(First published in Progressive Federalism: A Radical Solution. Red Paper Collective, Spring 2017.)
Our current system is a recipe for disaster.
Our society has an appetite for change.
The establishment may consider that there is no alternative to neoliberalism but working class people know the system is stacked against them – from the off-shoring of taxes and jobs to the austerity agenda – whilst witnessing governments continue their tax cuts for companies and the wealthy.
Ideologically-driven funding cuts to public services are expected from Conservative governments.
Many councils are now struggling to deliver statutory services.
The central government department responsible for councils has had its budget reduced by 22% since 2010.
Councils serving deprived communities, such as Liverpool, have been the worst affected.
To balance its budget gap from 2017-2020, the City is expecting to cut another 10 percent from adults and children’s services which support the most vulnerable, and cutting all other departments by a further 50 percent.
Scotland was in part protected from these cuts from 2010/11 -2015/6.
However, the deep cuts are now being felt. Councils faced £500m cut in 2016/17 and are forecasting £327m for 2017/18.
In addition to these cuts, there are imbalances in how the government raises its revenue.
Taxes associated with employees raise three times as much as the combined revenue raised from companies or wealth.
This ratio needs to change especially with the threat of rapid automation, which the Bank of England’s Chief Economist stated up to 15 million jobs could be at risk of automation that is approximately 40% of the UK’s jobs.
Currently in the UK, there are an estimated 30 million taxpayers and a significant proportion of these people will be at risk of losing their job to automation.
Thus, automation is likely to have a sizeable impact on the government’s revenue.
So, a new system is desperately needed.
This piece aims to complement the new economics work led by Labour Shadow Chancellor, John McDonnell MP, by illuminating why changes to the redistribution of income and wealth are urgently needed for Scotland and the UK.
The Barnett Formula and Scotland Post-Smith
Historically, Scotland, Wales and Northern Ireland received their funding – to cover the devolved responsibilities – in the form of a block grant (baseline plus annual incremental changes) from Westminster.
The original baseline set in 1979 when the Formula was first applied now represents barely one tenth of the total expenditure but there are a culminating series of new baselines, which become increasingly out of date, leading to further anomalies.
Together, these account for the vast bulk of the block grant.
The Barnett Formula determines how these block grants change from year to year.
As relative needs change over time, a fair system should regularly review each devolved administration’s relative needs, such as every five years, but this never happened.
Scotland’s public services are now dependent on investment from both Westminster and Holyrood governments.
The block grants are adjusted to accommodate the new powers.
Additional spending powers will see block grants increase, while additional tax powers will see block grants decrease.
The IFS identified a “flaw” with the Barnett formula, which meant Scotland and Northern Ireland were somewhat protected from the local government cuts from 2010/11 to 2015/16, for Scotland, which amounts to £600m.
The Treasury corrected this “flaw” in 2015 with a change in the local government comparability factor.
So, Scotland has felt the full force of the local government austerity from 2016/17 onwards.
In post-Smith Commission Scotland, the Scottish Parliament devolved or assigned revenues account for just over half the Scottish Government’s budget, prior to the 2016/17 budget, it was only 7% and the 93% was the block grant from Westminster.
The Parliament now has responsibility for a number of taxes including: land and buildings transaction tax (LBTT), landfill taxes, the Scottish rate of income tax.
So, given these changes, the block grant has to be adjusted accordingly. Scottish Government and the UK Government reached agreement on how to adjust the grant for a transitional period, which ends in 2021/22.
There is concern that negotiation on the post 2021/22 block grant adjustment may fuel further SNP grievance and allow them to seek their long-time goal – full fiscal autonomy (FFA).
FFA would not be in Scotland’s interest, as the Scottish economy has three structural risks: a slower population growth rate than the rest of the UK, over-exposure to the volatility of oil and gas sector, and, over-dependence on financial services.
The most recent Government Expenditure and Revenue Scotland (GERS) data illuminate these structural issues by highlighting the deficit in 2015/16 of £14.8bn (9.5% of its GDP), the corresponding UK figures is 4% of GDP.
However, Scotland’s public purse could be protected by a Labour Government in 2020 implementing an improved redistribution system, which is cognisant of the threat from automation and fair for all people across the UK.
Inequality is increasing across the UK.
This needs to be addressed and could be done by increasing the proportion for some of the ingredients to the Treasury’s fiscal pie, such as enhancing the rates on companies’ profits and wealth, as well as upping the higher and additional rates of income tax.
With respect to redistributing slices of the pie, the Barnett formula was based on a crude assessment of relative need in the 1970s, and a 21st century needs-based assessment is required to evaluate where resources ought to be redistributed to and this ought to be reviewed regularly.
There is substantial evidence highlighting similarities across the nations and regions.
The poverty faced by deprived communities in Glasgow and Dundee, is very similar to the lived experience of people in poverty in Liverpool and Redcar.
Child poverty data shows Scotland has fared slightly better than the rest of the UK but there is still a significant challenge ahead to eradicate it.
Understanding the Fiscal Pie Total UK government receipts are forecast to be £716.5 billion in 2016–17, tax receipts account for 93% of this sum, which equates to 34.2% of UK GDP.
The Treasury’s current recipe is largely dependent on taxes related to labour, as Table 1 shows, with 46% of the revenue coming from income tax and national insurance contributions.
Wealth taxes only account for 4% of the pie; corporation taxes are 11% of the total and, indirect taxes contribute 29%.
Highly regressive taxes such as tobacco and spirits collect more than inheritance and capital gains tax; this is not a fair system.
Thus, wealth and corporations ought to contribute more to grow the pie.
An additional reason for changing the recipe is that labour’s share of national income has fallen since 2009, from around 58% to 53%, as figure 1 depicts.
If further automation leads to capital replacing labour at a higher rate than in the past, worker’s bargaining power and share of income might be significantly lower.
It is clear that the fiscal pie is shrinking as labour’s position in the economy is weakened.
Consequently, there is a clear role for trade unions to play to aid labour’s resilience.
FIGURE 1: LABOUR’S SHARE OF GDP, UK
Source: Haldane (2015)
Table 2 shows that basic rate income taxpayers generate one-third of the income tax raised (£55,599 million) from the 24.7 million workers.
Thus, if automation leads to a further hollowing out, this proportion is likely to reduce; consequently, more revenue should be raised from the higher and additional rate payers.
Thirty-nine percent of the income tax comes from the 4.4 million higher rate workers (£64,557 million), and the 333,000 additional rate taxpayers pay 28% (£46,841 million).
TABLE 1: GROUPED PERCENTAGES OF THE TREASURY RECEIPTS FORECAST, 2016/17
Adapted from OBR (2016) March 2016 Economic and fiscal outlook, Table 4.6: Current receipts
TABLE 2: TAXPAYERS AND TAX LIABILITIES, UK 2016/17 ESTIMATES AND AUTOMATION SCENARIO
Source: HMRC (2016) Individual income taxpayers and income tax liabilities (Table 2.6), scenario data: author’s own calculations based on 2016/17 forecast data
With the Bank of England estimating almost 40% of jobs could be lost due to automation, a 25% reduction in revenue from basic rate taxpayers appears to be a modest estimate to explore a likely scenario resulting from automation.
This estimate would result in the UK losing of approximately £14 billion for based on the 2016/17 forecast.
To fill this gap, the higher and additional rates could be raised to 45% and 60% respectively. Increasing these rates would generate £15 billion. Table 2 details this scenario.
Whilst the gap would be filled, the reduction in labour would see increases in demand for social security.
Therefore, additional revenue needs to be raised to invest in services, communities and people.
One starting point would be increasing the tax rate on dividends by a third, to 10% for ordinary, 43.3% for higher and 50.8% for additional, which generates another £3 billion.
TABLE 3: NUMBER OF INDIVIDUAL INCOME TAXPAYERS BY MARGINAL RATE BY COUNTRY
Source: HMRC (2016) Income tax statistics and distributions, table 2.2
The Scottish Government noted only 0.7% of Scottish income taxpayers pay the additional rate, whereas, across the UK, there are 333,000 UK additional rate taxpayers, which equates to 1.1% of the UK income taxpayers.
So, proportionally the UK has over a third more additional rate taxpayers than Scotland. This more diverse tax base is another reason for remaining within the UK, which table 3 illustrates.
Three billion pounds may seem like a lot of money, but we need to remember that this is less than 0.5% of the Treasury’s tax revenue.
Consequently, a society that wishes to provide good quality, universal services needs to be properly funded. Taxes on wealth and corporations should be the priority.
The wealthiest 10% of households in the UK owned 45% of total aggregate household wealth.
Multinational companies are exploiting the system to ruthlessly minimise their tax liabilities.
Therefore, the UK’s whole tax regime needs to be thoroughly re-examined, which is beyond the scope of this paper; however, for illustrative purposes corporation tax, inheritance tax and capital gains tax are briefly examined.
The contribution to the fiscal pie from companies needs to increase.
There are a number of approaches to increase corporation tax collected, one is an international agreement to implement a unitary tax for multinational companies to reduce tax avoidance and evasion.
Only 11% of the taxes collected are paid by companies on their profits.
Some accountancy firms suggest that companies pay huge amounts of tax; however, this includes income tax, national insurance contributions and VAT.
Companies need to be honest about their profits and pay a fair rate of tax.
Corporation tax is now at 20%, if it was increased to 25% - all other things being equal – it would generate another £11 billion. Clamping down on tax evasion and avoidance could generate another £10.4 billion.
FIGURE 2: THE TREND IN UK CORPORATION TAX RATES
FIGURE 3: PROPORTION OF DEATHS LIABLE TO INHERITANCE TAX
With respect to wealth, the inheritance tax rate and threshold should be re-considered.
This tax raises just under £5 billion.
Only 3.5% of deaths are liable to inheritance tax.
It was almost 6% in 2006/07.
This would suggest that the threshold needs to be reviewed with the target to raise an additional £5 billion per annum.
Capital gains tax is charged on gains realised on the disposal of assets.
The capital gain is broadly the difference between the disposal proceeds and the cost of acquiring the asset.
There have been huge changes in this tax, but, the key issue is that this tax is collecting £800 million less in nominal terms that it was in 2007/08.
This needs urgent attention.
The current regime is not working for working class people in Scotland and across the UK.
With the transitional arrangement for the Scottish block grant adjustment ending in 2021/22, this gives an opportunity for Labour to deliver a new deal for Scotland and the UK with a new recipe for the Treasury fiscal pie, which is equitable.
By increasing the size of the pie with more progressive tax rates, Scotland can continue to enjoy greater resilience from being part of the UK, services can receive increased investment and we can work towards eradicating poverty.