Warning Over Income Tax Devolution

3 November 2014, 06:02 | Updated: 3 November 2014, 06:37

Handing the Scottish Parliament full control over income tax could undermine the integrity of the UK, an economic think-tank has warned.

Full devolution of income tax would greatly strengthen the case for English votes for English laws, depriving Scottish MPs of their right to vote on English tax despite its massive influence on UK macroeconomic policy, according to the National Institute of Economic and Social Research (Niesr).

All of the main Scottish parties have advocated full income tax, except Labour which has called for three-quarters of the basic rate.

However, Scottish Labour leadership candidate Neil Findlay has expressed sympathy with calls for full income tax.

His leadership rival Jim Murphy is expected to unveil his tax policy within the next few weeks, but he has dismissed former Labour chancellor Gordon Brown's warning that full income tax is a "Tory trap'' designed to strip Scottish MPs of their voting rights.

Niesr said full income tax would make it difficult to justify Scottish MPs voting on English income tax, in a submission to the Smith Commission on Scottish devolution.

But it said Westminster should extend the Scottish Parliament's "paltry'' borrowing limit, which currently amounts to one hundredths of 1% of the UK national debt, saying the risk of a "profligate'' Scotland is unlikely to threaten the UK government if it spends beyond its means.

Further borrowing powers would then make the devolution of North Sea oil revenues feasable, allowing Holyrood to smooth out its notoriously volatile income stream, it added.

The next stage of devolution should end the "pocket money'' Scottish Parliament and make its politicians fully accountable for their spending, it said.

Prime Minister David Cameron provoked a nationalist backlash when he insisted Scottish devolution should proceed at the same pace as devolution to the English regions, but Niesr said this is "unlikely to be in place in the short term''.

Niesr said: "If income tax is fully devolved this greatly strengthens the case for 'English votes for English laws'.

"It would be difficult to justify Scottish MPs voting on income taxes which are in effect exclusively in another jurisdiction.

"Yet because England is 84% of the Union, its decisions on income tax would have a strong influence on macroeconomic policy for the whole of the UK.

"Since an English government may not be the same as a UK government, Scotland would have no say on what would effectively be UK-wide macroeconomic policy. Imposing a symmetric solution on an asymmetric union would be undemocratic.''

It added: "Because of the sheer size of England relative to the other nations, a true federal system of government is only possible with equally devolved regional powers in England.

"While devolving power to regional governments in England has many desirable features, this is unlikely to be in place in the short term.''

Scotland strict borrowing limits "will become highly problematic if significant tax raising powers are devolved'', Niesr said.

"Scotland could easily find itself forced to cut spending and/or raise taxes in a recession to make up for a drop in income tax or other revenues and balance its budget.

"It is difficult to see how this paltry amount of borrowing could suffice to smooth out income tax revenues over the cycle, so the Scottish government might find itself forced into running a potentially damaging pro-cyclical fiscal policy.''

It went on: "There is no evidence to suggest that the Scottish Government would not learn to accept the market discipline imposed by borrowing. Indeed, discovering Scotland's borrowing costs might be an excellent disciplining device for its Government.

"Even if we are wrong and underestimate the risk of Scottish profligacy, the amounts involved do not seem likely to threaten the UK government.

"After the largest financial crisis in three generations the average debt burden of the six OECD (Organisation for Economic Co-operation and Development) federal states is 23%. A similar debt burden for Scotland is 2% of UK GDP.

"This risk may simply be the price to pay to ensure that devolution is structured to encourage accountability and responsibility and reinforces, rather than undermines, the Union.''

Niesr concluded: "The ability to borrow would also make devolving tax revenues from North Sea oil and gas to Scotland feasible.

"Tax revenues from North Sea oil and gas are notoriously difficult to predict accurately and highly volatile: year to- year drops of #4-5 billion (equivalent to more than 10% of total devolved spending) have occurred twice in the past decade. With the ability to borrow, Scotland could smooth out these fluctuations.''