Guest Post by Strathturret

Strathturret has been kind enough to summarise Jim and Margaret Cuthbert's analysis of the Calman Report's financial plans. For those of you who haven't heard of the Cuthberts, they are highly respected Scottish economists.

Jim and Margaret Cuthbert’s critique on Calman’s financial plans.

How Calman's Income Tax Proposals Set a Trap for Scotland

‘We argue here that Calman’s proposals on income tax have serious technical flaws, and pose a grave danger to Scotland.’

I have tried to summarise the Cuthbert’s arguments.

The basic plan is for central government to reduce all income tax rates for all Scots tax payers by 10% points. So you pay 10% rather than 20% if a basic rate tax payer and 30% rather than 40% if a higher rate payer. Westminster reduces Scotland’s block grant by a calculated value equivalent to this 10% tax reduction. The Scots Government then raises additional tax (to replace 10% reduction) and retains this sum collected by these nice people in HMRC.

The Cuthbert’s say that this sounds reasonable at first examination but has two serious flaws.

Effects if Scots Government changes tax rates. Let’s say we decide to reduce tax rate to 8% cf nominal 10%. So a basic tax payer in Scotland pays 18% income tax. Let’s assume that this measure stimulates Scots economy (we all work harder and are more entrepreneurial) and thus the overall Government tax take increases. This could happen as we would have a competitive advantage compared to the rest of the UK. The Cuthberts are concerned that Scotland might get less because the total tax take will be higher but our share could be lower (see example below). So despite stimulating the economy, the Scots Government would take less tax. Perversely, the UK Treasury would benefit from this measure.

Worked example.

Pre Calman. Economy 100 units. Scottish tax 10%, UK tax 10%. Both Governments get 10 units of tax.

Post Calman. Economy boosted to 110 units by tax change by Scots Government, Scottish tax 8%, UK 10%. So Scotland gets 8.8 units and UK gets 11units.

Fiscal drag. The total amount of tax over time tends to come increasingly from higher rate tax payers. So initially Scotland would get 50% from basic, 25% from higher (40%) tax payers and 20% from super tax payers (new 50% rate). Now over time tax payers move upscale. So as we move upscale Scotland gets a smaller percentage of the total Income Tax take. Also Cuthberts caution that any change in higher rates could adversely affect Scotland.

The Cuthberts propose that the best solution would be to follow the Canadian system where the Provinces get a fixed percentage of total provincial tax take. Calman looked closely at the Canadian scheme but adopted his own mechanism.

Further to the Cuthbert critique, I would add my own concerns. The tax system must be kept consistent to avoid evasion and distortions. The two that concern me are Capital Gains Tax and Small Company Corporation Tax. Scotland would only get power to set Income tax.

At present these tax rates are as follows:

Income tax 20% std rate

Capital Gains 18%

Small company Corporation Tax 21%.

Clearly all these rates are similar!

Now lets imagine that Scotland decided to increase Income Tax to 25% (10% UK +15% Scots). I’m a self employed plumber. I incorporate my business and pay 21% company tax to avoid higher personal tax. Business owners with assets could take Capital gains at 18% rather than paying higher personal taxes of 25%. So I would argue that all these taxes are interlinked and Scotland altering Income Tax but not the others would be unworkable and lead to avoidance and distortion. This leads me to think that either Calman has not through this issue or he does not expect any Government to use these tax varying powers.

A further thought occurred to me this morning. With Cuthberts first point, if we stimulate Scots Economy by cutting IT, we could also see a growth in Corporation Tax, VAT, Stamp duty, National Insurance and so on. Who benefits? The UK Exchequor yet the Scots Government could lose out by getting less from its cut of Income Tax.

My thinking is that Calman has produced something that is 'reasonably' easy to understand and sounds plausible but in reality will not be used. A bit like the existing +/- 3% measure. Unless we do a thorough professional job or move to full fiscal independence, we're just fiddling at the edges.

Of course I'm not an economist!

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