IFS - Scotland’s fiscal position improves in 2013–14 but this is set to stall as oil price falls bite
Yesterday, the Scottish Government published the latest version of its annual Government Expenditure and Revenues Scotland (GERS) publication covering 2013–14.
In this observation we first discuss what the figures tell us about Scotland’s notional fiscal position in that year. The key finding is that Scotland’s overall budget deficit of 8.1% of GDP during 2013–14 was significantly higher than the UK wide deficit of 5.6% of GDP. This reflects the fact that disproportionately high oil revenues in Scotland are not sufficient to “pay for” higher public spending in Scotland.
We then project figures forward to 2015–16 over which period expected revenues from the North Sea have fallen further. Based on the Office for Budget Responsibility (OBR)’s December forecasts, we project Scotland’s deficit in 2014–15 and 2015–16 to be 8.6% of GDP and 8.0% of GDP, respectively, compared to 5.0% and 4.0% for the UK as a whole. The gap would likely be even larger if oil prices remained at current levels – which are significantly below those used in the OBR’s December forecasts – but could be smaller if oil prices or production rebound.
Finally, we place these figures in the context of the evolving constitutional debate – including the debate about whether Scotland should become “fully fiscally autonomous”.
Scotland’s fiscal position in 2013–14
Table 1 shows how Scotland and the UK’s net fiscal balance – which is the difference between government revenues and government spending (including investment spending) – evolved between 2009–10 and 2013–14. Figures are reported both excluding and including North Sea oil and gas revenues.
Excluding North Sea revenues, Scotland’s net fiscal balance was in deficit to the tune of 12.2% of GDP (or £16.4bn) in 2013–14. This represents a fairly sizeable reduction in the onshore fiscal deficit compared to the previous year, driven by government expenditure falling by 4.2% in real-terms.
Scotland’s onshore deficit is estimated to have fallen by more than that of the UK during 2013–14. This is despite the growth in onshore revenues being slower in Scotland than the UK as a whole; it instead reflects the fact the fall in government spending is estimated to have been larger in Scotland than in the rest of the UK. However, the level of the onshore deficit in Scotland remains around double that for the UK as a whole (6.0% of GDP) because government spending per person is much higher than the UK average, while onshore revenues are a little lower than the UK average.
Allocating a geographic share of North Sea revenues to Scotland unsurprisingly improves its fiscal position, although a large deficit of 8.1% of GDP remains. But these revenues did not help as much in 2013–14 as in earlier years, as declines in oil and gas production took their toll. In the two years between 2011–12 and 2013–14, Scotland’s North Sea revenues fell by more than half from £9.7bn to £4.0bn. This has driven Scotland’s overall net fiscal balance from 5.9% of GDP in deficit in 2011–12 to 8.1% of GDP in deficit in 2013–14, a period during which its onshore deficit shrank by a similar magnitude.
In contrast, the UK’s overall net fiscal deficit shrank from 6.9% to 5.6% of GDP over the same two-year period. Of course, the decline in North Sea revenues was not helpful to the UK public finances either. But, because most North Sea revenues are estimated to come from the Scottish portion of the North Sea (84% in 2013–14), and because the onshore economy and tax-base of Scotland is much smaller than that of the UK as a whole, a fall in this revenue stream has a much larger impact on Scotland’s fiscal position.
Projecting Scotland’s fiscal position for 2014–15 and beyond
The falls in North Sea revenues have continued during the current financial year. The current low price of oil, if sustained, would also lead to further declines in revenue in future years. With this in mind it is worthwhile examining the impact ongoing weakness of North Sea revenues may have on Scotland’s public finances in 2014–15 and 2015–16. We do this by projecting the figures in GERS forward using official OBR forecasts for the UK as a whole, and a number of additional assumptions (see notes below for further details).
Table 2 shows projections for Scotland and the UK’s net fiscal balance in 2014–15 and 2015–16 based on the latest OBR forecasts published in December 2014. This shows Scotland’s onshore budget deficit continuing to decline, from 12.2% of GDP to 10.3% of GDP in 2015–16, driven by growth in the economy and ongoing public spending cuts. However, under this projection, Scotland’s North Sea revenues would fall from around £4.0 billion in 2013–14 to around £1.8 billion in 2015–16. Such a decline in North Sea revenues would offset the projected improvement in the onshore fiscal balance, leaving Scotland’s overall fiscal deficit virtually the same in 2015–16 as in 2013–14 at 8.0% of GDP. In contrast, the UK’s overall fiscal deficit is forecast to decline from 5.6% of GDP to 4.0% of GDP during the same period. In cash terms, Scotland’s fiscal deficit in 2015–16 would be more than twice as high per person (around £2,600) as that in the UK as a whole (around £1,200).
At the time the OBR made its forecasts, the oil price was $70 a barrel, and the OBR’s forecast was based on an assumed average price for 2015–16 of $83 a barrel. Since then, the oil price has fallen further, and futures markets currently have an average price of around $60 a barrel for oil to be delivered during 2015–16. Updated forecasts will be published next week alongside the UK government’s Budget but it seems likely that these oil price falls will result in lower revenues from the North Sea. For instance, a recent report by the UK parliament’s Scottish Affairs Committee suggests North Sea revenues for the UK as a whole may amount to £1.5 billion a year at an oil price of $60 a barrel. The direct effect of this would be to increase Scotland’s deficit in 2015–16 by around a further 0.3% of GDP; indirect effects on the wider economy in Scotland could be positive or negative.
The GERS figures in the context of the devolution debate
The figures described above represent Scotland’s notional fiscal position if it had to raise or borrow the money needed to pay for government spending undertaken in, or for the benefit of, Scotland. This is not the case at the moment though. Instead, most tax paid in Scotland goes to the UK government, which is responsible for defence, foreign affairs and for paying benefits and state pensions to those in Scotland. It also gives money as a block grant to the Scottish Government to pay for devolved services – like health and education. The size of this grant does not depend on how much tax revenue is raised in Scotland but is based on historic spending in Scotland, adjusted each year using the Barnett formula so that changes in spending broadly match changes in government spending in England. Scotland is therefore insulated from the fiscal implications of volatile North Sea revenues.
Under existing plans for further devolution, Scotland would be exposed to some revenue risks associated with its economy performing better or worse than that of the UK as a whole. This is because part of the Scottish Government’s block grant will be replaced with revenues from income tax raised in Scotland and a share of VAT raised in Scotland (and a number of smaller taxes). However, existing levels of funding would largely be maintained as the Barnett formula will remain in place, and as North Sea taxation is not being devolved, Scotland will remain insulated from the fiscal risk associated with these revenues.
It has been suggested that devolution could go much further, however, with the Scottish National Party calling for “full fiscal autonomy”. Under such an arrangement, all taxes and the vast majority of spending would be devolved to Scotland – with the Scottish Government making transfers to the UK government to cover things like defence, foreign affairs, and Scotland’s share of the UK’s debt interest payments. In that case the notional fiscal position set out in GERS and our projections would have direct implications. The Scottish Government would have to borrow if its spending were greater than its revenues. It would also have to bear the risk of volatile North Sea and other tax revenues.
Our projections suggest that if Scotland were fiscally autonomous in 2015–16, its budget deficit would be around 4.0% of GDP higher than that of the UK as a whole. In cash terms, this is equivalent to a difference of around £6.6 billion. To put this in context, we project government spending in Scotland to be £68.8 billion in 2015–16, and onshore tax revenues to be £53.7 billion.
It has been suggested that the powers obtained under full fiscal autonomy would allow the Scottish Government to implement policies that would boost the growth rate of the Scottish economy, thereby improving its fiscal balance. This could be the case: full fiscal autonomy would give more freedom to pursue different, and perhaps better fiscal policy, and to undertake the radical, politically challenging reforms that could generate additional growth. There are undoubtedly areas where existing UK policy could be improved upon. But it is much easier to say things would be better if the economy grows more quickly than it is to develop and implement policies that would actually deliver that extra growth. The Scottish Government has previously suggested policies to boost growth – such as cuts to corporation tax and expanded childcare – but the immediate effect would be to weaken its finances; and it is not clear that even in the longer term the effects on growth would be enough to pay for such tax cuts and spending increases.
Yesterday’s figures therefore illustrate that full fiscal autonomy would likely involve substantial spending cuts or tax rises in Scotland – unless oil revenues rebound and remain at consistently high levels, or credible policies to boost the growth of Scotland’s onshore economies and revenues can be developed.
Notes on methodology for projecting Scotland’s fiscal position beyond 2013–14
In order to project forward the GERS figures to 2014–15 and 2015–16 using figures from the OBR’s December 2014 Economic and Fiscal Outlook, the following method is used:
- Spending is projected on the basis that government spending in Scotland remains the same proportion (9.2%) of UK-wide government spending as in 2013–14.
- Onshore taxes are projected on the basis that the amount paid per person in Scotland grows in line with forecast growth in onshore revenues per person for the UK as a whole. This means onshore tax revenues per person in Scotland are projected to be 97.0% of the average for the UK as a whole, as in 2013–14.
- Offshore (oil and gas) taxes are projected under the assumption that Scotland’s share of overall UK offshore tax revenues remains the same as in 2013–14 at 83.8%.
We have chosen the assumptions on the basis of their simplicity. As with any economic or fiscal forecast or projection, the projections outlined in this observation are subject to a number of sources of potential error that mean actual outturns may differ. This includes errors in the OBR forecasts for the UK as a whole; and trends in spending and government revenues in Scotland relative to the UK differing from the above assumptions. There are some reasons to suggest that, if anything, the assumptions are more likely to lead us to under-estimate rather than over-estimate Scotland’s fiscal deficit relative to that of the UK as a whole. First the workings of the Barnett formula and Scottish Government plans to borrow additional money to fund capital investment in 2015–16 mean that Scottish Government spending is set to fall less between 2013–14 and 2015–16 than equivalent spending in the rest of the UK. This would tend to increase Scotland’s share of overall UK government spending; in contrast, we have assumed this share would remain constant. Second, the OBR forecasts revenue growth to be particularly strong for taxes like capital gains tax and stamp duties, which make up a relatively smaller share of Scottish revenues. All else equal, this would tend to suggest growth in revenues per person in Scotland would be lower than for the UK as a whole. Third, while our revenue projections account for declines in oil revenues, our projections assume that GDP from the North Sea rises in line with onshore GDP. If North Sea GDP declined, as one might actually expect, then Scotland’s cash-terms deficit would represent a larger percentage of GDP.
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