THE CASE FOR FISCAL AUTONOMY in SCOTLAND

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THE CASE FOR FISCAL AUTONOMYin SCOTLAND

• Ronald MacDonald
• University of Glasgow

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Fiscal Autonomy for Scotland

• Talk based on
• Hallwood and MacDonald, 2004 and MacDonald and
  Hallwood 2005, (Allander Series papers)
• MacDonald and Hallwood (2006) (Policy Institute)
• and Hallwood and MacDonald (2006) (FAI QEC).

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Fiscal Autonomy for Scotland

• Nomenclature Fiscal devolution umbrella title
  under have
• Fiscal federalism Mix of tax assignment and
  limited devolution.
• Fiscal autonomy substantial devolution of
  spending and taxes.
• Full fiscal autonomy devolution of all taxes
  and spending, synonymous with political
  independence.

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Fiscal Autonomy for Scotland

• Focus on Fiscal Autonomy
• Bottom line FA provides
• 1. Accountability transparency between what is
  spent and what is raised in taxes
• 2. Incentives for individuals and companies.

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Fiscal Autonomy for Scotland

• Two main economic arguments for FA
• 1. current large gap between spending by, and
  taxes raised, through Holyrood vertical
  imbalance or fiscal mismatch
• - Inefficient - does not provide sufficient
  incentives for Holyrood to make efficient use of
  public revenues.

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Fiscal Autonomy for Scotland

• - Public finance lit suggests decision-makers
  (Scottish electorate as principal and its agents
  the Scottish Government and Parliament) make
  efficient decisions wrt public money if have to
  bear costs,
• - efficiency of use and allocation between
  spending categories.
• - Think of this as Accountability.

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Fiscal Autonomy for Scotland

• Basic idea
• Sub-central gov better able to provide goods
  and services which match preferences of
  constituents.
• - This should max efficiency econ welfare
  above that from uniform allocation mechanism.
• - Benefit rule rational decisions made when
  agents who benefit from spend pay the costs. So
  own source revenue should parallel spending.

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Fiscal Autonomy for Scotland

• 2A Efficiency argument of FD should apply in
  dynamic economic growth framework. E.g.
  ability of local politicians better reflect local
  preferences on, say, education, innovation,
  private capital and infrastructure - can have
  implications for growth.
• 2B. Also having the fiscal tools allows
  politicos to alter incentive structure and
  address frictions. Currently have no incentive to
  improve economic growth given lump sum - spent
  on public services and goods. Any increased tax
  revenue due to growth accrues to London.

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Fiscal Autonomy for Scotland

• Equity vs. Efficiency trade off. Perhapsl depends
  on fiscal balance.
• If need block grant for equity, raises moral
  hazard issue caused by lack of hard budget
  constraint on public spending.
• i.e. if Holyrood knows size of bloc grant
  received related to size of fiscal imbalances,
  incentive to reduce fiscal imbalance compromised
  region in effect faces soft budget constraint.
  Under Barnett little or no incentive to cut
  government spending and taxes).

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Fiscal Autonomy for Scotland

• New fiscal federalism takes public choice
  perspective contends that politicians and civil
  servants not necessarily behaving to maximize the
  welfare of the electorate.
• At issue how to align more closely decisions of
  politicians and bureaucrats (the agents) with
  those of electorate (the principal).
• From public choice perspective horizontal tax
  competition between fiscal jurisdictions reduces
  scope for wasteful government spending and,
  therefore, increased fiscal decentralization
  should limit the size of the public sector.
• We argue for hard budget constraint the maximum
  possible devolution of revenues raised in
  Scotland.

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Fiscal Autonomy for Scotland

• What does our system look like?
• Complete autonomy for income tax
• Complete autonomy for corporation tax
• Autonomy for 'minor' taxes i.e. fuel duty, car
  tax etc.
• VAT revenues assigned (in devolved set up)
• Oil revenues to be included. Address volatility
  of oil prices with oil revenue stabilisation
  fund. Norwegian/ Alberta/ Alaska examples.
• Borrowing power to issue bonds.

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Fiscal Autonomy for Scotland

• Also favour some macro stabilisation function for
  fiscal policy in Scotland to counter the effects
  of a one-size-fits all monetary policy and
  potential reduced insurance of moving to more FA.
  
• Bloc grant should be as small as possible, if
  any. Have advocated a glide path of 5 years in
  case of adjustment issues.

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Fiscal Autonomy for Scotland

• FD and Economic Growth Empirical Evidence
• Empirical evidence on altering fiscal incentives
  and economic growth?
• Lee and Gordon (2005) cross-section data for 70
  countries over period 1970 to 1997. Lower rates
  of corporation tax contribute to faster rates of
  economic growth lowering corporate tax rates by
  ten-percent can increase the growth rate of real
  GDP by between one- and two-percent per year.
  Results robust to sample/ endogeneity issues.
• Short and Long run effects of this Headquarters
  effect could address this and hard econometric
  evidence (Voget (2008) supports the effect is in
  the data.

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Fiscal Autonomy for Scotland

• In sum, FA for Scotland can stimulate efficiency
  in public spending, both in terms of provision
  and balance of spending categories.
• Provide dynamic/ growth incentives for both
  public and private sectors - address frictions -
  empirical evidence provide support for effects of
  incentives.