Saturday, 25 April 2015

Full Fiscal Autonomy in 700 Words

This piece originally appeared in the Daily Record on 25/04/2015

When the SNP campaigned for Independence they convinced many voters that a Yes vote would make us better off. Those voters should now be asking themselves why the SNP is backing away from the idea of Full Fiscal Autonomy (FFA) anytime soon.

Full Fiscal Autonomy is a very simple concept. It means Scotland keeping everything we raise from taxes and using that money to pay for our own public spending.  We’d need to pay the UK government for some shared costs (like defence and foreign affairs) but effectively it means we’d get to run our own economy, to stand on our own feet.

In fact FFA would give us many of the claimed benefits of independence without some of the big risks like currency.  We would keep our oil revenues and choose what taxes to raise and how to spend our money.

Under FFA we would still be sharing a currency and a national debt with the rest of the UK, so to be paying our way we would simply need to be running a deficit at a similar rate.

The Scottish Government's own figures (GERS) tell us where we would start from.  These are not Westminster's numbers; the Scottish Government's Chief Statistician takes responsibility for them.

The GERS figures simply show us how much we spend and how much we raise through taxes. The difference between the two is our deficit. By comparing to the rest of the UK on a per person basis we can see our relative deficit rate – how much better or worse off our stand-alone finances are than those we share as an integral part of the UK.

First let’s look at what we spend. Over the last 15 years (adjusted for inflation) we spent on average over £1,400 more per person than the rest of the UK.  This is largely due to the fact that our population density is 20% of the UK’s so it’s more expensive to provide the same level of public services in areas such as education, health, and transport. This higher spend is very consistent and is the equivalent of £7.8bn per year.

Next let’s look at the taxes we raise before oil is included. Again there is a remarkably consistent trend. We generate similar but slightly less tax per person than the UK average. Over the last 15 years (adjusted for inflation) the average difference is £250 per person or £1.3bn per year

During the referendum we were told by the SNP that oil revenues were just a bonus.  Yet before we take into account oil revenues, these figures show Scotland has consistently run a £9.1bn per year higher deficit than the rest of the UK for the last 15 years.

Some people react to this by suggesting it shows that Westminster is somehow letting Scotland down. But our economy does pretty well at generating revenue. It seems harsh to blame Westminster because they allowing us to spend more.

So does keeping “our oil” overcome this deficit gap? It has done in only three of the last 15 years, the most recent of which was 2011-12 (the base year used for the Independence White Paper).  Since then oil revenues have plummeted and as they decline we are seeing more and more of the underlying £9.1bn deficit gap exposed. This is what is often referred to as the “black-hole” in the SNP’s plans.

But we’ve just looked at the past, what of the future?

Oil is extremely unlikely to come to our rescue.  Tax revenues are generated by oil industry profits and the North Sea oil industry’s profitability has been in long term decline. The oil price crash just makes it worse.

Some pin their hopes on Scotland achieving unheard of economic growth. This is of course what any country’s government wants. Achieving it is another matter and the SNP haven’t suggested any radical policies that might actually make it happen.

So the most likely solution would be to pile on additional austerity measures (on top of those the rest of the UK choose) and/or to take on even more debt.

No wonder the SNP aren’t that keen on FFA anymore.  They might even be secretly relieved we didn’t vote Yes.

For those who are visually minded the following graph represents the data described above.

The solid red line is actual higher Scottish public spending per capita; the solid blue line is Scotland's lower onshore tax revenues per capita; the solid black line is Scotland’s actual higher tax generation per capita when “our” oil is included.  

The gap between the blue and black lines is oil & gas tax revenues.  The gap between the red and black lines is Scotland’s higher deficit (when black below red) or lower deficit (when black above red).

For a more complete explanations see;

> Full Fiscal Autonomy for Dummies
> Oil Price & Scottish Tax Generation

Monday, 20 April 2015

Oil Price and Scottish Tax Generation

It's highly frustrating when the debate on Scotland's economy is reduced to a simplistic "when the oil price recovers we'll be fine".

Take this example from Gordon McIntyre-Kemp of "Business for Scotland" (who have given up any pretence of being anything other than SNP cheerleaders as evidenced in detail here);
Labour are feverishly promoting the £7.6bn black hole scare-story to put people off FFA but it’s a myth; firstly because it assumes oil prices won’t ever recover, and even a moderate increase to $70/80 would wipe out any additional deficit.
This is nonsense.

First of all let's look at recent history.  In 2014 the average oil price was $99 and Scotland generated £2.6bn of North Sea tax revenue.  That's £2bn more than the £0.6bn assumed in the IFS forecast that leads to their £7.6bn "black-hole".  So based on recent history a $99 oil price fills about a only quarter of the back hole, leaves us still with over £5.6bn to find.

As an aside: if you doubt the existence of the black-hole I suggest you read Full Fiscal Autonomy for Dummies which explains that the black-hole is a long-term structural deficit difference that is simply revealed by falling oil revenues

Secondly let's consider whether there might be more to our North Sea tax revenue generation than just the oil price.  Of course there is;  it's profit that gets taxed which means tax revenue generation is a function of  [production volume] x [profitability] x [tax rates].

First let's look at (inflation adjusted) North Sea oil tax revenues and oil price on the same chart

Notice how there's a clear relationship but particularly in recent years the revenue line declined even when the oil price held up?

Take a few seconds to think about the following graph because it tells us an awful lot. I've plotted the ratio between the two lines; the ratio of N Sea oil revenue generated (£m) to the average $ oil price in that year. So what we're able to observe here is the real terms relationship over time between $ oil price and actual Scottish tax revenue generated - it's a measure of North Sea oil's tax generation productivity

Is it just me or can you see a trend emerging here?

We shouldn't be surprised by this. As the most economically attractive reserves become depleted production moves to less economically attractive ones - profit per barrel reduces even if the $ oil price doesn't move. Combine that with production volume declines and reductions in tax rates to protect the viability of North Sea activity (and jobs) and you'd expect to see exactly what we can empirically observe; we get less bang for the oil price buck over time.

To quote Oil & Gas UK
After more than a decade of spiralling costs, over-taxation and weak regulation, the UK offshore oil and gas industry is now bottom of the league in terms of the cost of producing a barrel of oil and gas.  The UK’s difficulties have been greatly exacerbated by the sudden drop in oil price but it would be a grave mistake to believe that the price fall is the cause of the problem.  A recovery in the price, even to $100 per barrel, would not resolve matters
This might be forcing the data a little -  but based on the trend line above it would seem reasonable to suggest £40m/$ is an optimistic forward assumption (the last three years have been 44, 26 and 13 respectively).  To get the £8.2bn oil revenue we'd need (the £0.6bn the IFS already forecast + the £7.6bn "black-hole") we'd need an oil price of 8,200/40 = $205.

This is clearly an extremely crude (ahem) analysis but I think my point is made; to suggest all will be well for an FFA Scotland if the oil price just recovers to $70/80 is just ridiculous.

In case you're thinking "what about exchange rates" or "is this maybe a function of absolute oil price" here's that same productivity graph with UK GDP inflation adjusted average oil price on it

As you can see the productivity decline has happened independent of whether the exchange rate adjusted oil price has been rising or falling - absolute oil price and exchange rate are not the tax productivity drivers.


I suppose I'd better address the other points that Gordon McIntyre-Kemp raises in that article. This won't take long.
Secondly FFA will give the Scottish Government powers to balance income and expenditure [...] FFA is the key to rapid economic growth and prosperity for Scotland. Here are five key ways Scottish FFA can balance the books, cut the deficit, raise revenues and create jobs
Sounds great doesn't it?  Gordon's found the silver-bullets that will fix our economic woes.

1. "Refocusing the Economy on SMEs"
Sounds reasonable. But don't all government's want a successful SME sector? What's Gordon's innovative idea? "Targeted tax incentives". Fair enough, tax cuts for SMEs might work - it's hardly ground-breaking but we've got another four ideas to go

2. "Targeted Tax Incentives"
Within this idea he goes on to explain that "SMEs hold the key to rapid economic growth".  So this is the same as number one really - tax cuts for SMEs. Maybe he was rushing when he wrote these.

3. "Increasing Research & Development". 
Sounds like a great idea. I mean there are plenty of incentives for this already like R&D tax credits and patent boxing but maybe Gordon's got a new idea. Guess what? It's "targeted tax incentives". This is getting a little silly

4. "Abolishing Air Passenger Duty"
This is a targeted tax incentive - reducing a guaranteed tax take in the hope of a net gain from boosting tourism. It might work - but of course the Smith Commission recommended that this tax be devolved anyway so we'll find out soon enough; no need for FFA.

5. "Reducing VAT on Tourism"
Well this a targeted tax incentive too. We lose a guaranteed tax take through VAT on tourism in the hope that the economy net gains from the boost in tourism that could result.

I'm afraid that's it.  It's basically one idea; reduce taxes in the hope the net effect will be beneficial to the economy.

Now I'm not saying that isn't a chance that some business and consumer tax reductions could result in net economic improvement. They might be beneficial or they might be detrimental, it's a tough call. Not for our Gordon though. He concludes - with the spectacular confidence that comes from knowing you'll never be held to account -
If Scotland had FFA we would have the power to do all of the above and grow our economy at unprecedented rates, thus demonstrating conclusively that Scotland would be better off as an independent partner to the other countries of these isles but worse off by remaining a devo-lite region without fiscal autonomy. 

Would grow our economy at "unprecedented" rates - so by definition at rate that have never been known before.  Just by reducing some taxes.  There will be finance ministers all over Europe kicking themselves that they hadn't thought of this. "Thus demonstrating conclusively" - he's hypothesised an outcome which he admits would be unprecedented and continues as if he's proven something. Extraordinary.

There's more
Just the few policies highlighted above would make 5% growth attainable for Scotland 
Well he plucked that number out of his nether regions didn't he?

You'll forgive me if I don't waste more of my time on this - if you believe that some tax reductions will deliver 5% growth because Gordon says so then I'm afraid you're beyond my reach.

Saturday, 18 April 2015

Full Fiscal Autonomy for Dummies

Full Fiscal Autonomy (FFA) means Scotland keeping everything we raise from taxes and using that money for our own spending (including paying the UK government for defence and foreign affairs and certain shared administrative services).

If we spend more than we raise we run a deficit. That is not in itself necessarily a problem; FFA doesn't mean we can't run a deficit.

Under FFA we would still be sharing a currency and a national debt with the rest of the UK, so to be paying our way we would simply need to be running a deficit at a similar rate1 to the rest of the UK.

If Scotland's deficit rate1 was higher there would be a funding gap  (i.e. our fair share1 of UK debt would not be enough to balance the books). It's expected this would be handled by Scotland having its own limited borrowing powers.  A limit would need to be agreed because we'd be sharing a currency meaning Scotland's borrowing could affect the UK's international credit rating and cost of debt.

Of course if Scotland's deficit rate was lower than the UK's we would be running a relative surplus. Under FFA any such funds would be kept for Scotland to pay for future tax cuts and/or public spending increases or - whisper it - to build a wealth fund.

In summary: for Scotland to be truly fully fiscally autonomous we would cease exceptional transfers to or from the rest of the UK.

Now let's remind ourselves of some of the rhetoric used by the Yes campaign and think what it would means in the context of FFA;

If these economic claims made by the SNP during the Independence Referendum can be taken at face-value then FFA would be a highly attractive proposition for Scotland.

The Numbers

We can see what FFA would have meant historically for Scotland’s finances by simply looking at the Scottish Government's own GERS report.  We need to be absolutely clear about this: these are not Westminster's figures - the Scottish Government's Chief Statistician takes responsibility for them.

If you don't think the GERS figures are meaningful then please read footnote 2. If you still doubt them please read this > How Scotland's Economy Contributes to the UK. If you still doubt them after that please stop reading this blog.

Public Spending

The GERS figures shows how Scotland's public spending is consistently higher per person than the rest of the UK3.  Over the last 15 years (adjusted for inflation) the average higher spend is £1,4564 per person or £7.8bn per year.

If we break this spend difference down by category it shows we spend more per capita in every major cost area5,6

These higher per capita spend levels should not be interpreted as evidence of some wild profligacy by the Scottish Government or excessive generosity on the part of the UK towards Scotland. Our population density is 80% lower than the rest of the UK and we have extensive island communities to serve - this obviously makes it more expensive to provide the same level of public services in areas such as education, health, and transport.  There are of course other reasons for higher per capita costs in Scotland related to our demographics and health needs - but let's not get distracted by that topic here7.

The point is that today - based on the principle that where possible the same public service levels should be provided nationally - these higher costs are spread across the whole UK population. Of course under FFA (as with Independence) the burden of our higher "costs-to-serve" would have to be borne exclusively by Scottish tax payers.

As an aside: you might spot in the graph above that these figures expose the fact that under the SNP government education spending has been cut in relative terms. Widespread access to good quality education is surely crucial both to address "social justice" concerns and to ensure we have well-educated talent entering our working population to help grow the economy. This prioritisation of education spending is something we'll surely here more of come the Holyrood elections in 2016.

Tax Revenues excluding Oil

The GERS figures show that - before oil is included - we generate slightly less tax per person then the UK average. This is a remarkably consistent trend; over the last 15 years (adjusted for inflation) the average difference is £250 per person or £1.3bn per year

As with the costs it's interesting to break this figure down into its component parts8

What's striking is the extent to which Scotland's income and wealth tax generation lags the rest of the UK.  Given that the same tax rates apply UK wide this is of course primarily a function of average employment and pay levels.  Since 2006 the unemployment rate in Scotland has generally been near or below the UK rate (see UK regional employment stats over time) so we can infer that the difference is due to lower average wage levels.  There does at least appear to be an encouraging trend in this respect.

As a slightly depressing aside it's worth noting that we generate just over £100 per capita (or £0.5bn) more than the rest of the UK through "sin taxes" on alcohol, betting and tobacco.

Relative Deficit Excluding Oil

During the referendum the SNP told us "Oil revenues will be a "bonus" but not the basis of the economy in an independent Scotland" [ Alex Salmond, July 2013].

So before including the "bonus" of oil let's look at the last 15 years actual difference in deficit per capita between Scotland and the rest of the UK;

Of course this will come as no surprise if you're following the logic here; we spend about £1,450 more and raise about £250 less per person so we'd expect an average deficit difference of about £1,700 per person and that's exactly what we see.

Gross that up by Scotland's 5.3m population and you get to an underlying (before oil) deficit gap of £9.1bn.  This is not just a snapshot - this has been true (give or take9) for every one of the 15 years for which data is available.

At this stage somebody normally argues that this observation is evidence that the UK has failed Scotland - it must be Westminster's fault that our underlying deficit is so much worse. Let's just think about that for a moment. Of that £9.1bn gap only £1.3bn is due to lower tax generation (i.e. less successful economic activity); the balance of £7.8bn is due to higher public expenditure. It seems a little harsh to cry foul against the rest of the UK for making us suffer higher levels of public funding.

The Impact of Oil

So now let's move on to the "bonus" that is oil.  The following graph shows the higher spend per capita (the red line) and the lower ex-oil revenue per capita (blue line) that we've just been looking at. The new black line is the total revenue per capita difference if we include Scotland's full geographic share10 of North Sea oil

Clearly when the black line is above the red line Scotland's deficit per capita is less than the rest of the UK's.  That's happened three times in the last 15 years as the graph below perhaps more clearly shows (we're just plotting the difference between the red and black lines).

Surely by now its clear. Oil is not a bonus; in fact it's all about the oil.

Three times in the last 15 years the oil tide has risen high enough to submerge the underlying £1,700 per capita deficit difference and give Scotland a lower deficit than the rest of the UK. When the oil tide flows out we can see more of that underlying £1,700/person deficit difference, we see more of the £9.1bn.

So let's take a closer look at the oil figures.

For Scotland to cover the underlying £9.1bn deficit gap we' need total North Sea oil revenues of £10.1bn (because c.90% of North Sea oil revenues are attributable to Scotland11).

Let's look at that in the context of historical actual figures (grey bars) and the OBR's latest forecasts (sludgy bars). The solid green line is the approximate actual North Sea revenues we would have needed in each year to off-set our deficit difference to the rest of the UK; the dotted green line is the 15 year average requirement.

Roughly speaking: the gap between the bars and the green line is the size of the deficit gap that Scotland would have faced (or would be expected to face) under FFA.

This is where the IFS £7.6bn "black-hole" figure comes from; they're simply recognising that when Scotland's share of North Sea oil revenues slumps as low as £600m (as the OBR forecast for 2015-16) then more of the underlying deficit gap will be exposed. Note that the OBR forecast a further slight deterioration of North Sea oil revenues in 2016-17; the black-hole is not expected to be getting any smaller.

Note also that £7.6bn is not the size of Scotland's forecast deficit as some seem to think - the forecast deficit is £14.2bn or 8.6% of GDP.

The sharper of you will have noticed that our figure of £9.1bn - £0.6bn from oil = £8.5bn compared to the IFS headline "black-hole" figure of £7.6bn.  There are good methodological reasons12 for the difference but frankly these are not worth arguing about in the big scheme of things.

Let's stick with the easy round number of a forecast £8bn deficit gap - this is the FFA "Black-hole".

Addendum: You might be thinking that a recovery in the oil price changes everything.  It doesn't as I explain in detail here > Oil Price and Scottish Tax Generation.  The problem - simply - is that it's profit that gets taxed and the profitability of North Sea oil production is in long-term decline because of increasing production costs. The tax that an oil price of $100 generated 2 years ago is a lot more than the tax a $100 price would generate in 2 years' time

So What?

Clearly for the SNP the undeniable reality of the FFA figures is a huge problem, particularly given the boldness of their referendum rhetoric. Remember:
It must be pretty difficult for Yes voters who were won over by these oft repeated sound-bites to understand how we can now see that a Fully Fiscally Autonomous Scotland would be c.£8bn a year worse off.  You'll forgive me if I suggest that those who read Chokkablog will not find that so difficult to grasp; well done you.

So what of the Independence case now?  Well there appear to be two approaches being taken to deal with the inconvenient economic truth;

1. The "No Detriment" Defence

This is the line taken by Alex salmond in what Kenny Farquharson (Deputy Editor of the Scotsman and Scotland on Sunday) described as "perhaps the most ludicrous political intervention of his career"

Salmond's argument goes something like this (forgive me but it's hard to paraphrase logical nonsense);
The Smith Commission decided against full fiscal autonomy but instead recommended a far more nuanced solution that allowed a number of principles to be maintained, one of which was "no detriment".  I want to throw away everything the Smith Commission recommended except "no detriment" and use that to suggest we couldn't be worse off under FFA because it would be a betrayal of the Smith Commission commitment  
Is it necessary to spell out the insanity of this position?  The Smith Commission had a number of principles (Frances Coppola covers the detail in her excellent Pieria piece on this topic) - you can't just cherry-pick one and throw away the rest.  The "no detriment" principle is clearly intended to cover the fact that the transfer of any specific tax to Scotland would be off-set on day one by a commensurate reduction in the Barnett Formula so that no immediate gain or loss resulted for either party.  Smith did not recommend devolving oil revenues to Scotland presumably at least in part because it is so volatile -  the day chosen as "day one" for the transfer would make a huge difference to the long-run implications for both parties.

More fundamentally; arguing that Barnett needs to be maintained to avoid Scotland losing out financially as a result of FFA gives a lie to all of Salmon's pre-Indyref rhetoric about Scotland being better off, being "the 14th richest country in the world".  Remember: those statements were not made about what Scotland could become, they were assertions about where Scotland already is.

2. The "Kick It Into The Long Grass" Defence

This seems to be the approach favoured by Sturgeon.  The argument goes something like this
Look it won't happen soon anyway so don't bother looking at the numbers now because they'll all have changed before we could negotiate this. Ooh Look over there - see that foodbank?  Torys are nasty bastards aren't they? Labour are just as bad but if you vote for us we'll make them better etc.
Despite her best attempts to distract from the economic facts it's clear that the only ways the figures will get better for an FFA Scotland are

  • If oil recovers dramatically. Which it might. But surely now every Scottish voter "gets" how volatile oil revenue is, understands that a decision to leap for fiscal freedom in a good oil year is likely to bite us in the arse come the next oil slump
  • If we dramatically reduce public spending in Scotland beyond the levels of UK wide cuts (remember: its the deficit difference to the rest of the UK that counts here). Frankly that clearly won't happen unless it's forced on us through Barnett cuts.
  • If we increase tax rates dramatically such that we raise an additional £8bn or so from onshore taxes.  The current onshore tax take in Scotland is £50bn so that would be a 16% increase.
  • If we manage to buck the trend of the last 15 years (at least) and start generating economic growth over and above that of the rest of the UK so that our tax take increases without having to increase tax rates.  The sum is the same as the one above; this would require 16% growth over and above that achieved by the rest of the UK to close the FFA gap 

Even assuming a following wind and some combination of all of the above happening it's hard to see how things could particularly rosy for the Independence case even by 2020.

The possible exception I suppose is the possibility that the Barnett Formula could end up being scrapped. Given her antagonistic approach to the Tories maybe that's what Sturgeon is secretly hoping for? Sure Scots would suffer directly as a result - but if all you care about is achieving Independence, I guess you consider that a price worth paying.

Implications for Independence

Of course all of the above is about FFA, so some would argue that it merely proves that a compromise won't work and only full Independence can give the Scots what they want.  Fair enough.  All I've ever argued is that voters should be aware of the economic realities of what they're voting for and not be misled by the Yes campaign's rhetoric.

The possible upside differences between FFA and Independence are reasonably easy to describe in summary;
  • We'd get control of the defence expenditure that would remain devolved to Westminster under FFA.  Given the SNP's commitment to NATO and their target of spending 2% of GDP on defence this is unlikely to be a significant cost saving: the GERS figure allocated for defence is £3.0bn or almost exactly 2% of GDP already13
  • Similarly "International Services", but these are only £0.8bn and Scotland would need to create its own  international diplomatic and trade networks
  • We'd no longer have to pay our share of UK wide administrative costs - although these would likely be more than offset by the requirement to create our own administrative infrastructures14.
  • If oil booms again as it did in the 1980's we'd get to keep the surplus riches for ourselves
  • We'd get to pursue our own economic policies and not be forced to follow the Westminster led austerity plans.
Unless you're in favour of impotently waiting for the global oil market to recover and hoping our oil reserves have long-term economic viability ... the last of these is the big question.

I've yet to hear a compelling argument as to why an independent Scotland would achieve superior economic growth compared to being in the UK.  If Westminster parties believed relaxing spending cuts would be self-funding through improved economic growth they'd be all over it - but they could of course be completely wrong and it may be that simply "not pursuing austerity" could make the difference.

I don't mean to understate the alternative choices that we would have under independence. One of the major frustrations of the indyref campaign was that so much bollocks was talked about what our economic starting position really was that we never managed to have a substantive debate about what we might actually do with the power that independence would give us.

Remember that what we've shown here is that our underlying (excluding oil) economic under-performance versus the rest of the UK is mainly down to higher spending not lower revenue generation - it's predominantly a structural cost-side issue which is not going to be easily overcome.

Of course it goes without saying that there are additional downsides of independence that we don't need to revisit in full here. Suffice to say that currency, hindrance to UK trading, risk of job losses as companies serving the wider UK market head south to avoid exposure to export risk, EU membership conditions etc. are all major uncertainties introduced by independence that would appear to offer us more downside than upside.

But let's run some simple numbers to think about what growing out of the deficit gap would actually require.  We need to grow our tax revenue base by 16% over and above the UK's growth to off-set the underlying deficit gap.

The Independence White Paper itself provided an illustration of what might be a realistic superior growth rate to assume as the "bonus of being independent". I cover the detail in a separate blog post (> Let's Talk About Growth), but the summary is this;
The Scottish Government's own attempt at scaling the economic growth benefits that "the bonus of being independent" might bring a cumulative benefit of 3.8% over 30 years. We're looking for 16.0% to grow our way out of the deficit gap. As one of my erstwhile American colleagues used to say: you do the math.
But let's be incredibly optimistic and say we were able to consistently grow 1% faster than the rest of the UK - in that case it would take us 15 years (compound growth) to get there.

What would the average deficit gap be over that period - how much would it cost us to get there?

Well given the strategy seems to involve spending more to make it happen (avoiding austerity cuts) the starting deficit gap would in fact be more than £8bn and - if we'd continue to spend more - it would take us more than 15 years to close the gap.  But let's be highly optimistic and assume the average deficit gap would be £4bn over a 15 year period. 15 x £4bn = £60bn.  Let's assume we fund that with debt - that's over £12,000 of debt for every man, woman and child in Scotland.

Now there are many who would still argue that independence is a worthwhile cause even if it incredibly optimistically would cost us £12k per head. If they are willing to recognise the reality of the economic challenges we face and still argue for Independence despite them, then I think we will have some very interesting debates ahead of us.



1. I've intentionally referred to "deficit rate" and "fair share" of borrowing to avoid getting bogged down in definitions that make little material difference.  Basically these can be defined as being on a per head basis or percent of GDP basis. There is an inconsistency in most figures used at the moment because debt costs tend to be allocated on a per capita basis but deficits compared on a % GDP basis. To make it easier for readers to relate figures to those widely quoted I'm going to follow this inconsistent method. If we defined deficit rate on a per capita basis instead of % GDP it would make the case look slightly worse for Scotland.

2. Although you won't hear the accuracy of GERS figures questioned by serious politicians, some disreputable commentators have been responsible for spreading ridiculous misconceptions about them. The likes of Business for Scotland and Wings Over Scotland have made startlingly misinformed statements about VAT and Alcohol Duty not being fully included in Scotland's numbers. If they were right it would be a terrifying indictment of the Scottish Government's incompetence.  They are wrong of course: references to VAT being "paid at companies' headquarters" and Scotland not getting attributed "Alcohol Duty at point of export" demonstrate a fundamental misunderstanding of how these taxes work and how they are attributed in GERS. These are consumption taxes and GERS estimates Scotland's share of these based on consumption data. There is no such thing as "Export Duty" on whisky.

3. I compare Scotland to "rest of UK"  (rUK) because otherwise we are comparing to a UK figure which includes us. I don't understand why so few others do this - maybe because it's a little more analytical work.

4. This figure is commonly quoted as £1,200. That figure is the non-inflation adjusted average from 07-08 to 11-12 (the period available when the White Paper was produced) based on comparing Scotland to total UK rather than "rest of UK".  I f we update to the most recent available 5 years GERS (09-10 - 13-14) the figure would be £1,245; adjust to be vs rUK instead of vs UK and it becomes £1,360; adjust for inflation and it becomes £1,415; take a 15 year average it becomes £1,465.  I'd say £1,400 is a good figure to use.

5. Note that defence, foreign affairs and debt interest costs are not included on this graph because in GERS figures they are allocated on a simple per capita basis so the per capita difference is of course zero. This is consistent with the principles of FFA.

6. The "Accounting Adjustment/Other" line is worth explaining.  It's primarily the difference between capital expenditure and depreciation (and of course we are looking at the relative difference in this difference).  In layman's terms it means Scotland is (very slightly and only in the latest year) at a point where it's rate of investment in capital programmes (compared to its historical average) is lower than rUK's.

7 A technical point is worth highlighting as mentioned in GERS - "water and sewerage services are a public sector responsibility in Scotland, and are therefore included in Scottish public expenditure, whilst in England they are operated by the private sector". This is of course balanced on the "tax generated" side by the operating surplus that Scottish Water contributes to our revenues

8. The Gross Operating Surplus (GOS) is mainly due to publicly owned Scottish Water; to some extent this surplus will offset associated higher spending compared to the UK where this utility is privatised

9. Th e actual range over the 15 year period is £1,405 to £2,003

10.  Geographic share means we get to keep our oil - I'm stunned how often I still have to explain this

11. The percentage of North Sea Oil revenues attributable to Scotland varies because there are North Sea oil fields that lie in "rest of UK" waters and it depends on their relative production output levels.  Using the Scottish Government's preferred geographic share methodology the average Scottish share of North Sea oil over the last 15 years has been about 90%

12. I've recreated the £7.6bn using the IFS assumptions here (> Explaining the £7.6bn "black-hole") and there are two factors that explain the difference. Firstly the figures above assume that the equivalent deficit rate we'd be required to achieve would be defined on a per capita basis.  Given this is how debt costs are currently allocated in GERS I think that is a better assumption than the IFS's which requires the deficit to match as a percentage of GDP basis. Secondly the IFS analysis compares Scotland to UK total (where UK obviously includes Scotland).  I have stripped Scotland out of the UK figures to compare Scotland and rUK which again I think is a better analysis

13. Defence spending allocated to in GERS is £3.0bn in 2013-14 which is exactly 2.0% of GDP

14. The House of Lords costs £87m to run - Scotland's share of that cost is therefore <£10m

Saturday, 11 April 2015

Explaining the £7.6bn "FFA Black-Hole"

Today (Sunday 12th April 2015) there's a piece in the Guardian by Kevin McKenna that quotes the IFS's £7.6bn Full Fiscal Autonomy "black-hole" figure and casually dismisses it. I'll go into the detail of McKenna's argument (and why it's completely flawed) later in this post but first we need to establish what that figure actually is.

The simple table below gives us all the information we need, sourced from GERS (actual 2013-14), OBR (March 2015 outlook) and the IFS (the quoted source for the £7.6bn "black hole");

Let's start with 2013-14 known actual data per Scottish Government's own GERS figures. 

I'll assume anybody reading this blog is familiar with GERS figures (if not see this post > GERS simple summary). Those figures show that in 2013-14 Scotland generated a deficit per capita £800 greater than the UK average - if you multiply that by our 5.3m Scottish Population you get a £4.4bn deficit gap. Because our GDP/capita is higher than UK average, if you use %GDP to pro-rate the figure it's £3.9bn.

So what are the forecast assumptions to get to £7.6bn?

Actually this is really simple.  The table above shows OBR assumptions on UK deficit; the IFS simply assume Scotland's figures follow the UK trend but adjust for the exceptional decline in North Sea Oil revenues.

The implication of the latest OBR North Sea oil forecast is that Scotland's tax revenue will decline by £3.6bn from 13-14  to 15-16. [Which is why we need to keep caveating 13-14 actuals with "this is before the impact of the oil crash"].

So take the £3.9bn actual 2013-14 deficit gap and add the additional £3.6bn caused by oil decline and you get £7.5bn.  I'm not going to bother digging to explain the other £0.1bn.

So What?

Well first of all let's clear up a common misconception; the £7.6bn is not Scotland's forecast deficit; the forecast deficit is £14.2bn (8.6% of GDP).  The £7.6bn is the amount we'd have to find (through tax rises or spending cuts) to match the expected deficit level of the rest of the UK (4.0% of GDP). That is what FFA would require us to do (give or take - we would likely have some limited borrowing powers but if we're sharing a currency we have to follow similar fiscal rules).

Secondly let's recognise that this is a forecast and therefore uncertain.  However we start with a £4bn known gap and the only assumption that drives Scotland to get worse than the UK is oil; most of that is already know so it's hardly a controversial forecast.

Thirdly what does £7.6bn mean?  The IFS figure implicitly assumes that part of the deficit decline caused by the oil decline is offset by planned "Westminster cuts" (you may have noticed in the table above that we lose £3.6bn of oil revenue but our deficit only increases by £1.8bn).  If you think "Westminster Cuts" of £30bn are scary then consider this; Scotland's share of those cuts would be about £3bn - this £7.6bn would be in addition to that.  We really would be talking about Austerity2

Finally - as ever - this is really all about oil.  For context the graph below shows actual North Sea Oil revenues over the last 34 years + 3 year OBR forecast.  The green line is the approximate level of North Sea Oil revenue required for Scotland to offset our higher spending versus the rest of the UK. Put simply: if oil is above that green line we are better off fiscally autonomous; when it's below it we're worse off.

The gap between the green line (£9.7bn) and the grey bars (actual North Sea revenues) is roughly the size of the "black-hole" caused by fiscal autonomy.

** 12/04/2015 Correction **

I'm grateful to @boatyjames for pointing out that by presenting the current deficit gap with historical nominal figures this graph is misleading.  He's right - I leave the graph above in here in the interest of openness.  I've now been able to find the time to adjust the historical nominal data into real terms (using the GDP deflator) and have added historical pre-oil deficit gap detail.

This is certainly a fairer representation of the scale of the 80's oil boom - but it doesn't change the conclusion that North Sea revenues need to return to c.£10bn if they are to close Scotland's deficit gap with rUK.

People who dislike the inevitable conclusions that result from my analyses tend to accuse me of being selective and biased - if I was I would simply have excluded the 1980's from that graph.  That said; unless somebody believes we have another 1980's style oil boom coming it does make sense to see the graph scaled from 1990

** Correction Ends **

So having established what the £7.6bn figure means, let's now look at the offending paragraph in this piece by Kevin McKenna in the Guardian;

  • "Of course the IFS figure doesn’t bear close scrutiny: it is using numbers gathered in one year to define Scotland’s economy in perpetuity. It also fails to take into account that by 2020 Scotland’s onshore revenues are predicted to grow by £15bn. It should also be taken into account that the UK’s deficit was £98bn last year and that over the five years to 2014 the UK’s cumulative deficit has been worth more than £600bn, yet in two of the past four years Scotland’s GDP percentage deficit has been less than the UK’s. Factor in the fact that, in each of the past 34 years, Scotland has paid more tax per person than the rest of the UK and a future without Barnett looks a lot less gloomy."

There are so many flaws in this one paragraph of text that we'll have to take this step by step;

"Of course the IFS figure doesn’t bear close scrutiny" 
  • "Of course" -  presumably because the figure casts the SNP's economic policies in a bad light and that simply can't be right?
  • "close scrutiny" - he's setting himself up here by implying he's applied close scrutiny. Let's see shall we?
"it is using numbers gathered in one year..."
  • Using numbers gathered in one year?  There are 15 years' worth of GERS numbers and he's suggesting the IFS have only looked at the most recent year? That would be remarkably shoddy work from a highly respected think tank.
  • Actually what the IFS is doing is recognising that the underlying trend excluding oil & gas is remarkably consistent over the last 15 years.  To illustrate here's the GERS figures showing the difference between Scotland's deficit and the UK's expressed as a percentage of GDP but excluding Oil & Gas

  • Let's remember the deficit gap the IFS is forecasting for 2015-16 is 4.6% - given this is when the assumed Oil & Gas contribution to Scotland's finances is 0.4% of GDP (£600m) the underlying deficit gap the IFS are assuming (excluding  oil & gas) is 5.0%.  Look at the graph above again; assuming a 5% underlying deficit gap between Scotland and the UK is hardly "using numbers gathered in one year" is it?
" define Scotland’s economy in perpetuity"
  • The IFS are explicitly forecasting what the figure will be in 2015-16.  His "close scrutiny" has led him to think they are claiming this figure in perpetuity. Golly.
"It also fails to take into account that by 2020 Scotland’s onshore revenues are predicted to grow by £15bn"
  • Quite how a forecast for 2015-16 should take into account forecast revenue growth to 2020 is beyond me
  • Let's be generous and assume he's making a wider point that the IFS is "failing to take into account" forecast revenue growth. Well of course the IFS have taken this into account; the issue is onshore revenue performance relative to the rest of the UK.  The £7.6bn figure is a relative gap not an absolute deficit number  Growing in line with the rest of the UK (as the £15bn forecast to 2020 assumes) has no impact at all on the £7.6bn gap.
"It should also be taken into account that..."
  • I love this phrase - it's like raising a red flag and screaming "there's a non-sequitur on the way".
"... the UK’s deficit was £98bn last year and that over the five years to 2014 the UK’s cumulative deficit has been worth more than £600bn..."
  • And here's the non-sequitur - a UK wide absolute deficit figure and a 5 year cumulative total. Of course these numbers bear no relevance to the deficit gap being discussed; presumably he's just chucked these numbers in so that we see numbers that are far bigger than the £7.6bn.
  • For what it's worth; Scotland's deficit last year was £12.4bn and it's cumulative deficit over that five year period was £62bn.  Both figures are higher on a per capita or share of GDP basis than the UK (and that's in a period where oil was relatively booming).
"...yet in two of the past four years Scotland’s GDP percentage deficit has been less than the UK’s"
  • Yet?  There is no logical linkage here whatsoever - he moves from quoting some absolute UK figures to making a selective observation of Scotland's performance relative to the UK before oil & gas revenues declined.  Here's the 15 year chart - he could equally have said in 11 of the last 15 years Scotland's GDP percentage deficit has been greater than the UK's.  Of course anybody who's studied GERS understands the fluctuations are all about the oil.

"Factor in the fact that, in each of the past 34 years, Scotland has paid more tax per person than the rest of the UK ..."
  • It's already factored in for heaven's sake! It's in the IFS figures, they've looked at where that tax revenue comes from and adjusted for known decline in Oil & Gas.  
  • I think he's just put this in because it's part of the SNP play-book to mention this fact whenever the economy is discussed.  Surely anybody paying attention knows by now that over the last 15 years (the period GERS figures exist for) on average the relative higher public services expenditure in Scotland more than off-sets the higher tax generation.  The chart below shows figures on a relative per capita basis between Scotland and rUK - the black line is the "more tax per person" and the red line is the "more spend per person".  When the black line is below the red line we generate a higher deficit per person.  For reference, the blue line is the relative tax generation figure excluding oil & gas.

"...and a future without Barnett looks a lot less gloomy"
  • Say what now?  
  • As is surely blindingly obvious to anybody who applies "close scrutiny" to the figures, the only way a future without Barnett looks less gloomy is if North Sea Oil revenues return to about £10bn pa - let me repeat the earlier chart to put that in context.

A future without Barnett looks pretty gloomy to me.

***** ADDENDUM *****

I should for balance have added that of course one way out of this gap is by growing our economy in Scotland faster than the rest of the UK.

I have yet to hear a compelling argument as to why this should happen under FFA - if Westminster parties believed relaxing spending cuts would be self-funding through improved economic growth they'd be all over it - but it's certainly an arguable case.

The numbers are simple: Scotland's onshore tax revenue (2013-14) was £50bn so 15% growth would generate the additional £7.5bn pa..  Of course that needs to be growth over and above that the rest of the UK achieves.

If we grew 1% faster than the rest of the UK it would take us 14 years (compound growth) to get there.  The average deficit gap during that period would be £3.8bn (7.6/2) so over 14  years we would have to find an additional £53bn.  Let's assume this could be funded with debt - that's £10,000 for every man, woman and child in Scotland.

But actually even this is overly optimistic because the basis of the £7.6bn is to assume we follow rUK spending cuts - in fact there would be additional deficit incurred in early years before this hoped for growth kicks in because the SNP assumption is that growth is driven by modest increase to spending instead of cuts.

So even on these highly optimistic assumptions - a pretty gloomy prospect.