Wednesday, 5 February 2020

Deficits, Deficit Gaps and Fiscal Transfers

To understand what is going on when we talk about implied fiscal transfers between different parts of the UK (as discussed here), it's perhaps easiest to think of what happens when we split the bill in a restaurant.

To know whether or not we benefit from splitting the bill, we only need to know two things:
  1. How much of the bill are we responsible for creating?
  2. How much of the bill do we actually have to pay?
If the first figure is greater than the second, we benefit from splitting the bill (we receive an implied transfer from the others we're splitting the bill with).

In the context of the debate around Scottish independence, the first of these questions is answered by the Scottish Government's own GERS report. This tells us, based on a series of explicit assumptions, how much of the UK's deficit (the bill) Scotland is responsbile for.

The second question is more contentious, as there are no "official figures" as to how responsibility for the national debt (the cumulation of annual deficits) is shared - so how much of the bill does Scotland have to pay?

Fortunately there is broad consensus around the view that the UK's debt should (or at the very least reasonably could) be shared on a population basis.
  1. The GERS figures include a population share of the interest charge generated by the UK's debt - given that debt is merely the accumulaton of the UK's deficits over time, that is effectively a population share of the UK's (cumulative) deficit
  2. The Independence White Paper in 2014 stated "Scotland and the rest of the UK will agree a share of the national debt. This could be by reference to the historical contribution made to the UK’s public finances by Scotland. An alternative approach would be to use our population share."
  3. The SNP's own Sustainable Growth Commission danced around this question, but eventually assumed a population share of UK debt interest within their proposed "solidarity payment"
So it's really pretty simple: the difference between the share of the UK's deficit Scotland is responsible for creating (see GERS) and the share of the UK's deficit Scotland pays for (assume population share) is the implied fiscal transfer.

As we'll come on to see, you can make different assumptions about the share of the UK's deficit Scotland will ultimately have to pay, and conclude a different figure for the implied fiscal transfer.

***

At the risk of labouring the restaurant analogy, let's run through an example with some illustrative figures to help us explain the differences between three terms that often get confused: the deficit, the deficit gap and the effective fiscal transfer:
  • Group A: 18 people go for a meal, the bill comes to £1,800 so they have spent £100/head
  • Group B: 2 different people go for a meal, their bill is £300 so they have spent £150/head
If Group A and Group B decide to get together and split the bill (to "pool & share the deficit"), what happens? The total bill would be £2,100 which split equally between 20 people would be £105/head. Here's a simple summary:


The spending gap between the groups is £50/head (Group B spent £50/head more than Group A), but the benefit of pooling and sharing - the effective transfer Group B receives - is £45/head2.

The total transfer from Group A to Group B is £45x2 = £90

Now let's replace the figures in our analogy with the fiscal reality (per GERS 2018-19) - the "bill" is the deficit, Group B is Scotland and Group A is the rest of the UK.


So Scotland's GERS deficit is £12.6bn, the deficit gap is £11.6bn and the effective fiscal transfer to Scotland is £10.7bn. 

A huge amount of confusion is caused by people failing to understand the conceptual the differences between these figures - if you've followed what's going on up to here, give yourself a pat on the back.

***
So armed with this understanding, let's take a look at the most common mistake made when people debate the "£10bn fiscal transfer". To illustrate, let me use the following screen-capture which (incredibly) is taken from Stuart Campbell's own "Wings Over Scotland" blog:


If you've been following this blog post so far, you will realise who the twit is in the exchange above (hint: it's not Paul). To walk through this carefully, per the figures above:
  • Scotland's deficit is £12.6bn
  • We assume Scotland bears a population share of the UK's deficit - so in this year Scotland takes on an additional "loan" of just £1.9bn
  • The difference of £10.7bn is the effective fiscal transfer Scotland receives - it's the amount over and above the "loan" Scotland takes on
Fun Fact: this means that those who argue Scotland should assume less than our population share of the UK's debt are - whether they realise it or not - arguing that the effective fiscal transfer in Scotland's favour is in fact larger than £10.7bn.

***

A common reaction to these figures is "how can Scotland's 8% of the UK population possibly be responsible for a third of the UK's deficit - that seems unbelievable". This is what is technically known as an "argument from incredulity" and is perhaps best summarised by this quote from Professor Richard Murphy:
"I have been continually bemused by the fact that GERS says that Scotland runs a deficit so  much larger in proportionate terms than that for the UK as a whole."
Here our restaurant bill analogy falls short, because what we're dealing with when we're sharing the deficit is not how much we've spent but the net effect of how much revenue we've generated less the amount we've spent. I've explained the dynamics involved here in this brief video (with apologies for my exasperated tone and the figures being a year out-of-date)




Another way to help understand this point is to look at fiscal transfers across the UK (including the English regions) as this blog has recently done here. There is nothing surprising or hard to fathom going on here - it's just simple fiscal arithemetic.


As I've pointed out before: it's not hard to imagine a situation where Scotland runs a small deficit while the the UK overall is in fiscal balance - in that scenario Scotland would be responsible for an infinite (or more accurately: a "divide by zero error") share of the UK's deficit. It's just maths.

***

When we use the GERS figures to scale the effective fiscal transfer, we have to recognise that these are only pro-forma figures, they represent what Scotland's stand-alone defict would be if we kept generating revenues and incurring spending as shown in GERS.


In case it's not already dead, let me flog the restaurant analogy one more time: "if we weren't sharing the bill, maybe we wouldn't have tipped the waiter 15% and perhaps we wouldn't have ordered the bottled water for the table."


This is a fair point. Even before we consider the likely economic shock impacts on revenue or spending that separation from the UK would cause (see Brexit), the scale of deficit that the GERS figures reveal means that current levels of spending would be unsustainable for a newly independent Scotland, particularly if trying to launch a new currency.

It's true that some of that spending in GERS is costs allocated from the rest of the UK on a simple population basis (defence, debt interest and international aid being the vast majority of these), so any case for independence needs to start by working out what an independent Scotland would replace these costs with. For reference: relative to that £10.7bn fiscal transfer, the notoriously optimistic White Paper on independence assumed a net saving of £0.6bn.

What typically happens at this point is that some of the more blindly-committed supporters of independence start suggesting that the GERS figures are all made up anyway as part of some vast conspiracy by which Westminster has managed to get the Scottish Government's own economists to pull the wool over the eyes of the SNP (and their Sustainable Growth Commission, their Fiscal Commission Working Group, the IFS, Fraser of Allandar, NIESR, UK Statistics Authority, etc. etc.).

This is of course a ridiculous position to adopt (which, to be fair, is why only those flakier members of the independence movement attempt to adopt it). Alex Salmond was certainly very clear about what the GERS figures told us when he thought he could spin them in his favour:



Salmond is the man who once proudly boasted of his ability to put “a gloss on statistics or any economic figure” to build a political case, and he certainly did his best to do that with the 2010-11 GERS figures. He made the highly dubious claim that they showed an independent Scotland could have been spending £2.7bn more and therefore should have been running an even higher deficit than that shown in GERS!




Still: desite the fact that he used a different method for "splitting the bill" (based on a GDP share not a population share), he was recognising the principle of the fiscal transfer3.

Unfortunately for independence supporters, taking the logic Salmond applied to the 2011-12 figures and applying them to the 2018-19 figures produces a massive fiscal transfer now in Scotland's favour - so by his own logic, an independent Scotland should now be spending £10bn less4.

At this point, most of those arguing for independence ignore how wedded they used to be to the figures and return to straight-froward "GERS denial" - fortunately this blog has already comprehensively dealt with those denials here > GERS Deniers.

Ah but wait: what about "this is just a snapshot"?

OK, well we can do this analysis over time and plot the size of the deficit gap5 for the last 21 years:


You can see why Alex Salmond was so excited about the 2008/09 to 2010/11 figures6.

The reason for the dramatic reversal and growth in that gap will be familiar to regular readers of Chokkablog - they are most easily summarised by this graph:


  • The gap closed when North Sea revenues boomed, but has grown massively as North Sea revenues have plummeted
  • Scotland has not only continued to spend more per head than the rest of the UK, that spending gap itself has actually grown (thanks to the Barnett Formula and low levels of absolute spending growth7
  • Scotland's onshore revenue performance has declined relative to rUK8
For completeness, we can plot the onshore deficit gap over time (i.e. to see what happens if we strip out North Sea revenue effects from these figures):



Without oil revenues, there would never have been a prime facie economic case for Scottish independence - and the vagaries of the Barnett Formula (plus perhaps the impact of the SNP's tax rises) have led to the scale of the fiscal transfer that Scotland benefits from within the UK actually increasing in recent years.

/Ends/



Notes




1. This very carefully worded FoI response is sometimes in debates around the fiscal transfer:
"Official figures for any fiscal transfer are not available.
The reason this information is not available is that such a figure requires a number of assumptions to be made. For example, as the UK as a whole spends more than is raised in revenue, an assumption would need to be made about which parts of the UK borrowing is undertaken for, or which types of public spending are financed by borrowing as opposed to taxation. This information is not available as, for example, some taxes are ringfenced to fund particular services; for example, some national insurance contributions are ring-fenced to fund the NHS. As such, any figure for a fiscal transfer from the rest of the UK to Scotland would rely on a number of assumptions."
this is entirely consistent with what this blog (and others) have always said - to calculate the implied fiscal transfer, we have to make some assumptions. In fact, argue we can calculate and implied fiscal transfer by only making one assumption: that the burden of the UK's deficit (and associated debt) is borne on a population share basis

2. People used to dealing with numbers will have spotted that the transfer = [(1-population share) x the gap] - something easily proved if you care for such things


This matters only insofar as we need to understand that, in the case of Scotland in the UK, the fiscal transfer is 92% of the deficit gap

3. The IFS implicitly use that same assumption when referring to the fiscal tranfer here
The most recent figures (2016–17) imply a budget deficit for Scotland of 8.3% of GDP. Managing this is the UK Government’s responsibility as it is part of the UK’s deficit, which was 2.3% of UK-wide GDP in the same year. Therefore there was a fiscal transfer from the rest of the UK to Scotland of about 6% of Scotland’s GDP (equivalent to around £1,750 per person in Scotland).
Because GDP/Capita is now about the same for Scotland and rUK, allocating the deficit on a per capita basis or per GDP basis makes no material difference - but I would still argue that per capta is the right way to do the analysis as long as GERS uses per capita allocations for all shared UK-wide costs
4. To be completely accurate: if we used his GDP share rather than population share method then the figure would be £9.8bn (rather than the £10.7bn we get using population share) - but the broader point stands

5. Remember: the implied fiscal transfer = [(1-population share) x the gap] = 92% of this figure

6. These are the latest available restated historical figures - when first released the figures showed a significantly more favourable position for Scotland, but later revisions lowered Scotland's apparent fiscal advantage vs rUK - covered in some here: The SNP: Living in the Past

7. A dynamic most easily understood if you imagine a scenario where UK spend (and therefore Scotland's spend) doesn't change, but Scotland's population grows more slowly than rUK's - under that scenario it is inevitable that the gap between Scotland's spend/head and rUK's must increase

8. Due to some combination of historically over-estimating the number of top-rate tax payers in Scotland and/or the increase in the Scotttish Rate of Income Tax causing some of those tax payers to redomicile

6 comments:

Anonymous said...

Great post but not actually sure why you bother Kevin.

The Scots seem by entranced now by the SNP and independence. I think from looking at the polls they seem to have shut their ears to any kind of logic.

Anonymous said...

I cannot post links to your blog either , this page of yours (linked ) is now 4.5 years old so perhaps you need to update it with your latest viewing stats against errors rate ? https://chokkablog.blogspot.com/2015/10/wings-and-his-wee-blue-book-of-errors.html

I don't think its Nats complaining , I think its official SNP action personally, you are the major threat to them (not the Labour party ...sad isn't it ) and they don't like it. (not for publication thanks )

Anonymous said...

Interesting info obtained by FOI requests

question
"Source of financing £45 billion expenditure of Scottish government, Scottish local government, Scottish public corporations?"

answer
"As set out in my previous response, the main sources of funding for the
Scottish Government and Local Government in 2018-19 are:

1. Around £20 billion comes from the adjusted Block Grant from the UK
Government;

2. Around £5 billion in additional funding from the UK Government outside
of the Block Grant;

3. Around £13 billion funding from devolved Scottish Government taxes;

4. Around £5 billion funding from council tax and non-domestic rates; and

5. Around £2 billion from a number of other sources"

Additionally no mention of £5bn accounting adjustments revenues (which are offset be £5bn of accounting adjusts expenditure)

FOI request about accounting adjustments
"The figures reported in Government Expenditure & Revenue Scotland (GERS) are consistent with the UK Public Sector Finances, which are published by the Office for National Statistics in accordance with National Accounts principles, an international reporting standard used by governments to ensure international consistency.

This requires a number of accounting adjustments to be included in both expenditure and revenue.
These are primarily symmetric adjustments, and therefore do not affect the net fiscal balance."

https://www.whatdotheyknow.com/request/628401/response/1490600/attach/html/3/finalResponse%20201900010315.pdf.html

£50bn expenditure for above!

I note exclusion of funding sources for Public bodies, Scottish water which has expenditure of about £2bn and mostly financed by Scottish revenues.

https://www.whatdotheyknow.com/request/source_of_financing_ps45_billion#incoming-1514297


additionally confirmation of £18bn paid out by Westminster on social security to Scotland

https://www.whatdotheyknow.com/request/scottish_government_claims_uk_go#incoming-1510073

£68bn total of above

or
£63bn if one ignores the £5bn of accounting adjustments on the revenue and expenditure totals

my take on this excluding accounting adjustments (which offset each other on revenue and expenditure)

£58bn 'revenue'
£72bn 'expenditure'

of said £58bn 'revenue'
£45bn confirmed spend by Scottish government and Scottish local government (public corporations expenditure not included)
£18bn confirmed spend on social security in Scotland via Westminster.

Anonymous said...

Difficult to honestly respond to this FOI request

Dear Scottish Government,

I have accepted and assumed GERS figures as being truthful and well researched!

However public information from the Scottish Governments 'Cabinet Secretary for Government Business & Constitutional Relations' as included in Michael Russell's public identifier (see below), has led me to doubt the integrity and honesty of Roger Halliday and GERS!

Both Mr Halliday or Mr Russell can't be right!

GERS shows a deficit of £13bn and
Mr Russell claims the opposite with "Scotland pays out more than it gets back. Time to stop the fibs"

My FOI request is as follows:
What meetings / presentations / briefings, and on which dates has the 'Cabinet Secretary for Government Business & Constitutional Relations' participated in with regarding GERS, and the department that compiles GERS?

Please provide copies of transcripts / notes / emails in regarding GERS between the 'Cabinet Secretary for Government Business & Constitutional Relations' and the department that compiles GERS?

Does the Scottish government fully support the department compiling GERS and Roger Halliday or the 'Cabinet Secretary for Government Business & Constitutional Relations' regarding GERS?

Michael Russell
@Feorlean
MSP for Argyll & Bute
Cabinet Secretary for Government Business & Constitutional Relations

"Scotland pays out more than it gets back. Time to stop the fibs"

https://twitter.com/Feorlean/status/1225...

Yours faithfully,

Manfred Stobartson

https://www.whatdotheyknow.com/request/cabinet_secretary_for_government

soccer doc said...

Can I just say how helpful your analogy of friends splitting the bill in a restaurant with UK public finance is.
Not entirely unreasonably you treat the entire process as consensual, which in an ideal world it would be. But let's introduce a complexity - I don't drink (nothing religious or anything like that, just never acquired the taste), so, if say there are 4 of us, do I participate in the whole bill? Or just the bill minus drinks (+ perhaps an allowance for lemonade or tonic and lime which some restaurants charge at an exorbitant rate).
If we take this complexity over to the UK (and no, the irony of Scotland not drinking is not lost on me)then I think it's clear that the policy of the head of the table (ie Westminster) is that I am part of the group and therefore I pay the same proportion as everyone else. They may have been knocking back vintage champers at a rate of knots, while I am on orange juice, but I make the same proportionate contribution as everyone else.
Therefore I would say your first contention (that "How much of the bill are we responsible for creating?") is by no means as uncontentious as you suggest, even in the context of a group in a restaurant never mind in the UK,
let's suppose one of our group - let's call him Nigel - decides he is going to buy this big car. Nigel is the big guy in the group - you know, floppy hair, much to say etc etc., waves his arms about a lot. As the car will be used for group outings Nigel insists that we all contribute to its costs, but the fact is that the car is Nigel's and as it's a babe magnet it will be particularly to his advantage.
If you think this has certain parallels with HS1 and 2, you are dead right. It's all very well to argue as Alastair Cameron did the other day, that Scotland will get a population share (8 billion) of HS1 and 2 costs, but the fact is that HS1 and 2 will add to the economic attractiveness of the area it services, which wont be any closer to Scotland than Leeds. In other words, the issue is not only the cost and how it is apportioned, but also, in the longer term what it means for future economic performance of the different parts of the UK. To take a not Scottish example, London is getting Crossrail to enhance movement within London while it is very difficult (at best) to get a train across the North of England. How surprising is it then when the former outperforms the other regions of the UK by a degree that it is the only region above the UK average?
In short Kevin, your analogy only works if we treat all the people round that dinner table as homogeneous, when they are not. Some are more powerful/ advantaged than others. You may be happy to play around with numbers and spread sheets, avoiding the difficulties of power differences. Moreover, it could be argued that the dynamic of economic development in the UK is such that their heterogeneity will not diminish, but increase.In other words that the best we can say about analogy is that it's nearer right now (though still wrong) than it will be in the future.

Kevin Hague said...

sorry soccer doc, you're wrong again

"Scotland will get a population share (8 billion) of HS1 and 2 costs" - Scotland is allocated just 2% of Hs2 costs as the Scottish Government economists accept that is the share of economic value that will pass to Scotland -- and its the *only* exception to the rule that in GERS infrastructure spending is allocated to Scotland on an *in* basis (ie only spend *in* Scotland is counted in the "how much of the bill are we responsible for", with this single Hs2 exception) -- so frankly this £57m (that's what Hs2 cost Scotland last year in GERS) is the only "contentious" infrastructure spend

I pointed out in the blog somebody can always say "if we weren't sharing the bill, maybe i wouldn't have tipped the waiter 15% and perhaps we wouldn't have ordered the bottled water for the table." - you're (as usual) avoiding the MASSIVE issue here which is that our meal costs more than our fellow diners; you're the guy who had the lobster and the sirloin stake, swigged back the wine, had an expensive desert and is now complaining that it's not fair the "balance of power" means as a group we tip the waiter 15% because you'd only tip 10% -- you're That Guy.

It amuses me you make light of me "playing around with numbers" -- I'm the one using actual numbers and they show your attempt to generate a grievance here is desperate and unfounded -- I'll continue to look at the *actual* numbers, you can continue to make up pretend scenarios which fuel your chronic need for grievance