Tax devolution: Fiscal independence comes at a price and should not be rushed

Published: 11 May 2015 09:30

By Chas Roy-Chowdhury, ACCA's head of taxation

IN the final few days of last year’s referendum campaign promises of further fiscal powers were offered by the ‘Better Together’ campaign. While they may have fallen short – or well short if you believe the SNP claims – of full fiscal devolution, they do give Scotland more power over their income than is currently enjoyed by the Welsh or Northern Ireland Assembly, however, as is always the case, there is a cost involved.

Chas Roy-Chowdhury, ACCA

The balancing act that the Scottish government will have to get right is how to use those powers to fuel the economic recovery, attract more foreign investment, make exports more attractive and keep their promises on welfare, the NHS and education, and look at the Smith Commission’s proposals - this will not be an easy task.

The Scotland Act 2012 set out clear powers for Holyrood in respect to income tax and stamp duty land tax. The Smith Commission went further and allocated power over – among other areas – Air Passenger Duty (APD) and VAT.

The case for devolving APD seems a simple one - the Scottish Government is convinced that not being able to lower APD is harming their ability to compete in the tourism market. Tourism is a valuable industry, bringing in around £9 billion in 2013. The Scottish Government feel it is losing out on tourism compared to other parts of the UK, most significantly London, and having the ability to lower APD believes Scotland will see an increase in the number of tourists coming and crucially spending money.

A recent report by Edinburgh Airport suggested that cutting APD by 50% would be worth millions to the Scottish economy and create around 800 jobs. This may be optimistic given that Edinburgh Airport has a vested interest in APD being cut, but in a price competitive market anything the government can do to increase the number of foreign visitors would be beneficial to the country. The report estimates an increase in passenger numbers of 900,000 passengers per year by 2020. Under the proposals the government will be required to reimburse Westminster around £650m to cover the lost revenue. The Smith Commission requires Scotland to repay any lost revenue to Westminster should the government decide to introduce its own APD scheme.

The lost revenue is definite, whereas the possible benefit to the economy is based on predictions, and while they may be well researched predictions they are still a ‘best-guess’. If Scotland does not see the increase in passenger numbers that the report and the SNP suggests there will be a large hole in the nation’s finances to be filled.

The case around VAT is much simpler, under the Smith Commission’s proposals, the first 10 percentage points within the standard VAT range, raised in Scotland, will go to the Scottish government. At the moment, with the standard rate of VAT being 20%, half of all VAT receipts raised in Scotland will go to Holyrood. Of course this will come at the expense of a reduction in the block grant. This agreement does not cover other VAT rates – the most common being 5% on domestic fuel. It also does not give the power to change the rate to the Scottish government, that power will remain with Westminster.

The push for more tax devolution by the SNP is where the situation gets really complicated, although surprisingly there was very little mention of tax in their 2015 general election manifesto. The powers over income tax as set out by the Scotland Act are well known, however as with APD and VAT there will be a reduction in the block grant, and also an expectation of Scotland reimbursing HMRC for the cost of collecting Scottish income tax. The Scottish government will need to consider these costs if they decide to change the rates.

National Insurance would be extremely complicated to devolve due to its links to benefits and pensions, which are administered by Westminster. In order to National Insurance powers to be transferred to Holyrood it would require much more than just further fiscal devolution, which is unlikely even in the event of the SNP holding the balance of power following the general election. Both Labour and the Conservatives have ruled out further independence discussion for at least the next parliament.

The case for corporation tax devolution is an interesting one, Northern Ireland has convinced Westminster to transfer power to them, but its argument is a very specific one. Many businesses in Northern Ireland are directly competing with those from Ireland, and the Republic has lowered their rate to 12.5%, by doing so they have attracted many multinationals such as Apple and Google to base their European operations there. What the Westminster government will be keen to avoid is a race to the bottom, while there are obvious benefits from lowering Corporation Tax is does come at the expense of revenue, especially if lowering the tax does result in an increase of businesses moving their operations.

Westminster will not want to be in direct competition with Scotland over the issue of corporation tax. It should be remembered that while this is a source of debate, the UK has Corporation Tax rates significantly lower than other European powerhouses, such as France and Germany, so it is possible to conclude that the issue is not the biggest factor for multinationals.

It is clear that the case for further fiscal devolution will continue to be pursued by the SNP in both Holyrood and Westminster. Our over-riding concern, and I raised this at the Treasury Select Committee in December, is that we do not continue to complicate the UK tax system. We have a needlessly complicated tax system and in my view this more than the actual rates is what is holding the UK back – both sides of the border. Until we simplify the tax system as a whole, further fiscal devolution from Westminster will only compound the problem. The system is holding back further devolution and also making it possible for individuals and companies to aggressively avoid tax. Simplifying the system should be the priority for the next parliament, not arguing about which powers can be transferred. You have to put solid foundations in place before you start building.

Chas Roy-Chowdhury is head of taxation at ACCA (Association of Chartered Certified Accountants).

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