How the Treasury outplayed Scotland in fiscal settlement negotiations

It is becoming clear that the Treasury comprehensively outplayed Scotland in the recent Fiscal Settlement review negotiations. This will cost Scotland hundreds of millions of pounds. A report of mine published today by Common Weal gives fuller details (“The Turkey that voted for Christmas (Twice): How poor negotiation of the Fiscal Settlement has failed Scotland”).

The outcome of the review is essentially continuation of the post-Smith Commission status quo (the one that was set up to look at the powers of the Scottish Government after "The Vow"). Although the Scottish Government has spun the outcome favourably, the defects in the original settlement were not overcome.

For example, on borrowing, the Scottish Government limits will be uprated for inflation after 2023/24: But the headline limits themselves have not increased. The key point is that the borrowing limits remain grossly inadequate: This, for example, forces the Scottish Government to retain the option to use the discredited Public Private Partnership approach to funding infrastructure investment. And, incomprehensibly, no action was taken on an original Smith Commission recommendation, about granting the Scottish Government prudential borrowing powers. 

Even more damaging is the decision about which indexation method should be used on the Block Grant Adjustment (BGA): That is, the amount subtracted from the block grant to allow for the revenues raised by Scottish taxes.

Here, the decision was to continue using the Indexed Per Capita (IPC) approach. As the Common Weal paper explains, this means Scotland has to engage in an economic race with the rest of the UK, in which there is a real danger of Scotland falling into a self-perpetuating cycle of relative economic decline. This danger is well known. But, as the Common Weal paper points out, there is now clear evidence that such a negative cycle is indeed likely to become established.

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How did this happen?

How did the fiscal settlement review come to this, and how can the Scottish Government possibly try to claim this as a victory? The answers to these questions are to be found in the negotiating tactics by which the Treasury outplayed the Scottish side; tactics we now know much more about, following information from a recent freedom of information request.

The fiscal settlement is an attempt to put flesh on the bones of various principles which were laid down in the report of the Smith Commission: principles dealing with, for example, concepts of taxpayer fairness, and of no detriment. The Treasury tactic was clearly to ensure that the Smith principles were interpreted in a very narrow, literal, sense. If a narrow interpretation of the principles is conceded, this greatly limits the possible outcomes of any review.

The review was informed by an independent report on the arrangements for indexing the BGA. In fact, within the narrow remit given to the authors of the independent report, only two feasible candidates for indexation methods emerge, one of them very damaging for Scotland, the other, the IPC approach, less so. Within this limited negotiation space, the Treasury could well afford to appear generous, and concede use of the IPC approach, and the Scottish Government could claim a sort of victory. But the outcome is nevertheless very dangerous for Scotland.

A good insight into the Treasury negotiating tactic comes from a recent freedom of information request of mine, asking the Treasury for sight of their comments on the earlier drafts of the independent report. In their response, the Treasury stated that their comments had been aimed at keeping the independent report to its intended scope: Namely, focusing on the Smith Commission principles.

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And when, in their first draft, the authors stated that an alternative approach would be “to focus less on the Smith Commission Agreement’s principles per se” the Treasury immediately jumped on this, and said that they did not feel that setting out to do this would be compatible with the independent report’s terms of reference. The offending phrase was then dropped from the final version of the independent report.

As the Common Weal paper explains, the glaring flaw in the narrow, Treasury interpretation of the Smith Commission principles is that it neglects the substantial detriment which Scotland will incur through damage done to the operation of the UK monetary union. By accident, and imperfectly, the old Barnett Formula meant that the UK monetary union did in effect have some of the characteristics which would be expected in a properly functioning monetary union.

By contrast, under the fiscal settlement as we now have it, this feature of Barnett is greatly weakened. Scotland therefore moves from being part of a fairly inefficient, but somewhat functioning monetary union, to being a member of a very inefficient and malfunctioning monetary union. The greater risks inherent in this latter position represent a clear detriment to Scotland: And there should have been proper consideration of this aspect in the review.

The overall outcome is thus extremely unsatisfactory and is already costing the Scottish Government hundreds of millions of pounds. The Common Weal paper suggests the following actions:

• The Scottish and Westminster Governments should release a full account of the fiscal settlement review negotiations.
• The original Smith Commission recommendation about prudential borrowing powers for the Scottish Government should be re-opened.
• There should be a debate about the extent of the detriment Scotland incurs through the sub-optimal performance of the UK monetary union implied by the current fiscal settlement: And how this should be compensated for.
• And the fiscal settlement itself should be re-opened, as allowed for under the Joint Exchequer Committee arrangements.