Smokescreen is hiding ‘deeply flawed’ Scotland Bill

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By Andrew Hughes Hallett and Drew Scott

The fixation of some politicians and academics about trying to disprove the economic benefits of fiscal autonomy is dangerously distracting.  It has led to the Scotland Bill, the forerunner to the most significant package of devolution since the Scottish Parliament was re‐established in 1999, being reduced to second fiddle.

Let’s be clear ‐ there is no legislative proposal to make Scotland fiscally autonomous.  Those who promote that impression are creating a smokescreen.

What is on the legislative table is a Bill which, in our view and for reasons we set out in evidence to the Scotland Bill Committee, is deeply flawed.  Since it was published we have repeatedly sought to engage advocates of the Bill in debate about its shortcomings but to no avail.

We have never argued that the answer to the defects in the Bill is to simply convert it into a legislative proposal for fiscal autonomy without the additional measures and institutional changes needed to support it.

That is not to suggest that our arguments, or evidence, in support of fiscal autonomy have been undermined.  Indeed given the economic challenges that confront Scotland over the foreseeable future, a significant transfer of fiscal powers to the Scottish Government is, if anything, more urgently required than previously.  Why do we argue this?

Academic research, including ours, does not assert that an increase in fiscal devolution would, in and of itself, lead to a systematic increase in the rate of growth in the economy without additional measures and institutional changes to support it.  However, what we, together with the overwhelming bulk of academic research, do claim is that an increase in fiscal devolution typically leads to an increase in efficiency and hence better economic performance – defined as an increase in incomes (GDP) per head.  This body of research provides evidence from first principles that greater fiscal autonomy will be unambiguously associated with higher output levels and higher steady state growth rates if taxes move to support chosen levels of public spending; that is, if tax devolution is included along with spending devolution.  This result continues to hold if tax competition is allowed between regions.  But it does not follow if the tax regime involves a shared tax base, as it does in the Scotland Bill.

Secondly, if there is to be an uplift in GDP, then logically the economy must expand to get there.  That means a short period of extra growth, but you don’t grow faster than before unless you also adopt the additional measures that the higher revenues just created make possible.

An analogy may help here.  An increase in GDP can be compared to a pay award for good performance.  Your earnings will be permanently higher than they would otherwise have been, but the underlying growth rate in your salary (the “rate of growth” of the economy) remains the same.  Of course, if you keep on getting awards because you consistently perform better, your earnings will continue to grow at a faster rate. But that is not guaranteed.  This is why we supplied figures only for what can be expected to happen over five years.

You don’t have to take our word for this.  Professor Lars Feld, of Freiburg University, makes the exact same point in his Committee evidence:
Decentralisation of taxes and spending leads to a more efficient public sector and it enhances economic performance..”  It is clear that we and Professor Feld are in agreement.

Thirdly, it is important to note Professor Feld’s evidence when he states:
Revenue decentralisation has the expected positive effect on productivity, and is consistently highly significant.”  That again supports our argument; but also suggests that the Scotland Bill, which is to remain 85% expenditure‐based, will be distinctly unhelpful.

Fourthly, the empirical evidence goes much further than our critics suggest.  There are many other studies of OECD countries (e.g. Germany) that show that improvements in GDP per head come with tax and spending devolution.  A look at the performance of the regions with devolved taxes in Spain, relative to the rest of Spain, shows the same thing.  In Navarra, GDP per head grew from 25.9% above the non‐autonomous average to 29.3% above between 1995 and 2009.  And for the Basque country, GDP per head rose from 19.3% to 34.2% above that average.  The point is not that these two regions were richer than the rest of Spain; they were, but that they increased the degree to which they were richer after tax devolution was brought in.

Recent research reported in the American Economic Journal provides even more evidence; for OECD countries, a 10% reduction in corporation tax ‐ or factors that reduce that tax liability, such as R&D credits ‐ typically increases the investment rate by 2%; growth by 1%‐2%; the number of entrepreneurs from 3 to 5 per 100 population; and company registrations by 20%.

IMF data for 2010, on a sample of nine OECD countries, shows the same; an increase in revenue devolution produces a robust and statistically significant positive impact on GDP per head.  In this calculation, a 1% increase in revenue devolution could, at the UK’s level of GDP per head, be expected to increase a country’s GDP per head by a figure in the exact same range as that reported in our own paper.  It is very hard to believe that these countries would go to all the trouble and expense of changing the way they manage their regions if they did not see some advantage in it.

Hence the question that proponents of the Bill such as Professor Anton Muscatelli have to answer is ‐ why do they want to argue themselves into a position where they cannot even consider these options for increasing incomes in the Scottish economy?  We can offer no explanation.  But we do note that the Scotland Bill faces the same problem: no economic levers, such as might improve the performance of the Scottish economy, are on offer.

And what of the Scotland Bill?  As we made clear in our submission to the Committee we consider these proposals to be flawed.  None of our concerns regarding the deflationary bias inherent to the proposals, its pro‐cyclical economic bias, the additional spending cuts (or tax rises) that could well be required in Scotland as a consequence of the funding regime proposed in the Bill, the inadequacy of the provisions for borrowing or the job losses that could stem from its implementation have yet been addressed by advocates (or authors) of the Scotland Bill – including Professor Muscatelli and his colleagues.

The economic challenges facing Scotland over the coming years are as serious as any in living memory.  It is essential that all options for addressing these challenges are fully discussed, including devolving to Scotland’s government significant and economically meaningful powers over both the taxes that are levied as well as public spending disbursed in Scotland.

Only such measures will properly equip Scotland’s government to design a fiscal system best suited both to tackle Scotland’s considerable economic challenges and to exploit new economic opportunities which arise.  The evidence we have cited clearly demonstrates that potentially significant economic benefits are available from greater decentralisation of fiscal powers.

However, it remains imperative that, notwithstanding this debate, the financial provisions of the Scotland Bill actually before the Holyrood and Westminster parliaments are properly scrutinised.  Thus far, there is no evidence that the majority of MSPs on the Scotland Bill Committee, or indeed their advisors, have any appetite for this crucial process.

Andrew Hughes Hallett is Professor of Economics and Public Policy, St Andrews University and George Mason University, Washington.

Drew Scott is Professor of European Union Studies, Edinburgh University.