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Scotland enters brave new tax world

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2nd Mar 2016
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Donald Drysdale comments on the new fiscal framework negotiated between the Westminster and Holyrood governments.

Agreement reached

After protracted negotiations behind closed doors, the UK and Scottish governments announced on 23 February that they had reached agreement on a new fiscal framework to underpin the further powers over tax and welfare now being devolved to Scotland.

‘The agreement between the Scottish Government and the United Kingdom Government on the Scottish Government’s fiscal framework’ finally reveals what has been decided.  The need for this fiscal framework was explained in our article ‘Scotland’s devolved taxes: A never-ending story’.

Tax powers

Given the slow progress of the Scotland Bill, there had been speculation about whether Holyrood’s new, wider powers over income tax rates and thresholds would be introduced in 2017 or 2018. The governments have agreed that this should happen on 6 April 2017.

The Scottish government will retain all devolved and assigned Scottish tax revenues. Revenues from tribunals and courts in Scotland will be retained by the Scottish government from April 2017. Air passenger duty is to be devolved in April 2018, and the devolution of aggregates levy will begin once current legal issues relating to state aid and other matters have been resolved. The assignment of VAT revenues will be implemented in 2019/20.

Dates for devolution of welfare responsibilities have still to be agreed by the Joint Ministerial Working Group on Welfare, which was set up last year by the UK and Scottish governments.

The block grant

Changes in the Scottish block grant will continue to be determined in accordance with the Barnett formula, a non-statutory convention adopted as a ‘temporary’ measure in 1978. This may not receive whole-hearted support at Westminster, where the Barnett formula has many critics because it has allegedly favoured the Scots.

Much of the 20-page fiscal framework focuses on the way the block grant will be adjusted to reflect the devolution and assignment of revenues and the transfer of welfare responsibilities. Following an initial baseline adjustment to the block grant, indexation mechanisms will be applied annually – operating separately for each tax and welfare power.

For a transitional period up to and including 2021/22, the block grant adjustment for tax will be made using Barnett’s ‘comparable model (Scotland’s share)’, with indexation based on relative revenue changes per capita for tax and welfare to ensure that Holyrood’s overall funding will be unaffected if Scotland’s rate of population growth differs from that in the rest of the UK.

Borrowing powers

Holyrood’s statutory limit on borrowings for capital expenditure will increase to £3bn from April 2017, subject to an annual limit of £450m. In addition, the capital block grant will continue to be calculated by reference to the Barnett formula. The Scottish government will be permitted to borrow for capital purposes (in Sterling only) through the UK government from the National Loans Fund, by way of commercial loans, or through the issue of bonds.

From 2017/18 onwards the Scottish government will be allowed to borrow up to £600m each year within a statutory overall resource borrowing limit of £1.75bn, subject to individual limits for in-year cash management, forecast error, and Scotland-specific economic shocks. Where a Scotland-specific shock requires a higher level of cyclical borrowing, the resource borrowing limits may be raised temporarily to give Holyrood the necessary tools to manage extreme levels of volatility.

The ‘Scotland Reserve’

The Scottish government already has power to accumulate a cash reserve with the UK government when devolved revenues exceed forecast, and draw down funds when devolved revenues fall short of forecast. A new Scotland Reserve will replace this from 2017/18 onwards, enabling Holyrood to smooth all types of spending, manage tax volatility and determine the timing of expenditure.

The Scotland Reserve cannot exceed £700m. Annual drawdowns will be limited to £250m for resource and £100m for capital, although these limits may be waived temporarily in the face of a Scotland-specific economic shock. There are no annual limits for payments into the Scotland Reserve.

Fiscal scrutiny

The remit of the independent Scottish Fiscal Commission is to be expanded to reflect the additional devolved tax and spending powers and the associated fiscal framework. The Commission will share a reciprocal statutory duty of cooperation with the Office for Budget Responsibility (OBR).

Review of the fiscal framework

The Smith Commission recommended that the fiscal framework should be reviewed periodically to ensure that it continues to be seen as fair, transparent and effective.

The two governments have agreed that the arrangements will be reviewed following the UK and Scottish Parliament elections in 2020 and 2021 respectively, allowing an assessment at that time with the benefit of experience. The review will be informed by an independent report with recommendations presented to both governments by the end of 2021.

The fiscal framework does not consider how the block grant might be adjusted beyond 2021/22. As part of the review, the two governments will jointly agree on a method to deliver results consistent with the Smith Commission’s recommendations, including the principles of no detriment, taxpayer fairness and economic responsibility.

Donald Drysdale of Taxing Words is a freelance author and series editor of Bloomsbury Professional's Scottish tax list.

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