Nick Clegg set out his support for Scotland to have "greater discretion" and "freedom" for how they spent public money, during an evidence session in parliament on Wednesday.
Clegg said devolution was a "living, breathing, thing" - adding he believes in "home rule in Scotland", which specifically related to money and "greater steps" towards fiscal autonomy.
"I believe there should be greater steps, fiscal and otherwise, towards autonomy in Scotland," Clegg told the House of Lords constitutional committee.
"I am a passionate advocate of a strong Scotland in a strong united Kingdom," he added.
The deputy prime minister described devolution as a "process." But he hit out at the SNP for engendering a "falsely polarised" debate. He said "some people" wanted to "falsely characterise" the choices facing Scotland.
Clegg also challenged the SNP to have "the courage of their convictions" and hold a referendum soon.
"They have a democratic mandate to put to the Scottish people the issue of independence," he told the committee.
He added that more devolution could only be looked at once the issue of Scottish independence had been resolved "in an atmosphere of mutual respect."
The deputy prime minister also gave a strong hint the next Queen's speech would contain a "definitive bill" on Lords reform, telling peers that in order to change the upper chamber by 2015 "one would need to get moving pretty quickly."
"We're not seeking to abolish the House of Lords," he told peers. Clegg stressed the need to make the upper chamber more accountable.
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