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.

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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

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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.


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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. 

Gosh.

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.