Written evidence submitted by Richard Parry, Honorary Fellow, School of Social and Political Science, University of Edinburgh (FSG0005)
The Financing of the Scottish Government
Richard Parry, now based at the Centre on Constitutional Change, has written about devolution and public expenditure issues since the 1980s and was involved in Economic and Social Research Council projects on the Treasury and social policy, the implementation of devolution from 1999, and the Smith commission’s work in 2014.
Introduction
1.The Committee’s present inquiry builds on work over many decades into the funding of the Scottish administration pre- and post-devolution. This work is necessary because the United Kingdom lacks stable and impartial institutional mechanisms for managing financial transfers between levels of government. Instead, expenditure management flows from the unitary power of the UK executive, embodied in the Treasury. There is a lack of correspondence between policy responsibilities and funding rights, which for decades before devolution has made central-local relations intractable. Spending by all levels of government forms part of the total expenditure managed by the Treasury, which is embedded into the management of the UK economy.
2.The lack of an impartial monitor of multi-level fiscal relationships has placed great responsibility on external monitors of the system – for a long time David Heald, Iain McLean and David Bell, and more recently the Institute for Fiscal Studies (especially David Phillips). In Scotland the Fraser of Allander Institute at the University of Strathclyde has been an influential source of economic forecasting. In an important link into the institutions of devolved government, Strathclyde professor Graeme Roy heads the Scottish Fiscal Commission while continuing to write in the public media. The evidence of these experts, typically coming from an economics background, will no doubt be central to the inquiry, and those without their technical expertise should be cautious about what they say. Nevertheless, some longer-term perspectives from a political science background may be of some use.
How we reached the present position
3.The financing of the Scottish public sector pre-devolution was a constant political struggle by Scottish interests to convince the UK centre that Scotland deserved more generous public expenditure than the UK average. This was partly a matter of needs – poverty, deprivation, climate, sparsity – and partly one of history – strong health and education systems (coming together in medical education) that were admired as UK assets.
4.These contentions did not receive much objective scrutiny until the Needs Assessment Study of 1979 which confirmed Treasury suspicions that Scotland had acquired a financial premium from its political clout (16% greater need, 28% greater expenditure than England in programmes proposed for devolution in 1978) and that Wales and Northern Ireland were relatively more deserving. Doing something about it was more difficult; Labour governments were strong in Scotland and so spent, but Conservative governments also spent because they were weak but aspired to regain their former position.
5.The answer when it came was to set in place a formula that at least capped the Scottish advantage. At the end of the 1970s what came to be called the Barnett formula crept in unannounced to relate non-English expenditure changes to changes in comparable English expenditure on a population basis. This was made possible by an institutional structure of territorial departments in UK government with budgetary lines (the ‘block’ within total managed expenditure). For the Treasury, the system could now be set free from the need for spending claims that inconvenienced both parties, while leaving them within a mechanism that basically expressed control and discretion. The extraordinary thing is that this system, intended to be temporary and rough-and-ready, was made to work both pre- and post-legislative devolution.
6. For all the criticism it has faced, Barnett is actually very simple. But it does rely on two things – accurate delineation of English-equivalent expenditure, and agreed protocols for adjusting population shares. Both are contentious, but work in different directions. It is tempting for the Treasury to see some spending in England as not exclusively benefiting England, and so not qualifying for Barnett adjustment; there have been well-publicised disputes over the 2012 London Olympics and rail spending in England contended to also benefit Wales. And for devolved administrations, the long-term decline of their population relative to the UK total has created a dividend from resisting for as long as possible accurately-measured real-time adjustments of the spending ratio. Scottish civil servants have a long history of this, dating from the Goschen formula of 1888 (actually based on tax revenues) of England and Wales 80%, Scotland 11%, Ireland 9%. Barnett’s England 85%, Scotland 10%, Wales 5% was a rounded population basis whose numbers did not start to be adjusted until 1992.
7.Here the lack of independent monitoring is a political problem. The Treasury’s Statement of Funding Policy in its successive editions (the tenth coming in November 2023) is just that – a statement of what is possible within an ultimately non-federal structure. This mirrors central-local relations throughout the UK, in which financial rules can be changed from the centre in a way that puts local government in a constant state of uncertainty and disadvantage. Recent cases in England of authorities needing to go into special measures (usually in order to give them leeway to realise capital assets) have often arisen from issues where they feel themselves victims, such as adult social care costs mandated by the health service, and (often over-estimated) costs of settling equal pay cases.
8.The 1999 devolved financial arrangements built upon the institutional carry-over from Scottish Office to Scottish Executive (from 2007 Scottish Government (SG)). The Parliament was new, the administration was not. Very limited powers on income tax were secured by a second question in the 1997 referendum, and these built in two longer-lasting principles: that the taxation of savings and dividends was not within devolved scope, and that the test of residence was the balance of time spent in Scotland and the rest of the UK (not a ‘domicile’ concept, and in time allowing a taxpayer to have a significant business and personal life in Scotland while paying English tax rates).
9. For a long time after 1999, the extraordinary lack of fiscal autonomy in devolved Scotland went unnoticed in the context of the lesser political consent for tax-varying powers than for legislative devolution in the referendum (63% against 74%). The SG was content not to use its 3p rights over parts of income tax, knowing the dangers of opening up the needs/resources issue; to this day Wales and Northern Ireland take that stance. What had seemed a source of discretion requiring Treasury monitoring – punitive rises in council tax or non-domestic rates – turned out not to be an active variable at all given the political salience of rises in these taxes.
10.It was only when ‘more devolution’ got back on to the political agenda after the SNP took office in 2007 that financing had to come into play. The Calman Commission was a unionist response to the SNP and led to the Scotland Act 2012 and the concept of the Scottish rate of income tax, again approached with caution from the SG end (10 points of tax revenue were deducted from SG income, but simultaneously reinstated by devolved decision). Having the power but not using it seemed to become the optimal political position. The annual publication of data on Government Revenue and Expenditure in Scotland has, in years where North Sea oil revenue is low, put the SG on the defensive about the fiscal effort it might be making.
Implementation issues around the post-Smith arrangements
11.It was the extraordinary concentration of events in late 2014 that allowed major tax-raising discretion to be implemented without the specific referendum that in 1997 had seemed necessary to endorse it. In the run-up to the independence vote, all the unionist parties had prepared their own prospectus of extended devolution. In the two weeks before the vote, when the polls showed that a ‘Yes’ victory and moved from being inconceivable to entirely possible, their party leaders agreed the ‘Vow’ to have a rapid post-poll exercise to reconcile their ‘more devolution’ positions in a way that the SNP could scarcely refuse.
12.The Smith Commission that that resulted was a cross-political exercise in both membership and servicing. The official team consisted of officials from the Scottish and UK governments and the Scottish Parliament and was led by a Treasury civil servant. The biggest debate was over the devolution of welfare benefits, leading to many non-pension benefits being transferred while maintaining the basic concepts of Universal Credit. This somewhat diverted attention from tax issues, where Conservative Party wishes to promote fiscal responsibility to the Scottish Parliament facilitated the expansion of the Scottish rate of income tax to cover all rates and bands beyond the UK-set personal allowance. The concept was that the cost of welfare benefits and the yield from revenue streams was to pass at the point of devolution into the Scottish budget, thereafter to set its own course. But it has not been so simple.
13.The underlying issue was that Smith took devolved policy in a much bigger way into ‘annually managed expenditure’ (AME), demand-led entitlement spending (mainly social security) that could not be planned or capped in the same way as ‘departmental expenditure limits’ (DEL). DELs are the basis of ‘Barnettable’ English spending that can be constructed into the Scottish block grant, but AME is less clear-cut in both definition and control, and the SG had realistic fears that they would lose out from the need to finance existing policies, let alone change them.
14. It took years before the SG agreed to the detailed working-out of the Smith arrangements, after gaining an indexation mechanism (‘indexed per capita’) to prevent losses to Scotland from slower population growth than the rest of the UK: the interim ‘Fiscal Framework’ agreed in 2016 was updated in 2023 following an independent review. The Treasury insisted on the concept of ‘block grant adjustment’ which – to oversimplify – seeks to prevent a double-dip by the SG into both tax money funded from their own powers and grant money generated by policies funded by English taxpayers. This requires a dynamic appraisal of what the tax and benefit outcomes would have been for Scotland if the powers had not been transferred and policies had not diverged. The estimations required cannot be done totally accurately in real time. Tax yields and demand-led spending totals are subject to retrospective amendment but by then the point of political decision may have passed. The analogue is the compensation of local authorities from the SG for the revenue lost from council tax freezes; the subordinate level has a structural tendency to lose out.
The political stakes around financial issues
15. The central issue behind financial and many other issues around Scottish devolution is the extent of possible stability between devolution as implemented in 1999 and full independence. The whole devolution movement posits that such stability can both be found and adjusted over time. The assumption is that pro-independence sentiment can be assuaged by incrementally letting go of UK policy responsibilities and control mechanisms.
16. The 1999 arrangements were fiscally stable because they kept the new devolved administration out of decisions on taxes and benefits and let them choose how to spend grant transfers from the UK on public services. It was only the unusual political provenance of the Smith Commission that forced the whole responsibility for income tax rates and bands into devolved hands. Politically this had to be used, but budgetary freedom is hampered by incomplete control even over income tax and lack of control over most other taxes.
17. Naturally the SNP see this position as evidence of the need for independence. For unionists it is more difficult. Over the years ‘Barnett consequentials’ of English policy changes have often been presented as a kind of specific grant – money is passed over with some presumption that it should be spend on the same thing. This gives a double political divided – credit is taken for the generation of the funding, blame is thrown when it is subsumed into general resources.
18.At a technical level, progress has been made over the years in the more efficient management of in-year expenditure. Year-end carry-overs and limited borrowing powers to aid spending management are the fruits of long interactions with the Treasury. Devolved finance ministers have found a ready interlocutor in the Chief Secretary to the Treasury, and dispute resolution on financial matters is more systematic – but still a matter of escalation up to higher political levels with the UK having the last word. The completion of the migration of benefits to Social Security Scotland offers some stability. The spending announcements of the UK government in October 2024 offered an easement of the Barnett-related fiscal climate that was evident in the Scottish Budget a month later. The five-yearly review of the Fiscal Framework due for 2028 would provide an opportunity to reappraise some of the concepts underlying what is already a detailed document, a product of much engagement.
19. But in the end, financial matters are part of the general pattern of consent to devolution and its optimal functioning. The nationalist dilemma was exposed during the Smith Commission’s deliberations. They wanted more powers as way-stations on their road to both independence and progressive social outcomes, but in accepting them they took on risk and exposure. The generation of income tax revenues through higher tax rates when ‘flight to England’ is possible has proved something of an uphill struggle. Admirable policies to end child poverty are best pursued through income maintenance programmes that may be expensive challengers to other spending priorities.
20. For unionist parties dilemmas are also present, especially when they are in government at UK level. Devolution was meant to be the ‘best of both worlds’ but this implied relative generosity to Scotland in a situation where there is a lack of evidence of large relative economic disadvantage (unlike Wales, which has secured a minimum 15% advantage in per capita spending). Generosity towards devolved nations, 15% of the UK population, is has always been relatively cheap, and the bypassing of the Barnett formula regime and direct UK funding into Scottish projects has proved technically possible. This in turn has slowed the erosion of the Scottish spending advantage that was meant to happen as more and more spending represented Barnett-based population allocation rather than the historic base. The Treasury has long hoped that if Scotland wants better services it should be made to pay for them. For unionist parties with elections to win in Scotland, the matter is more nuanced, and that is why politics and history need to be part of an analysis of the financing of Scottish government.
January 2025