If Scotland needs UK help to pay for devo max, how could it possibly afford separation?

What is the problem?

On the eve of the independence referendum, the leaders of the No campaign issued the so-called vow to grant Scotland much greater devolution. Though the Yes vote failed to reach 45 per cent, they kept their promise. The result was the Smith Commission, in which all Scottish political parties, but no others, took part.

After only nine weeks, the commission proposed that the Scottish Government should have real control over Income Tax, VAT, Air Passenger Duty, Stamp Duty Land Tax, Landfill Tax and Aggregates Tax. All Scottish political parties agreed to, and signed, the report. In May last year, the Scotland Bill delivered on the devolution package, subject to agreeing the fiscal framework.

It took months before Scottish ministers admitted to themselves the stark truth: the Scottish economic and tax base was so poor, in relation to that of the UK, and the prospective population growths so different, that the future yield of the devolved taxes was likely to leave Scotland significantly worse off than it currently was as recipient of the annual block grant from the UK Treasury. It became undeniable that taxpayers elsewhere were subsidising Scottish public spending.

This embarrassing fact would have been even clearer but for the operation of the Barnett formula. This formula, used first in the 1970s economic crisis and intended to last only for a few years, gives Scotland more tax receipts to spend per capita in Scotland than any other part of Great Britain: taxpayers in England and Wales are subsidising the Scots; the Barnett formula is the principal channel for that subsidy.

But, under the Smith agreement, the block grant has to be reduced to reflect Scotland’s increased income, raised directly from the newly devolved taxation powers: the fiscal framework has to effect that annual reduction. The SNP Government argues that the other UK taxpayers should continue to subsidise the Scots, and even increase the subsidy if devolved tax revenues fall relatively. That argument is based not upon some high principle of fairness but upon a curious notion invented in the Smith report, called the “no detriment” principle.

There has never been any common understanding as to what that means. The SNP argues that the existing tax subsidies should continue. The UK Government is increasingly aware that the Smith agreement, written entirely by Scots politicians and preserving Barnett, is seen by the rest of Great Britain as an unfair vehicle for taking money from south of the Border to enable Scots to pay for free university education, extra help for the elderly, reduction in National Health charges and so on.

A second stark truth has emerged: for if Scotland needs UK help to pay for devo-max, how could it possibly afford separation? Separation would inevitably end the UK subsidies that underpin Scottish public expenditure. If Scotland had become independent in March 2016, as the referendum envisaged, it would have lost the generous subsidies paid to Scotland by the block grant. That loss, on top of the disappearance of any meaningful revenue from North Sea oil, would have produced an economic black hole.

In short, the debate about the fiscal framework has made it plain that if Scotland’s finances were likely – unless subsidised - to suffer seriously under the new Smith Commission devolution package, they would suffer even more severely on separation.

Meanwhile, the UK Government, if it caves in to the demand for continuing generous subsidy, will have to explain to the taxpayers of Wales and England – who were not represented on the Smith Commission – why they should so generously subsidise the Scots. That will not be easy, as the Barnett formula is now widely perceived as unfairly generous to Scotland. The UK Government has either to surrender and promise long-terms subsidies to a devolved Scotland – facing the resulting wrath of taxpayers elsewhere – or to argue that, as “no detriment” should apply equally to protect non-Scot taxpayers, then Scotland must accept the economic consequences of devolution. If it does that, it must expect the SNP to lay the blame on the UK Government.

We shall soon know the result of the secret talks.

Lord McCluskey, a former High Court judge and Solicitor General for Scotland, is a Labour peer.