Funding deal fails to meet taxpayer fairness test for whole of UK, report claims

The new funding deal for Scotland fails to meet the test of taxpayer fairness for the whole of the UK, analysis by an economic think-tank has found.

The Institute for Fiscal Studies (IFS) has examined the five-year fiscal framework agreement negotiated by the UK and Scottish governments last month.

The framework sets out how Scotland's budget - the block grant - should be adjusted to take into account new powers being devolved in the Scotland Bill and was the subject of protracted talks between the two administrations.

The Scottish Government called for Scotland's slower population growth to be taken into account in the new funding model in order to meet the "no detriment" principle set out by the Smith Commission.

The IFS found the deal meets this principle but does not meet the ideal of "taxpayer fairness", which the UK Government placed more weight on.

The deal agreed will protect the Scottish budget from revenue and welfare spending risks associated with Scotland's lower population growth, the report states.

Equally, Scotland will not benefit from the higher revenues that might result if its population grows more quickly than expected.

"This is the approach that the Scottish Government wanted and satisfies its interpretation of the Smith Commission's principle that there should be 'no detriment (simply) from the decision to devolve' a power," the IFS said.

"But it does not satisfy the commission's 'taxpayer fairness' principle, which the UK Government placed more weight on. Scotland's budget could fall a little if income tax rates are cut (or thresholds increased) in rUK and vice versa."

The IFS also found that under the agreement, part of the growth in devolved tax revenues in the rest of the UK will continue to be redistributed to Scotland to help fund its higher levels of government spending, something the UK Government said should no longer happen once a tax is devolved.

By 2021/22 about £900 million of additional revenues from the rest of the UK could be redistributed to Scotland, it found.

The method agreed for adjusting the block grant also largely insulates Scotland from the impact of any shocks that hit the whole of the UK, such as the global financial crisis.

"But the Scottish Government's budget will be exposed to long and short-term economic risks that affect Scotland differently from the rest of the UK," the IFS said.

Faster or slower growth in devolved revenues or welfare spending per person could impact on the Scottish budget by more than £500 million a year after five years and over £2 billion a year after 15 years, it found.

David Phillips, a senior research economist and one of the authors of the report, said: "It was never going to be possible to design a fiscal framework that satisfied all the Smith Commission's principles.

"In the end, the Scottish Government's preferred approach was chosen, which prioritises the 'no detriment' principle.

"During the negotiations, the UK Government had claimed this approach was unfair because it violates the 'taxpayer fairness' principle. This begs the question of whether the UK Government has changed its mind or merely conceded the point."

Co-author Professor David Bell said the Scottish Government did not get everything it wanted, and had had to accept much lower borrowing limits than it had hoped for.

"These limits look like they should be enough to cope with fluctuations in its revenues and welfare spending. But the rules about when the borrowing powers can be used may be more constraining," he said.

Deputy First Minister John Swinney said: "The fiscal framework agreement implements the principles of the Smith Commission and is fair to taxpayers in Scotland and across the UK."

The IFS found that using the Scottish Government's preferred Indexed Per Capita model means Scotland's budget may be around £300 million a year more by 2021/22 than it would have been had the UK Government's proposed comparable model been used instead.

Mr Swinney added: "This analysis by the IFS demonstrates Scotland's budget could have been cut by £300 million a year by 2020/21 if the UK Government's preferred model had been implemented.

"That is why we ensured that Scotland's block grant will be adjusted annually, by indexed deduction per capita, to ensure no detriment to Scotland as a result of having new powers."

A Treasury spokesman said: "The historic fiscal framework is fair for Scotland and fair for the rest of the UK."