Devolving tax powers benefits Scotland more than the rest of Britain but may do little to keep the union together

SCOTLAND is fast becoming one of the world’s most powerful subnational states, along with Canadian provinces and Swiss cantons. It is now adding significant control over fiscal policy, in particular income tax, to the substantial autonomy it has enjoyed since 1999. The devolution deal, hastily concluded by an alarmed British government when only 55% of Scots voted in 2014 against independence, favours Scottish taxpayers over those in the rest of Britain. Even so it may only whet the appetite for full sovereignty.

Traditionally the British Treasury has collected revenues in Scotland, as elsewhere, and handed the Scottish government a slug of money, the “block grant”, to finance most of its spending. On April 6th a new Scottish rate of income tax (SRIT) was introduced that will take ten pence from every pound subject to income taxes. Scottish taxes due to Westminster have been correspondingly reduced. Scotland will keep the revenue from its new tax band, but its grant will be smaller. Next year Scotland will gain full control over income tax, collecting roughly half the money it spends, and the grant will shrink further. Other powers are also being devolved, including more say on welfare spending and the ability to borrow a little more.

It looks like a bad time, however, for Scotland to assume control of its fiscal destiny. The effects of lower world prices for oil and gas, exports of which accounted for one-quarter of Scotland’s GDP in 2012, may worsen in 2016, as contracts for fabricating and maintaining oil rigs expire and are not renewed. Forthcoming revisions could show that the Scottish economy contracted in the fourth quarter of 2015.

In the area around Inverness, Scotland’s biggest oil region after Aberdeen, unemployment has risen for five straight months. The Port of Cromarty Firth, where rigs are stored when they are not needed in the North Sea, is jammed (see picture). Diversifying into renewable energy and tourism will not offset job losses in oil. Pay packets in the industry are about 50% above the British average, so having fewer to tax takes a big bite out of receipts.

The fine print of the devolution agreement should help the Scots to cope with a slowing economy, however. The British government cut Scotland a sweet deal. Though the Scottish government is now in charge of a chunk of income tax, it will not run any economic risk in 2016-17, says Jim Gallagher of Oxford University. The reduction in the block grant will exactly offset the tax receipts generated this year by SRIT, he says. If revenues are low, London will make up the difference. Scotland will take on much more risk when it gets full control over income tax in April 2017, but the fine print of the deal may still mitigate it. Scotland’s income-tax take in 2016-17 will help to determine how big a block grant it receives thereafter. If the economy performs badly this year, the grant next year will be more generous. If growth then bounces back, Scotland could find itself with both juicy tax receipts and a hefty handout from London. The way in which the block grant will be adjusted in future years is also to Scotland’s advantage. Its population is growing much more slowly than Britain’s. Revenues from income tax can be expected to grow more slowly too, and so can demand for public services. Some argue that any adjustment to the block grant should take into account Scotland’s diminishing need for cash relative to needs elsewhere in Britain. In fact its budget will be protected from its relatively lower population growth—precisely what the ruling Scottish National Party (SNP) was aiming for in the negotiations over devolution. Public spending per person in Scotland is already more than 10% higher than it is in Britain as a whole, though Scotland is not particularly impoverished. The deal ensures that it is unlikely to decline toward the British average, says Mr Gallagher.

This latest round of devolution comes at an interesting time. The government at Holyrood is controlled by the SNP, which advocates independence, lost the referendum on it and went on to stunning victory in the British general election in 2015. It now hopes to do as well in the Scottish elections scheduled for May 5th.

One view is that the new tax powers could weaken the SNP. Since 2011, and especially since the referendum, it has built a sprawling coalition of support by bashing London and the British government’s austerity policies, combining left-wing rhetoric with middle-class goodies. Its opponents hope the transfer of fiscal powers will make it harder for the SNP to disavow responsibility for Scotland’s problems and promise all things to all people. That, in turn, might dampen popular enthusiasm for independence.

Some evidence points this way. Tax, not independence, has dominated the election campaign, with Labour seeking to outflank the SNP on the left (pledging tax rises to pay for expanded services) and the Conservatives on the right (hinting at cuts). Some think Scotland’s move towards fiscal autonomy—on generous terms—will convince people that full independence is neither necessary nor desirable.

Their hope is probably optimistic. Past transfers of powers have not stopped the SNP from fingering London for its failures in devolved areas such as education. If the Scottish economy takes off after the tax changes, the SNP can argue that Scotland deserves still more autonomy. If the new regime creates disgruntled losers, or if economic growth is weak, the party can blame Westminster for not giving it enough control over other things: employment law, say, or corporation tax. It will also grumble that the deal forces it to implement the central government’s austerity policies, given that Scotland still has very limited power to borrow.

Those who oppose the break-up of the United Kingdom will breathe a sigh of relief if Britain votes to stay in the European Union on June 23rd, as the SNP has all but promised a new Scottish independence referendum in the event it does not. But even if the Remain camp wins, Scotland is drifting away from the rest of the country, one round of devolution at a time. The new tax powers were designed to keep Scots in the union. They may nudge it closer to the exit.