Scotland currently has limited tax-raising powers: its government does not collect or legislate over the broad-based taxes that are needed for high fiscal capacity. Developing a sense of common purpose is critical for nation-building – and it would be a key issue for an independent Scotland.
Political economists understand that the power to tax is at the heart of effective states. This is far from being a purely technocratic issue: a government must be able to raise revenues to spend on infrastructure and a range of public services.
But throughout history, enlarging the public purse has been a surprisingly difficult task for many countries. Although since 1998, Scotland has been granted some limited tax-raising powers and autonomy over public spending, the nation currently does not have the capacity to collect broad-based taxes. Hence it is not a strong fiscal state in its own right, given that – under the current constitutional settlement – it is not responsible for its own tax system and lacks the institutions to raise revenues.
A government’s accountability rests primarily on how it chooses to spend money rather than how it raises it. This would change were Scotland to become an independent country, and it is important to be aware of the tasks that would be entailed in making such a transition.
The importance of fiscal capacity
There are many politico-economic studies emphasising the importance of fiscal capacity in the history of nation-building. Over the past century, fiscal capacity has increased dramatically (Besley and Persson, 2014). Expanding the base for taxes on income and consumption is the fulcrum of modern fiscal capacity.
Far from impeding prosperity, it is high-growth countries that tend to have a larger share of tax revenues in GDP (Dincecco and Prado, 2016). This is partly because governments with high fiscal capacity have strong incentives to invest in prosperity to maintain and build the tax base; and hence they tend to strengthen other branches of the state that support economic development (Besley and Persson, 2011; Besley et al, 2021). For example, investing in the health and education of citizens or regulating an economy in a way that supports growth will pay dividends in the form of higher tax revenue.
High fiscal capacity can also support protection against economic shocks, as was apparent with the scale of the furlough scheme during the Covid-19 pandemic. It can also increase economic flexibility by sharing the burden of economic transitions, as is likely to be seen in the coming years as we move towards a low-carbon economy.
It is also fiscal powers that enable a state to borrow at reasonable cost. But a good part of building these powers lies in acquiring a reputation for using them wisely and having appropriate constraints in place to underpin this.
Excluding revenues from North Sea offshore oil and gas activity, Scotland’s average tax revenue as a share of GDP is 39.2% (over the period from 2016 to 2021). By this standard measure, Scotland looks like a country with high fiscal capacity, in parallel with many high-income countries. Notwithstanding this, most fiscal decision-making still lies with Westminster.
Research has shown that collecting broad-based taxes, such as income tax and value-added tax (VAT), is key to this endeavour (Migdal, 1988; Besley and Persson, 2014). This stands in contrast to more ‘basic’ taxes, such as trade tariffs, which can simply be collected at ports by monitoring flows of goods.
Revenue Scotland, which was established in 2015 as the nation’s tax authority, currently oversees only the collection of fully devolved taxes – the Land and Buildings Transaction Tax (the replacement for Stamp Duty) and the Scottish Landfill Tax. Two other taxes – Air Departure Tax and Aggregates Levy – will also be collected by Revenue Scotland, although full devolution has been delayed.
While Scotland has its share of the administrative infrastructure for income tax collection, it does not currently have oversight over broad-based taxes, which are collected by HM Revenue and Customs (HMRC).
Even though the Scottish government can vary tax bands and rates on income tax, administration is still undertaken by HMRC. Around half of VAT revenues estimated to be raised in Scotland are planned to be assigned to the nation in the future, but again these will be collected by HMRC, with an estimate of how much has been collected in Scotland allocated to the Scottish budget.
Essentially therefore, Scotland’s government spending is currently dependent on the fiscal capacity institutions of the UK as a whole, which have been built up over more than two hundred years. Although Scotland has been part of these two centuries of history, does it matter if the current set-up changes?
Where does fiscal capacity come from?
Historically, war has been the key impetus for a state to build its fiscal capacity (Dincecco and Prado, 2012). As the late historical sociologist Charles Tilly’s famous aphorism goes, ‘war made the state and the state made war’.
Although war is destructive, it can also be a key source for creating a sense of ‘common purpose’. November commemorations of the fallen in world wars that take place everywhere in the UK are a collective appreciation of the sacrifices that were made to maintain the territorial integrity and independence of the UK.
Following this logic, creating a sense of common purpose will be key if there is a referendum vote in favour of Scottish independence. If the referendum is divisive, that may not be easy; the ordeal of trying to resolve Brexit in a harmonious way is a salutary experience.
We would expect Scotland to retain the broad administrative and political institutions that are conducive to this, especially strong constraints on executive power and openly contested elections. Of course, much would depend on the future party configuration that emerges in a post-independent Scotland once the raison d’être for the Scottish National Party (SNP) is no longer relevant.
Robust checks and balances have been a key part of the institutional fabric that has built strong fiscal states throughout history, as a means of limiting the possibility that a government is run by a narrow unaccountable elite (Besley et al, 2013).
Being part of the UK adds to the checks and balances on both the reserved and devolved powers of the Scottish government. Once these have gone, debates surrounding the role of a second chamber and a constitutional court would surely become salient.
Scotland already has it own fiscal commission to support fiscal forecasting, and if it aspires to rejoin the European Union (EU) post-independence, it is likely that it would have to step in line with the requirements for entry to the euro area (although these seem to be only loosely adhered to and policed for existing members).
How to design the tax system would open a host of new political cleavages and possibly some new constraints for Scotland. As will be covered by other authors in this series, irrespective of the long-term views on the success or otherwise of independence, the post-independence Scottish government would need to act carefully to counter any threat of exit by firms and high-earning individuals.
Since 2015, Revenue Scotland has been a well-established bureaucratic agency for administering tax collection, and there are unlikely to be significant start-up costs in establishing a tax collection system if registered taxpayers under HMRC are simply ‘handed over’ to Revenue Scotland. Nevertheless, the core challenge goes beyond administrative concerns, since relying exclusively on the coercive and administrative power of the state is unlikely to be enough in itself.
The importance of trust and confidence
Evidence suggests that higher confidence in government is correlated with higher levels of willingness to comply with taxes (Besley, 2020). Fiscal capacity is thus generally complemented by strong norms and values – what is often referred to as ‘civic culture’.
Building this confidence comes, in part, from institutional constraints such as checks and balances. States with a record of accomplishment in raising revenues and spending have a reservoir of confidence on which they can draw. For new states taking on new tax-raising powers, this needs to be built. States that are, or have been, dependent on external aid or natural resources have often struggled to build such confidence (Deaton, 2015; Jensen, 2011).
To succeed as an independent fiscal state, Scotland would have to rely on its strong civic culture to bolster the piecemeal process of state capacity. Figure 1 presents data from the Scottish Social Attitudes (SSA) survey, showing that Scots have far more trust in Holyrood than Westminster based on the question ‘How much do you trust the [UK government/Scottish Parliament] to work in Scotland’s best interests?’, of which we take the proportion of respondents answering ‘only some of the time’, ‘most of the time’ or ‘just about always’, relative to ‘almost never’.
Figure 1: Scots’ trust in the UK government or the Scottish Parliament to work in Scotland’s best interests
Source: Scottish Social Attitudes (SSA) survey
Note: Data missing for 2008 and 2014
This has been a fairly stable relationship going back to even the early 2000s, although trust in Westminster has dipped even more since the independence referendum in 2014. Despite lacking data for 2017 onwards, this pattern is also reported to have remained in more recent years.
In line with greater confidence in Holyrood versus Westminster, it is plausible that strong norms and values could bolster an independent Scotland’s fiscal capacity in the long run. But this has been based on fiscal powers being located in Westminster. It is arguably easier to build trust when the government is spending money than when it is raising it. Either way, there would be a new era of accountability for Scotland were it to take control of its tax affairs.
Confidence in government and tax morale, both of which enhance fiscal capacity, are further derivative of perceptions of government effectiveness (Torgler, 2003; Daude et al, 2012). If citizens see their taxes being put to fruitful uses, then there should be greater public willingness to comply (Carrillo et al, 2021).
Scotland’s more cautious approach out of lockdown is argued to have helped the nation to fare better in terms of excess deaths from the pandemic early in 2021, indicative of a government that can do its job well. Although past performance is not always a good predictor of future performance, the management of Covid-19 by the Scottish government may provide some insight as to whether an effective state could emerge from independence, something that could be leveraged in building a strong fiscal state.
One of the big changes following Scottish independence would be taking responsibility for raising tax revenues. When a country needs to raise 40% of GDP in taxation to support its spending ambitions, there are considerable administrative fiscal challenges, which are untested for Scotland under current arrangements. By being part of the UK fiscal state, like any other constituent part of the UK, these issues are dealt with by Westminster at present.
How Scotland handles debates about the design of tax systems would also be a new challenge for the political economy of Scotland, with the degree of progressivity in the tax system and the structure of business taxation having to be resolved.
This would be key if Scotland wished to evolve a different model for the role of the state, with more generous social provision. Whether it would be able to replicate the generous corporate tax policies that Ireland and Luxemburg have evolved, while aspiring to join the EU, is a further key issue.
It remains unclear whether the implications for tax policy will become central debating points in any referendum, should one transpire. How the fiscal capacity of the UK, as currently constituted, transfers tax powers to a newly independent Scotland would also be an important question. No successful state, large or small, can neglect the exigencies of taxation if it is to serve its citizens effectively.
Where can I find out more?
- Scotland's new financial powers: Report from Audit Scotland
- Scottish Social Attitudes Survey
- Scotland’s economic and fiscal forecasts from the Scottish Fiscal Commission
- Government expenditure and revenue Scotland 2020-21
- Taxes in Scotland: Background and policies
- State capacity and long?run economic performance: Paper on the relationship between a state’s fiscal and administrative powers and economic growth