Where next for Scotland and the UK?


A talk given by Jim Gallagher, Nuffield College, University of Oxford at the Open University, Edinburgh for a Policy Scotland and URESG Joint Seminar on 22 January 2015

We are equidistant between the independence referendum and the general election, 4 months after one and 4 months before the other. Scotland’s constitutional future is still very much a live issue. Today the United Kingdom government has produced a draft bill to give effect to the recommendations of the Smith Commission, agreed after the referendum result. Meanwhile the SNP are still riding high in the Scottish opinion polls, and at least their former leader sees himself exercising leverage at Westminster to get even greater powers if the Nationalists do well in the general election.

So it seems there is still a lot to play for, even though the voters decided against independence by a pretty substantial margin. What happens next? This paper will explore the implications of the choice that Scotland made 4 months ago, and look at the options that might be on the table in 4 months time.

Choices made: economic and social union

Let us begin by following through the logic of the choice made in the referendum.

The referendum was at least as much a test of the union as it was of the idea of independence. Independence was a concept presented with relentless positivity, but it was a blank canvas onto which virtually any hope or aspiration could be projected. An independent Scotland could be richer, or fairer, or greener: who was to say that was impossible? Union with the rest of the UK, by contrast, was a concrete reality. Perhaps its virtues could be for granted, but its faults were easy to criticise. In the end, the voters seem to have concluded that the risks of change were too great; and I am sure they were right. But it is perhaps more fruitful to focus on the positive arguments which underlay those calculations of risk, and so the nature of the union which was defended – and accepted by the electorate.

I’ve written about this extensively elsewhere. Formally speaking, the choice in front of the voters was whether to end the political union of the UK. But the real debate was about the other two connected aspects of the union – the UK as an economic union, the single market, the single currency and so on, and the UK as a social union, a state which shared resources across its territory to guarantee certain levels of public service, pensions etc. These aspects of the union are closely intertwined.

One of the big arguments of the referendum campaign, of course, was whether an independent Scotland could continue to share a currency with the rest of the UK. Of course of one truly believed in economic independence, one would argue for a separate Scottish currency, but the politics were obvious: voters trusted the currency they knew, so the Yes campaign somewhat uneasily argued for an economic policy driven from London. The most interesting contribution to this debate, however, was technocratic. The Governor of the Bank of England made clear his view that a stable currency union required a fiscal union, with a state authority controlling resources of at least 25% of GDP, in UK terms about half of public spending.

Of course you cannot have a fiscal union without a political union. Mr Carney was making a point about the EU as well; it is a currency union that cannot bring itself to be a fiscal union, because it lacks the necessary political cohesion. To put it in practical terms, no one in Germany pays the public spending bills in Greece: there is no democratic mandate across the eurozone for this. But because Greece is a currency union it cannot devalue its way out of its present economic difficulties. No sensible Scottish government would put Scotland in that position.

A fiscal union means sharing resources across the whole territory. This promotes economic stability, but public spending is driven by normative principles, rather than just economic technicalities. In a word, it is distributed according to need, if imperfectly. The most obvious example of that is the whole social security system, driven by the needs and circumstances of individuals, irrespective of their geographic location. As a result the Social Security system acts as not only an automatic stabiliser over time – increasing expenditure when the economy turns down–but an economic stabiliser across geographies, transferring resources to areas where employment is lower. If it did not do that, there would be a risk of a multiplier effect, with the local downturn resulting in more public expenditure, exacerbating the economic bad news.

So much for the logic of union. This matters because it is what the voters bought into, and conditions what they should get, and so devolution plans should be tested against it. But it wasn’t all they were promised.

Choices made: political union, Smith and “the vow”

Voters were promised about a vote to stay in the UK was also a vote for change in the political union, notably more powers for the Scottish Parliament, through what became the Smith Commission.

A striking thing about the referendum campaign was the way in which it acknowledged a radical view of the union between Scotland and the rest of the UK. In accepting that the Scottish people could unilaterally choose to leave the UK, the UK government and Parliament accepted that Scotland was a nation which could make this choice. As an inevitable consequence it follows that the UK is (and actually has always been) a multi-national state. It’s a state which provides the constitutional framework and the external identity for more than one nation. That’s always been the case since 1707, but the expression of this separate national identity only became democratic in 1999. Before that it was expressed in the separate Scottish church, for many, and in the different institutions of Scottish government. The Smith Commission adopted the Labour party recommendations of making this explicit by entrenching the Scottish Parliament and giving the Sewel convention legal force.

But what Scots were promised inside this multinational state was greater freedom and flexibility for the Scottish Parliament. Each of the pro-union parties had their offers, remarkably similar, and they agreed to come together in very short order after the referendum (together with the SNP and the Greens) to produce a settlement involving greater powers. This was all set out in a “vow” in, of all places, the Daily Record. Some readings of the campaign suggest that this was a turning point, though who knows. It is important however to understand all the contents of this vow: notably, as well as greater tax powers, it also promised retaining the Barnett formula.

In the event the Smith Commission produced more radical plans than had been canvassed by the parties before the referendum. This was no doubt driven by the immediate post-referendum political environment. The result is a set of devolution plans under which the Scottish Parliament will have markedly wider tax powers –essentially over income tax – and will be assigned half of the revenue of VAT in Scotland. In consequence something approaching 60% of the Parliament’s budget will be funded from its “own resources”, and nearly 40% of the tax revenue in Scotland will belong to the Scottish Parliament. Additionally, the Scottish Parliament is being given the control over about £2.5 billion of welfare spending (excluding universal credit and pensions), the ability to set the housing element of universal credit, and a remarkably wide power supplement to UK benefit paid in Scotland from its own resources.

As a result, on any reasonable view, this produces a very decentralised system. Comparable on the two dimensions of spending and taxation to decentralisation in the US or Switzerland, and an extraordinary leap from the wholly centralised UK of 1998. The draft legislation has now been produced, and would require the consent of the Edinburgh Parliament as well as enactment at Westminster. Much requires to be sorted out, though the principles of a financial settlement have been proposed by the UK government. In essence the Scottish Parliament will take on the risk of differential economic growth in Scotland on its own revenues (60% of the total), but will be supported by a share of UK revenues, still mostly calculated via Barnett, for the remaining 40%. Much detail no doubt remains to be sorted.

A Way forward?

Should Unionists accept this plan, and will Nationalists?

Look at this from the perspective of sustaining the union of the United Kingdom. Does it meet the tests of economic union, and of social solidarity? It is at the edge of both. In terms of economic union, the UK government will be responsible for less than £20 billion of direct expenditure in Scotland (Social Security), but also for Barnett transfers of another £20bn or so. This is probably enough to meet Governor Carney’s test of keeping the currency union stable. Scotland is taking on some economic risk, as the budget of the Scottish Parliament will be heavily influenced by the Scottish economy. This will in part be mitigated by increased borrowing powers Keeping a single UK pension system, and most of Social Security, notably universal credit, probably also meets the social solidarity test, though the complete devolution of income tax does cut across redistribution across the territory in the UK, as income tax is the main redistributive tax. So with a little hesitation, it can be concluded that this plan is consistent with maintaining the United Kingdom. Much more tax devolution, or much more welfare devolution, would not be, as they would undermine economic union or social solidarity, or both.

Together with the acknowledgement that Scotland is a nation which has exercised its right to self-determination, and has as of right a Parliament with very substantial powers, a devolution package which puts Scotland at the leading edge of international practice might be seen by Unionists as a fair response to the aspirations of the minority of Scots who supported independence.

Nationalist reaction to the plan was known before it was published. Uncharacteristically, Mr John Swinney participated in the negotiations but rubbished the outcome before it was published. The SNP might after some prevarication accept the outcome, as they will be unwilling to reject additional powers for the Scottish Parliament, while saying it falls short of their ideal. But before they do that, it seems likely that they will push for very much more.

Maxing out on devolution

This takes us from the aftermath of the referendum to the run-up to the general election. Since the referendum the SNP have been riding high in the opinion polls. There is no certainty that will continue until the election, as voters’ minds may change as they focus on that choice, rather than the independence issue. If it were to continue, however, a substantial phalanx of SNP MPs could be relevant to the Westminster arithmetic for the first time since they helped to bring down the Callaghan government in 1979. It might even be that the concerns of non-English MPs were critical at Westminster in a way which they have not been since the days of Lloyd George. If this were so, it would provide the SNP with leverage to pursue their constitutional aims.

Just what those aims are is not clear. The idea of pursuing a further referendum seems to have been ruled out. Nicola Sturgeon has suggested that the SNP might pursue other aims, such as abolishing Trident and the House of Lords. But Alex Salmond (who hopes to return as a Westminster MP) has announced that the SNP’s objective should be to secure “devo max”, which he defines to be exercising all powers at Holyrood except for defence and foreign affairs; to this, responsibility for the currency and macroeconomic management would presumably be added, as it is SNP policy that even an independent Scotland would share the currency.

This idea surfaced at various points before the independence debate, and at one point seemed even to be the Scottish government’s favoured alternative to independence. In the event, Scottish ministers pursued ‘independence-light’ rather than ‘devolution-max’ in their White Paper.

The analogy is made, sometimes, with the Channel Islands or the Isle of Man, which run other own domestic affairs, but rely on the United Kingdom for external relations. This is an instructive comparison. These islands are something of a constitutional anomaly. They are not part of the United Kingdom, nor are they part of the European Union. They send no MPs in Westminster, they pay no UK taxes (the Isle of Man does share in the UK VAT system) and make no contribution to UK defence. They do not use the pound sterling, but instead maintain sterling reserves to match, one for one, the issue of their local pounds. They make a living, especially the Channel Islands, by being a tax haven in which wealthy individuals and companies shelter from the UK taxes. Above all, they are very small. Taken together, their population is about that of Aberdeen, that is to say less than one 20th of the population of Scotland.
Should anyone buy Devo Max?

The Nationalist leadership might argue to their supporters this approach can be seen as a stepping stone to full independence. The analogy with Dominion status for Ireland in 1923, leading to full independence in the 1930s, is an obvious one; hopefully the concomitant Civil War would be avoided. It also has a commonsense attraction, as the polls show, in that the population are inclined to assume that such a system makes practical sense. After all, surely the Scottish Parliament can deal with everything domestic, leaving Westminster to deal with the outside world. But does it work, and what would the consequences be?

The simplest model of devolution max has the following characteristics:

•  Defence and foreign affairs and macroeconomic management are UK responsibility
•  all other (domestic) policies, including pensions and benefits, are dealt with the Scottish level
•  all taxes in Scotland are collected by the Scottish Parliament (other than VAT which is completely assigned)
•  the Scottish Parliament pays a sum to Westminster for common services, most obviously on a per capita basis.
•  Scotland would be able to borrow to finance capital expenditure and any deficit it ran.

There would be no fiscal transfers from the rest of the United Kingdom to Scotland, but a relatively small (under £10bn a year, declining as Scotland’s share of inherited debt declined) fiscal transfer from the Scottish budget the UK government, some of which would return to create economic activity in Scotland example at the defence bases on the Clyde.

The first implications for the UK (or strictly speaking the rest of the UK) of such a plan are economic. The fiscal union which underlies a common currency would be broken, and the stability of the currency called into question. Most of that risk would be borne by Scotland, as it is by far the smaller part of the currency union – it might, for example, find that its economy was diverging from the UK’s in a way which made the sterling exchange rate inappropriate. Some would however be borne by the rest of the UK. On the fiscal side, the UK would gain as the loss of North Sea oil revenues would be more than offset by no longer requiring to support Scottish public spending. The UK would however carry the risk of a substantial onshore tax haven, potentially more damaging than the tiny Channel Islands.

There are very substantial political implications also. Scotland could hardly expect to send MPs to Westminster, as they would set only English taxes (other than VAT) and legislate almost exclusively on English matters. This is exactly the position of the Channel Islands. So Scotland would have no or virtually no say in defence or foreign affairs. While this might be in some partisan interests, it is certainly not consistent with maintaining the UK as a union.

The most significant effects for Scotland would be fiscal. This paper does not contain a detailed analysis, but a broad brush look at the numbers makes it very plain that this system would imply cuts in pensions, benefits and public spending of at least 10%, and probably more.

Broadly speaking, total public expenditure for the benefit of Scotland is about £65 billion a year, and total Scottish tax income is about £55 billion. This gap has increased markedly because of the decline in oil revenues, though other tax revenues might rise if the economy grows. In very broad terms, around half of the gap today is filled by Scotland’s share of the UK’s borrowing, and another half by fiscal transfers from England. It is very hard to imagine that the markets would be prepared to lend to Scotland over £10 billion a year to sustain current levels of spending. That would be around 20% of tax revenue. Whatever was loaned would cost more, as Scotland would be a small economy, borrowing proportionately more of its GDP. The gap will increase as time goes on, because of Scotland’s demographic pressures and as oil revenues dwindle to zero. Scottish GDP would have to leap by something like 20% if present levels of public spending were to be affordable.

This form of devo max is in the interests neither of Scotland nor of the UK, though it would appear to be more damaging to Scotland than to the rest of the country. It is certainly not consistent with the promises made during the referendum campaign to sustain the Barnett formula, nor with with the union which was supported by a majority of voters in the referendum. In Scotland’s interest, no rational Scottish government should argue for it, and in the UK’s interest no principled UK government should accept it. At the UK level, the only party in whose partisan interest it might be seen to be is one with whom the SNP will refuse to do business.

Conclusion

Halfway between the rock of the referendum and the hard place of the general election is not a good position to forecast from. The follow-up to the referendum offers the possibility of a highly decentralised Scotland still within the United Kingdom, but it’s not clear that the present Scottish government are willing to accept that. As we move towards the general election, the superficially attractive idea of devolution max appears to be the SNP’s preferred political option. But it is clearly not consistent with the promises which were made by the winning side in the referendum campaign, and carries risks that no rational Scottish government should run.