Competitive and fair tax in Scotland: ICAS responds to commission

By Charlotte Barbour and Christine Scott

3 August 2015

Charlotte Barbour, Director of Taxation, and Christine Scott, Assistant Director, Charities and Pensions, set out the key points raised by ICAS in its response to the Commission for Competitive and Fair Taxation in Scotland.

Significant public policy challenges

ICAS highlighted that the three most significant public policy challenges facing Scotland are:

  • Sustainable economic growth;
  • Public service reform; and
  • The development of a Scottish fiscal framework.

Ability to pursue different policies

Scotland already has a number of policies that are significantly different from the rest of the UK.  However, there should perhaps be caution about the extent to which Scotland will be able to pursue increasingly different policies from the UK post-Smith.  This is because the funding of policies comes from taxation and to a lesser extent from borrowing, and there needs to be recognition that the different components in the UK fiscal framework are intricately intertwined.  This will remain the case when the 'Smith' powers are devolved because income tax, which will be the main source of 'Scottish taxation', will be a partially devolved tax involving joint responsibilities. 

Political responsibility will be split between the UK and Scottish Parliaments, with the UK Parliament responsible for the tax base (what is considered to be income, and how it is measured) and the Scottish Parliament responsible for the rates and the bands (how much is assessed for collection).  It may not be easy to obtain a substantial degree of flexibility from partially devolved income tax powers to set rates and bands.

Scotland's taxation system

ICAS also highlighted that a taxation system works on a number of complex and interrelated principles and interactions.  The success of Scotland's taxation system depends on it being an integrated and coherent part of the country's wider economic, legal and constitutional package.  Tax competition is one element that can be used to attract investment and encourage certain behaviours.  However, there can be downsides to tax competition such as:

  • If a tax is devolved to Scotland but its tax base is not clear cut then this can create significant new complexities and administrative burdens.
  • Tax competition is usually effected by reducing rates or offering attractive reliefs from tax but this can encourage a damaging "race to the bottom" between different jurisdictions which would reduce tax receipts for both the Scottish and UK Governments.
  • Tax competition can also lead to tax avoidance and tax planning.

ICAS noted that Air Passenger Duty and Aggregates Levy are standalone taxes that do not have significant interaction with other taxes so they lend themselves to being devolved.  The nature of the taxes, the legislation, and the associated collection and management duties are fully devolved and entirely the responsibility of those in Scotland.

VAT, however, remains the responsibility of the EU (in terms of defining the tax base), and the UK Parliament (in setting the tax rates), with administration and collection by HMRC.  How accountability to the Scottish Parliament is arrived at through assignment has yet to be decided, and is not determined or directed in the draft tax clauses in the Scotland Bill.   Considerable analytical and statistical work will be required if there is to be an amount that can be identified which truly reflects the VAT attributable to Scotland and will in future reflect any changes in the Scottish economy.

Local taxation

ICAS emphasised that reform of local taxation should not be undertaken in isolation but form part of the wider topic of local government funding and devolution of powers. At present, the financial position of councils is challenging yet there is currently a high collection rate of local taxation. The timing and nature of reform will need to consider that, at present, the system is likely to have less capacity to absorb financial shocks.

Barriers to public service reform

In terms of public sector reform ICAS focussed on some examples of barriers to public service reform to consider as part of a wider review:

  • VAT exemptions – a more level playing field across the public sector;
  • State Aid rules – a radical simplification through raising the threshold to exempt smaller organisations; and
  • Revenue borrowing powers for preventative spending.

ICAS repeated its comments in support for a shift from crisis spending towards preventative spending. During this extended period of public spending restraint and increasing demand for public services, there is a need to help facilitate the development and roll out of arrangements which support a preventative spend agenda to achieve better outcomes for communities over the longer term.  However, if real transformational change is to take place within our public services, then further revenue borrowing powers than have been articulated so far are needed.

Borrowing for capital projects has always been viewed as preferable to borrowing to fund revenue expenditure on public services due to the benefits accrued from capital expenditure being spread over more than one financial year.  A key overarching objective of preventative spending initiatives is to reduce demand for public services and create future savings.  Therefore, preventative spending, like capital spending, is about investing in the future.  ICAS believes this provides clear justification for the extension of the Scottish Government's revenue borrowing powers to fund preventative spend initiatives within prescribed limits.

Preventative spending does not guarantee success and therefore there are risks attached to it.  Nevertheless, ICAS believes that it is appropriate for the Scottish Government to be able to borrow to fund the revenue aspects of preventative spend initiatives, within an overall prescribed cash limit, where there is a realistic prospect of achieving savings. 

The resultant savings could reduce public spending in the long-term or free up resources which could be re-deployed elsewhere in the public services. In addition to placing an overall cash limit on the amount the Scottish Government can borrow for preventative spending initiatives, ICAS would envisage that borrowings would need to be repaid within a specified period of time and that governance arrangements would include measures to ensure that borrowings could not be used to fund recurrent revenue expenditure.

Borrowing must be affordable, sustainable and prudent and should be shared proportionately with future generations.  Therefore, borrowing powers, in the context of the fiscal framework must be structured with these principles in mind whether these are exercised to fund shortfalls in taxation revenue, investment in assets or for preventative spending.

About the Commission for Competitive and Fair Taxation in Scotland

The Commission was established by the Scottish Conservatives as an independent body to examine Scotland's existing and new taxation powers with the aim of assessing how best they can be used to promote Scotland's economy and competitiveness.

The Commission's aim is to find balance between a taxation system which achieves that objective while ensuring strong and sustainable public services and a regime which is fair to the taxpayer.

ICAS response: Competitive and fair taxation in Scotland

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