Scotland Bill — Second Reading

Part of the debate – in the House of Lords at 3:43 pm on 24th November 2015.

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Photo of Lord Hollick Lord Hollick Chair, Economic Affairs Committee, Chair, Economic Affairs Committee 3:43 pm, 24th November 2015

My Lords, the Economic Affairs Committee, which I chair, has over the past four months conducted an inquiry into the devolution of public finances to Scotland. We heard evidence in London and Edinburgh from academics, economists, politicians and business leaders, and we met the Scottish Parliament’s Finance Committee. Based upon the evidence that we heard, we unanimously concluded that the financial measures in the Bill could be understood and scrutinised only once the fiscal framework was available. The amendment in my name seeks to ensure that the framework is available to Parliament in time to allow a full and informed consideration of the Bill. As the Minister mentioned, the Governments in Westminster and Holyrood declined to appear before us, citing the need to maintain confidentiality until agreement had been reached. Therefore, the terms of the fiscal framework remain shrouded in mystery.

The Scotland Bill is based on the recommendations of the Smith commission, the aspiration of which was,

“to bring about a durable but responsive democratic constitutional settlement, which maintains Scotland’s place in the UK and enhances mutual cooperation and partnership working”.

There are three aspects to the Smith commission recommendations on financial matters: the tax powers, the welfare powers and the fiscal framework. The latter is the mechanism to make the first two work. The Bill contains the tax provisions and the welfare provisions. It does not contain, nor is it accompanied by, the fiscal framework. This lacuna prompted the former Chancellor, the right honourable Alistair Darling, to tell us that the process was a “rotten” one, and that,

“nobody has a clue what is going on”.

So what is the fiscal framework, apart from elusive? On 14 October 2015, the Secretary of State for Scotland told the Scottish Affairs Committee that:

“The fiscal framework is a vital element of the package that will make Holyrood one of the most powerful devolved parliaments in the world”.

In Scotland, the Deputy First Minister has said the framework is,

“an integral part of the devolution of further responsibilities”.

The Smith commission stated that the framework would contain,

“the funding of the Scottish budget, planning, management and scrutiny of public revenues and spending, the manner in which the block grant is adjusted to accommodate further devolution, the operation of borrowing powers and cash reserve, fiscal rules, and independent fiscal institutions”.

The fiscal rules will provide the operating system for Scotland’s devolved financial powers under the Bill. For example, Scotland will need to be able to borrow more to manage the potentially increased income volatility arising from its reliance on devolved tax income, which, unlike the block grant, may fluctuate. Without the fiscal framework we do not know how much it can borrow, the limits to that borrowing or what would happen if the borrowings cannot be repaid. Scotland’s block grant will need to be adjusted annually to take into account the devolved taxes. How this is done may operate to Scotland’s detriment over time. The mechanism to make the annual adjustment will be a crucial part of the fiscal framework.

On 14 October, the noble Lord, Lord Dunlop, told the Scottish Affairs Committee he was confident that agreement on the fiscal framework would be reached this autumn. More recent reports suggest that the target date for publication is now mid-January, which would of course be in time for consideration in Committee. Our report identified seven crucial problems with the Bill, the first of which is the absence of the fiscal frame-work. The majority of the other problems also arise from its absence. Let me describe four of the problems.

How will devolution affect Scotland’s funding? Scotland is funded through the block grant as adjusted each year by the Barnett formula. The formula has been used since 1978 and produces disparity in spending per head between regions of the UK. The latest Treasury figures, published last week, show that taking the UK’s identifiable spending as 100%, England is 97%, or 3% below the average; Scotland is 116%; Wales is 111%; and Northern Ireland is 125%. It is generally assumed that the disparities reflect the differing needs of the four countries. That may well be the case but, at present, this assumption is not based on any logical underlying assessment. Six years ago, the Select Committee on the Barnett Formula recommended that the assessment of funding should be based on need and introduced over a 10-year period. We endorse its conclusion and urge the Government to consider this option. It will produce a fairer, more transparent and, crucially, more sustainable outcome for the whole of the UK.

One of the most important and complex issues is how to determine the amount by which the block grant paid to Scotland would be adjusted each year to take account of devolved powers. In the first year, the block grant is set by subtracting the revenues foregone by the UK Government from the total block grant. This fulfils the first no- detriment principle enunciated by the Smith commission. In following years, it must be indexed to reflect the tax foregone by the UK Government. The choice of a method of indexation may seem technical, but it is of vital importance to Scotland and the rest of the UK. If it is not transparent and judged to be fair, it will become a source of annual grievance—and the figures involved are substantial.

As we have heard, Scotland will be taking responsibility for £11 billion of income tax revenue, which is 30% of Scotland’s total block grant of £37 billion. We looked at three indexation options: a fixed percentage, indexed deduction to changes in the rest of UK revenues, and indexed deduction to changes in the rest of UK revenues per head. In each case, even if Scotland matched UK economic performance and grew its tax base by the same rate as the UK, the amount deducted from the block grant would be bigger than the revenues collected from tax. Within three or four years, the Scottish budget could be hundreds of millions of pounds lower as a result. Over 20 years, we calculate that it would reduce in real terms by between 34% and 27%. This is unlikely to be a recipe for harmony between nations.

Deciding who bears the risk is another thorny subject. Devolution gives the devolved entity the powers to take responsibility for its overall economic performance. If successful, Scotland expects to benefit from that success. But what if it is less successful or its economy suffers from a UK-wide shock, such as the banking crisis? To what extent should it be protected in such adverse circumstances? Well, that will depend on the fiscal framework.

Another principle governing the financial relationship between Scotland and the UK is the Smith commission’s second no-detriment principle, which states that there should be no detriment to the UK or the Scottish Government as a result of policy decisions made after devolution. But how will this work in practice? Professor Kay asked what would happen if you reduced health expenditure in England and made people pay for certain procedures, with the result that ill people would be more inclined to go to Scotland and healthy people more inclined to go to England. Does anybody really imagine that compensation will be paid between the two jurisdictions to reflect that? Furthermore, if the Scottish Government lowered air passenger duty, would they have to compensate Newcastle Airport for any loss of revenue caused by passengers moving their custom to Scottish airports? How would the compensation be decided? Would there be an annual negotiation between the Scottish Government and HM Treasury? If one side is dissatisfied, who would decide? That is yet another opportunity for an annual row. Our witnesses concluded that the second no-detriment principle was simply unworkable and should be abandoned.

The Scotland Act 2012 granted Scotland increased borrowing powers and the power to borrow on the market. Witnesses agreed that the current powers were insufficient to cover the additional devolution in the Bill. Any changes to Scotland’s borrowing will be part of the fiscal framework and require legislation. Linked to expanded borrowing is the question of what will happen if Scotland is unable to meet its debt obligations. Is a “no bailout” rule really feasible? We have seen what happened to that rule in the eurozone, while during the financial crisis the UK Government bailed out the largest Scottish bank. The evidence that we heard was clear: a “no bailout” rule would simply not be believed by the markets. It is therefore essential that there are clear and consistent rules in the fiscal framework specifying the amounts that can be borrowed.

Much hangs on the terms and principles of the fiscal framework. It deserves very close scrutiny. Yesterday, the Constitution Committee said that:

“In the absence of any information about the fiscal framework, it will be impossible for the House to assess whether or not the Bill will cause detriment to all or part of the United Kingdom”.

Holyrood has made it clear that it will not give legislative consent to the Bill until it is satisfied by the fiscal frame- work and until MSPs have the opportunity to consider the fiscal framework in detail. However, the House of

Commons completed all stages of the Bill without sight of the framework. The Government’s haste to legislate risks adding insult to injury. Not only is this major constitutional change being made on the hoof; it is being made in the dark. This is currently, in the words of Alistair Darling, a “rotten” process but does not have to be so.

In the overview accompanying his letter to Peers dated 11 November, the noble Lord, Lord Dunlop, stated that the Government aimed,

“to give respective Parliaments time for due consideration of both the Fiscal Framework and the Scotland Bill”.

He has today confirmed that this remains the Government’s firm intention. This is welcome, but meaningful only if the fiscal framework is available while the Bill is scrutinised in Committee. By moving Parts 2 and 3 to the end of Committee stage, the Minister no doubt hopes to ensure that the framework will be published before the final Committee day, but if it is not he must assure the House that he will defer the final Committee day until it is published. If he cannot give that assurance today, will he explain how the Government will make good on the promise given in the overview, repeated today, to allow Parliament time for due consideration of the financial framework if its publication is further delayed? This is a settlement that must endure. Undue haste will make for a bad outcome. I beg to move.