In writing a fast budget analysis from my sickbed last week I omitted to include something which was important. It is important to explain what is the mechanism which is squeezing funding in Scotland and to ask who signed it off and why.
To understand the problem it is important to understand that there have been dire warnings about what has caused the current funding squeeze since it was put in place. Those warnings were shared in private by a wide range of economists but it was left to the redoubtable Jim and Margaret Cuthbert to really pursue the issue in public.
In 2014, after the last-minute ‘vow’ which promised Scotland ‘as close as damn it to federalism’ as long as it voted against independence, some substance had to be retrofitted to the claims in the vow. It is this which led to the Smith Commission.
This was led by Lord Smith of Kelvin and was established by David Cameron to ‘make good’ the vow’s commitment. It undertook a fast review and sought views on what additional powers Scotland could and should get. This put forward a number of proposed changes to the devolution settlement and these were then negotiated with the Scottish Goverenment.
(It should be noted that the recommendations of the preceding Calman Commission hadn’t actually been enacted by this point and the Smith Commission moved at a very sharp pace indeed, leaving much less time for scrutiny than desirable.)
Some of what happened is conjecture, but it is widely viewed in Whitehall as having been something of a ‘cunning trap’. Basically there were two changes to devolved powers which acted like a trap for the public sector in Scotland.
The first of these was the piecemeal devolution of some parts of social security. Social security can quickly become a money pit, absorbing large sums of public funding. If it is not attached to full fiscal and monetary powers the inevitable logic of failure demand in social security will simply suck more funding after itself in its wake.
This is partly what has happened; the Scottish Government signed up to new social security powers and in a period of rising poverty had little choice but to use them – but without the ability properly to raise the money to fund them. This is a big draw on a budget and requires greater ability to raise additional income.
This is where it comes to the second half of the problematic part of the deal – a complex formula which meant that Scottish tax take was more predicated on GDP and income than before. Basically the block grant was to be adjusted according to GDP growth to ‘reward’ governments which used tax and then ‘grew the economy’.
The budget squeeze Scotland is now facing was an inevitable outcome when the Scottish Government blindly negotiated a package it clearly didn’t properly understand, in the process dismissing the concerns of people who actually understood what was going on
The problem is that the UK and Scottish tax base are very different, the income tax powers ceded to Scotland were very narrow and the budget reconciliation process meant that a Scotland that used tax powers would see its core budget decline rapidly if it did not also increase GDP metrics (very roughly).
And that is where we have arrived. Even the very minor use of tax powers the Scottish Government has engaged in has brought fiscal trade-offs for the main block grant. By taxing but not seeing the chosen GDP measure rise in the right way, Scotland is effectively punished for raising tax.
That explains a lot of the funding gap which is leading to the brutal cuts in the Scottish Government budget.
What it doesn’t explain is why the Scottish Government signed up to this deal in the first place. John Swinney was the lead negotiator on this package of measures and he was warned in no uncertain terms both publicly and privately that signing up to the package was an act of self-harm. Sadly, the Scottish Government of the time was deeply enmeshed in its own propaganda.
This meant that the Scottish Government didn’t look too closely at the package, convinced that any win was a win and that ‘somehow’ the Scottish Government would make it work later on through sheer cleverness.
Sadly the Treasury has not exactly disguised the fact that this package was always intended as a ‘trap’ and that the way it is operating now is precisely the way it was intended to operate – effectively to punish Scotland for using tax or social security powers.
Equally sadly the Scottish Government didn’t seem to believe the risk (despite the very substantial warnings it received) until now. Now the flaw in the system the Scottish Government negotiated are clear for all to see.
That was the missing part in what I wrote. The budget squeeze Scotland is now facing was an inevitable outcome when the Scottish Government blindly negotiated a package it clearly didn’t properly understand, in the process dismissing the concerns of people who actually understood what was going on.
It will do no good for the Scottish Government to complain about this – this is the operation of the formula it agreed but was strongly advised not to agree. This appears not just to be a serious ministerial failure but also a major failure within the civil service (unless its advice was presented to ministers and then ignored).
A final addendum on this; while Jim Cuthbert has been most vocal on this, it was a widespread view and must be accepted as such. In early 2015 I had a coffee in Edinburgh with a respected but pretty ‘middle of the road’ economist. Our conversation turned to what was being negotiated.
His view (in private) was that was was being negotiated was ‘madness’ and that Scotland would soon pay a serious price for it. It has taken six years for this mess to catch up with us – but catch up it certainly has.