By Anton Muscatelli

Negotiations between the Scottish and UK governments on the financial arrangements that will underpin the Scotland Bill, and that determine the funding available for the NHS, schools and other public services that we all rely upon are reaching a crucial stage.

Agreeing how to adjust the block grant Scotland receives from Westminster to accommodate the new tax powers remains vital. I believe a mechanism called “Per Capita Indexed Deduction" (PCID) provides a fair deal for both Scotland and the rest of the UK.

This method ensures that the simple transfer of the new tax powers would not in itself lead to an increase or cut in Scotland’s budget. This is of crucial importance, as it retains the Barnett formula as the principal determinant of public spending in Scotland, something that was central to the Smith recommendations.

It also ensures that if Scotland’s economy outperformed the rest of the UK, the Scottish Government would retain the proceeds of this higher growth through an increase in its budget. Just as importantly, if Scotland’s economy lagged behind the rest of the UK, the Scottish Government would see its budget cut.

Recently a variation of this methodology has been advocated called “Index Deduction”(ID). Rather than indexing the block grant adjustment to the growth in income tax receipts per person, the adjustment would be linked to the growth in total income tax receipts in the rest of the UK.

The two approaches appear similar. However, there is an important difference. Index Deduction exposes Scotland to the risk that its tax take grows more slowly than in the rest of the UK because of slower population growth. This is a significant risk. Over the past thirty years Scotland’s population has grown by just three per cent, whilst the rest of the UK has seen its population rise by 14 per cent. UK demographic trends are skewed by migration to London and the south east and the long-term demographic structure of Scotland cannot be erased overnight.

The Office for National Statistics forecasts that over the next 20 years Scotland’s population will continue to grow more slowly than in the rest of the UK.

Some have said that the Scottish Government should take on this population risk and use its new powers to boost Scotland’s population.This is a false argument. Under the Barnett formula Scotland’s budget is already exposed to some degree of population risk. PCID retains this existing risk but does not substantially increase it. The key levers to boost population lie not with the Scottish Government but the UK Government. For example, despite widespread support for its re-introduction, the UK Government has blocked proposals for post study work visas. The scale of the population risk that Scotland would face under ID is significant. Scotland could lose approximately £3.5 billion from its block grant in the first ten years of the new powers. This loss would only increase in subsequent years. Indeed, at the extreme, the Institute for Fiscal Studies estimates that under ID the block grant adjustment could eventually become so large that Scotland’s budget would become negative! Any ad hoc adjustments which could be made to Index Deduction or the other block grant adjustment methodologies that have been proposed would at best be partial fixes. Per Capita Indexation is the only option which will comprehensibly ensure that differences in population growth do not pose a systematic risk to the Scottish budget.

There is also a danger that in all the complexity a simple truth becomes lost. The promise of the vow and of the Smith Commission was not that the cost to Scotland would be minimised. The principle wasn’t "not-too-much detriment". The principle all the political parties and both governments agreed was "no detriment".

Scotland should be no better and no worse off simply by the act of devolution. Indexed Deduction doesn’t deliver that. It doesn’t deliver Smith. PCID can deliver Smith and can be further refined to take account of the 'tax-payer fairness' argument which ensures that if the UK Government wishes to raise income tax to pay, say, for additional English NHS spending additional UK taxpayer money doesn't add to the Scottish budget. The fiscal framework is as important as the content of the Scotland Bill itself. Designed correctly it will ensure that the Scottish Government’s accountability and opportunity to grow both the economy is increased. It can be made fair to the UK taxpayer. However, a poorly designed package would pose an unacceptable risk to the Scottish Government budget and Scottish public services.

Professor Muscatelli is Principal of the University of Glasgow.