7.1 This Chapter discusses the financial arrangements which will apply to the Scottish Parliament. It proposes a continuation of the existing "Block and formula" system of funding most of Scotland’s public expenditure programmes which has applied continuously since the late 1970s. There will of course be adjustments to reflect the terms of the financial arrangements arising out of the Bill which will follow this White Paper. It proposes also that the Scottish Parliament should be able to raise limited income at its own hand by means of a defined but limited power to vary income tax in Scotland and that the Scottish Parliament should be responsible for local government finance including local taxation.

Objectives

7.2 The financial arrangements for the Scottish Parliament will be designed to ensure that:

• Scotland will continue to benefit from its appropriate share of UK public expenditure;

• the Scottish Parliament’s assigned budget is determined by a method which is objective, transparent and widely accepted;

• the Scottish Parliament has the maximum freedom to determine its own expenditure priorities;

• the Scottish Parliament has a defined and limited power to vary central government taxation in Scotland and alter its overall spending accordingly;

• the UK Government can maintain proper control over public expenditure and public borrowing at the UK level;

• there are clear lines of accountability for local government spending and taxation; and

• UK taxpayers as a whole will be insulated from the effects of local decisions which add to Exchequer-funded expenditure in Scotland.

Present arrangements

7.3 For many years most of the expenditure programmes which fall within the Secretary of State for Scotland’s budget have been controlled through an arrangement

known commonly as the Scottish Block. Under this arrangement a block of resources, the annual changes in which have been determined by means of a population-based formula, has been made available annually to the Secretary of State for Scotland, who has then had the freedom to distribute those resources between Scottish programmes as he has thought fit. He has not been bound to replicate the spending decisions of Whitehall Departments but has been able annually to determine a specific Scottish set of priorities. Annex B provides further details of how the Block currently operates and how it will do so under the new arrangements.

7.4 In practice these arrangements, based on the Block and formula, have produced fair settlements for Scotland in annual public expenditure rounds and have allowed the Secretary of State for Scotland to determine his spending decisions in accordance with Scottish needs and priorities. They have largely removed the need for annual negotiation between The Scottish Office and the Treasury. The Government have therefore concluded that the financial framework for the Scottish Parliament should be based on these existing arrangements with, in future, the Scottish Parliament determining Scottish spending priorities.

The assigned budget

7.5 The Scottish Parliament will have an overall assigned budget broadly comparable to the present overall budget of the Secretary of State for Scotland. The majority of the assigned budget will be a new Block and, subject to paragraph 7.7 below, any future changes to the Block will be determined through the formula-based arrangements which have become known as the "Barnett formula". The details of the operation of the formula each year will be a matter of public record.

7.6 In practice, therefore, the Scottish Parliament’s assigned budget, like the Secretary of State’s budget at present, will be determined each year largely through the Block arrangements. The annual changes to the new Block will be calculated by reference to the existing formula, providing continuity with current arrangements. That means that each year the new Block will be adjusted by the population share of changes to comparable English or English and Welsh programmes.

7.7 The formula will be updated from time to time to take account of population and other technical changes. Any more substantial revision would need to be preceded by an in depth study of relative spending requirements and would be the subject of full consultation between the Scottish Executive and the UK Government.

7.8 Once the amount of the assigned budget for any forthcoming year is determined the Scottish Executive, subject to the consent of the Scottish Parliament and to its legal obligations, will have complete freedom to allocate resources across the programmes within the assigned budget.

7.9 Decisions taken by the Scottish Parliament or Executive will sometimes have financial implications for Departments of the UK Government. Similarly, UK Government Departments may on occasion implement policies which will lead to additional costs for the Scottish Parliament. Generally, it will be right, in line with long-standing conventions, for the body whose decision leads to higher or extra costs to meet those costs. This general rule will continue to apply between the Scottish Parliament and Executive and UK Government Departments. Many of the UK Government’s decisions will result in automatic adjustments for Scotland through the Barnett formula.

Funding

7.10 Once the proportion of the assigned budget which requires Exchequer funding has been determined, the UK Parliament will be invited to vote the necessary resources through a grant. Further elements of the assigned budget will be covered, as at present, by funding from the European Union and by borrowing by local authorities and other public bodies, to fund their capital spending. The Scottish Parliament will have power to authorise the Scottish Executive to undertake short-term borrowing to assist in the short-term matching of income and expenditure. It will not have a long-term borrowing power on its own account.

Tax varying powers

7.11 Subject to the outcome of the proposed referendum on this issue the Scottish Parliament will be given a power to vary tax.

7.12 The Government propose that the tax varying power should operate on income tax, because it is broadly based and easy to administer. Income tax is relatively simple and easy to understand and has none of the difficulties associated with the other major tax bases: different rates of VAT on different sides of the border would cause practical problems and there would be specific difficulties with EU rules; corporation tax would place an unreasonable burden on companies operating in Scotland; National Insurance is inappropriate because of its direct link with the social security system; and council tax and non-domestic rates would over-burden the local government finance system and undermine the accountability of local government to its electorate.

7.13 The Scottish Parliament will have the power to increase or decrease the basic rate of income tax set by the UK Parliament by a maximum of 3p. This is consistent with the recommendations of the Scottish Constitutional Convention. Since each 1p change would currently vary revenue by around £150m, the Scottish Parliament would be able to levy or to reduce income tax for basic rate taxpayers in Scotland by up to around £450m. It is of course possible that future changes to the UK income tax structure might reduce the value of the product of the Scottish Parliament’s tax-varying power. In these circumstances, the Parliament’s ability to raise or forgo up to £450m through the tax system will be preserved. This sum will be index linked to maintain its real value.

7.14 Any mechanism that might be required in future for protecting the Scottish tax take would be dependent upon the tax structure that was in place or had been announced at that time. As the Scottish Parliament will be fully operational from the financial year 2000-01 onwards, the appropriate arrangements would have to be jointly discussed by the Scottish Executive and the UK Government as and when such circumstances arose.

7.15 Savings and dividend income under current arrangements will not be subject to the Scottish Parliament’s 3p basic rate power as it is taxed only at the lower or higher rate. The Government believe that savings and dividend income should in future remain exempt from any income tax variation power, in order to ensure that such income is taxed on a consistent basis throughout the UK, thus avoiding economic distortion.

7.16 The test of liability will be residence - a well established concept in tax law. A Scottish resident will be an individual who is resident in the UK for income tax purposes and who in any tax year either spends at least half of his time in Scotland (when in the UK) or whose principal home is in Scotland. These concepts will be set out in legislation.

7.17 Any tax due to the Scottish Parliament will be collected by the Inland Revenue. Normal arrangements would apply. Self-employed taxpayers would pay through their Self Assessment. Employees would pay through PAYE with their employers operating a special tax table which would reflect any varied rate set by the Scottish Parliament.

7.18 The direct costs to the Government of establishing the mechanisms for tax variation in Scotland is estimated at around £10m. Running costs for the Government of collecting the tax are expected to be around £8m per annum, but may vary depending upon whether or not the Scottish Parliament chooses to vary the rate of tax. The Scottish Parliament will meet the administration costs incurred by the Inland Revenue.

7.19 Collection through PAYE will also generate additional costs for employers. Their setting up costs are estimated to be around £50m (which could be phased) and running costs at around £6-£15m. Costs will vary from employer to employer. For illustrative purposes, an employer with 5 Scottish resident employees, (most cases in practice) would typically face setting-up costs in the range £50-£100. A larger firm, with 200 Scottish resident employees operating PAYE could expect set up costs in the range of £700-£1,400, around £5 per employee. Once the legislation enacting the tax-varying power is in place, the Government will publish a formal compliance cost assessment, following consultation with employers.

7.20 If the Scottish Parliament exercises the tax-varying powers the resources available to it will be adjusted upwards or downwards by the appropriate amount.

Local government expenditure

7.21 The case for the Scottish Parliament is built on the range of powers and legislative responsibilities which it will enjoy. It follows that the Scottish Parliament’s control of the powers and functions of Scottish local government should extend to the financing of local government expenditure. This represents continuity with long established arrangements.

7.22 The Government’s objective is to establish clear lines of accountability for local government spending and taxation. Its aim is a system in which fiscal self-discipline is reinforced, both by the proper accountability of local authorities and the Scottish Parliament to their respective electorates and by the obligation on the Scottish Parliament to absorb any costs for UK taxpayers flowing from decisions on local government finance.

7.23 Support for local authority current expenditure will remain in the new Block, and so will capital allocations to councils. Responsibility for the control of local authority spending - current and capital - will be a devolved matter, so that the Scottish Parliament will have discretion to alter the existing regimes if it wishes, provided of course it stays within the total of the assigned budget. Local authorities will continue to be able to borrow from the Public Works Loan Board under existing arrangements.

7.24 The remainder of local authority self-financed expenditure, which consists largely of council tax revenue will, as at present, fall outwith the Scottish Parliament’s assigned budget just as, at present, it falls outside the Scottish Block. The Scottish Parliament will have the powers to control local authority current expenditure, through capping or other means, and it will be for the Scottish Parliament to decide whether and how to exercise these powers. Should self-financed expenditure start to rise steeply, the Scottish Parliament would clearly come under pressure from council tax payers in Scotland to exercise its powers. If growth relative to England were excessive and were such as to threaten targets set for public expenditure as part of the management of the UK economy, and the Scottish Parliament nevertheless chose not to exercise its powers, it would be open to the UK Government to take the excess into account in considering the level of their support for expenditure in Scotland.

7.25 Decisions by local authorities on their council tax levels and their housing rent levels could lead to expenditure on council tax benefits and rent rebates growing more rapidly in Scotland than in England. This could put an unfair burden on UK taxpayers. Arrangements will therefore be made to include the resources for these benefits in the Block, so that any resultant extra costs would have to be found by the Scottish Parliament.

Local taxation

7.26 The Scottish Parliament will be responsible for determining the form of local taxation, both domestic and non-domestic, which local authorities will be permitted to levy. It will therefore be able to alter the form of the council tax, or replace it if it so decides. Non-domestic rates are also an important part of the local finance system, and they too will be a devolved matter. It will be for the Scottish Parliament to decide whether to retain the power to set the non-domestic rate poundage within its own control or to devolve that responsibility to local councils. It will clearly need to consult business interests before making any changes. In the period until the Scottish Parliament is established, the Government will continue with their existing policy for non-domestic rates.

Propriety and value for money

7.27 The detailed arrangements which the Scottish Parliament makes to control and scrutinise the spending of the Scottish Executive will be a matter for the Scottish Parliament and its committees, but the Scotland Bill will lay a general obligation on the Scottish Parliament to establish effective scrutiny and audit arrangements. Suitable machinery will have to be agreed before the Scottish Parliament becomes fully operational to ensure that the actions of the Scottish Executive can be called to account as soon as it assumes its responsibilities. In common with other central government expenditure the grant to the Scottish Parliament will fall to be audited by the UK Comptroller and Auditor General.

7.28 These arrangements provide a structure for funding the Scottish Parliament that will establish that Parliament on a sound financial basis both on its own terms and in terms of its relationship with the rest of the UK. The system will provide an important element of continuity and the stability necessary for sensible long-term planning. It crucially will introduce direct accountability for spending priorities in Scotland. The proposals provide new opportunities. They will support the establishment of a powerful and effective Scottish Parliament capable of serving fully Scotland’s interests and at the same time they recognise and acknowledge the continuing and legitimate interests of the UK as a whole.