the academics who were looking at it and who have studied it in great detail. There does seem to be an emerging consensus about the per capita index deduction, and it seems to be the way that meets the principles of Smith, and I think you said that in your opening statement too. What is stopping everybody just agreeing to this as a means of meeting the spirit of Smith, the no detriment principles and the issues about making sure there is going to be no great impact on Scotland’s budget as we go forward? What is sticking? Is the UK Government dragging their feet when it comes to considering the per capita?
John Swinney: On the first point that you make, Chair, it is very clear to me from the academic analysis that has been undertaken on this matter, and you heard from a selection of the academic experts just a moment ago. Emerging out of the contribution that has been made by Professor Muscatelli and Professor David Bell and the analysis of the Institute for Fiscal Studies is that the fulfilment of the no detriment principle inherent in the Smith commission report essentially is the application of index deduction per capita. That strikes me as a pretty overwhelming consensus in the academic analysis, having looked at the three possible options of index deduction per capita, index deduction and levels deduction. The consensus appears to me to be gravitating very much towards that point.
On the negotiations, I think all I could say at this stage is that we have not reached agreement. I believe that the Smith commission report is fulfilled by the agreement of index deduction per capita. It means that the Scottish budget is no better or no worse off as a consequence of the devolution of these powers, which is one of the central principles of the no detriment arrangements. It is then really a matter for us to conclude on this question as part of these discussions.
Q111 Mr Hepburn: What is the reason for the hold-up?
John Swinney: We have not concluded the discussion yet.
Q112 Mr Hepburn: We have had some very good visitors in today and they were as bemused as we were about the lack of transparency in this process. Why do you not just tell people what the issue is and, if it is the British Government, let people know that it is the British Government that is holding it up?
John Swinney: I think I am supported in the academic analysis that is put forward that index deduction per capita fulfils the details of the Smith commission report. If there was an agreement to that being the approach, then I would happily sign up to that. I do not have that agreement to sign up to yet, so the discussions go on to try to get to that point of view.
Q113 Mr Hepburn: So it is the per capita issue?
John Swinney: It is the fact that we do not have an agreement on the block grant adjustment mechanism. That is the difficulty, and that is what we are trying to resolve as part of this process.
Q114 Mr Chope: Can I ask you to put this in context? Is it correct that the Scottish Government are in favour of full fiscal autonomy?
John Swinney: We are, yes.
Q115 Mr Chope: What timescale do you have for implementing full fiscal autonomy?
John Swinney: That would depend on the political arrangements being in place to enable us to do that. Clearly the Scottish Government’s position on the constitutional question is that we believe in independence for Scotland and we would like Scotland to be an independent country, but I have to accept the fact that there was a referendum fairly recently that took the view that was not to be the case. We have argued as part of the discussions around the Smith commission for there to be a wider range of powers than we currently have, but that has not been agreed by the United Kingdom Government.
Q116 Mr Chope: Short of independence, you could have full fiscal autonomy, and surely consequent upon that would be taking responsibility for both the risks and rewards coming from the policies that were applied and implemented in Scotland?
John Swinney: That is correct, but what would also come with it would be a very broad range of powers to be able to do something about addressing those risks and making the most of those rewards. In the Smith commission report there is an acknowledgement, and the principle of economic responsibility is enshrined in the Smith commission report, because what Smith says—and this is an issue that really applies beyond the initial block grant adjustment—is that where the Scottish Government takes a decision, let us say, for example, on income tax, it has to live with the policy consequences of that, be they good or bad. The principle that Mr Chope raises with me of economic responsibility is actually enshrined within the Smith commission propositions. It is enshrined in a fashion and all the other arrangements are enshrined to reflect the fact that there are a certain number of powers being transferred to the Scottish Parliament to enable us to take policy choices, to improve economic performance or to take other decisions, but they are quite limited compared to the powers that would be available to us if we were to exercise full fiscal autonomy.
Q117 Mr Chope: If you had full fiscal autonomy, you would be bearing the risk in relation to the size of your population.
John Swinney: That would relate to whatever fiscal framework was put in place around those arrangements, because under full fiscal autonomy Scotland would still retain some degree of financial relationship with the rest of the United Kingdom. It would not be independence because there would still be areas in which there was a funding arrangement between the Scottish Parliament and the United Kingdom Parliament under full fiscal autonomy. There would still have to be a full fiscal framework that would have to be available to Government to navigate the issues that would arise out of such a constitutional arrangement.
Q118 Mr Chope: If your Government is re-elected in May, do you see full fiscal autonomy being implemented before the next Scottish Parliament elections?
John Swinney: That would depend on a whole series of questions around the constitutional debate and the interaction between the Scottish and United Kingdom Governments on the constitutional question.
Q119 Mr Chope: What is happening at the moment in these discussions that you are having at intergovernmental level is that it is basically an interim position that you are getting to. This is not going to be something that is going to last for very long because it is going to be superseded by full fiscal autonomy.
John Swinney: I think that depends on your point of view. I do not think that is an absolute point. There would be a body of opinion that would say what the Smith commission represents is the line in the sand; that is the definition of the constitutional arrangements. That is not my view because obviously I believe in Scottish independence. There will be people who will view the Smith commission report as a substantive transfer of responsibility that then becomes a settlement that they would want to see lasting for a very long period of time. Therefore, the fiscal arrangements must be able to support such a proposition and not to be in need of constant revisiting.
Q120 Mr Chope: One of the problems with the Smith report is that there is an inbuilt ambiguity into this whole issue about the nature of the fiscal framework, and that is the cause, is it not, of the dispute and discussions that you are having at the moment? With that ambiguity, different interpretations can be put upon the wording of Smith, and some of the experts that we have heard from have said it is impossible to implement all the Smith principles together because they are mutually incompatible.
John Swinney: I do not agree with that analysis because I think the Smith commission report is very clear on the questions that underpin the issues around the block grant adjustment. Also, I have the advantage that I was one of the members of the Smith commission, so I sat through the entirety of its deliberations. As well as seeing what is in the report, I also know what was in the thinking of my colleagues around the table of the Smith commission as the report was being put together. The position that I take is about making sure that the substance and the sentiments that are implicit in the Smith commission report are the ones that then see their way into the fiscal framework. I think the Smith commission report was very clear on the principle of no detriment as it relates to the core of the fiscal framework, which is that the Scottish budget should be no better or worse off as a consequence of the devolution of these responsibilities but, once exercised by policy, the Scottish Government must be held accountable and responsible for the successes and the failures of the exercise of that policy.
Q121 Mr Anderson: John, can you explain exactly why the deadline of 12 February has been put in place? My understanding is that Parliament is dissolved on 23 March, so you have something like six weeks. Why is that so tight, and why has it taken so long? My understanding is that originally the timetable was looking to get this resolved by the autumn, and in December your leader said that she would expect that it would be finished by mid-February. We might still get there. What if we do not? Why has it taken that long and why is that block there?
John Swinney: The discussions on the fiscal framework effectively started when I had a conversation with the Chancellor of the Exchequer. I might have to write to the Committee with the exact dates of this, but I am pretty sure the conversation was before the UK Budget in March 2015. The Chancellor and I had a meeting in which we decided to kick off the whole process of taking forward the fiscal framework arrangements. The UK Parliament was being dissolved for the Westminster election and we agreed that that would be undertaken at official level. My officials interacted with that.
Then I think in about early June I met again with the Chancellor to take stock of the work that had been undertaken at official level and to start the ministerial discussions. Those ministerial discussions went on pretty regularly over the course of the late summer, getting us to a point whereby in about late October we came to the conclusion that we were not going to be able to resolve the issues in advance of the UK spending review, which is what had been our intention and we had not got to agreement before that time.
After the UK spending review, in December we recommenced the discussions, albeit I was also wrestling with setting a budget in the Scottish Parliament at the same time but we pressed ahead with the discussions and we have had a number of them since. Fundamentally—this goes back to my answers to Mr Hepburn—we are involved in a discussion to try to get to agreement, but we have not got to agreement yet and that is the challenge that remains.
In relation to the timescale of why 12 February matters, our Parliament has to undertake scrutiny of the legislative consent motion that will surround the Scotland Bill and the fiscal framework, and that would be the case in relation to any piece of legislation that requires legislative consent. Our Parliament, like the United Kingdom Parliament, goes into recess on 12 February until 21 February. There is then a window from 21 February until, we reckon, about 17 March, in which our Committee of Parliament can consider the details of the legislative consent motion and then for Parliament to have a plenary debate about that, to conclude by 17 March, to enable the third reading at the Lords by 24 March, which is the interaction between the parliamentary timetable in Scotland and the parliamentary timetable in the United Kingdom Parliament.
Q122 Chair: We have the Chief Secretary of the Treasury appearing before this Committee a week on Wednesday and we will ask him this too, but just your view: do you get the sense that the Treasury get the seriousness of this? Are they aware of the timelines that are involved? Do they understand that without a proper, full agreement there might be massive issues about the Scotland Bill being passed before the end of this parliamentary session at Westminster?
John Swinney: I cannot see into the minds of the Treasury, Chair, but what I would say is that nobody in the Treasury could be in any doubt about the significance and the seriousness of the timetable that I have outlined to the Committee today.
Q123 Chair: I am grateful. We will move on to some of the bigger issues about all this. I want to first of all ask you about exposure to risk, which is something that has come out in a number of discussions and debates about fiscal frameworks. It is particularly something that came out when David Phillips gave evidence in the House of Commons last week, and this was about who bears the risk of exogenous shocks. I think an example that was raised and the one that we have not had a sufficient answer to is that these are shocks that affect Scotland but over which the Scottish Government have no control. Who bears the risk of these exogenous shocks? Is that something that you would expect would be the UK Government or would that be the responsibility of the Scottish Government?
John Swinney: The question of a shock that was a United Kingdom-wide, general economic shock clearly rests with the United Kingdom Government, given the provisions of the Scotland Act 1998 and the fact that that carries specific reservation around the issue of macroeconomic stability. Those issues are essentially reserved for the United Kingdom Government, and nothing in this legislation on the fiscal framework would change that. The relevant question is what happens to a Scotland-only shock that takes place outwith any shock to the rest of the United Kingdom. The point to me is that we have to accept that there will be that assumption of responsibility here in Scotland as a consequence of that fact, but we have to be able to take effective action to mitigate that. I think the distinctive economic levers that we can utilise to try to deal with such an economic shock are limited within Scotland, but I do think there is a necessity for us to have sufficient financial flexibility to deal with the implications of a Scotland-only economic shock for which we should be responsible and for which we should handle and manage the issues that would be implicit in that.
Although we would undoubtedly, in a Smith commission process, given the tax issues that will now be devolved as a consequence, increase the volume of risk being carried by the Scottish Government, I think we need to have sufficient financial flexibility to be able to handle that. I would also like us to have sufficient financial powers to be able to handle that, but I think that is a limited factor in the conclusions of the Smith commission.
Chair: I am grateful.
Q124 Chris Law: I want to touch a little bit more on flexibility. Given that you have to run balanced budgets every year at the moment, under the new devolved powers do you think that should continue?
John Swinney: I think running a balanced budget generally is a pretty good thing and instils a degree of fiscal discipline into the choices that have to be made by any administration. What we have to recognise, however, is that with the assumption of a much greater degree of risk that the Scottish Government will be assuming as part of the Smith commission process, there also is a requirement for us to have some counterbalancing flexibilities to enable us to handle that. For those reasons we have been discussing, as part of the fiscal framework arrangements, the implementation of the arguments inherent in the Smith commission report about the importance of us having sufficient capacity and capability to handle fluctuations in volatility and revenue to enable us to operate within that context.
Q125 Chair: It has been mentioned that the figure that we see for the increase in borrowing is up to a maximum of £500 million. I do not know if that is a figure that you recognise and whether that is something you feel would be sufficient to mitigate against any shocks that may be Scottish-based.
John Swinney: There has to be sufficient borrowing capability to enable the Scottish Government to manage their circumstances. There also has to be sufficient flexibility around issues in connection with the utilisation of budget exchange facilities that will transfer financial resources from one year to another to enable us to maximise spending power and to ensure that at no stage is spending power ever lost from the process of the advantage of the Scottish Parliament. These are obviously details that are the subject of active negotiation, but there has to be an agreement around an acceptable level of resource borrowing.
Q126 Margaret Ferrier: On the sources and cost of Scottish borrowing, currently the cost of Scottish Government borrowing is borne by the UK Government. Under the new framework, how will Scotland contribute to the cost of both UK borrowing and its own borrowing, and would it be going down the route of the National Loans Fund?
John Swinney: Essentially Scotland’s contribution to supporting United Kingdom borrowing will be funded by the existing constitutional and financial arrangements where tax income from the individual and corporate sector in Scotland is channelled into the United Kingdom Treasury, which makes strategic decisions about the macro finances of the United Kingdom and supports the appropriate level of borrowing from those resources. That would not change under these arrangements.
Under the devolution arrangements, we already have a borrowing facility through the Calman commission, and this is the first year in which that borrowing power is being exercised. I have signalled in my budget for the current financial year that we expect to borrow about £304 million, although we have not as yet borrowed that money given the fact that we will only get around to borrowing it when we actually need the cash to support investment programmes. That will be supported by the public finances of Scotland, for which I am responsible, so when the Scottish Government take on any borrowing it will be up to the Scottish Government to service that borrowing arrangement. I suppose the clearest way I can answer the final point that Margaret Ferrier has raised with me is that we will raise the borrowing at the cheapest price we can get, so that is what will be uppermost in my mind as we seek appropriate borrowing to support capital programmes.
Q127 Margaret Ferrier: The Chancellor currently delivers borrowing forecasts twice a year, which are scrutinised by the OBR. Would the Scottish Government be prepared to make a similar commitment?
John Swinney: I certainly recognise the importance of independent scrutiny of our fiscal decisions and fiscal plans. For that reason I established, in shadow form, the Scottish Fiscal Commission, which is a panel of three members appointed by Parliament to scrutinise the forecasts that are made of tax that would be generated within Scotland. The Fiscal Commission has exercised its responsibilities now on two occasions for the 2015-2016 budget and is just as involved in the scrutiny around the 2016-2017 budget. The Scottish Parliament is currently considering the Scottish Fiscal Commission Bill, which will put the Fiscal Commission on to a statutory footing to enable it to exercise its full responsibilities.
Chair: Kirsty Blackman has some questions on the block grant and some of the indices that we have already discussed.
Q128 Kirsty Blackman: I am going to start off with one about borrowing, and then I will move on. In terms of the constraints on the Scottish Government’s borrowing, do you have a final position or an agreed position, that you can tell us, on what will constrain the Scottish Government’s borrowing levels? Will it be constrained by the UK Government’s fiscal charges, for example? If the UK Government over borrows, will that reduce the ability of Scotland to borrow?
John Swinney: I do not think it should. Essentially where the United Kingdom Parliament provides, by statute or by agreement, a certain amount of borrowing capability for the Scottish Government to undertake then that should be an end to the matter from the perspective of the United Kingdom Government. The issue the UK Government would have to wrestle with, given the changes that have been made through the fiscal charter, is to ensure that the UK Government can fulfil their commitment to the Scottish Parliament to enable the Scottish Government to borrow within the limits that are set. Clearly, if a limit is set we have to live within that limit, and I have no issue with that. That is a perfectly reasonable proposition for the UK Government to put forward. What would constrain it would be the fiscal decisions that we make about whether we are able to support that level of borrowing with revenue support to make sure that the borrowing was effectively supported and repaid accordingly.
Q129 Chair: Before we leave borrowing entirely because I know that we are coming on to block grants, could you let this Committee know: are we closer to an arrangement that deals with borrowing? Is that still outstanding, your conversation with the UK Government? Is that a bit easier to deal with than some of the bigger things about the block grant adjustment?
John Swinney: I probably should have put a caveat or shared with the Committee the parameters within which we are operating on the Joint Exchequer Committee. Essentially we operate on the principle —and I think Members of the House of Commons may have heard this through the Chief Secretary—that nothing is agreed until everything is agreed. Therefore, it makes it difficult for me to answer specifically. I know exactly why you are asking the question. Some of the issues are easier to resolve. There are issues around revenue borrowing, for example, where it is clear to see how we can make a way through some of these issues. Other issues are more challenging.
Q130 Kirsty Blackman: A few questions now on the adjustment of the block grant. The first one is about the initial deductions from the block grant. What is your point of view on how the initial deductions should be agreed from the block grant?
John Swinney: In relation to the steps that have to be taken—I have said to the Committee already—we have a view about the most appropriate mechanism for adjustment and that the arrangement should be put in place to enable that to happen. Obviously that will have made, in the course of the last two years, specific one-off agreements with the United Kingdom Government upon block grant adjustments for the devolution of the smaller taxes, in both 2015-2016 and 2016-2017. Essentially, we would put in place for those arrangements to be arrived at and then implemented as part of our budget saving process.
Q131 Kirsty Blackman: Is it your position that the per capita index deduction should be used for all of the revenue streams or is it just for certain ones?
John Swinney: That would be appropriate for all revenue streams, yes.
Q132 Kirsty Blackman: In terms of the budget of one Government not being affected by the other in getting on to the second no detriment principle, we heard from the academics earlier about how you could index production per capita in order to take account of those things. What is your position on that?
John Swinney: One of the things I have recognised as a consequence of the Smith commission decisions is that there will be circumstances in which there may be the potential for decisions to be taken, let’s say, by the United Kingdom Government or a tax that is a devolved tax to the Scottish Parliament whereby there may be a benefit to Scotland, if you apply index deductions per capita to that change. If that tax has been devolved to Scotland already we have to take account of the fact that by the normal run of the updating financial arrangements there might be a benefit that would come to the Scottish Parliament. That issue has to be addressed as part of the discussions. We are perfectly happy to address that.
Q133 Mr Chope: Following on from that, if the UK Government wanted to increase spending in a reserved area such as international development, how would Scotland’s contribution be captured under the new fiscal framework?
John Swinney: Essentially by the fact that we will be making our financial contributions to the individual and the corporate sector in Scotland into the public finances of the United Kingdom. The UK Government will then make their decisions across 100% of their public expenditure, some of which may affect devolved areas, some of which may affect reserved areas. The Barnett formula essentially will take account of that point, as it currently does. The Barnett formula determines what are the proceeds for the public finances of Scotland as a consequence of decisions taken quite properly by the United Kingdom Government. The balance between reserved and devolved areas of expenditure has a material effect on the budget available to the Scottish Government as a consequence of applying the Barnett formula.
Q134 Mr Chope: Is it as simple as that? We have heard that the United Kingdom Government say that there will need to be a shared understanding of the second principle in the Smith agreement, the no detriment principle. There will need to be a shared understanding of this principle in order to deliver a workable outcome. Do you think there is a shared understanding between the Scottish Government and the UK Government on that?
John Swinney: When it comes to the Smith commission report—and it is quite helpful here—in section 95(4) it talks about, “No detriment as a result of UK Government or Scottish Government policy decisions post devolution”. We can quite clearly chart what are policy decisions by the United Kingdom Government for the Scottish Government. It would be possible to design a set of arrangements that would take due account of that factor and to see that applied through the financial arrangements. That is perfectly possible to be achieved. It is preferable if that can be achieved in a mechanistic fashion. If I give the Committee a comparable example: the Barnett formula includes a whole series of compatibility factors between lines of public expenditure in the rest of the United Kingdom, right across public expenditure and the rest of the UK. For example, on defence the compatibility factor is zero whereas on health it is 100%.
When the United Kingdom Government take their decisions on putting however much money into defence, however much money into health, it is entirely mechanistic about what then flows through into Scotland as a consequence. In my eight and a half years as a Finance Minister I struggle to think of an occasion where I found it necessary to take issue with a Barnett application, because it is mechanistic. I can look at what the Treasury shows in the Red Book about the policy change decisions. I can see where it then flows into the spreadsheet on the Barnett formula. I can look at compatibility factors and there is the answer. It takes a bit of interrogating and the word “transparent” might be a bit of an exaggeration of its simplicity but it is perfectly open as a piece of analysis.
Q135 Mr Chope: What you are saying is that the no detriment principle is basically another way of expressing the retention of the Barnett formula? It does not add anything beyond what is already in the Barnett formula?
John Swinney: No, I am using the Barnett formula as an illustration of something that can be designed mechanistically to try to address this point. That is the only comparison I am making there. There are two no detriment principles. The first is that the Scottish budget should be no better or worse off as a consequence of the devolution of their powers. That is why index deduction per capita is the right solution to that. The second no detriment principle is the one I have just rehearsed with the Committee, which is no detriment as a result of UK Government or Scottish policy decisions across devolution. That will take a bit of defining but it can be defined. It would be preferable if it was defined mechanistically.
Q136 Mr Chope: You say you want to get this all sorted out by 12 February—two or three weeks away—and it does not seem as though you and the UK Government are anywhere near having a shared understanding of the principle in the Smith agreement, like no detriment.
John Swinney: I said in an earlier answer to the Chair that all of the information, all of the detail is out on the table. It is a question of coming to conclusions about it. That is the space that remains to be resolved and filled between now and 12 February.
Q137 Chair: You were on the Smith commission and I think you have said several times now that what underpinned most of the discussion, arrangements and agreement is the Barnett formula. In response to Mr Chope, you said that it is relatively straightforward and transparent; people can see what is happening with the Barnett formula. Was there ever any conversation that suggested that Barnett should not have been at the heart of all this? We have had conversations in the Westminster Parliament, particularly from some Government Back-Benchers, that we should be moving towards a needs-based formula across the United Kingdom. Was that ever a feature of the conversations you had and is Barnett central to every arrangement we have when we come to the fiscal framework?
John Swinney: Barnett is utterly central to this process. The reason for that is very simple. In the last few days of the referendum campaign the three United Kingdom party leaders agreed the vow, as it is known, and shared that widely with the electorate in Scotland. One of the key elements of that was the maintenance of the Barnett formula as the means of determining public expenditure within Scotland. That was essentially followed up by being anchored in the Smith commission report, which at paragraph 95(1) says, “The block grant from the United Kingdom Government to Scotland will continue to be determined via the operation of the Barnett formula”, and that was agreed by all participants in the Smith commission. It was one of the areas where the members of the Smith commission were at their strongest, clearest, most specific that that had to remain the case. Why? Because it emanated from the vow that was so central to the promise that was made to people about additional powers after the referendum. It was, of course, part of the current United Kingdom Government’s manifesto at the 2015 election.
Q138 Chair: Why I am asking you this—and again this is something we will put to the Chief Secretary when he does appear before the Committee—is that maybe the hesitation and failure to reach an agreement in the Treasury is because they are looking possibly at how they could undermine Barnett because of some political pressures that may be coming to the Government about this. I do not know if you want to respond to that. Is there any sense that Barnett is central, as you said, to all this and it runs through every single principle, but we must recognise that there is a hostility to Barnett that is expressed several times in the House of Commons? Do you think this might be informing some of the Treasury’s approach to some of these issues?
John Swinney: There would be no basis upon which that could be the case because the agreement that was made by the three party leaders to essentially reaffirm to people in Scotland that the Barnett formula would determine public expenditure in Scotland was central to the vow. It then became central to the Smith commission. It would be an act of very bad faith if there was an attempt to walk away from that commitment.
We can row forward—and academics have done this, the Institute for Fiscal Studies has done this, Professor Muscatelli has done this—to what does the application of the Barnett formula look like to the public expenditure of Scotland in the years to come? We can apply to that the different mechanisms—index deduction per capita, index deduction levels—and can see what is the difference. Only with index deduction per capita do you get to a point where the public expenditure that would have been envisaged under the Barnett formula will come if you apply index deduction per capita. That essentially fulfils the first no detriment principle that the Scottish budget should be no better or worse off as a consequence of the devolution of these powers.
Q139 Mr Anderson: Could I get to the bottom of this: are the obstacles to moving forward political or technical? If they are political, surely that should be shared with parliamentarians across both Scotland and the UK so we can disassociate the people concerned. Scotland politics is too important. If it is technical—and this came up in earlier hearings—surely we should be allowing other people to have a look at the problems that you are hitting so that they can give a view on whether there is another way or address the problems you are having. My understanding is that both your Government and the UK Government refuse to produce papers, share minutes with the Joint Exchequer Committee on what did happen, by the sounds of it, in 2012 plus the 2012 Act. If we were allowed to give people like Professor Muscatelli and others access to these, could not there be a debate about is there no relevance or there is no other way to know what you are doing is correct? Without that clear understanding, from my point of view, the transparency is not there, but also a possible wrong way. I keep thinking back that 25 years ago the same people who were probably advising the UK Government are the same people who are advising the Conservative Government and the Labour Government in the 1990s, the private finance initiative is the greatest thing since sliced bread, and other people on the side were saying, “No, you are not right”. If you are not opening up access to what is going on you are potentially missing a chance to get this resolved.
John Swinney: On your point, Mr Anderson, on the private finance initiative, I could not agree with you more about your observations on that. Consider yourself with an ally over here on your concerns about that.
First, on the issue of transparency, I have to accept 50% of the responsibility for it. When we started this process we agreed that we would respect the confidence of that negotiation, that we would not provide an external running commentary. I signed up to that, so I have to accept in front of the Committee that I am part of that agreement that said we will respect the confidence of this agreement. That is very clear acceptance of responsibility on my part.
Secondly, I do not think there is a technical obstacle here, because you have had the technical experts in front of you. You have had Professor Muscatelli, Professor Bell and the IFS who have been across all of this. I do not see any evidence in the commentary from further afield that suggests in any way there is a technical impediment to this issue being able to be resolved.
Ultimately it comes down to agreement. Your point, Mr Anderson, about the issues being viewed and considered and a judgment being made about where the impediments lie, that moment will come if we are unable to get to an agreement. We are not at the moment of no agreement yet. We have a couple of weeks in which we have to conclude this process. If we do not conclude this process then we will not be able to advise Parliament to support a legislative consent motion. We are not at the end of the road yet. We are getting close to the end of the road and we still have a lot of distance to travel, but the material that we need to inform the decision-making that will get us to an agreed position at the end of the road is available to all of us.
Q140 Mr Anderson: Surely, before getting to the end of the road is the time to try to get it resolved. If we get to 12 February, unfortunately there is nothing we can do. I understand what you said about legislative process, so that means there is a hiatus for at least three months or whatever, instead of if we start from today saying it is time, collectively, we are going to work together, surely that is the time to start ringing bells.
John Swinney: I can assure the Committee—and I give this very clear assurance to the Committee—that I am absolutely committed to giving whatever time is required to secure the necessary deal between now and 12 February. That is my absolute commitment to the Committee today. It is my commitment to the Parliament of Scotland as well. I recognise the importance of this issue, I recognise the importance of getting it right, and I am prepared to spend the time to do so.
Q141 Chair: We will move on. As well as the block grant adjustment in terms of the budget in its totality, there is the devolution of significant welfare powers, 10 new welfare powers coming to the Scottish Parliament. Tell me if it is correct, but you would see the way that these were to be worked out is that the per capita index deductions to that would be how they would be applied in order to assume the responsibility for this. Given the level of welfare spending there is in Scotland compared to the rest of the United Kingdom, do you see particular difficulties in assessing how this should be accounted for in the Scottish budget and should the block grant be adjusted to take account of the devolution of these spending powers?
John Swinney: What is appropriate is to recognise the starting point for the levels of benefit payment and to adjust to respect and to protect; that was part of the process.
Chair: Margaret Ferrier has a question about the relationship between devolved and reserved benefits.
Q142 Margaret Ferrier: Third sector organisations state that a further complication is that a number of the benefits that were due to be devolved are used to determine eligibility for benefits that will remain reserved. An example is the carers allowance is going to be devolved and it reduces eligibility for other benefits such as income support and universal credit that are going to be reserved. What steps will you take to ensure that people who rely on benefits will be able to understand and not be disadvantaged by two separate systems and all the interdependencies that may well result from that?
John Swinney: We would have to be particularly attentive to making sure that that difficulty and danger is avoided and that we are careful to ensure that the dialogue between the Scottish Government and the Department for Work and Pensions is of such a nature that nobody suffers as a consequence of that approach.
Chair: Does anybody have other questions on the welfare? I know we are rushing through.
Q143 Mr Chope: In the Smith commission it was said that if a tax or spending decision causes financial detriment to the other party then compensation should be paid. Could you tell us how that is going to be resolved? Who is going to decide that compensation is due and how much?
John Swinney: The first point on that is we have to get the rules of engagement correct at the outset so that we know what is potentially in scope for that type of what I might call spill-over effect, so we define that correctly to begin with. Secondly, it has to be evidenced to substantiate a link between the actions of a Government and the direct increase in cost upon another. Thirdly, given the sensitivity of what is involved here, it would benefit from third-party scrutiny to ensure that there was an independent assessment of what are the implications of many of these issues and choices.
Q144 Mr Chope: All that is being worked on as part of this agreement?
John Swinney: Yes.
Q145 Chair: One of the things we explored with our academic guests was this idea of no detriment and how it is applied between Scotland and the United Kingdom. Given that we are only 8.7% of the population, what possible detriment could we inflict upon the rest of the United Kingdom? They have much more ability, given the size and the fact that there are so many reserved powers still in the hands of UK Government, to have a detrimental impact on Scotland. Do you have a view about how detriment in terms of balance should be shaped up as we approach these issues?
John Swinney: That is why it is so important—my first point in answer to Mr Chope is critical in this—that these issues are defined clearly and substantively to enable the gathering of evidence to substantiate it. I rather take your view, Chair, that there are going to be circumstances where the Scottish Government or the United Kingdom Government may take particular decisions. It is less likely for our decisions to have a significant impact on the UK Government, but there could be others, the other way around, which might be material.
It is important that these issues are clarified better than they are just now. The Committee may well be familiar with the issue around free personal care where the Scottish Parliament a number of years ago decided to introduce free personal care. There was a beneficial impact then on the United Kingdom Government’s payments for attendance allowance for which we did not get any compensatory benefit. It is not all that it is just decisions in Scotland may cause detriment to the United Kingdom Government; we can create benefits from which we are entitled to have some form of recompense.
Chair: If we can briefly touch on VAT. I know that with the first 10% standard rate VAT will be devolved as part of this package, and Chris Law has a question on VAT.
Q146 Chris Law: It is a general question about VAT being assigned to Scotland. How will Scotland benefit as a result? How will it be measured effectively, given that a good percentage of VAT is done through online sales?
John Swinney: Again this is an area where we will be creating a new dataset to try to establish the levels of VAT that are appropriate to be allocated towards Scotland. There is a lot of official work that has been undertaken to try to get us to that position and to form a view of what is the best assessment mechanism for VAT assignment. Without breaching too much of the confidence of the process, there is a general agreement that the consumption method is the best way of doing exactly that and to essentially use that to determine the basis of the assignment process.
Q147 Chair: On VAT, we heard from Professor Muscatelli and Professor Bell that this could work to the advantage of the Scottish Government if they are able to grow the economy, and they cited tourism as an example of that. Is that a devolution of a power that you welcome? How would you see the Scottish Government being able to use the new responsibilities when it comes to collecting that first 10% of VAT?
John Swinney: We do not get any power over VAT. We have assigned to us the receipts, and clearly it is an incentive mechanism. It is an incentive for us to improve the performance of the Scottish economy because if we do that then there will be the potential for it to be a benefit as a consequence of more successful economic activity. You asked, Chair, if I saw it as a welcome power. I welcome the Smith commission report. I welcome the new powers that are proposed to come to Scotland. I can see in the assignation of VAT a mechanism and a means whereby we could be able to deliver stronger economic performance and gain a result as a consequence.
Q148 Chair: I am just noting the evidence from Dr James Cuthbert to the Lords Economic Affairs Committee where he says it is difficult to see where Scotland gets anything from the proposal to hypothecate to Scotland a share of VAT revenues. I am presuming that is not a view that you share.
John Swinney: I do not share that view.
Q149 Chair: We were going to go on to some of the issues around forecasting and transparency, and Mr Anderson had a question. We have dealt with most of these issues and questions, unless anybody else has anything in terms of forecasting and transparency. We know the Scottish Government’s desire to have the Fiscal Commission on a statutory basis. I have noted your comments that you do not want this to be read or be visited, but by its nature this is something that will inevitably arise as we go forward to see how it is working. I am presuming that you see the Fiscal Commission as having the oversight of this as it goes forward. Would it be a task for the Office of Budget Responsibility or a combination of them both to review this as we go forward?
John Swinney: To review?
Chair: The fiscal framework to see how it is working and assessing whether it is delivering the principles of no detriment; it is just an overview about how successful it has been.
John Swinney: I generally take the view that, given the nature of some of these issues, some independent scrutiny of the process would be a good thing. I am quite open to what that might be like, depending on the nature of the fiscal framework that emerges. There could well be a strong case for third-party arbitration but certainly independent scrutiny from independent fiscal institutions would be beneficial.
Q150 Chair: How would you see that taking shape? Would it be a combination of Fiscal Commission and OBR or exclusive responsibility to the Fiscal Commission?
John Swinney: It would have to be a degree of joint endeavour.
Q151 Mr Chope: What about the courts? Do you see scope for judicial review, court cases?
John Swinney: Generally not very keen on that.
Q152 Mr Chope: No, but will they be excluded by the agreement?
John Swinney: That is a good question. I was hoping I was coming here to shorten the list of questions, Mr Chope, but you have just expanded it. Generally these are issues that should be solved through appropriate intergovernmental machinery.
Q153 Chris Law: One of the main roles of the Scottish Affairs Select Committee is to scrutinise work in the Scotland House, but am I right in understanding that there has been no negotiation between the Scottish Government and David Mundell, particularly the negotiations on fiscal framework?
John Swinney: The negotiations on the fiscal framework have been taken forward between the Scottish Government and the Treasury, to the delight of the Treasury. My first discussion was with the Chancellor and my second was with the Chancellor. All of the subsequent discussions have been with the Chief Secretary to the Treasury and his officials. Lord Dunlop has been participating in those discussions. I think he has been participating in those discussions as a special adviser but the Committee is the best place to explore that point.
Q154 Chair: The last question from me: what happens next? Is there a timetable for further conversations and discussions with the UK Government? You have set the date; everybody clearly understands that 12 February is a critical date in the calendar for coming to an arrangement and agreement on this. Where do we go now and what is left of the conversations and negotiations?
John Swinney: Mr Anderson asked me about the longer timescale of this whole process. I generally think there has been enough time devoted to get us to where we are just now. I last met the Chief Secretary on Thursday last week to discuss these issues. My officials are involved in a teleconference with the Treasury in about an hour's time this afternoon to take forward that meeting. I am scheduled to see the Chief Secretary again at the start of next week, although I am always available for telephone contact and other discussions in the shorter term than that. There is a further discussion next week and obviously there is scope for interaction between our respective officials to take these issues forward.
Q155 Chair: Would it be fair to characterise conversations as intense and a real desire to get these things fixed out?
John Swinney: Yes.
Q156 Chair: Do you sense an emerging mood that wants to get these things resolved? Is there an understanding just how critical all this is?
John Swinney: I can only speak on behalf of the Scottish Government and we welcome the powers that are allocated to that and suggested through the Scotland Act 2015. We want to secure those powers and we want to secure the fiscal framework that enables us to exercise those powers consistent with the Smith commission report. As I indicated previously, I will allocate whatever time is required to make sure that is done to enable us to recommend to Parliament that legislative consent be given, but we have to make sure there is adequate time for that issue to be considered and that we have a fiscal framework that is appropriate and fair to Scotland.
Chair: I am grateful, Deputy First Minister. Unless there are any further questions, we are grateful for your evidence. You have shared with us a number of issues that we will be able to consider. We are looking to speak to the Chief Secretary of Treasury next Wednesday. If there is anything further that you feel would assist the Committee on this inquiry, I am sure you know where you will be able to give it. But we are grateful for your time this afternoon, and thank you.