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?

"...to 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.

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