The Implementation of the Smith Agreement - Scottish Affairs Contents

3  Protection from shocks

40. The Smith Agreement devolves substantial new powers while allowing Scotland to continue to pool risk and share resources with the rest of the United Kingdom. It does not deliver full fiscal autonomy to Scotland. Indeed, the benefits of pooling risk and resources would be lost under full fiscal autonomy, as it would have been had Scotland opted for separation. The financial security of being part of the United Kingdom is perhaps one of the main reasons why the majority of the people in Scotland voted against separation and why the Smith Commission rejected full fiscal autonomy as an option.[63]

Full fiscal autonomy

41. In an interview with the BBC which focused on potential negotiations in forming the next UK Government, the First Minister and leader of the SNP, Nicola Sturgeon MSP, outlined her position:

    I want full fiscal autonomy for the Scottish Government. I want us to be responsible for raising our own revenues and deciding how those revenues are spent.[64]

    Under full fiscal autonomy, the Scottish Government would receive all revenues raised in Scotland and be responsible for almost all public expenditure in, and for the benefit of, Scotland. Only certain UK services such as defence, intelligence and foreign affairs would remain delivered at a UK level—the Scottish Government would pay the UK Government for these services. There would also need to be agreements over borrowing powers and debt repayment.

42. In comparison with the Smith Agreement, full fiscal autonomy would deliver additional powers and responsibilities, but it would also expose Scotland to greater risks. It would allow the Scottish Government to shape the tax and welfare systems in Scotland without having to work within a framework set by the UK. Scotland would also benefit directly from any increase in Scottish revenues. However, under full fiscal autonomy, Scotland would also bear the consequences of a reduction in any revenue stream as well as any unexpected increase in public spending.

43. The current constitutional arrangements mean that a shock to the demand for welfare within Scotland would be met by the resources of the whole of the United Kingdom. This safety net is carefully preserved in the Smith Agreement. By contrast, under full fiscal autonomy, to cover any unexpected increase in an area of public expenditure, Scotland would have to raise taxes, increase borrowing, or cut spending elsewhere. Similarly, any unexpected drop in revenues would have to be covered by Scottish finances, either through higher taxation, reduced spending or increased borrowing, all of which would impact on attempts to grow the Scottish economy. Currently, any drop in revenues in areas that, under the Smith Agreement, are to remain reserved would be absorbed by the UK's larger and more diverse tax base: the UK economy's ability to absorb the fluctuations of the oil price is a good example of this.


44. In the run up to the referendum, the Scottish Government predicted that "production in Scottish waters could generate approximately £48 billion in tax revenues between 2012-13 and 2017-18 based on industry estimates of production and an average cash price of $113 dollars per barrel."[65] Since the Scottish Government made those predictions the oil price has collapsed, at one point trading at less than $50 dollars per barrel. Table 1 shows the difference between the Scottish Government's most recent central projections[66] and those of the OBR (the OBR's figures are based on an oil price of $85 per barrel, the Scottish Government's are based on $110 per barrel).[67]

Table 1: May 2014 Scottish Government forecast and OBR autumn 2014 forecast (figures in £billion)
2014-15 2015-16 2016-17 2017-18 2018-19 Total 2014-15 to 2018-19
Scottish Government £5.8 £8.3 £6.9 £7.3 £6.0 £34.3
OBR* £2.8£2.2 £2.4£2.6 £3.1£13.1

* Figures are for the UK. Scottish receipts are approximately 90% of the UK total.

45. North Sea oil and gas revenues make up a much smaller proportion of overall UK tax revenues than Scottish revenues. In the past five years revenues from tax on offshore oil and gas receipts have averaged less than 2% of total UK revenues, while, for the same period, they would have averaged 15% of total Scottish revenues.[68] The sudden reduction in oil revenues therefore has less of an impact at a UK level then it would at a Scottish level if oil revenues were devolved, or if Scotland had full fiscal autonomy. Dr Mark Carney, Governor of the Bank of England, told the Treasury Committee earlier this year that:

    The change in the oil price is net positive for the United Kingdom economy. It is a negative shock to the Scottish economy, but it is a negative shock to the Scottish economy that is substantially mitigated by the fiscal arrangements that exist in the United Kingdom—the automatic stabilisers that exist: less revenue taken out of Scotland, more spending into Scotland—and by the nature of the economic and financial union that exists in the United Kingdom and continues to exist.[69]

An erratic tax base would also make it more difficult to plan public spending and more borrowing powers would be required to mitigate any shocks to revenues.

46. The volatility of the oil price is in stark contrast to the more predictable stream of funding that is transferred to Scotland via the Barnett formula and block grant. The Barnett formula is the Treasury mechanism which calculates the amount of public expenditure allocated to Scotland, Wales and Northern Ireland for devolved services. Under this system Scotland enjoys higher public spending per capita than the UK as a whole; in 2012-13 this amounted to an additional £1,364 per person which meant Scotland received an additional £7.25 billion in funding for public services.[70]

47. The existing fiscal arrangements also mitigate the impact of Scotland's per capita tax revenues being lower than the UK average.[71] In 2012-13 non-North Sea revenues in Scotland were £8,947 per person compared with £9,096 for the UK, a gap that amounts to £792 million.[72] Taken together, the difference between Scotland's per capita expenditure and revenues and those of the UK demonstrates that Scotland benefits from around £8 billion in additional funding. To put that into context, David Phillips told us, "£8 billion is about 14% of overall public spending in Scotland. It is about 18% of tax revenues in Scotland, so it is a sizeable amount."[73]

48. The Smith Agreement leaves the Barnett formula and block grant in place. Without them, if Scotland were fiscally autonomous, there would be no such transfer of funds from the UK Exchequer and the Scottish Government would have to look elsewhere to address the shortfall.[74] In boom times the oil industry would be the obvious place to find such revenues. Professor John McLaren explained to us that:

    Scotland benefits from being part of the UK at the minute by about £7 billion to £8 billion in terms of transfer […] that is what North Sea revenues would have to be. In 2011­12 it was £11 billion, so it was well above; this year it is expected to be £3 billion, which clearly is well below. Even at the time of much of the debate around the referendum, I think the Scottish Government's top scenario for North Sea revenues, scenario six, was about £8 billion. Even at the top scenario, it was only just breaking even"[75].

49. In its December 2014 Economic and Fiscal Outlook the OBR predicted oil tax revenues from Scottish waters to be less than £12 billion for the five years between 2014-15 and 2018-19.[76] This is over £22 billion short of the most recent central forecast from the Scottish Government for the same period and £28 billion short of £8 billion per year in higher funding that is currently delivered by the Barnett-based block grant. The OBR's autumn 2014 forecast was based on an oil price of $85 per barrel and already looks optimistic; Fiscal Affairs Scotland report that for the first half of 2014-15 revenues from oil amounted to just £1.1 billion; figures for the second half of the year are likely to be worse.[77] In 2015 the oil price has not been above $63 per barrel and for most of January it was around $50. The Secretary of State told us that at $55 per barrel oil revenues would be in the region of just £1 billion per year and that a $1 fall in the oil price would equate to a fiscally autonomous Scottish Government having to deal with £100 million less in revenue.[78]

50. The oil price rose in February 2015 and by the end of the month stood at $60 per barrel, at this price tax revenues might be expected to deliver approximately £1.5 billion per year, still over £5 billion short of the Scottish Government's average forecast of £6.8 billion per year and nowhere near enough to offset the loss of the £8 billion in extra funding that Scotland currently benefits from. As we have previously stated, if Scotland were fiscally autonomous then any drop in revenues would have to be covered by Scottish finances, either through increased tax revenues, cuts in public spending or increased borrowing.[79] A cut in public expenditure of £6.5 billion per year[80] equates to over half of Scotland's health budget or three quarters of Scotland's spending on education and training.[81] Were the £6.5 billion shortfall to be recouped via income tax then the Scottish Government would need to increase the basic rate of income tax in Scotland by 17 points in pound.[82]

51. The fall in the oil price does not just affect revenues from petroleum tax. It is predicted that if the oil price stays at its current level then between 10,000 and 35,000 jobs could be lost from the oil industry, many of them based in Aberdeen, the centre of the UK's oil industry.[83] The loss of jobs from the sector could have a knock on effect for other areas of the local economy. The Smith Commission's decision to broadly retain a shared welfare system means that were there to be increased demand for welfare in Scotland as a result of a downturn in the oil industry then the cost would be borne by the broader shoulders of the UK tax base. As Professor David Bell of the University of Stirling explains:

    The case for not devolving Universal Credit might be based on the argument that supporting labour markets in areas that have been hit by adverse economic events underpins both political and macroeconomic stability and therefore must be controlled from the centre.[84]

52. The collapse in the oil price is a stark reminder of the risks that face economies which rely on a volatile revenue stream to fund a large proportion of their public spending. The conclusion of the Smith Commission not to devolve such a volatile source of revenue, nor to recommend full fiscal autonomy, but instead to retain the system of shared benefit and pooled risk across the United Kingdom has already proved to be a wise decision, and one that is of obvious and immediate benefit to the people of Scotland.

53. Were the Scottish Government to move towards full fiscal autonomy, it would mean Scotland losing £8 billion in additional funds that are delivered via the Barnett formula and block grant. This could put the existing level of public spending in Scotland at risk.[85] Furthermore, the Scottish Government would be replacing the security of Barnett with oil revenues which are volatile and not within the Scottish Government's control. The majority of the people of Scotland voted to retain the safety net of the UK's broad tax base, and the Smith Agreement respects that decision. The Scottish Government's pursuit of full fiscal autonomy does not and, as recent events have shown, would expose Scotland to increased financial risk and an immediate hole in its budget of £6.5 billion.[86] We cannot see how Scotland benefits from such a scenario.

63   HC Deb 22 October 2014, Col 894 Back

64   Andrew Marr Show, BBC One, 25 January 2015, transcript Back

65   Scottish Government White Paper, Scotland's Future: your guide to an independent Scotland, p510 Back

66   Scottish Government, Oil and Gas Bulletin, May 2014 Back

67   Office for Budget Responsibility, Economic and Fiscal Outlook 2014, December 2014, p112 Back

68   HM Government, Scotland analysis: fiscal sustainability, Cm 8854, May 2014, p21 Back

69   Oral evidence taken before the Treasury Committee, 14 January 2015, Q163 Back

70   According to the HM Treasury publication Public Expenditure: Statistical Analyses 2014, p115, identifiable public spending on services per head in 2012-13 was £10,152 in Scotland and £8,788 for the UK. The difference between these figures multiplied by Scotland's population of 5.314 million gives the figure of £7.25 billion in additional funding. GERS also notes that total public expenditure in Scotland was an estimated 9.3% of UK public sector expenditure, higher than its 8.2% share of population and higher than its non-North Sea revenues which were an estimated 8.2% of total UK non-North Sea revenues. Back

71   Not including revenues from oil which we discuss separately. Back

72   The difference between Scotland and the United Kingdom multiplied by the population of Scotland Back

73   Q288 Back

74   Evidence to the Smith Commission submitted by Fiscal Affairs Scotland  Back

75   Q285 Back

76   Office for Budget Responsibility, Economic and Fiscal Outlook 2014, December 2014, p112 Back

77   Fiscal Affairs Scotland Press Release, October 2014 Back

78   Letter from Rt Hon Alistair Carmichael MP, Secretary of State for Scotland to the Chairman of the Committee, 12 February 2015 and Q285 Back

79   In evidence to the Treasury Committee the Chancellor stated that the revised fiscal framework being drawn up to implement the Smith Agreement would require the Scottish Government to run a balanced budget. At the very least, this is likely to mean Scotland not being allowed a deficit that is greater proportionately than that of the UK. Scotland currently has a fiscal deficit of £17.6 billion (14% of GDP) without including oil revenues. Including oil revenues of £1.5 billion brings the deficit down to 12.8% of GDP. In contrast, the UK position is around 7% of GDP. Therefore, in order to bring Scotland's deficit down to UK levels under full fiscal autonomy the Scottish Government would need to address the £8 billion shortfall we have identified. Back

80   The loss of £8 billion mitigated by the addition of £1.5 billion in oil revenues. Back

81   Government expenditure and revenue Scotland 2012-13, p23 Back

82   Letter from Rt Hon Alistair Carmichael MP, Secretary of State for Scotland to the Chairman of the Committee, 12 February 2015: "The IFS estimated that an increase of 1 percentage point in the basic rate of income tax would raise around £365 million, and the same increase in the higher rate would increase tax revenues by around £60 million." Back

83   Q325 Back

84   Professor David Bell, 'Why Scotland is unlikely to become a welfare paradise', available at Back

85   Evidence to the Smith Commission submitted by Fiscal Affairs Scotland Back

86   This figure is based on Scotland losing the £8 billion in higher per capita public spending delivered by the Barnett formula and block grant but only gaining £1.5 billion in oil tax revenues based on the current oil price of $60 per barrel. Back

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Prepared 10 March 2015