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The Economic Case for Fiscal Federalism in Scotland

Author

Listed:
  • Ronald MacDonald

    (University of Glasgow)

  • Paul Hallwood

    (University of Connecticut)

Abstract
In this paper we consider the case for assigning tax revenues to Scotland, by which we mean that taxes levied on Scottish tax bases should be returned to the Scottish budget. The budget, however, would continue to be supplemented by transfers from the Westminster budget. This arrangement differs from the current situation whereby public spending is largely financed by a bloc grant from Westminster. Our suggestion falls short of full fiscal federalism for Scotland . meaning that Scotland had control over choice of tax base and of tax rates, and fiscal transfers from Westminster would be minimal. We use propositions drawn from the theory of fiscal federalism to argue for a smaller vertical imbalance between taxes retained in Scotland and public spending in Scotland. A closer matching of spending with taxes would better signal to beneficiaries the true costs of public spending in terms of taxes raised. It would also create more complete incentives for politicians to provide public goods and services in quantities and at qualities that voters are actually willing to pay for. Under the current bloc grant system, the marginal tax cost of spending does not enter into political agents. calculations as spending is out of a fixed total budget. Moreover, the Scottish electorate is hindered in signaling its desire for local public goods and services since the size of the total budget is determined by a rigid formula set by Westminster. At the present time we reject proposals for full fiscal federalism because in sharply reducing vertical imbalance in the Scottish budget, it is likely to worsen horizontal balance between Scotland and the other UK regions. Horizontal balance occurs where similarly situated regions enjoy the same per capita level of public goods and services at the same per capita tax cost. The complete removal of the bloc grant under full fiscal federalism would remove the mechanism that currently promotes horizontal equity in the UK. Variability in own-source tax revenues creates other problems with full fiscal federalism. Taxes derived from North Sea oil would constitute a large proportion of Scottish taxes, but these are known to be volatile in the face of variable oil prices and the pound-dollar exchange rate. At the present time variability in oil tax revenue is absorbed by Westminster. Scotland is insulated through the bloc grant. This risk sharing mechanism would be lost with full fiscal federalism. It is true that Scotland could turn to financial markets to tide itself over oil tax revenue downturns, but as a much smaller and less diversified financial entity than the UK as a whole it would probably have to borrow on less favorable terms than can Westminster. Scotland would have to bear this extra cost itself. Also, with full fiscal federalism it is difficult to see how the Scottish budget could be used as a macroeconomic stabilizer. At present, tax revenue downturns in Scotland - together with the steady bloc grant - are absorbed through an increase in vertical imbalance. This acts as an automatic stabilizer for the Scottish economy. No such mechanism would exist under full fiscal federalism. The borrowing alternative would still exist but on the less favorable terms - as with borrowing to finance oil tax shortfalls

Suggested Citation

  • Ronald MacDonald & Paul Hallwood, 2004. "The Economic Case for Fiscal Federalism in Scotland," Working papers 2004-42, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2004-42
    Note: The authors are grateful to Wendy Alexander, Jo Armstrong, Brian Ashcroft, Tam Bayoumi, Diane Coyle, Dhammika Dhamapala, David Heald, John McLaren and Arthur Midwinter for their very helpful comments on an earlier version of this paper. The usual disclaimer applies: we are responsible for any remaining errors of omission or commission and for the views expressed in the paper
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    Cited by:

    1. Paul Hallwood & Ronald MacDonald, 2008. "A Review of the Empirical Evidence on the Effects of Fiscal Decentralization on Economic Efficiency: With Comments on Tax Devolution to Scotland," Working papers 2008-46, University of Connecticut, Department of Economics.
    2. Sharma, Chanchal Kumar, 2010. "Beyond Gaps and Imbalances: Re-Structuring the Debate on Intergovernmental Fiscal Relations," MPRA Paper 32145, University Library of Munich, Germany.
    3. Tamayo, Adrian, 2017. "Assignment of powers and number of states in Federal Philippines Discussion paper on federalizing Philippines," MPRA Paper 79545, University Library of Munich, Germany.
    4. Chen, Xiaoshan & Kirsanova, Tatiana & Leith, Campbell, 2014. "An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area," SIRE Discussion Papers 2015-04, Scottish Institute for Research in Economics (SIRE).
    5. Paul Hallwood & Ronald MacDonald, 2014. "Picking The Right Budget Constraint For Scotland," Working Papers 2014_18, Business School - Economics, University of Glasgow.
    6. Hallwood, Paul & MacDonald, Ronald, 2014. "Picking the Right Budget Constraint for Scotland," 2007 Annual Meeting, July 29-August 1, 2007, Portland, Oregon TN 2015-27, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    7. Patrizio Lecca & Peter McGregor & Kim Swales & Ya Ping Yin, 2010. "Inverted Haavelmo Effects in a General Equilibrium Analysis of the Impact of Implementing the Scottish Variable Rate of Income Tax," Working Papers 1013, University of Strathclyde Business School, Department of Economics.
    8. Sharma, Chanchal Kumar, 2007. "Rescuing the concept of vertical fiscal imbalance," MPRA Paper 39343, University Library of Munich, Germany, revised 2010.
    9. P Hallwood & R.MacDonald, "undated". "A Restatement of the Case for Fiscal Autonomy (or: The Barnett Formula - a formula for Rake's Progress)," Working Papers 2006_14, Business School - Economics, University of Glasgow.
    10. Paul Hallwood, 2008. "Minimizing the Price of Tranquility: How to Discourage Scotland's Secession from the United Kingdom," Working papers 2008-23, University of Connecticut, Department of Economics.
    11. James Gallagher & Daniel Hinze, "undated". "Financing Options for Devolved Government in the UK," Working Papers 2005_24, Business School - Economics, University of Glasgow.
    12. David Heald & Alasdair Mcleod, 2005. "Embeddedness of UK devolution finance within the public expenditure system," Regional Studies, Taylor & Francis Journals, vol. 39(4), pages 495-518.
    13. Alex Christie & Kim Swales, 2006. "The Efficiency of Decentralised and Devolved Government: A Framework," ERSA conference papers ersa06p533, European Regional Science Association.

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    More about this item

    Keywords

    Barnett formula; bloc grants; devolution; fiscal federalism; local public goods; oil taxes; regional economics; Scottish economy; soft budget constraint; tax assignment; UK economy; UK fiscal system.;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H1 - Public Economics - - Structure and Scope of Government
    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems
    • H7 - Public Economics - - State and Local Government; Intergovernmental Relations
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods

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    1. Full fiscal autonomy for Scotland in Wikipedia English

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