UK VAT rise poses strategic dilemma for Salmond

A piece I did for Newsnet Scotland:

by Alex Porter, Economy Editor

So the latest measure to save the UK economy from collapse has been rolled out by the ConDem coalition government in London. Everything consumers buy - except most food products, prescription drugs, baby's clothing, passenger transport and books - will now be taxed by the UK treasury at 20 percent - a rise of 2.5 percent from 17.5 percent.

The Scottish government has estimated that this VAT hike along with rising gas bills will cost the average Scottish family £600 in 2011, extracting £1.4 billion from the Scottish economy to help plug the UK's deficit. Government borrowing in November reached a staggering £23.3bn according to the Office for National Statistics (ONS). Total UK government debt is now accelerating towards the £1 trillion mark. To put this into context, if you think of it in terms of the Scottish bloc grant from Westminster the money that the UK government now owes is the equivalent of over 30 Scotlands.

These Spiralling debts and collapsing tax revenues are the legacy of the last Labour government to Britain's public finances. In an attempt to wrestle with the magnitude of this problem the ConDem coalition have brought in an austerity package which is a combination of cuts in public services and benefits as well as today's VAT increase.

Holyrood Impact

This latest raid on family budgets will fuel further calls for economic independence in order to protect Scottish taxpayers, businesses and institutions from the worst effects of the UK's deficit crisis. Scotland's national accounts (GERS) shows a surplus and that is currently sent to London. On top of that, cuts to the Scottish bloc grant will see a further £1.3 billion leave Scotland this year and head to the London treasury.

With the Holyrood elections looming the governing party in Edinburgh, the SNP, will hope to be re-elected by arguing for economic independence. The nationalists' argument is that Scotland should not be made to take the economic medicine for an economic disease it doesn't have. This case will resonate strongly during the campaign as the ConDem austerity measures are introduced forcing the leading electoral contender, Labour, to argue why they support the Scotland Bill.

The Scotland Bill is Westminster legislation, falls well short of 'fiscal autonomy' which has the support of the Scottish population, if opinion polls are to be believed, and leaves the Scottish economy fully exposed to the UK's escalating deficit problems and the ConDem coalition cuts.

Social Impact

With thousands of families across Scotland already struggling because of the UK's rapid economic decline this latest measure will tip many more families into poverty and hardship. SNP Lothians MSP Shirley Anne Somerville said: "There will be few families in Scotland that can afford the cost of a Tory government in London."

Families are under a lot of financial pressure already. Stress on family budgets is known to contribute to break-ups, homelessness and domestic violence. The accountancy firm PKF has warned that that 440 Scots are likely to be declared bankrupt every week in 2011. Increasing VAT will tip many Scottish families into desperate circumstances putting an increased burden on social services which are simultaneously facing ConDem austerity cuts.

Institutions such as those in Scotland's university sector face a funding crisis as Westminster reduces Scotland's budget. The SNP have promised to keep access to university free but it is not yet clear how universities can afford to maintain standards and at the same time absorb the ConDem cuts.

Unless a percentage of North Sea oil revenues are assigned to ringfence university funding, or some other solution is found, it is likely that fewer students will be offered higher education places. Also, with less high paying jobs to graduate into, students from poorer backgrounds will think again before taking on student debts. The VAT effect on Scottish families will pressurise poorer students into taking a low paid job instead to contribute to the family budget.

Businesses, especially in the retail sector, will be hit hard as goods become more expensive to buy and so demand will drop off. There are also forecasts of job losses in the building industry where companies fear reduced demand for repairs and maintenance work. Many of these job losses will hit the low paid and part-time workers.

Economic Impact

These likely consequences raise the spectre of an increase to the VAT rate being counter-productive. This outcome is a very real possibility and economists, investors and business leaders are anxious. At a certain rate of VAT consumers are priced out of the market and move into the black market. A combination of this and falling sales could see VAT receipts remain static or fall meaning that there will be no gain for the treasury whilst private sector activity actually shrinks and jobs are shed.

Should this scenario play out at the same time as public sector cuts, the combination of the two could be a lethal concoction. The reaction by the ConDem government in London and the Bank of England will undoubtedly be more 'quantative easing' aka money printing, which will cause devaluation. Devaluation means that everyone's money becomes worth less as its purchasing power diminishes - your salary stays the same but you buy less with it. This is a backdoor wage cut.

Without economic independence money will continue to be drained out of the Scottish economy. The SNP government's freeze on council tax bills is therefore absolutely pivotal in offsetting the VAT hike in Scotland in order to ensure that as many families as possible can afford the essentials.

However, making matters worse is London's policy of devaluing the pound which combined with a sharp rise in commodity prices and oil - still to be priced in to the economy - has led to analysts forecasting increased inflation and so reducing the average household's purchasing power further still.

Salmond's Dilemma

The Scottish government has called for the VAT rise to be postponed, but in reality Alex Salmond's Cabinet has no influence over the principle economic powers that steer economies.

In view of increasingly grim economic assessments of the UK economy First Minister Salmond will come under pressure to explain to fellow nationalists how the powers of economic independence are sufficient to protect Scots from the UK's sovereign debt, financial and currency crises.

The UK's VAT increase will impact on the UK's monetary position. The powers of 'economic independence' will protect Scotland from the UK's fiscal impasse but not the deeply troubling monetary predicament south of the border.

It may not suit Salmond's political strategy to campaign for full independence but it is now imperative economically that full independence is prominent on the political agenda so that Scots have the comfort of knowing they can - if they need or wish to - escape from the pound, establish a Scottish currency and protect the Scottish population from the inherent dangers of the UK economy: sovereign debt default, currency devaluation and price inflation.