The Price of Independence

Summary

This analysis uses the 2014-15 Government Expenditure & Revenue Scotland (GERS) report as its primary source.  These figures are used to explain Scotland’s past economic performance (as an integral part of the UK) so as to inform our understanding of the future choices a possible independent Scotland would face.

During the Independence Referendum the Scottish Government proposed March 24th 2016 as “Independence Day”.  This context is highly significant.  Had there been a Yes vote, the GERS figures analysed within this report would have been the “actuals” used for negotiations around EU membership and currency sharing.

The GERS figures show that Scotland’s total net fiscal deficit in 2014-15 was £14.9bn or 9.7% of GDP.  Scotland’s deficit/GDP was bigger than any EU country in 2014.  Only Greece and Ireland (at the peak of the financial crash) and more recently Slovenia have shown worse deficits over the last 14 years.  In 2014-15 the UK as a whole ran a deficit of 4.9%; on a comparable basis Scotland’s deficit was twice as bad.

In the Independence White Paper (“Scotland’s Future: your guide to an independent Scotland”) the Scottish Government asserted: “On independence in 2016, Scotland’s estimated financial position will continue to be healthier than the UK as a whole. We will set out on a firm financial footing” (p.78).  Those who suggested at the time that this was at best an extremely optimistic assertion were accused of “talking Scotland down”.  The actual figures now show that those people were guilty of nothing more than understanding the tenuous nature of the case presented.

The EU’s Stability and Growth Pact Excessive Deficit Procedure (EDP) defines an excessive deficit as 3% of GDP.  It’s inconceivable that a prospective independent Scotland could be negotiating EU membership terms today without having a clear and aggressive deficit reduction programme in place.

Scotland has had an onshore deficit gap to the UK of £8bn – £10bn over the last decade.  This onshore deficit gap has been disguised in the past by North Sea revenues.  In three of the last 16 years these revenues have been sufficient to more than eliminate that gap and make Scotland a net contributor to the UK.  Declining North Sea revenues fully explain why Scotland’s deficit has diverged from the UK’s.  This onshore deficit gap is not just a snapshot view, it’s a long-term structural reality.

The outlook for North Sea revenues is bleak, with the OBR now forecasting negative revenues for the foreseeable future.  Even a significant recovery in the oil price is unlikely to lead to them returning to anything like their historic levels.  An independent Scotland would need to be fiscally sustainable without income from the North Sea, would need to be fiscally sustainable based on its onshore economy alone.

In this context the crude economic case presented in the Scottish Government’s Independence White Paper is, frankly, discredited.  The North Sea oil revenue forecasts used were clearly optimistic at the time, and subsequent claims that “oil is a bonus” simply cannot be reconciled with the harsh economic reality described in the Scottish Government’s own GERS report.

Arguments that the onshore deficit gap between Scotland and the rest of the UK represents evidence of Westminster mismanagement are difficult to substantiate.  As a region of the UK, in absolute terms Scotland’s onshore revenue generation per capita is relatively healthy and Scottish onshore revenues have been growing in line with the UK as a whole.  The deficit gap is primarily a result of higher expenditure per capita in Scotland due to structural issues that would not go away were Scotland to become independent.  It seems perverse to blame “Westminster mismanagement” for allowing Scotland to continue to receive £1,500 higher spend per capita than the rest of the UK.

Had Scotland voted Yes, EU and currency negotiations would place Scotland under pressure to rapidly find in the region of £9bn pa through increased taxes or reduced spend.  That’s equivalent to £1,700 annually for every man woman and child in Scotland.

For context: £9bn pa represents 13% of total Scottish public spending and is greater than Scotland’s entire education & training budget; it’s 17% of total Scottish onshore revenue and 77% of the total amount Scotland raises in income tax.

The White Paper proposed just £0.6bn of net savings, primarily through defence cuts.  These saving were not to be used to reduce the deficit but to pay for childcare reforms, end the bedroom tax and introducing “competitive business taxation”.  Not only is it clear that in fact a newly independent Scotland couldn’t afford these reforms, there would need to be net savings 18 times as large as anything identified in the White Paper.  There can be no reasonable doubt that had Scotland voted Yes we would be required to pile austerity on top of austerity, we would be subject to austerity squared.

Because Scotland voted No it is possible to take a more considered long-term view of how to close this deficit gap; we have time to try and address the deficit gap through economic growth while benefitting from support from the rest of the UK.

That the rest of the UK provides fiscal support to Scotland can be seen as simply the quid pro quo for Scotland’s North Sea tax revenue contributions since 1980.  If we had “started the clock” in 1980 then Scotland would still be in credit as a result of the large contribution made during the oil boom years (and seems likely to remain so for the next 7 years).  Of course starting this calculation in 1980 paints the most favourable picture for Scotland, but it clearly illustrate the benefits of pooling and sharing over time.

To close the deficit gap with the UK – to be in a situation where becoming independent wouldn’t make Scots immediately worse off – would require Scotland to out-grow the rest of the UK by 17%. That’s quite a challenge. If Scotland were to achieve the rates of superior growth that the White Paper suggested as illustrative of the “bonus of being independent” it would take over 90 years.

None of this is to suggest that Scotland couldn’t be an independent country or that raw economics should be the only consideration. But if we’re to be honest about the economic implications, it now seems clear that independence will only happen within our lifetimes if the majority of Scots are willing to vote to become considerably worse off, quite possibly for generations to come.
  

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Read the Full Report Here

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The linked pdf above provides full explanations around methodology and sources along with a carefully worded commentary - so please do read it if you are interested in the detail (and before posting ill-informed comments that will lead me to post a reply saying "why don't you just read the full report?").

For those who would rather just surf the data or want quick and easy access to the exhibits without the caveats and methodological explanations, I include them all below.

Please note that the pdf above includes considerably more information than the following HTML, it covers all the tediously predictable "but GERS tells us nothing about an independent Scotland" arguments you'll here from the mouth-breathers on Twitter ...you really should just read the pdf. 

You're not going to are you? OK let me just drop this in here then

It is worth noting that those commentators who suggest that “the GERS figures tells us almost nothing that can be related to the finances of an independent Scotland”  are insulting not only the intelligence of their readers but the also the Scottish Government’s statisticians and the authors of the Independence White paper (which cites GERS figures on no less than 15 occasions and used them as the basis for the economic case presented). To deny the validity of the GERS data would be to deny the source of the data that gave rise to such observations as:

• “Scotland is the 14th richest nation in the world” 
• “Scotland’s GDP per head is £2,300 higher than the UK as a whole” 
• “[Scots have] paid more tax per head of population every year for the past 34 years” 
• “Scotland more than pays her way in the UK” 

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1. How does Scotland’s fiscal position compare with the UK’s and other EU countries’?

The following charts show absolute and % GDP figures for Scotland and the UK

Th next chart shows the difference between Scotland's and the UK's deficit. Above the line Scotland's doing better, below the line we're doing worse (than the UK as a whole including Scotland)

This is a helpful graph for placing some of the independence referendum rhetoric in context. Although the numbers have been restated slightly since, the highlighted area below shows the figures used to support the many “in the last 5 years” ^[1][2][3][4] claims made by Alex Salmond during independence referendum debates and the (at the time correct) assertion by John Swinney that “Scotland more than pays her way in the UK”. This is worth remembering when some of the more intellectually challenged cybernats suggest that GERS tells us nothing of value.

The chart below place the UK's and Scotland's deficits in an EU context. Note these figures use calendar year and "general government" deficit figures (so as to be consistent with Eurostat EU deficit definitions)

The following chart places Scotland's 2014 deficit (when we still had £1.8bn of oil revenues) in the context of the EU Stability and Growth Pact's 3% "excessive deficit" threshold

It's tedious, but to preempt the knee-jerk reaction of the reality deniers, let me state one more time:

We should be very clear about what this analysis of historical fiscal data can and cannot tell us.

The figures only tell us how an independent Scotland’s finances would have looked if we had already been independent but were still raising taxes and incurring public spending (including reserved expenditure) as we have been as an integral part of the UK. We are looking at what in financial accounting terms would be considered pro-forma accounts.

The figures do not tell us what the future accounts of an independent Scotland would look like. They do however describe the starting point (the “run-rate”) from where we can start to consider the possible impact and fiscal implications of independence.

2. What causes the fiscal gap between Scotland and the rest of the UK?

In this section comparisons are all on a per capita basis, in real terms (inflation adjusted using the UK GDP deflator) and compare Scotland with the rest of the UK (i.e. the UK minus Scotland).

Revenue

The charts below show Scotland's onshore (i.e. excluding North Sea) revenue generation by year by major category - note the steady year-on-year growth since 09-10

The chart below comparing these figures on a per capita basis with the rest of the UK:

The chart below simply adds up all the lines from the graph above to show that, in aggregate, Scotland’s onshore economic activity (i.e. before factoring in the impact of North Sea oil) consistently generates £300 - £400  per capita less than the rest of the UK.

The chart below shows the actual total oil & gas revenues over our analysis period, as split in GERS using the Scottish Government’s preferred geographic share definition

The following chart shows the implications of this in terms of per capita revenue difference (the grey line). Adding this to the onshore revenue per capita difference (the green line) show Scotland’s total public sector revenue per capita difference to the rest of the UK (the black line).

Spending

The following chart shows absolute total Scottish public sector spending in real terms over the last 17 years, broken down into main categories.

The following chart illustrates how this varies by major spending category on a per capita basis vs rUK. Note that because Defence, Debt Interest and Foreign Affairs are allocated on a per capita basis they’re excluded from this chart (as they would simply show zero in every year).

As with the revenue categories, the chart below simply adds up all the lines from the graph above to show that, in aggregate, Scotland receives public spending (including shared UK costs) of around £1,500 per capita more than the rest of the UK. This gap has increased in real terms by £500 per person since 1998-99.

The Net Fiscal Deficit Gap

To understand how these figures create a fiscal gap we simply need to combine the per capita figures we’ve already shown for revenue and spending.

When Scotland’s relatively higher revenue raised exceeds the relatively higher expenditure received (when the black line is above the red line) then Scotland has a lower deficit per capita than the rest of the UK. Simply plotting that gap between the red and blue lines shows us the difference between Scotland’s per capita deficit performance and the rest of the UK.

Given we know the split of the revenue difference between onshore and offshore revenue sources, we can now summarise on one chart the scale and historical trend in both the total deficit gap and the onshore deficit gap.

The onshore deficit gap (the gap between the red and the green lines) is the most important figure to understand here. Whilst the actual deficit gap has been volatile as a result of fluctuations in oil & gas revenues, the onshore deficit gap has been fairly consistent. In the most recent year this gap is £10bn (or £1,900 for every man woman and child in Scotland).

The following chart plots this onshore deficit gap over time and compares it to the figures we would get if we had instead used GDP (excluding oil & gas) and total UK as our comparison basis. The analytical method chosen makes no material difference.

3. What does this mean for the case for Independence?

Reliance on North Sea Oil

The importance of North Sea revenues (oil & gas) to Scotland's performance is clear. The following chart shows the difference between Scotland's historic deficit with and without oil

For comparison and on the same scale, the next chart shows the UK's with and without oil - illustrating how much less exposed the UK economy is to oil revenue fluctuations

The importance of oil & gas to the Scottish economy is perhaps most starkly illustrated if we place a notional independent Scotland without oil & gas revenues in an historical EU context. This is surely compelling evidence of the absurdity of Alex Salmond’s assertion that, within the context of Scotland’s economic performance, oil is merely “a bonus”.

The Scottish Government have produced illustrative figures that go back to 1980  which, although not as robust as the GERS figures, allows us to place oil & gas revenues in a more complete historical context.

[Where the old and new data overlap we see the impact of historical restatements to the GERS figures]

This graph shows us the massive contribution that “Scotland’s Oil” made to the UK economy in the 1980’s. Given that when the black “higher per capita revenue” line is above the red “higher per capita spend” line, Scotland can be judged a net contributor to the UK (and vice-versa) we can work out Scotland’s real terms net contribution since the oil boom began. These numbers are relatively crude, but Scotland’s cumulative net contribution from 1980-81 to 2014-15 on this basis works out at £12,600 per capita (or £67bn).  With Scotland’s run-rate onshore deficit gap being £1,900 per capita, assuming no oil recovery it will take about 7 years before Scotland becomes a net recipient of funds since 1980. Of course 1980 is the starting date that most favours Scotland; were we to start at an earlier date we’d see a different picture.

This is a rather narrow transactional view of Scotland’s relationship with the rest of the UK and based on an arbitrary date that favours Scotland - but this analysis does show that within the context of the last 35 years Scotland can be said to still be “in credit” with the rest of the UK. Some would argue this is all the more reason for Scotland to remain within the UK: Scotland made a massive net contribution to the UK during the 1980’s and the current ongoing fiscal support the rest of the UK offers is simply the quid pro quo for that. It could be said that we’re experiencing pooling and sharing in action. 

Outlook for North Sea Oil

The key point here is that oil & gas tax revenues are a function of a lot more than just the oil price because they are a tax on total production profit . We can illustrate this very simply by plotting the ratio between actual oil & gas revenues and the dollar oil price. If there was a direct correlation between $ oil price and North Sea Tax generated then this would be a horizontal line.  This illustrates why a return to $100 a barrel oil prices would not translate into a return to historical North Sea revenue levels).

The optimism of the White Paper oil and gas revenue scenarios is clear to see when we look at how they compared with contemporaneous OBR forecasts, actuals and more recent OBR forecasts.

At the time of writing the White Paper, the Scottish Government chose scenarios (£6.8bn and 7.9bn) which were about twice as optimistic as the OBR were forecasting at that time. The OBR had always been shown to be optimistic prior to this date, a record which it continues to maintain. The effect of decommissioning costs and tax credits from the carry back of trading losses means that the OBR is now forecasting a negative contribution from the North Sea for the foreseeable future .

It’s clear that oil & gas revenues would not come to an independent Scotland’s rescue any time soon, if ever.

Conclusion

In this context and assuming we’d voted Yes, Scotland would have to find roughly £9bn  a year through some combination of higher onshore revenues or lower public spending (than that allocated to Scotland in GERS). This would be required simply to close the gap with the UK (to avoid independence making Scots poorer) or, within an EU context, to be seen to be addressing the excessive deficit.

For both EU membership negotiations and UK currency sharing arrangements a plan to rapidly reduce the deficit (to close the deficit gap with the UK) would clearly be required. It is simply not credible that in this context an independent Scotland would be able to simply borrow more to fund what would be considered by most observers to be an excessive deficit.  

There are really only three ways this £9bn pa could be achieved;

1. Reducing public spending (compared to that allocated to Scotland in GERS)
2. Increasing public revenue through raising tax rates
3. Increasing public spending through real economic growth

1. Reducing Public Spending

We’ve seen that GERS shows Scotland receiving £68.4bn of public spending in 2014-15, so in overall terms a £9bn saving would represent a 13% real terms spending reduction. To put that figure in context, in the five years from 2009-10 to 2014-15, Scotland has seen real terms spending reduced by just 2.3%.

The White Paper suggested that “savings or increases in revenues” could have generated £0.6bn a year, primarily from a £0.5bn reduction in defence spending (i.e. effectively including “scrapping Trident”). This figure also includes £0.05bn savings related to “contributions to the costs of the House of Commons and the House of Lords”. This money was then to be used to pay for childcare reforms, end the bedroom tax and introducing “competitive business taxation".

If there were other easy wins we can be confident that the SNP would have included them in their outline economic case. That there aren’t is testament to the quality of the GERS cost allocations and gives a lie to the often repeated (but simply wrong) claims that Scotland is unfairly burdened with costs in the GERS figures.

Debt interest is sometimes cited as a possible saving on the basis that Scotland might negotiate to not take on its per capita share of debt. Given that this would be seen by capital markets as an effective debt default and that the “Plan A” for currency was to share Sterling with the UK, this seems a somewhat unlikely scenario. Scotland’s total per capita allocated debt cost in 2014-15 was just £2.8bn, so even if this figure could be wished away, it doesn’t come close to solving the £9bn deficit gap we’ve identified.

Considering the fact that the notoriously optimistic White Paper could only come up with £0.6bn of savings helps us appreciate the scale of this challenge. Scotland’s draft budget for 2015-16  shows just a £0.5bn saving to Fiscal Departmental Expenditure Limits (DEL). £9bn is more than 3 times Scotland’s total annual Public Order & Safety spend, greater than total Education & Training costs, is 80% of Scotland’s total Health costs.

It would be no exaggeration to say that were Scotland to be in a position of having to rapidly tackle its stand-alone deficit – had the Yes campaign prevailed – the level of austerity required would have put existing austerity measures in the shade. This would be austerity on austerity: austerity squared.

2. Increase Public Revenue through raising taxes

Raising revenues through raising tax rates is of course fraught with difficulty, not least because the act of raising tax rates can adversely affect the level of economic activity available to be taxed.

We’ve seen that GERS shows Scotland generated £51.6bn of onshore revenue in 2014-15, so in overall terms generating an additional £9bn would require a 17% real terms increase.

£9bn is 77% of Scotland’s income tax generation, it’s 84% of total VAT raised in Scotland, it’s 4.5 times the total amount raised through council tax.

It seems pretty clear that to have a material impact on Scotland’s deficit, a combination of higher taxes and dramatically reduced public spending would be unavoidable.

3. Increase Public Revenues through real economic growth

In the five years from 2009-10 to 2014-15 Scotland has seen real terms onshore revenue increase by 8%. So even if spending was frozen in real terms, at this rate it would take a decade to deliver the £9bn required from onshore revenue growth alone. This is time that Scotland would be unlikely to be given by the EU or indeed the UK as a currency partner had we voted Yes.

But reducing the deficit through revenue growth while freezing public spending for a decade doesn’t close the gap versus the UK. This would only get us to where the UK is today (a 4.9% deficit) in ten years’ time - by which time of course the UK itself would have grown. Growing in line with the UK doesn’t help close the deficit gap, it doesn’t address the issue of Independence making Scots poorer. To address that issue Scotland needs to deliver superior growth to the rest of the UK.

It’s very hard to find any evidence or indeed any tangible policy ideas (other than reducing Air Passenger Duty, which frankly simply isn’t that significant) that might explain how an independent Scotland could use policy levers to out-perform the UK. In fact the White Paper itself had a go at scaling the likely superior revenue growth that the “bonus of being independent” might deliver;

“Similar countries to Scotland have seen higher levels of economic growth over the past generation. That is because they have the bonus of being independent and are able to make the right choices for their nation and economy. If Scotland had matched the levels of growth of these other independent nations between 1977 and 2007, GDP per head in Scotland would now be 3.8 per cent higher” 

Putting aside the arbitrary nature of the time period chosen and countries used for the illustration, the suggested figure was 3.8% cumulatively over a 30 year period. At that rate it would take over 90 years to close the fiscal gap with the UK through superior GDP growth alone . 

It is worth noting that while Independence would undoubtedly give Scotland the freedom to pursue different economic policies from the UK, there is little evidence (particularly given the decline in North Sea revenues) that the Scottish economy has significantly different needs from the rest of the UK. In this case the pro-independence argument collapses down to little more than a belief that Scottish politicians serving Scottish people would simply make better decisions. 

One doesn’t need to believe that the case for independence is just about the economics to wish for the economic implications to be understood. None of this analysis suggests that Scotland couldn’t be independent, it merely highlights the likely price that we would have to pay. 

What the GERS numbers show us is that the likely price we would have paid for independence had there been a Yes vote would have been of the order of £9bn a year; that’s about £1,700 a year for every man, woman and child in Scotland.