Meeting of the Parliament 07 October 2015
One of the key priorities of the Finance Committee throughout the current session has been to ensure effective parliamentary scrutiny of the implementation and operation of further fiscal devolution. The committee has carried out a considerable amount of work on the fiscal powers arising from the Scotland Act 2012, and that has given us a firm grounding for our scrutiny of the fiscal powers that will arise from the work of the Smith commission. Our primary focus has been on the recommendations in the commission’s report for an updated fiscal framework for Scotland.
The committee is strongly of the view that the workability and effectiveness of further fiscal devolution are largely dependent on the revised framework. It is therefore essential that the framework is subject to rigorous parliamentary scrutiny. However, as it is not included in the Scotland Bill, it will not be subject to formal legislative scrutiny; rather, the framework is being developed in private through negotiations between the United Kingdom and Scottish Governments. Understandably, both Governments have agreed not to provide a running commentary on the negotiations, and it is entirely reasonable that they discuss the intricacies of the negotiations in private. At the same time, it is also entirely reasonable that the Westminster Parliament and our Parliament have sufficient time to comment on a draft of the framework prior to its final agreement by the two Governments.
The committee therefore welcomes the commitment from the Deputy First Minister that the Scottish Parliament needs to agree the fiscal framework prior to being asked to agree the legislative consent motion for the Scotland Bill that is currently being considered at Westminster. The committee would welcome a commitment from the Deputy First Minister during this debate that that will include sufficient opportunity for Parliament to scrutinise a draft of the proposed framework prior to final agreement with the UK Government.
I now turn to some of the substantive issues in the committee’s report. A central issue for the committee is the extent to which the new fiscal powers and the fiscal framework will provide the Scottish Government with the flexibility to pursue separate fiscal policies from the UK Government. The Deputy First Minister stated in his response to our report:
“it is essential that the fiscal framework provides the Scottish Government with genuine flexibility and choice to pursue its own distinct policy.”
However, the committee is concerned that the UK Government command paper that was published in response to the Smith commission suggests a much greater level of constraint. For example, paragraph 2.2.7 of the command paper states:
“the fiscal framework must require Scotland to contribute proportionally to fiscal consolidation at the pace set out by the UK Government across devolved and reserved areas.”
The Deputy First Minister made it clear in evidence to us that he did not accept that wording, which does not reflect the Scottish Government’s position. It would be helpful if the Deputy First Minister could confirm during the debate that he would not ask the Parliament to support a fiscal agreement that required Scotland
“to contribute proportionally to fiscal consolidation at the pace set out by the UK Government”.
Integral to fiscal flexibility will be the extent of the additional borrowing powers beyond those already devolved as part of the Scotland Act 2012. However, the current Scotland Bill does not include any new borrowing provisions. The Scottish ministers have indicated that they expect amendments to be lodged as the bill proceeds through Westminster. In relation to current borrowing, the committee does not believe that a cash limit is appropriate given the Scotland-specific cyclical risks that will potentially be faced by the Scottish Government post-Smith in future years. Instead, the committee supports a fiscal rule such as the requirement to balance the budget over the economic cycle. We welcome the Deputy First Minister’s agreement with our recommendations on current borrowing.
The committee noted that the block grant adjustment method in relation to income tax is intended to protect Scotland from some of the cyclical volatility in the UK as a whole. The two Governments previously agreed the Holtham method for the indexation of the block grant adjustment following the introduction of the income tax powers in the Scotland Act 2012. The Deputy First Minister has indicated that he believes that the Holtham method is also the most robust mechanism for indexing the block grant adjustment in relation to the income tax powers in the current Scotland Bill.
However, the committee heard from some witnesses during our inquiry that the Holtham method might penalise Scotland because we have both a relatively smaller number of higher-rate tax payers and slower population growth. Indeed, Professor Holtham previously advised the committee that his indexation method is
“not in the devolved territory’s interest if its own tax base is inevitably slower growing than that of the UK.”
The committee asked the Scottish Government whether it had carried out any analysis of the impact of the number of higher-rate tax payers and population growth. The committee also asked whether consideration had been given to the indexation of the block grant adjustment on the per capita tax base rather than the overall growth of the UK tax base and whether any analysis of that approach had been carried out.
The Government did not provide an answer to either question in its response to our report. In subsequent oral evidence to the committee, the Deputy First Minister confirmed:
“we are doing that analysis as part of our discussions with the UK Government.”—[Official Report, Finance Committee, 2 September 2015; c 25.]
Given his previous emphasis on the need for transparency in relation to the block grant adjustment, it would be helpful if the Deputy First Minister could confirm during the debate that that analysis will be published before the Parliament is asked to agree the fiscal framework.
The committee supports the introduction of a prudential capital borrowing regime on a statutory basis, and the Devolution (Further Powers) Committee is also supportive of the move towards a prudential regime. Although the Deputy First Minister welcomed the committee’s support for the introduction of a prudential regime, he made it clear in oral evidence that he is seeking prudential borrowing in addition to the existing capital departmental expenditure limit—a matter on which the committee concurs.
The committee also agrees that there needs to be a fiscal rule governing the medium to long-term limit on net debt, and we agree, too, with the Devolution (Further Powers) Committee that consideration should be given to a debt rule as a percentage of cyclically adjusted gross domestic product. A related issue is moral hazard, which was explained by one of our witnesses as
“when the sub-central level of government believes it can engage in ill-disciplined policies and ultimately has to be bailed out by the centre.”
Our witnesses agreed that the question of a possible bail-out needs to be addressed at the outset, and the committee has recommended that moral hazard needs to be explicitly addressed in the fiscal framework.
One of the primary concerns to be raised during our inquiry related to the second no-detriment principle that was proposed by the Smith commission. The committee was content with the first principle that neither Scotland nor the rest of the UK should be adversely affected as a result of the decision to devolve further powers. However, the second principle, which is intended to apply to policy decisions of the two Governments after the devolution of tax or spending powers, is much more problematic. None of our witnesses could provide an example of a similar principle in any other fiscally federal country, and it was pointed out that any methodology to implement the principle would be complex and likely to provoke disagreement.
The committee recommended that the second principle be treated as a high-level guide for both Governments in the application of the fiscal framework and in adjusting the block grant. However, even if it is treated as a high-level principle, further work needs to be done on refining the boundaries within which the principle applies.