39
SCOTLAND’S FISCAL DEFICIT or THE ELEPHANT IN THE ROOM REPORT 1
SCOTLAND’S FISCAL DEFICIT
or
THE ELEPHANT IN THE ROOM
REPORT
May 2019 Update
1
SUMMARYChart 1
2010-11 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 *0
5
10
15
20
25
20
1716 16
15 15 14
8
3
10 0
1 1
1213
1415
1413 13
Scotland's deficit£ billions
On shore deficitOil incomeNet deficit
*Author’s Forecast
Scotland has two measured economies – offshore (potential taxes on North Sea Oil profits) and onshore (everything else). Although there are some signs of recovery in oil revenues both are in serious trouble with oil taxes having collapsed from historic highs and the onshore economy in chronic, unsustainable deficit.
This is the fourth edition of this paper and it is fair to say that there is much more public awareness that there is a problem. A report by the Sustainable Growth Commission under Andrew Wilson - ‘Scotland – the new case for optimism’ produced for the First Minister - at least begins to address it even if, as the title suggests, it looks at it through rose tinted glasses.
What has not changed is that the Scottish Government is doing nothing to tackle the problem. The premise is that all problems are due to Scotland being part of the UK and that remedial action cannot happen before independence has been achieved.
One major problem with this approach is that if independence is indeed achieved it will be a cold turkey remedy where overnight the economy would lose the external funding needed to maintain public services. If this is to happen it would be sensible to make the problem as small as possible and that means a remedial action plan now and not at the cliff edge.
The hard truth is that Scotland does not raise nearly enough in tax to pay for its public services. Ignoring the problem is not a strategy.
The purpose of this paper is to contribute to a debate on the deficit by analysing the performance of the Scottish economy using data from official Government sources and providing an audit trail back to source. It is intended to make regular updates as further data becomes available.
2
CONTENTS
Page
1 MAIN CONCLUSIONS
2 DEFINITIONS AND SOURCES
3 NORTH SEA OIL AND SCOTLAND’S ECONOMY
4 SCOTLAND’S DEFICIT AND EUROPE
5 SCOTLAND’S DEFICIT AND THE UK
6 SCOTLAND v THE ROUK – THE ONSHORE DEFICIT GAP
7 THE £10.5 BILLION DEFICIT GAP WITH THE ROUK: PART ONE
8 THE £10.5 BILLION DEFICIT GAP WITH THE ROUK: PART TWO
9 EXPLAINING THE REST OF THE DEFICIT
10 THE FUTURE
11 THE NEED FOR BETTER PLANNING, INFORMATION AND SCRUTINY
APPENDIX 1: INCOME AND EXPENDITURE BREAKDOWN
APPENDIX 2: INCOME TAX
APPENDIX 3: HISTORY REWRITTEN
4
5
6
8
10
12
14
16
18
19
21
22
25
27
3
1 MAIN CONCLUSIONS
On the basis of current forecasts, for the foreseeable future North Sea Oil income will not return to the previous high levels.
Scotland’s total fiscal deficit including a geographic share of North Sea Oil was £13.4bn in 2017-18. This is likely to remain broadly steady in 2018-19 and will be equivalent to 8% of total GDP. On the latest available data this would again be the worst in Europe.
Scotland’s total economy is significantly weaker than the UK as a whole. Scotland makes up just over 8% of the UK population but accounted for 34% of the UK deficit in 2017-18. In 2018-19 it is likely to exceed 50%.
Scotland’s onshore deficit in 2017-18 was just under £15bn, broadly unchanged on the year before. It is likely to remain broadly the same in 2018-19.
Of the £15bn 2017-18 onshore deficit, a little more than £2bn relates to external economic cycles. As the UK, European and World economies improve so this element will shrink. But when external economic conditions worsen – as they will - it will grow again.
The rest – over £12bn - is due to Scotland’s onshore economy being much weaker than the rest of the UK (ROUK). This a long term and structural gap.
Of this gap around £3.1bn is due to lower per capita income and £9.3bn to higher per capita public expenditure compared with the ROUK.
The £3.1bn income gap is mainly due to weakness in income tax. This is caused by Scotland having proportionally fewer top rate income taxpayers than the ROUK with lower average incomes. The last available analysis of income tax in Scotland by tax band is for the year 2013-14. This should be a key metric of the effect of income tax policy in Scotland. If the impact of changing tax rates by band is not measured or budgeted for how can its effectiveness be known?
The £9.3bn expenditure gap is a direct result of the long term application of the Barnett Formula. This has supported public services at a higher level in Scotland than the ROUK for many years. As a consequence it is the biggest single element in Scotland’s deficit and the biggest obstacle in the way of resolving it.
Simply defending subsidies paid to Scotland while failing to evolve a strategy to grow to live without them is driving the country towards a fiscal cliff edge.
Scotland needs better, more frequent and independent information on its overall economic performance and in particular on its deficit. Attention needs to be paid to how revisions in historical numbers reveal past errors of published facts and how these should be dealt with. At present the deficit is an issue for a few days in August each year on publication of GERS. Then it is ignored again.
Even more, Scotland needs a government strategy which acknowledges the deficit problem and sets out to deal with it. The numbers are very big and no easy solutions will present themselves. It is a problem which has been long in building and it will take many years to resolve. And it is a problem which is getting worse.
4
2 DEFINITIONS AND SOURCES
An introduction to the sources of information, attached spreadsheets and definitions of terms
The following tables and graphs look in some detail and from various angles at the gap between Scotland’s public income and expenditure.
NFB is Net Fiscal Balance and is the difference between total government revenues and expenditure including capital expenditure.
A deficit is when expenditure is greater than income over a year. Debt is an accumulation of deficits.
GDP is Gross Domestic Product and is the monetary value of all finished goods and services. The relationship between the two in percentage terms is a standard guide to the health of an economy. A GDP deficit (expenditure exceeds income) consistently higher than a country’s underlying economic growth rate is considered to be problematic. For a country seeking to join the Euro the maximum permitted is 3%.
Scotland’s oil income is Scotland’s North Sea Oil Revenue (geographic share) as defined in GERS (Government Expenditure and Revenue Scotland).
Non-oil income or ex-oil income is Total Revenue Excluding North Sea Revenue as defined in GERS.
Public expenditure is Total Managed Expenditure as defined in GERS and includes capital expenditure and a population share of UK public debt interest and other indirect costs.
This paper is based to a large extent on information published by the Scottish Government in its GERS report for 2017-18 but a number of other resources have also been used. The tables shown below are summary extracts from the attached spreadsheets which also contain references to the original sources of data. Sheet 1 Summary contains copies of all the tables below and the reader can use these to follow data and calculations back to the detailed supporting sheets.
In the spread-sheets the original and unedited data is shown without background colour. Cells shaded green show the areas where summaries and other calculations have been made.
GERS 2017-18 gives information for Scotland and the UK on public income, expenditure and national output (GDP) in many cases over the 20 years up to 2017-18. While the income elements record taxes raised in Scotland, some of these are not under the control of the Scottish Government. Further, some of the public expenditure recorded is not controlled by the Scottish Government and parts are allocated to Scotland on a per capita basis (eg public debt interest and the costs of UK armed forces). However in each case increased devolution is increasing the amounts controlled by the Scottish Government.
But differences in reported levels of income and expenditure between Scotland and the UK or the ROUK reflect real differences in levels and distributions of incomes and real differences in the amounts spent on supporting real social needs.
5
3 NORTH SEA OIL AND SCOTLAND’S ECONOMY
How Scotland’s geographic share of North Sea oil taxes has changed.
Anyone can take a view on whether, when, how quickly and by how much the price of oil and North Sea output might recover sufficiently to again be of relevance and will be just as likely to be correct as the most informed expert. But it should be understood that the old assumed certainties of North Sea Oil income have gone
To show how the ground has shifted here is a table of the value produced from that part of the North Sea described as ‘Scotland’s geographic share’ over the past 1, 5 10 and 20 years and as currently projected for the next 6 years. This is followed by a graph based on the same data.
Table 1
Scotland geographic oil - historical and projected revenue
Average per annum over
Historic Historic Historic Historic Projected*1 years 5 years 10 years 20 years 6 years2017-18 2014-18 2009-18 1999-2018 2019-24
£bn £bn £bn £bn £bn
1.3 1.3 4.1 4.3 1.6
*OBR March 2019 @ 88%
Chart 2
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
2018-19
2020-21
2022-23
0.01.02.03.04.05.06.07.08.09.0
10.0
Scotland geographic share of oil revenues£ billion
6
Had Scotland been an independent country and oil revenues divided on the basisof its assumed geographical share over the 5 years to 2017/18 the average annual valueof Scotland’s oil income would have been around £1.3bn. This was substantially lowerthan the levels which would have applied prior to the global collapse in the price of oil.
The latest OBR (UK Office of Budgetary Responsibility, March 2019) forecast is that total UK oil income while recovering from recent lows will remain largely below £2bn a year for the next 5 years. The table and graph above assume Scotland’s share of this income at 88% of the total. These forecasts assume the oil price remaining in a range of from $60 to $65 per barrel.
However the graph shows how much oil income has fluctuated over the last 20 years and emphasises the need to look at and understand Scotland’s onshore economy. It also shows the need not to rely on oil as a way to avoid having to face up to the unpleasant realities of the underlying facts.
An extract of oil income projections from the most recent UK OBR projections (March 2019) is set out below. Previously the Scottish Government had produced its own Oil and Gas Bulletin which also included its projections of oil income. However the author has been unable to find any Bulletin dated later than 2015 and this is now well out of date. This leaves the only readily available source for projected oil income as the OBR projections. The Scottish allocation of 88% is my own based on the latest GERS analysis of Scotland’s geographic share over the last 5 years. As far as I am aware the Scottish Government has not published oil revenue forecasts since it stopped publishing its Oil and Gas Bulletin
Table 2
OBR ActualOBR March 2018 2017-18 2018-19 2019-20 2020-21
£ bn £ bn £ bnScotland Geographic Share (88%) 1.3 1.3 1.0
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4 SCOTLAND’S DEFICT AND EUROPE
How Scotland’s deficit has evolved over the last 19 years including and excluding oil.
The graphs show the value of Scotland’s annual deficits in £ billions and what they represent as a % of GDP.
Chart 3
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-25
-20
-15
-10
-5
0
Scotland's NFB deficit£ billion
Including oil
Excluding oil
Chart 4
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-18.0%
-16.0%
-14.0%
-12.0%
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
Scotland NFB deficit as % of GDP
Including oilExcluding oil
Total Economy (Including Oil) It can be seen that the deficits go back well before the recession began in 2008-09. In 1999 the total deficit including oil was £2.6bn (3.1% of GDP). In the most recent
8
year it was £13.4bn (7.9% of GDP) – a growth of £10.8 billion or 4.8 percentage points over the last 19 years.
To put these results in context sheet 2 ‘Europe Deficits’ shows this ratio for all European countries in 2017 sorted in order of deficit %. Scotland’s performance including oil income would put it at the bottom of this table. This is not a news item as it has been the case for some years.
Onshore economy (excluding oil)
The ‘excluding oil’ lines in charts 3 and 4 show the deficit in the onshore economy has grown from £4.2bn in 1999 (5.3% of GDP) to £14.8bn (9.5% of GDP) in 2017 - a growth of £10.6bn or 4.2 percentage points. Given the volatility in oil income in the past and the relatively low levels anticipated in coming years, understanding how the onshore deficit has arisen is essential in planning how to deal with it.
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5 SCOTLAND’S DEFICIT AND THE UK
Scotland’s onshore economy has a major deficit problem. But it also has a bigger deficit problem than the UK as a whole. This is shown first by looking at Scotland’s % share of the UK’s deficit including and excluding oil income and comparing this with its population share:
Scotland V UKScotland's share of UK NFB and UK population over
1 Year 5 years 10 years 20 years
2017-18 2014-18 2009-2018 1999-2018
Table 3 % % % %
NFB share total economy 34% 20% 13% 14%
NFB share onshore economy 36% 22% 49% 20%
Scotland's share of UK population 8.2% 8.3% 8.3% 8.4%
This shows that over the last 1, 5, 10 and 20 years, Scotland’s share of the UK total deficit (ie including oil income) was higher than its population share and in 2017-18 with just 8.2% of the UK population Scotland produced 34% of the UK deficit. In the current year this proportion is likely to exceed 50% (Author’s forecast)
Another way of looking at it is to compare the gap between Scotland’s NFB deficit % of GDP and the UK’s. (ie Scotland NFB as % of GDP minus UK NFB as % of GFP) - again including and excluding oil revenues:
Chart 5
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
Scotland v UK NFB deficit gap as % of GDP
Including oilExcluding oil
The blue line shows that in its total economy (including oil) Scotland’s deficit gap with the UK was positive (ie Scotland’s deficit % was lower than the UK’s) in only 3 years out of the last 20 – years of high oil revenues. The red line shows that for the onshore economy (excluding oil) Scotland’s deficit was consistently between 6 and 8 percentage points worse than the UK.
Since the recession would have impacted roughly equally on Scotland and the rest of the UK (ROUK) it is unlikely to have had any material effect on the relative
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performances of the onshore economies (the red line). This red line reflects real sustained structural weakness in Scotland’s onshore economy relative to the UK.
Scotland’s weaker numbers dilute the overall UK results of which Scotland is a part. To fully understand Scotland’s relative onshore economic weakness we need to look at how Scotland compares with the ROUK.
Much of the rest of this paper will therefore focus on the onshore economies of Scotland and the ROUK. Understanding why Scotland’s onshore economy is so much weaker than the UK’s as a whole may not solve the problem but it may help to define the challenge more clearly.
There will be those who say there is little point in comparing Scotland’s data with that of the average of the ROUK and that Scotland actually compares reasonably well with a number of other regions. This may be the case but generally these regions are not faced with the possibility of leaving the UK and crystalising the immediate problem of how to fund their own deficits. While the following notes attempt to understand better how the deficit has come about it is the scale of the deficit which is the real problem and whether Scotland performs better or worse than the ROUK in specific areas will be of little comfort if the IMF comes calling.
Finally, stating that Scotland’s economy is weaker than the UK as a whole is directly contrary to claims made as a cornerstone of the financial case for Scottish Independence. The Scottish Government claimed prior to the 2014 referendum that Scotland’s economy was fundamentally stronger than the rest of the UK.
This claims were made in the 2013 white paper Scotland’s Future ‘Scotland stronger than the UK by £12.6 billion over 5 years’ and again following publication of GERS 2012/13 in March 2014 ‘Scotland stronger than UK by £8.3 billion over 5 years’
The data on which these claims were made was wrong – as were the claims. Using the latest GERS data for these same years ‘£12.6 billion stronger’ becomes ‘£1.4 billion stronger’ and ‘£8,3 billion stronger becomes £1.2 billion weaker’. That is a loss of just over £11 billion and £9.5 billion respectively over the two 5 year periods. That is a lot of money to lose down the back of the sofa without a word of explanation.
Appendix 3 (History Rewritten) gives further detail.
6 SCOTLAND v THE ROUK – THE ONSHORE DEFICIT GAP
11
The following charts show how Scotland’s onshore NFB deficit has evolved in comparison with the ROUK.Chart 6
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0% Scotland and ROUK onshore NFB as % of GDP
ROUKScotland
The chart confirms that Scotland’s onshore economy has been significantly further in deficit than the ROUK since at least 1999. It also shows that Scotland and the ROUK share very similar trends in depression and recovery.
The next chart confirms the steadiness of the gap between the two economiesChart 7
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
-9.0%
-8.0%
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
Scotland v ROUK NFB gap in % points
The gap has generally stayed between 6 and 8 percentage points over a 20 year period but has deteriorated to just over 8% over the last 3 years.
If we take this deficit percentage gap between Scotland and the ROUK and apply it to Scotland’s onshore GDP it gives a cash value of the difference – the amount in £ billions by which Scotland’s onshore economy is weaker each year than the ROUK and by which it would have to improve through lower expenditure and / or higher income to achieve ROUK deficit levels. As noted above this measure was used by
12
the Scottish Government extensively in the 2014 referendum campaign.
The next chart takes the last chart and adds a line for this cash value gap. (The £ billions values have been inverted to avoid overlap of the lines)Chart 8
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
-9.0%-8.0%-7.0%-6.0%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%
0
2
4
6
8
10
12
14
Scotland v ROUK GDP gap in % points and £ billions
£ bi
llion
s
We can see again that the % gap with the ROUK has stayed roughly steady generally between 6 and 8 percentage points but the value gap has doubled since 1999 from around £4.5 billion to £12.5 billion in the latest year. In the context of the Scottish economy this is a very big number and to put it in context total income tax in Scotland in 2017-18 was also £12.5 billion.
We now know that Scotland has a chronic onshore deficit, that this deficit is worse than the ROUK and that the gap with the ROUK is relatively steady as a % of GDP but has doubled in value over the last 19 years. Of course, if GDP grows and the percentage difference stays the same the value of the gap will grow in proportion to growth in GDP.
But is it only growth in GDP which caused the gap with the ROUK to grow to £12.5bn and why should there be a gap in any case? To answer these questions we need to look in more detail at how the gap with the ROUK is made up.
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7 THE £12.5 BILLION DEFICIT GAP WITH THE ROUK: PART ONEHow Scotland’s onshore deficit gap with the ROUK evolved over the last 20 years.
In order to understand what is driving the onshore deficit gap between Scotland the data needs to be reworked so that more detailed comparisons can be made. A commonly used way of doing this is to convert income, expenditure and the NFB into per capita equivalents. This is done by dividing the deficit and the underlying income and expenditure numbers by population numbers.
As an example here is the data for 2017-18 set out this way. (Red numbers in this table and the rest of the paper mean Scotland has an adverse comparison with ROUK)
2017-18 Onshore comparison Scotland v ROUK
Table 4 Scotland ROUK Scotland v UK
Population (millions) 5.4 60.6
£ bn £ bn
Revenue (ex oil) 59 690
Expenditure 73 716
NFB Onshore -15 -26
Per capita £ £ £ %
Revenue (ex oil) 10808 11388 580 95%
Expenditure 13530 11813 1717 115%
NFB -2722 -425 2297 640%
Comparing the total income and expenditure numbers tells us nothing. But with the per capita comparison it becomes clear that
Scotland’s per capita onshore income levels are £580 less than the ROUK or 95% of UK levels – 5% lower.
Expenditure is £1,717 higher - 15% higher The net onshore deficit is £2,297 per person in Scotland compared with the
ROUK’s £425 – 5 times higher.
The evolution of this over the last 20 years can be seen in the following chart. The numbers are broken down in greater detail in Appendix 1 Income and Expenditure.
Chart 9 shows that the Scotland has a long-term pattern of lower income and higher expenditure per head than the ROUK, going back to at least 1999.
14
Chart 9
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-2500
-2000
-1500
-1000
-500
0
Onshore comparison Scotland v ROUK£ per capita
Lower Income Higher expendi-tureNFB deficit
It can be seen that the difference has grown due to the income gap stayingrelatively constant until 2015-16, while the expenditure gap grew.
The gap in income is largely due to Scotland being weak relative to the ROUK in income tax. This is covered in Appendix 1 – Income and Expenditure. This weakness is due to Scotland lacking high rate taxpayers and to lower incomes among those high rate taxpayers it currently has. The most recent published analysis of income tax in Scotland showing how much is raised in each tax band was done on a 2% sample of incomes in 2013-14. This is hardly cutting edge and means that no historic or budget yardsticks are published allowing the effectiveness of manipulation of tax rates and bands to be measure. Appendix 2 gives further information.
There is a much more significant driver of the expenditure gap – the Barnett Formula. This is a mechanism used by the UK Treasury to automatically adjust the amounts of public expenditure allocated to Northern Ireland, Scotland and Wales. It was introduced in 1978 but built on a previous formula – the Goschen Proportion – which dated back nearly 100 years before then. These have ensured that Scotland receives annual increases in its block grant from Westminster which grow the per capita gap with the ROUK. This is largely what was responsible for the gap between Scotland and the ROUK in 1999 and it has driven the growth in expenditure per capita since then.
What are these worth in total each year?
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8 THE £12.5 BILLION DEFICIT GAP WITH THE ROUK PART TWOIf the per capita differences between Scotland and the ROUK are multiplied by the Scottish population, total cash values of these differences are produced.
These are the amounts by which Scotland’s total income, expenditure and NFB deficit would change if Scotland achieved the same levels of income and expenditure per capita as the ROUK. For example 2017-18
Table 5 2017-18 Scotland v ROUK
Cash Values of Differences
Difference Scottish
Per capita population
£ Millions £ bn
Revenue (ex oil) 580 5.4 3.1
Expenditure 1717 5.4 9.3
NFB 2297 5.4 12.5
(difference due to rounding)In total the NFB difference of £2297 per capita is equivalent to a gap of £12.5 billion. Of this total, £3.1 billion or 25% is due to Scotland’s lower revenue and £9.3 billion or 75% to its higher expenditure.
The evolution of the cash value of the gap with the ROUK over the last 19 years is shown in the graph.
Chart 10
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
Onshore Comparison Scotland v ROUK£ per capita difference x Scotland population
£ Billion
incomeexpenditureNFB deficit
The graph is, unsurprisingly, the same shape as the previous one. And it confirms not surprisingly that over the last 20 years growing differences in income and expenditure between Scotland and the UK have added about £8 billion to Scotland’s NFB deficit.
Around £2 billion or 25% of this is from income underperformance but the bulk of it – around £6 billion or 75%% - is due to expenditure. As already said the expenditure
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differences are the consequence of the Barnett formula. This has been protected by the recent agreement between the Scottish Government and the United Kingdom Government on the Scottish Government’s fiscal framework which paved the way for the Scotland Bill 2016.
We had already seen in section 5 that the value of the onshore deficit gap between Scotland and the UK based on NFB as % of GDP had grown from around £4.5 billion to £12.5 billion and this further calculation indicates that these factors tie up almost exactly with this growth.
We can directly link the growth in the deficit gap with the ROUK to relative per capita differences in income and more importantly expenditure and the Barnett Formula. This chart picks up the comparison between the deficit % gap and value gap based on GDP calculations shown earlier (Chart 8) and adds on the value line produced from the per capita calculations. (Again the £bn. values are inverted)
Chart 11
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
0
2
4
6
8
10
12
14
-9%-8%-7%-6%-5%-4%-3%-2%-1%0%
Scotland v ROUK gap in % points and £ billions
GDP valuesPer capita values% Gap
£bn
There is a very good match between the two value lines. This seems to be good evidence that both the % deficit gap and the growth in the value of this gap between Scotland and the ROUK are largely caused by the Barnet formula.
If the formula continues to operate in the way it has done for at least the last 20 years Scotland’s per capita expenditure will continue to grow faster than the ROUK. Unless Scotland can produce faster per capita income growth than the ROUK this will have the effect that the value of the deficit gap with the ROUK will continue to grow and the deficit gap as a % of GDP will be at best maintained.
One possible mechanism that may change this will emerge from the operation of the Scotland Bill 2016. However it must be said that it is far from clear just what impact this will have given the complexities of the process. I have taken into account the Scottish Government’s commitment that the changes should not permit any reduction in subsidy and that therefore the scale of Barnett subsidy will be maintained.
Scotland needs to find ways to fill this deficit gap. This does not mean that it needs exactly to match ROUK for income and expenditure per capita values. But it does need to find the money from some combination of income growth and / or expenditure reduction. It is the key task of a Scottish government economic recovery strategy to determine how.
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9 EXPLAINING THE REST OF THE DEFICIT
Of Scotlands 2017-18 £14.8bn on shore deficit, £12.5bn is due to relative weakness versus ROUK. What accounts for the final £2.3bn? The answer is that it is an unavoidable consequence of Scotland’s economy being closely integrated with its much larger neighbour – the ROUK – and the ROUK’s and Scotland’s own economies being subject to wider economic cycles in Europe and beyond. It was shown earlier that Scotland’s deficit pattern very closely tracks the ROUK. This is because of the very strong influence of a very large economy being highly integrated with a neighbouring and much smaller one. As the ROUK moves into and out of recession Scotland is pulled along with it. Just as the UK is subject to world economic cycles, Scotland is subject to the ROUK’s. Readers may be familiar with the trade statistics published by the Scottish Government on 25th January 2017 which show that 64% of Scottish exports are made to the ROUK. An extract is included in sheet 2a Scotland Exports
At least in the short term and probably also in the long term Scotland probably can’t do very much about this as the ROUK economy is too large for Scotland to influence and its economic cycles will dominate and drive Scotland’s.
Even if Scotland achieved parity with the ROUK in terms of income and expenditure it would have a deficit if the UK is in deficit. Scotland needs to improve on ROUK comparators to escape this problem.
The next chart shows how much each of these factors impacted on the history of the onshore deficit.Chart 12
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
-25.0
-20.0
-15.0
-10.0
-5.0
0.0
5.0Scotland's onshore deficit history
£ billions
Barnett gap Income gapResidue
In 1999 if Scotland had parity with the ROUK in per capita income and expenditure there would have been a modest surplus. Scotland was pulled into deficit by the existing effects of Barnett and relatively weak income. External effects began to push the deficit from around 2003 and then more dramatically with the crash of 2008-09. The reason the onshore deficit is now improving is because Scotland is participating in the overall external economic recovery, not because the relative performance with the ROUK is improving.
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10 THE FUTURE
There are no formal forecasts produced for Scotland’s economy as a whole. However the OBR does produce regular forecasts for the UK as a whole. These project that the UK deficit will reduce from around 1% of GDP in 2017-18 to around 0.6% in 2023/24.
Assuming Scotland matches UK projected (by the OBR) growth rates in per capita onshore income and in expenditure the evolution of the Scottish onshore economy over the next 6 years can be projected. In the next chart these projections have been added to the previous historical graph.
Chart 13
-25.0
-20.0
-15.0
-10.0
-5.0
0.0
5.0 Scotland's onshore deficit history and projection£ billions
Barnett gap Income gapResidue
The push down effect of external cyclical factors will be very much reduced by 2023-24 but Scotland will still be left with the effects of its own weakness relative to the ROUK and a probable total onshore deficit of around £15 billion.
It should be remembered that these forecasts are the author’s and are based on limited information. However they do represent forward projections of long term fundamental trends and may well happen in the absence of any attempt to deal with the problem. An official Scottish Government forecast would be welcome and it is astonishing that none appear to have been published since the white paper ‘Scotland’s Future’ in 2013.
It should also be borne in mind that although the UK economy is forecast to maintain a reduced deficit its long term record in maintaining surpluses is very poor as this next chart shows. (see sheet 14 UK Long Term Deficit)
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Chart 14
-12.0%
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
UK NFB as % of GDP
As can be seen, years of surplus have been the exception rather than the rule.
To repeat what was said earlier UK Deficit plus 7% = Scotland Onshore Deficit.
The UK deficit effectively acts as a ceiling on what is possible in Scotland and without reduction of the gap with the ROUK any UK deficit will add to Scotland’s deficit in the future as it has in the past. And unless there is a fundamental change in the UK economy, history suggests that UK deficits will be the rule rather than the exception.
It looks like the elephant is not going away anytime soon.
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11 THE NEED FOR BETTER PLANNING, INFORMATION AND SCRUTINY
The need for better planning and more independent information on and independent monitoring of Scotland’s economy.
These numbers all help in understanding that Scotland has a big problem and how differences between Scotland and the ROUK might point to how much of this has arisen. They have shown that if Scotland could achieve ROUK levels of income and expenditure it would have gone very far down the road towards achieving a sustainable fiscal deficit.
But they do not explain how this should be achieved. This is a task for the Scottish Government. It is for the Scottish Government to determine how much of the remedy will be found through growing income and how much through cutting expenditure. Progress will be slow and painful and there is no magic bullet.
Scotland lacks information on key financial data and a general lack of independent scrutiny of what it does publish. For example it was mentioned earlier that while information is published regularly on the numbers of taxpayers per band there is no such formal report on how much tax is raised per tax band and this of obvious relevance given that control over setting income tax bands has been devolved.
More importantly Scotland lacks regular, comprehensive and official reports on its overall economic and fiscal performance and in particular on forecast performance. If the deficit is to be tackled fixing this must be a key priority.
The only comprehensive report on the health of the Scottish economy is the annual GERS report which is, as far as is known, the only official source of information on Scotland’s NFB and the only regular, if infrequent, source of information on total public expenditure in Scotland. It was encouraging that steps have been taken to accelerate the production of the latest version of this such that it appeared only 5 months after the fiscal year end.
The Scottish Government does not publish forecasts on the NFB or its key components. There is no equivalent of the OBR’s regular UK ‘Economic and fiscal outlook’ reports covering income, expenditure, the NFB and covering actual and forecast. The Scottish Government apparently no longer publishes its Oil and Gas Bulletin and as previously noted data on income tax distribution by tax band is long out of date. This is inadequate and unacceptable.
The obvious remedy is to and give the Scottish Fiscal Commission the powers and duties of an OBR direct equivalent to produce regular and independent economic and fiscal independent updates on all key aspects of Scotland’s economy.
It is hoped that this paper provides evidence that such changes are urgently required.
APPENDIX 1: INCOME AND EXPENDITURE BREAKDOWN
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A: SCOTLAND ONSHORE REVENUE V ROUK
The following table shows the main elements of Scotland’s onshore income for 2017-18, the percentage of total income each line accounts for, the per capita difference with the ROUK and this difference multiplied by the Scottish population.
Scotland: elements of ex oil income & v ROUK Year 2017-18
Scotland % of per capita Multiply by2017-18 Total v ROUK Scotland
Population
Table 6 £ bn % £ £ bn
Income tax 12.5 21% 462 2.5
National insurance contributions 10.6 18% 68 0.4
Value added tax 10.1 17% 27 0.1
Onshore Corporation tax 3.9 7% 141 0.8
Fuel duties 2.4 4% 14 0.1
Non-domestic rates 2.8 5% 60 0.3
Council tax 2.3 4% 77 0.4
Land & Building Taxes 0.5 1% -109 0.6
VAT refunds 1.2 2% 23 0.1
Tobacco duties 1.0 2% 51 0.3
Alcohol duties 1.1 2% 34 0.2
Gross operating surplus 4.6 8% 172 0.9
Others 5.5 9% 51 0.3
Total current revenue 58.6100% 580 3.1
The main elements of income are income tax, NI contributions and VAT which together account for 56% of the total.
Relative to the ROUK in 2015-16 the main negative differences are
Income tax, where Scotland produces £462 per capita or £2.5 billion less in total cash value
Corporation Tax, £141 per capita or £0.8 billion less. Stamp Duties / Land & Building Tax, where Scotland produces £109 per
capita or £0.6 billion less
The main positive difference is in
Gross Operating Surplus – Scotland produces £172 per person more than ROUK or £0.9 billion. Mainly due to income from state owned Scottish Water while ROUK water is mainly privatised
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Income tax accounts for most of the income cash value difference. The £348 per capita difference means that the ROUK produces 15% more than Scotland’s £2,361 per capita. When tax per income taxpayer is looked at, this increases to 19% as shown in the following table
Scotland v ROUK Income tax per taxpayer 2017-18
Table 7 Scotland ROUK DifferenceTotal Taxpayers 000's* 2588 28217Total income tax £ million 12544 168156
£ £ £ %
Income tax per taxpayer 4847 5959 1112 23%
*Excludes starter and saver tax payers. Data published May 2018
The income tax gap is mainly because Scotland raises less tax from additional tax rate payers (incomes over £150,000) than the ROUK. This appears to be because Scotland has proportionately fewer such taxpayers and they have lower average incomes than their ROUK equivalents. No current data is however available and the lack of published data means that the latest available figures relate to 2013-14.
,
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B: SCOTLAND EXPENDITURE V ROUK
The following table shows the main elements of Scotland’s expenditure for the year 2016-17, the percentage of the total each line accounts for, the per capita difference with the ROUK and this difference multiplied by the Scottish population.
Scotland: elements of expenditure & v ROUK Year 2017-18
Scotland % of per capita Multiply by2017-18 Total v ROUK Scotland
Population
Table 8 £ bn % £ £ bn
General public services
Public and common services 1.5 2% 92 0.5
Public sector debt interest 3.7 5% 2 0.0
Defence 3.2 4% 1 0.0
Public order and safety 2.8 4% 49 0.3
Economic affairsEnterprise and economic
development 1.3 2% 119 0.6
Agriculture, forestry and fisheries 0.9 1% 98 0.5
Transport 3.8 5% 257 1.4
Housing and community amenities 1.9 3% 185 1.0
Health 12.8 17% 171 0.9
Recreation, culture and religion 1.4 2% 87 0.5
Education and training 8.4 11% 236 1.3
Social protection 23.6 32% 306 1.7
Accounting adjustments 5.1 7% 94 0.5
Others 3.0 4% 21 0.1
Total 73.4100% 1717 9.3
In absolute terms social protection is by far the biggest element accounting for nearly one third of the total. The next biggest elements are health at 17% and education and training at 11% of the total. Together these amount to 60% of the total.
Relative to the ROUK the main negative differences are:
Social protection with a per capita difference of £305 more or £1.7 billion in total
Transport £257 per capita more or £1.4 billion Education and training £236 per capita more or £1.3 billion Housing and community amenities £185 per capita more or £1.0 billion Health £171 per capita more or £0.9 billion Enterprise and economic development £119 per capita more or £0.6 billion
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APPENDIX 2: INCOME TAX
As seen earlier (pages 22 and 23) income tax Scotland trails the ROUK as far as tax per capita and tax per taxpayer are concerned. It is worthwhile looking into this further to understand more about numbers of taxpayers and mix (between tax rate bands) of taxpayers and the amount they contribute. (In this section ‘high’ rate taxpayers means those paying the higher and additional rates)
HMRC publishes estimates annually of numbers of tax payers per band per region (including for Scotland and for the UK as a whole). It also publishes tax yield per band but only for the UK as a whole. The last time I have been able to find information on tax yield per band for Scotland was in a 2014 Scottish Parliamentary briefing paper date 5th February 2014. It gave data based on ‘personal correspondence with HMRC.
Absent any current information it is not possible to accurately compare Scotland’s performance with ROUK in any detail but broad conclusions are possible.
First this is the make up of tax yield by band based on HMRC data:
Total Tax Yield Contribution Average tax
per tax band to total income tax per tax payer
UK 2017/18 UK 2017-18 UK 2017-18
Table 9 £bn % £
Savers 1 0.4% 1114
Basic 59 33.0% 2302
Higher 65 36.8% 15352
Additional 53 29.7% 143478
Total 178
The biggest single contribution comes from tax payers in the higher rate band but the Additional Rate band has by far the highest contribution per capita.
Scotland v the ROUK:
Taxpayers per 1000 population 2017-18
Table 10 Uk Scotland ROUK
Savers 10.3 7.6 10.5
Basic 387.8 400.0 386.7
Higher 64.8 66.0 64.7
Additional 5.8 3.5 5.8
Expressing the number of tax payers in each band in terms of per 1000 population it becomes clear that Scotland has a lower number of savers, higher numbers of basic and higher rate and lower numbers of additional rate payers.
As noted above there is no current data on how much income tax is raised in
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Scotland by tax band but it is possible to estimate how much would have been raised if Scotland has the same average yield in each tax band as ROUK.
If Scotland had UK average yield per tax bandin 2017-18
Scotland UK Tax per Scotland Tax per
Table 11 taxpayers per band tax payer Band
000's £ £m
Savers 41 1114 0.0
Basic 2170 2302 5.0
Higher 358 15352 5.5
Additional 19 143478 2.7
Total 2588 13.3
Compare with actual income tax raised in 2017-18 of £12.5bn this would mean an increase of £0.8bn. Scotland’s tax payers in at least one of these bands must be lower than ROUK. In 2013-14 this was the additional rate band and it is likely that this remains the main culprit.
But what would happen to overall income tax yield in Scotland if Scotland had the same mix as ROUK of tax payers in each band?
If Scotland had UK average tax payers per 1000 populationIn 2017-18
Scotland new UK Tax per Scotland Tax per
Table 12 taxpayers per band tax payer Band
000's £ £m
Savers 56 1114 0.1
Basic 2104 2302 4.8
Higher 351 15352 5.4
Additional 30 143478 4.4
Total 2541 14.7
This represents a growth of £2.2bn over actual levels further strengthening the case that it is underperformance in the additional rate band which is responsible for the per capita underperformance seen earlier. Quite simply Scotland needs more affluent tax payers. Squeezing the pips of those already here is not going to close the gap and is unlikely to be of much use in recruiting new ones.
APPENDIX 3: HISTORY REWRITTEN
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Where did all the money go?
(see sheet 15 Earlier Versions)Table 13
Scottish Government
Claimed Relative Outperformance of Scottish Economy V The UK
Including Geographic Share of North Sea OilOriginal GERS 2017-18 Change
1) In 2013 claimed outperformance for 5 years to 2011-12 £12.6 bn £1.4bn £11.2bn
2) In 2014 claimed outperformance for 5 years to 2012-13 £8.3 bn (£1.2bn) £9.5bn
1) From 'Scotland's Future' eg pages 54 & 692) From Scottish Government press release 14.3.2014
The GERS report for 2011-12 covered the years 2007-8 to 2011-12 and was published 6th March 2013. Data from it was used in preparing the white paper ‘Scotland’s Future.’ In this it was claimed that “Taken as a whole, Scotland's national accounts are healthier than the UK's. Over the last five years they have been stronger to the tune of £12.6 billion - almost £2,400 for every person living in Scotland.’
Using the latest GERS data published for the same 5 years and repeating the calculations would mean that this statement should now read ‘Over the last five years they have been stronger to the tune of £1.4 billion, almost ££266 for every person living in Scotland.’ Over £11 billion has vanished.
The following year GERS 2012-13 covering the years 2008-9 to 2012-13 was published 12th March 2014. In a Scottish Government press statement which accompanied the publication it was stated ‘Scotland has been in a relatively stronger fiscal position than the UK over the five years to 2012-13 as a whole by the value of £8.3 billion – or £1,600 per person – according to new statistics published today.’
Using the latest GERS data published for these same 5 years and repeating the calculations would mean that this statement should now read ‘Scotland has been in a relatively weaker fiscal position than the UK over the five years to 2012-13 by the value of £1.2 billion or £233 per person.
This time £9.5 billion has vanished.
In each case around £5 billion appears to be notional oil income which has vanished – and this is not related to the collapse in the price of oil but to restated apportionment of North Sea taxes between the UK and Scotland.
It is perhaps understandable that revisions happen but ought not the level of publicity – which was substantial - given to the original claims be applied to the revised versions?
A further example is in GERS 2016-17. In the pdf version of this the following appears in an appendix:
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Totalling the revisions for Scotland’s share of geographic oil indicates that there has been a loss of income of £1.6 billion over 4 years against a loss of income for the UK of £1.2 billion. So there is a loss of income but this applies to both Scotland and the UK. But if one looks at the more detailed GERS spreadsheets (sheet 7 Oil Revenue) it becomes apparent that over 18 years to 2015-16 Scotland would have lost £9.1 billion against a UK loss of only £1.2 billion and that over these 18 years Scotland’s geographic share of North Sea Oil income would have been reduced from 88% to 81%. This is a material change which has had little or no attention.
ENDS
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