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Scottish fiscal settlement negotiations

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In a carefully constructed but sharply critical assessment of the recent Institute of Fiscal Studies (IFS) report entitled, ‘Adjusting Scotland’s Block Grant for Tax and welfare Powers; Assessing the Options’, leading independent economist, Jim Cuthbert, warns any negotiations deploying the assumptions and reasoning of the IFS report will ‘do Scotland gravely down’, and present a further twist to the present ‘fiscal trap’.

In the first of a new series of Jimmy Reid Foundation working papers entitled ‘IFS report provides inadequate basis for Scottish fiscal settlement negotiations’, Cuthbert demonstrates the IFS report by Messrs Bell, Eiser and Phillips represents ‘a very flawed assessment of the options for adjusting the Scottish government block grant and a significant danger for Scotland of falling into a ‘fiscal trap’ if the current negotiations take the IFS report seriously’.

The danger of being misled by the IFS report is significant because, while it does not recommend any specific method for adjusting the block grant and correctly identifies the difficulty of implementing the ‘no-detriment’ principles set down by Smith, the report nevertheless makes a series of incorrect decisions and assumptions about the characteristics of the block grant adjustment process.

One example is the report’s decision to use the method based on tax revenue indexation for adjusting the abatement to the block grant. This has profound implications for the types of risk to which the Scottish government’s revenues would be exposed, and for the way in which Smith’s second no-detriment principle will impact on the freedom of action of the Scottish government. The upshot is that, if the IFS report is used as a basis by which to negotiate the fiscal settlement, the decision to index on revenue, rather than tax base or some other approach, means that the Scottish government effectively loses control of its own full discretion over the income tax rates it wishes to set.

Other aspects which the IFS report either ignores, or to which it pays inadequate attention are:

  • What effect does the Scottish government’s lack of economic powers have in affecting the balance between risk and potential reward in the eventual fiscal settlement.
  • What are the limitations, and risks, of trying to run a monetary union on the basis of a largely formulaic approach to distributing resources.

Cuthbert’s conclusion is ‘the IFS study in effect represents a distorted assessment of the options for the post-Smith fiscal settlement. There are therefore grave dangers for Scotland if the IFS report were taken as the basis on which the fiscal settlement negotiations are conducted’.