Last week, the Scottish Government brought forward its first budget proposals in the new age of austerity, wriggling within the fiscal constraints imposed from Westminster.  It would be better for responsible public budgeting, and therefore better in the long run for both Scotland and the UK, if more of the money the Scottish public sector spends were raised by the Scottish government itself.   The coalition victory in the last UK election means that the only powerful opponents of such a reform are a few officials in the UK Treasury who will hold on to any purse string they see. 

       But it is much easier to advocate fiscal devolution than to implement it in practice.  The basic problem – experienced round the world – is that the most efficient units of government for collecting taxes are larger than the most efficient units for making most decisions about public expenditure.

       In common with other major states, Britain relies – to the extent of about 60% of total revenue – on three principal taxes.  Payroll taxes – national insurance contributions levied on employers and employees – are relatively easy to devolve, because they are collected at the workplace.  But these taxes are linked to benefit entitlements, and so long as pensions and other social security payments are a UK responsibility rather than a Scottish responsibility, the structure is difficult to disentangle.  So attention turns to VAT and income tax.

       If different jurisdictions have their own VAT regimes, they need to maintain a fiscal frontier.  When commercial transactions cross such a border, there needs to be a refund of the VAT already paid in the country they have left and a charge to VAT in the country they have entered – even if the two jurisdictions charge the same rate.

       These fiscal frontiers are a pain for tax collectors and for companies trading internationally, and run directly contrary to the idea of a single European market.  Border refunds give opportunities for fraud – the carousel scam, in which criminals trade small high value objects like mobile phones, is notorious.  The EU desperately wishes there could be a single European VAT regime: frustrated in this objective, it prohibits different rates of VAT within a single member state.  So Scotland cannot operate its own VAT without independence.

       There is no legal reason why Scotland could not have its own income tax.  But this turns out to be surprisingly complicated.  The income tax collector may know more about you than you would wish, but that doesn’t necessarily include knowing where you live.  The reason is that – almost uniquely – Britain tries to collect all income tax by deduction from source and so frees most of the population from the obligation to complete an annual tax return.

       Of course the Revenue and Customs could find out where you live.  And most Scots live and work in the same Scottish location and don’t derive much income from outside Scotland.  But this isn’t true of everyone, and the people for whom it isn’t true tend to have more income – often a lot more income.   Defining rules for what is and is not taxable in Scotland quickly becomes a complex business – and administering these rules is a burden not just for tax collectors in Scotland but for tax collectors in England as well.

       So if the Scottish Parliament were ever to vote for the allowable three pence variation in the rate of income tax it would require several years work before that rate could be implemented.  The practical consequence that the differential rate is not going to be implemented at all, since no government is going to take the blame for introducing a tartan tax without receiving the revenues.

       The Calman proposals would give Holyrood the power to raise around half the present UK income tax.  But when the last Labour government ‘accepted’ Calman it introduced a subtle but fundamental modification:  Scotland would receive, not the tax revenue its taxes raised, but the amount the UK Treasury estimated it would have raised.  As with the difference between pornography and sex, this looks like the real thing, but isn’t.  Simply to shift Scotland’s grant from the UK exchequer from a formula based on UK spending to one based on UK tax receipts is hardly a change at all – and if the shift isn’t accompanied by substantial borrowing powers, that change means less fiscal autonomy, not more.

       But perhaps there are the elements of a solution here.  Scotland should have assigned tax revenues – not just some part of income tax, but part of all taxes like a block grant.  Scotland should have its own borrowing capacity and pay the UK government for central services, like defence and debt interest.    And – this is crucial – the plan would be to move tax by tax step by step until Scotland collected its own revenue rather than receiving a share of the overall UK revenue.  Devolution can only be effective, and responsible, when the power to spend is matched to the obligation to tax.