Scottish taxes: Framework for devolution agreed

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Donald-Drysdale By Donald Drysdale for ICAS

29 February 2016

Tuesday, 23 February turned out to be a defining date in the relationship between the Scottish and UK governments, as Donald Drysdale explains.

The fiscal framework

Announced with a fanfare on 23 February, ‘The agreement between the Scottish Government and the United Kingdom Government on the Scottish Government’s fiscal framework’ is not an easy read. As its less-than-snappy title suggests, the document has been written by civil servants, for civil servants, with no attempt to make it accessible to the man on the Leith omnibus.

Nonetheless, as explained in our article The Scottish fiscal framework: What you need to know, this agreement will be crucial in underpinning the further powers over tax and welfare that are being devolved to Scotland. It will set and co-ordinate sustainable fiscal policy through its key elements – fiscal rules and fiscal institutions.

Devolution of tax powers

With the Scotland Bill’s slow progress at Westminster, it had been unclear whether Holyrood’s new, wider powers over income tax rates and thresholds for non-savings non-dividend income of Scottish taxpayers would be implemented in 2017 or 2018. The governments have now agreed that this should happen in April 2017.

Other stages in the devolution timeline have also been agreed. Revenues from courts and tribunals in Scotland will be retained by the Scottish Government from April 2017. Air passenger duty will be devolved in April 2018. The devolution of aggregates levy will begin once current legal issues relating to state aid and other matters have been resolved. And assignment of VAT revenues will be implemented in 2019/20.

The implementation dates for devolution of welfare responsibilities are still to be agreed by the Joint Ministerial Working Group on Welfare established by the UK and Scottish governments.

The Scottish block grant

The Scottish Government will retain all devolved and assigned Scottish tax revenues. Meanwhile, changes in the Scottish block grant will continue to be determined by the operation of the Barnett formula, a non-statutory convention devised as a ‘temporary’ measure in 1978.

Much of the fiscal framework concerns the way the block grant will be adjusted to reflect the introduction of devolved and assigned revenues and the transfer of responsibilities for welfare. Following an initial block grant baseline adjustment, indexation mechanisms will be operated separately for each tax and welfare power, and applied annually.

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

Borrowing powers

From April 2017 Holyrood’s statutory cap on borrowings for capital expenditure will increase to £3bn, subject to an annual limit of £450m. These are in addition to the capital block grant, which will continue to be calculated in accordance with the Barnett formula. The Scottish Government may borrow through the UK Government from the National Loans Fund, by way of commercial loans, or through the issue of bonds. Borrowing for capital expenditure will be in Sterling.

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

The ‘Scotland Reserve’

The Scottish Government is already able to build up a cash reserve with the UK Government when devolved revenues are higher than forecast, and drawdown funds when devolved revenues are lower than forecast. From 2017/18 onwards a new Scotland Reserve will replace this, enabling the Scottish Government 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, but 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

To reflect additional devolved tax and spending powers, and the associated fiscal framework, the remit of the Scottish Fiscal Commission is to be expanded. It 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 arrangements should be reviewed periodically to ensure that they continue to be seen as fair, transparent and effective.

The two governments have agreed that the fiscal framework 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 hindsight. 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 address the method that might be used for adjusting the block grant beyond 2012/22. As part of the review, the two governments will jointly agree on a method that will deliver results consistent with the Smith Commission’s recommendations, including the principles of no detriment, taxpayer fairness and economic responsibility.

Scottish Budget 2016/17

Coincidentally, the fiscal framework was agreed at the same time MSPs at Holyrood approved the Scottish Government’s budget for 2016/17.

Income tax

As expected, the Scottish Rate of Income Tax will be 10% from 6 April 2016 – ensuring that the basic, higher and additional rates of income tax on non-savings non-dividend income of Scottish taxpayers remain unchanged for the time being.

The SNP administration had held its ground on the Scottish rate in spite of stiff opposition from Scottish Labour and Scottish Liberal Democrat MSPs, who had wanted it set one penny higher at 11% to ease current pressures on public services. SNP favoured no change until April 2017, when there will be greater scope for varying the income tax rates and thresholds in Scotland.

For Scottish taxpayers, particularly middle and high earners who might be the target of any move towards harsher taxation, this provides a year of respite before they discover the true extent to which Holyrood may flex its income tax muscles.

Land and buildings transaction tax (LBTT)

From 1 April, 2016 a new 3% supplement will apply to LBTT on additional residential properties worth £40,000 or more. The Scottish Government hopes that this will complement its commitment to supporting home ownership in a balanced and sustainable way, while helping to ensure that the tax is proportionate to the taxpayer’s ability to pay.

Soundings taken by the Scottish Parliament’s Finance Committee have varied. As ICAS stated in its consultation response on the LBTT supplement, there may be an adverse impact on the supply of private rental accommodation. Other respondents have cautioned that the supplement may not assist first-time buyers.

Article supplied by Taxing Words Ltd


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