Every state with devolved institutions of government redistributes revenues among subsidiary jurisdictions. These allocations promote equalisation of resources – taking money from places with a large tax base and giving to those with less taxable capacity. Or they recognise differences in needs – grants compensate poor or scattered regions for the additional costs of achieving levels of welfare or public service provision available elsewhere in the state.

The financial arrangements between Scotland and the UK as a whole are not determined by either needs or resources, but by historic accident,  based on a formula named for Joel Barnett, a Treasury Minister in 1978,

The Barnett formula simply takes the level of public expenditure in Scotland in 1977 and adds annually a share, pro rata to population, of the additional expenditure in that year in England on functions devolved to Scotland.  The base year was  generous, and Scotland’s population has subsequently declined relative to that of England.  The outcome has been a level of per capita public expenditure in Scotland between 10% and 15% above English levels.  This figure cannot be objectively justified by reference to Scottish needs.  Average incomes in Scotland are much the same as the UK and Scotland’s remote areas  would justify only a much more modest subsidy.

Yet retention of the Barnett formula was part of the ‘vow’ made by UK party leaders in their panic preceding the narrow defeat of the independence campaign in last September’s referendum. However the devolution of income tax rates and bands to Scotland requires consequential adjustments to the Barnett formula. The White Paper published by the UK government on 22 January – optimistically entitled “An Enduring Settlement’ begins to describe these adjustments.

The complex principle is that you estimate what income tax revenue would have raised in Scotland at the base date, deduct this  amount from the grant, and subsequently index the deduction in line with the evolution of the tax base in the UK as a whole.  The Barnett formula remains, except that Scotland gains or loses from any relative increase or reduction in the Scottish tax base, and retains the revenue from its own changes in income tax structure.

But what if the rest of the UK (rUK) changes its income tax structure?   The paper recognises that these rUK decisions would require further adjustments to the Barnett formula but does not describe what these adjustments would be. This vagueness is probably deliberate. The requirement is that any increase or reduction in revenues from  rUK income tax will result in a proportionate reduction or increase in the grant to Scotland.

  Suppose rUK abolishes the National Health Service (health is a devolved function), and cuts rUK income tax as a result.  The Barnett formula cuts the grant to Scotland in line with reduced expenditure in England. Unless compensated, Scotland cannot either maintain its Health Service or reduce its own income tax . If the UK increases expenditure on a reserved function – it declares war on the European Union, and raises rUK income tax to pay for it – then a corresponding amount must be deducted from the block grant. This cut forces Scotland either to implement a similar increase in its own income tax or to make a compensating reduction in its own non-military expenditure. 

So even with income tax devolved, the Scottish government will be under fiscal pressure to match any changes in rUK tax.  Any action by the UK government which has  tax or expenditure implications anywhere in the UK, whether related to reserved or devolved functions, will have consequences for tax and expenditure decisions in Scotland through the Barnett formula.  

        Lord Barnett, who died recently, frequently criticised his funding mechanism and hoped it would not be his legacy. But it is, and institutionalised, taints any concept of ‘English votes for English laws’.