Fiscal framework for Scottish tax and welfare devolution is not workable

25 November 2015

The House of Lords Economic Affairs Committee, in its report A Fracturing Union?, argues that the process for determining the fiscal framework for Scottish tax and welfare devolution is flawed and that its design principles may not be workable and are not mutually compatible.

A new joint paper by researchers at the IFS, the University of Stirling and the Centre for Constitutional Change, funded by the Nuffield Foundation examines these issues and concludes that it is not possible to satisfy all of the Smith Commission’s ‘no detriment’ principles. It also finds that the precise way in which the remaining block grants are calculated and indexed over time could mean differences of over a billion pounds a year in the Scottish Government’s budget in the space of a decade or so. It concludes by suggesting the time may now have come for a more fundamental reassessment of devolved finance – including the operation of the Barnett Formula.

The paper analyses the different options for adjusting Scotland’s block grant. In particular it:

  • Uses historical tax revenues data from between 1999–00 and 2013–14 to get an idea of just how big a difference to the Scottish Government’s budget the different options could make. While these figures are approximate and refer to the past rather than the future, they show these differences can be substantial: well over £1 billion a year after a period of just over a decade is possible.
  • Finds that while an unreformed Barnett Formula remains in place it is impossible to design a system that simultaneously satisfies the Smith Commission’s principles that there should be ‘no detriment as a result of the decision to devolve a power’, and that post-devolution, changes to a devolved tax in the rest of the UK should not affect the amount of public spending in Scotland.
  • Argues that reform of Barnett may remove some of the conflicts between the Smith Commission’s principles. But if the Barnett Formula were reformed, a more comprehensive assessment of the UK’s system of devolved government finance than the Smith Commission was tasked with would be needed.

These issues are discussed in more detail in an IFS Observation on the options for calculating Scotland's block grant

David Bell, Professor of Economics at the University of Stirling and Fellow of the Centre on Constitutional Change and a co-author of the report, said: “The options available for calculating the block grant adjustments, and other elements of the fiscal framework will have major effects on Scottish Government’s budget and the fiscal risks and incentives it faces. These issues should be part of the public and parliamentary debate, as much as the tax and welfare powers set out in the Scotland Bill itself have been.”

David Phillips, a senior research economist at the IFS and another author of the paper, adds: “It may now be time for a more fundamental reassessment of how the devolved governments are financed: including whether the Barnett Formula should be reformed. Reform of Barnett may remove some of the conflicts between the Smith Commission’s principles that we have identified. The Smith Commission parked these issues to one side by committing to the current Barnett Formula. Making the UK’s fiscal framework sustainable for the long term may require reopening the debate.”