House of Lords - Economic Implications for the United Kingdom of Scottish Independence

Economic Implications for the United Kingdom of Scottish Independence - Economic Affairs Committee Contents

Chapter 4: Scotland's Fiscal Position

78. Independence would in principle allow the Scottish Government to run its own policy on taxation and spending. Mr John Swinney MSP, Cabinet Secretary for Finance, Employment and Sustainable Growth in the Scottish Government, told us that independence would create opportunities to "invest in growth", "support key industries" and "tackle key social issues" to "deliver the best results for Scotland".[93] This chapter addresses the question: to what extent would independence in practice give a Scottish Government the scope to develop a distinctive fiscal policy of its own?

79. Scotland's scope to develop a distinctive fiscal policy after independence depends on both its choice of currency and its share of current UK assets and liabilities. Since the intention of the Scottish Government is to continue to use sterling, as discussed in Chapter 3, the fiscal possibilities are discussed in this context. The principles for dividing the assets and liabilities were introduced in Chapter 2. North Sea oil and the public sector debt are the most important asset and liabilities and are discussed in more detail below.

North Sea oil and gas

80. The most important asset to be divided on Scottish independence would be the oil and gas reserves under the North Sea. The output is sold on world markets and the tax revenues are currently collected centrally by HM Revenue and Customs (HMRC). Over the past five years the average annual tax revenue from oil and gas has been £9.4bn. This represents only 1.7% of onshore tax revenues for the UK in 2011-12 but 20% of onshore tax revenues for Scotland.[94]

81. Professor Alex Kemp told us that the median line would be the starting point for negotiations between Scotland and the rest of the UK over division of North Sea oil and gas reserves. He thought that "there would not be too much controversy about that".[95]Most witnesses agreed that Scotland would gain approximately 90% of the oil and gas reserves.

82. The value of North Sea reserves depends on future exploration, investment, oil price, tax policy and decommissioning costs. Professor Kemp cited the most recent official estimates of the remaining reserves in the North Sea as between 10.3bn and 33bn barrels of oil equivalent.[96] His calculation of the oil tax revenues which might have accrued to Scotland from the UK Continental Shelf (UKCS) in past years is shown in Figure 1.

FIGURE 1

Hypothetical Scottish Royalty and Tax Revenues from the UKCS
(£m at 2009/10 prices)

Source: Professor Kemp written evidence

Professor Kemp's 'guesstimate' (to which we referred in Chapter 2) is that net tax revenues in the Scottish sector could range between £5bn and £10bn per year for the next decade.[97] The revenue flows are large but volatile.

83. Volatility in the oil price translates into volatility of tax revenues. For example, between 2008/09 and 2009/10 North Sea tax revenues halved from £12.9 billion to £6.5 billion.[98] It is easier for a large nation than a small nation to absorb the volatility of oil revenues, as they constitute a very much smaller proportion of total tax revenues. Professor David Bell noted that the volatility of oil-based tax revenues makes "longer term planning for public services … pretty fraught".[99]

84. An independent Scottish Government would need to ensure a seamless transition to a new framework of licensing, taxation and health and safety provisions and so on for an industry employing directly and indirectly almost 200,000 people. Professor Kemp added that "investors and Government would have to think about it much more".[100]

85. An independent Scotland would benefit substantially from tax revenues from a geographical share of North Sea oil and gas reserves. But, as the revenue from North Sea oil and gas would be a much larger proportion of total tax revenue in an independent Scotland than in the UK, its volatility would make it more difficult to conduct economic policy.

Public sector debt

86. Our witnesses agreed that the UK's public sector debt should be shared by population. The most widely used measure of public sector debt is the Public Sector Net Debt (PSND) which was £1,104bn or 71.8% of UK GDP in the fiscal year ending in March 2012.[101] Assuming that 8.4% of this debt is allocated to Scotland (so the share is £93bn) and North Sea oil is allocated on a geographical basis, the ratio of Scottish debt to GDP would be approximately 61.6%.[102] The public sector debt to GDP ratio for the rest of the UK would be approximately 73.5%.

87. But this measure of debt does not include known future public sector liabilities. According to the Office for Budget Responsibility (OBR) these future liabilities for the fiscal year ending March 2011 include inter alia: £960bn of UK public service pensions; £32bn of UK private finance initiatives; and £108bn of other expected future liabilities (e.g. decommissioning nuclear power stations).[103] Ms Johann Lamont MSP argued that some of these future liabilities clearly relate to Scotland.[104] Assuming that these future liabilities are apportioned on the same population basis as the public sector debt, the total liabilities of an independent Scotland would double to £185.4bn or 123% of GDP including a geographical share of North Sea oil.[105] The UK currently has all of these future liabilities.

88. The Scottish Government aims for independence in March 2016. The OBR projects that the UK's public sector debt (PSND) will then be significantly larger, at £1,502bn or 85.1% of GDP.[106] This suggests that the public sector debt to GDP ratios for both an independent Scotland and the rest of the UK would be significantly higher than the figures for the fiscal year ending 2012 referred to above. If, however, economic growth were faster than projected, this prospective debt burden would lighten.

89. We recommend that existing UK public sector debt should be apportioned between an independent Scotland and the rest of the UK by share of population. We also recommend that the UK's known future liabilities, such as public sector pensions and private finance initiatives, should be apportioned on the same population basis unless they can be clearly identified as applying to a particular nation only.

TRANSFER OF PUBLIC SECTOR DEBT

90. Transfer of an agreed share of the UK's public sector debt to an independent Scotland would not be straightforward. The terms on existing UK debt could not simply be altered to allow some to be owed by Scotland. This would constitute a meaningful change in contractual terms and would be a default. It would also take a newly-independent Scotland some time to establish a credit history successfully to issue enough debt to take on its share of the UK's liabilities. As Sir Nicholas Macpherson, Permanent Secretary of the UK Treasury, said: "Scotland will have to go into the market [and] it will not have the track record of the UK authorities, the sophistication of our debt management operations, or the extraordinary length of our yield curve, all of which means that it will face quite big risks."[107] Professor Bell noted that it was not clear how to assess the credit-worthiness of an independent Scotland in the absence of a credit history.[108]

91. Transferring to an independent Scotland its agreed share of UK liabilities would be fraught with difficulties. Creditors might not agree to a straight transfer of public debt from the UK to an independent Scotland on otherwise identical terms. The Scottish Government should explain to voters before the referendum how it would in practice take over its agreed share of UK public sector debt and future liabilities on independence.

Scotland's 'separate' fiscal deficit

92. The Government Expenditure and Revenue Scotland 2011-12 (GERS) report provides a sketch of Scotland's fiscal accounts. The spending data mostly reflects actual spending in Scotland whereas much of the revenue data is imputed from UK data. Public sector spending per person, measured by total managed expenditure (TME), has been on average £1,160 higher in Scotland than the UK overall over the last five years. By contrast there has been little difference in reported tax revenue raised per person. This is shown in Figure 2 where the difference between the two bars is the fiscal deficit per person. In 2011-12 the deficit per person was £3,390 in Scotland and £2,052 in the UK. This is before any re-categorisation of North Sea oil and gas.

FIGURE 2

Public sector spending and taxation per person, 2011-12

Source: Government Expenditure and Revenue Scotland 2011-12

93. The GERS report also presents an approximate fiscal balance for a separate Scotland. Without including any tax revenues or output from North Sea oil and gas, Scotland's separate fiscal deficit might be around £18.2bn or 14.6% of GDP in 2011-12. If, however, North Sea oil and gas revenues and output are apportioned on a geographic basis, as expected, the deficit for a separate Scotland might be £7.6bn or 5.0% of GDP in 2011-12. This is significantly lower than the OBR's estimate of the fiscal deficit (PSNB) for the UK overall of 7.9% of GDP in 2011-12. If the North Sea oil and gas output and tax revenue had been allocated to Scotland the fiscal deficit of the rest of the UK might be around 8.7% of GDP.

TABLE 1

Alternative measures of Scotland's fiscal balance

	2008-09	2009-10	2010-11	2011-12
Public sector spending (TME), £bn	59.0	62.0	64.0	64.5
Revenue, £bn	43.5	41.7	44.3	46.3
Fiscal balance, £bn	-15.5	-20.4	-19.7	-18.2
Fiscal balance, %GDP	-13.4%	-18.1%	-16.5%	-14.6%
Fiscal balance incl. NS oil, £bn	-3.7	-14.5	-11.7	-7.6
Fiscal balance incl. NS oil, %GDP	-2.6%	-10.7%	-8.1%	-5.0%
UK PSNB, % GDP	-6.9%	-11.2%	-9.5%	-7.9%

Note: Where North Sea (NS) oil is included in the table it is assumed that this is apportioned on a geographic basis.

Sources: Government Expenditure and Revenue Scotland 2011-12.

94. As things stand, most of the tax revenue is simply collected by HM Revenue and Customs (HMRC) and returned to Scotland as a block grant. GERS data do not therefore, represent amounts actually raised in Scotland. Instead they impute a large part of the revenue figures to Scotland from UK totals using a variety a methods. The Institute of Chartered Accounts of Scotland (ICAS) stated: "Let no-one be misled, there are no official statistics for tax paid by those in Scotland, simply because there has never before been a need to measure them."[109]ICAS also reported to us that "to design and implement an independent tax system in Scotland from scratch may realistically take a decade if not two, shorter if a more limited devolution of powers is involved".[110] If Scotland becomes independent the taxes paid in Scotland would no longer transfer to HMRC but remain in Scotland. The block transfer to Scotland would cease to exist. Professor John Kay said: "There could be no continuing transfer of this kind [the block grant] and Scotland would have to finance its activities from its own revenues."[111] Whether this might involve tax increases or reductions can only be determined once it becomes clear what the actual tax yield is for Scotland.

95. Lack of data on the tax base in Scotland impedes full understanding of the economics of independence. Although there can be no certainty we recommend that the Scottish Government and HMRC work together to make the best possible estimate of the tax base in Scotland.

Sustainability

96. An important factor which will influence an independent Scotland's fiscal sustainability is its future demographic profile. The Chief Secretary to the Treasury told us that Scotland's population is aging faster than for the UK overall.[112]Figure 3 shows an old age dependency ratio defined as the number of over 65 year olds relative to the working age population. The public purse in Scotland will face higher demands as a result of both the faster rise in the share of over 65 year olds relative to the work force and the more generous public sector support to retirees. Sir Nicholas Macpherson recalled that the newly-independent Irish state had to cut the value of the state pension in Ireland in 1924 to keep its public finances on track because of similar demographic problems.[113] Since Scotland's old age dependency ratio seems likely to worsen in future years, investors may charge a higher cost of capital before it materialises.

FIGURE 3

Old age dependency ratio projections (65+ year olds / 16-24 year olds)

Source: Office for National Statistics, 2010 projections

97. International investors will ultimately express their confidence in the sustainability of the finances of an independent Scotland through the cost of borrowing. Some small countries have high credit ratings. Professor Gavin McCrone noted: "The Swiss can run themselves perfectly satisfactorily and have very low interest rates, and so can the Norwegians. So it can be done."[114] Four countries in Europe (Norway, Denmark, Switzerland and Sweden) often cited as comparators of an independent Scotland all enjoy the highest credit rating. Each of these countries, however, has its own currency and in some cases a long track record of sound finances and a low debt burden. Sir Nicholas Macpherson pointed out, as already noted in paragraph 46:

115

Fiscal Policy in a Currency Union

98. Witnesses were clear that fiscal problems in an independent Scotland would have consequences for the rest of the UK. Professor Jim Gallagher thought "good neighbourliness"[116] would require the rest of the UK to help as the UK helped Ireland in 2010: "If I were sitting in the Treasury, I would say that there is always a risk that the markets will think that we will feel obliged to stand behind an independent Scotland, and therefore the amount that it borrows is inevitably of interest."[117]

99. The Bank of England might also have to provide emergency liquidity support to Scottish banks, as discussed in Chapter 3. Rt Hon Alistair Darling MP said that in a currency union with the Bank of England providing full central bank services, "we would presumably say 'okay, we're guaranteeing the Scottish banks, so someone needs to guarantee that payment to us' in the same way that currently the UK Government guarantee the Bank of England."[118] In the financial crisis of 2008, liquidity support from the Bank of England was insufficient. The UK Government bought newly issued shares to recapitalise the banks. Mr Darling reminded us that the total support extended to RBS during the financial crisis was equivalent to 211% of Scotland's GDP but only 21% of UK GDP.[119] While RBS was too big to fail for the UK it would have been too big to save for an independent Scotland alone.

100. Almost all witnesses expected that the rest of the UK would seek to impose limits on Scottish borrowing and debt in the event of a formal currency or monetary union. The Fiscal Commission Working Group acknowledged: "A common requirement for countries in a monetary union is an agreement over the overall fiscal position of each member (i.e. net debt and borrowing). This is to ensure that the fiscal position of one member state does not destabilise the monetary union."[120]

101. Within a formal currency union, were there to be one, the rest of the UK would clearly be the dominant partner. There may be parallels with the dominant core of the Eurozone and the policy coordination problems that arose with its weaker member states. The rest of the UK's policies might take scant account of an independent Scotland's interests. Mr Darling reminded us: "It was actually France and Germany that drove a coach and horses through that [the stability and growth pact], which demonstrates … who calls the shots in Europe."[121]

102. Some witnesses thought an independent Scotland would retain some room for manoeuvre over the composition of taxation. Mr Jeremy Peat of the David Hume Institute said: "There is a great deal of ability to vary individual taxes and indeed to operate the public finances independently, subject to an overarching constraint or two as to the overall fiscal position and the sustainability of that position."[122] Mr Swinney made clear the Scottish Government's interest in having the power to vary corporation tax as a means to promote economic growth.[123]

103. Professor Kay warned that within a single market "there are some areas where competition is destructive and corporation tax is one example".[124] Professor Gallagher agreed: "There is a general view and understandable principle that varying any taxation is a distortion of market activity. Varying tax across the territory is a greater distortion."[125]

104. A monetary union as advocated by the Scottish Government would require robust and credible limits on borrowing and indebtedness by both member states. So far the Eurozone has found this problem intractable. The Scottish and UK Governments would need to reach agreement on detailed and credible fiscal restraints, including sanctions for breaches, before the referendum if Scottish voters are to make an informed choice. We believe that it would be difficult for any such agreements to be made binding in all circumstances.

105. Currency and fiscal unions offer scope for risk sharing between the nations in the union. The British Academy stated: "As is the case with federations such as the United States, automatic stabilisers and risk sharing measures are part of the UK's current fiscal system. In the event of a local shock, tax revenue goes down and social security payments go up, thus cushioning the shock. These would be lost by an independent Scotland, and thought would have to be given to how they could be replaced."[126]

106. Mr Alexander also drew attention to the UK's automatic fiscal stabilisers, for example transfer payments through the welfare system, which cushion regional impacts. He said: "Those transfers would not be available in the context of an independent Scotland.''[127]Dismantling the current fiscal union would result in a loss of risk-sharing mechanisms between an independent Scotland and the rest of the UK. This would be an adverse consequence for the citizens of both states, but particularly for people in Scotland given the relative size of the two countries.

107. With no track record of issuing debt securities, the difficult mechanics of taking on a share of the UK's public sector debt, volatile tax revenue and the loss of risk-sharing with the rest of the UK, an independent Scotland would face considerable fiscal challenges.

93 Q 864 Back

94 Government Expenditure and Revenue Scotland 2011-12, tables 4.1 and 2.3 and Office for Budget Responsibility, Economic and Fiscal Outlook, table 4.6, December 2012 Back

95 Q 548 Back

96 Professor Kemp paragraph 17 Back

97 Q 553 Back

98 Government Expenditure and Revenue Scotland 2011-12, table 4.3 Back

99 Q 16 Back

100 Q 550 Back

101 It is the total issued financial liabilities (government bills and gilts and National Savings debt) minus liquid assets (foreign exchange reserves and cash deposits) measured on a cash basis (so without accruals). This is an ONS statistic. Back

102 The Government Expenditure and Revenue Services report estimate Scottish GDP for 2011/12 including a geographic share of North Sea oil to be £150.9bn. Back

103 Office of Budget Responsibility (2012), Fiscal Sustainability Report Back

104 Ms Johann Lamont paragraph 6 Back