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 shared¹  - 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.

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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.

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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.

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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.

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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.

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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."

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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/

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Notes

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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

GERS: An Inconvenient Truth

With the Scottish Government GERS figures published on Wednesday, the pro-independence spin-machine has been in over-drive trying to prevent people understanding what they show us.

The SNP’s own Independence White Paper clearly stated that GERS “provides a useful indication of the relative strength of Scotland’s public finances as part of the UK and a starting point for discussions of Scotland’s fiscal position following independence”. So let’s cut through the spin and discuss what this starting point now tells us.

The latest GERS figures show Scotland’s deficit is £1,900/person higher than the rest of the UK. This is the Deficit Gap - the amount effectively transferred to Scotland through UK-wide pooling & sharing – and it’s worth over £10 billion a year.

The graph on this page explains how that Deficit Gap arises.

The green line shows that Scotland’s onshore economy consistently generates about £350 per person less tax income than the rest of the UK. The black line shows what happens when you add on to that Scotland’s North Sea oil revenues. When the black line has been above the axis, Scotland has generated relatively higher tax that the rest of the UK - that has only ever been because of North Sea oil. With oil revenues now close to zero, Scotland would be reliant on its lower than UK average onshore revenues to fund its public spending.

The rest of the deficit gap – the large majority of it – is explained by Scotland’s now over £1,500/person higher spending, shown by the red line on the graph. The fiscal framework (underpinned by the Barnett Formula) ensures that Scotland can maintain these higher spending levels despite the loss of oil revenues. That’s what pooling & sharing means, that’s the safety net we would have lost had we voted Yes in 2014.

When the black line is higher than the red line, GERS figures demonstrate Scotland having stronger public sector finances than the rest of the UK. That’s only been materially true once in the last 17 years, when oil peaked in 2008-09¹.

That’s why the SNP’s independence White Paper assumed North Sea revenues of £6.8 - £7.9 billion a year – it was the only way they could make their economic case add up. Many of us observed at the time that those forecasts were recklessly optimistic. Now the actual figure turns out to be close to zero, we’ve been proven right.

So how do the SNP deal with this inconvenient truth?

They hint that we can’t trust the data because estimates are involved – neglecting to mention that these qualify as National Statistics and that the main differences they highlight relate to spending, where actual figures not estimates are used.

They talk in non-quantified terms about “different spending choices”, nearly always using Trident as their example - neglecting to mention that our share of Trident costs account for maybe £0.2bn of our allocated defence spending. In fact the SNP’s notoriously optimistic independence White Paper could only find net savings of £0.6bn through “different spending choices”.

No amount of SNP obfuscation can hide the fact that their economic case relied on nearly £8bn of oil revenues and they’ve yet to offer a credible answer as to how an independent Scotland would manage now those oil revenues have gone (and the fiscal gap is in fact now over £10bn).

So in what looks like a frankly desperate move, last week-end’s pro-independence press ran headlines blaming “Westminster mismanagement” for the decline in our oil tax revenues.

The support offered for this was a report from the unashamedly pro-SNP and notoriously flaky “Business for Scotland”. The report itself did little more than observe that Norway has generated lots of tax revenue from oil in the last few years and suggest that it would therefore “not be unreasonable to add Norway’s £11bn revenues” to Scotland’s fiscal balance².

I mean seriously? They might just as well argue that it wouldn’t be unreasonable to add the taxes generated by Norway’s forest and timber industry to Scotland’s fiscal balance, seeing as how we both grow trees.

To be clear: North Sea revenues are generated by taxing production profits. While it’s true that both the Norwegian and UK industries are exposed to the same oil market prices, our costs of production are much higher, our production volumes are lower and with more mature reserves we’re incurring greater decommissioning costs. This means the UK offshore industry simply doesn't produce production profits like Norway’s does – and without profit there is no tax.

The Business for Scotland report even argues – incredibly - that Westminster has failed to tax the North Sea oil industry heavily enough since the oil price crash in 2015. Do they think voters have memories like goldfish?

In 2015 the SNP’s then Finance Minister John Swinney called for tax cuts for the North Sea industry³. The SNP’s 2017 election manifesto then proclaimed “only after pressure from SNP MPs did the Tory Chancellor abolish the petroleum revenue tax and halve the supplementary charge to 10 per cent.”

Quite how protecting Scottish jobs by reducing the tax burden on the North Sea oil industry – as called for and celebrated by the SNP – is “mismanagement” is anybody’s guess. In fact the decline in profitability of our oil industry has been so dramatic that even if tax rates hadn’t been cut, the revenue generated would have dwindled to close to zero anyway, but that’s by the by.

To put the cherry on the cake, SNP MP Joanna Cherry QC took to Twitter to promote the Business for Scotland report, saying “Serious questions raised by this excellent research”⁴.

When their cheer-leaders in the press and one of their high-profile MP’s promote a misleading think tank making transparently ludicrous arguments, you know the SNP’s economic strategy is in tatters.

This Article Appeared in the Daily Record on August 25th 2017

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Notes

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1. In fact as explained within the GERS report itself and the GERS consultation document, past oil revenue assumptions used have been very significantly down-graded

The impact is material: the graph below shows the figure pre-revisions as dotted lines (note there have been some cost & onshore revenue revisions too, as is normally the case)

Because of the revisions to prior years that have since been made (most notably, but not only, the change to oil revenue assumptions) I thought it would be interesting to correct what the White Paper stated at the time:

Since 2007/08, Scotland has run an average net fiscal deficit of £8.3 billion £10.0 billion (5.9 per cent 6.8 percent of GDP). [..] In 2011/12, the latest year for which data is available, Scotland is estimated have run a net fiscal deficit equivalent to 5.0 per cent 7.0 percent of GDP. In the same year the UK is estimated to have had a deficit of 7.9 per cent  7.1 percent of GDP. 

2. For a full evisceration of that report, read The Big Oil Lie

3. Swinney calls for further North Sea tax relief

[Swinney] called for tax cuts for the North Sea, and additional moves to encourage exploration in the basin. Swinney also wants the government to make it easier for companies to access tax relief for decommissioning projects, and consider non-fiscal support such as government loan guarantees.

4. Joanna Cherry MP QC on Twitter

The Big Lie About Scotland's Oil

There was a time when the pro-independence movement at least made an effort to try and spin economic data to create the illusion that an economic case could be made for Scotland's separation from the UK. Judging by the latest contribution from the Sunday Herald and Business for Scotland, that time has passed. They can't even be bothered to try anymore.

As evidence, here's the front-page splash with which the Sunday Herald assaulted its readers - and insulted their intelligence - this week

I apologise for what follows. There's so much self-evident nonsense in this article that offering a structured debunking feels like writing literary criticism about a bowl of Alphabetti Spaghetti. With that in mind, I advise you take some simple precautions before reading further.

If possible, rest your elbows on the desk in front of you and use your finger tips to hold your head steady. As your brain tries to come to terms with the logical lunacy of what we're about to encounter, it may attempt to put itself out of its own misery by getting you to smash your head into something hard - by adopting the suggested safety position you should be able to resist this. When thwarted in its attempt to get you to knock yourself out, your brain is likely to attempt to save itself by making a bid for freedom - so the use of ear and nose plugs is also advised.

OK, you have been warned - we're going in (the full text  of the article is here).

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It turns out the source for the headline "revelation" is "leading think tank" Business for Scotland (BfS). Regular readers of this blog will know that BfS have an impressive track-record of being a misleading think tank - but in the interest of fairness, we'll put that track-record to one side¹ and judge their latest contribution on its own merits.

The article refers to a report by BfS which used "detailed oil price research since the price crash" and "contrasted the North Sea tax regimes of the Norwegian and UK governments". Having seen the spectacular wrong-headedness of the conclusions, with the same combination of compulsion and guilt that you feel when you slow down to look at the scene of a car-crash, I sought out the report in question.

Unfortunately the article provides no links to the "detailed research", Business for Scotland's Twitter feed refers to their "in-depth analysis" but only links to the same Herald article and a search of the BfS website reveals only this: "Why is Norway still getting much more tax from oil" - a 940 word article by Gordon McIntyre-Kemp¹ which basically made the same nonsense arguments 5 months ago.

For the avoidance of doubt: this is not how leading think-tanks operate, they don't publicise the findings of a report without making the report itself available for scrutiny. Fortunately for us the finding are so blatantly daft that we don't need to see the "in-depth analysis" to explain why the headline conclusions are ridiculous.

So let's unpick what is actually said in the Sunday Herald piece. Now would be a good time to adopt the safety position and put those ear and nose plugs in.

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The first sentence:

WESTMINSTER'S "mismanagement" of oil since the price slump two years ago has cost Scotland tens of billions of pounds and is being falsely used to attack independence

So Westminster's actions "since the price slump two years ago" have "cost Scotland tens of billions of pounds". I feel dizzy just typing this out.

It appears McIntyre-Kemp has given himself (been given?) the challenge of defending the economic case that was used to try and persuade Scots to vote Yes in 2014. He knows that even the most fervent nationalists don't believe a Yes vote would have allowed us to create a time-machine, so arguing "we should have had an oil fund 30 years ago" is pointless².

This means that to defend the economic case presented by the SNP - and championed by Business for Scotland with credibility-destroying disregard for economic sense - he has to defend the oil revenue forecasts used in the independence White Paper.  He has to argue that had we voted Yes we'd have generated this revenue despite the oil price crash.

Let's remind ourselves: insofar as any economic case was presented in the White Paper, it assumed £6.8bn - £7.9bn of annual oil revenues. None of the cheer-leaders for independence should ever be allowed to forget this fact.

So how can anybody argue that the current reality of effectively zero North Sea tax income could instead have been nearer £8bn if we'd voted Yes? Well, the article continues:

Scotland would be an economic powerhouse if UK ministers had not mishandled North Sea wealth since the start of the oil crisis [...] since the crash in oil prices in 2015 when the price of a barrel more than halved, Norway has made nearly £29.33bn in oil and gas revenues, while the UK lost almost £22.8m

The mind-numbingly simplistic argument here appears to be "Norway produced loads of tax revenues, so we should have been able to as well". To try and discern how the author thinks this could have been achieved, we need to give the Alphabetti Spaghetti a bit of a stir;

the UK government's mismanagement of oil and gas taxation removes billions in revenues from Scotland’s national accounts [...] Oil giant Shell was made to pay taxes in each of the 24 countries where it extracts oil and gas - apart from the UK [...] the UK also gave Shell £179m in tax rebates, while the multinational paid Norway £4.6bn [...] a further £342m was handed out in tax rebates to BP during the same period [...] [the UK Government have] protected big corporations' profits and their shareholders' dividends [...] [Norway is] not bailing out large oil companies.

So the argument being put forward here is that the UK government has not been taxing the UK oil industry heavily enough in the last two years - apparently that's why our tax revenues have crashed!

Now then. Maybe you remember the words of John Swinney following the oil price crash

[Swinney] called for tax cuts for the North Sea, and additional moves to encourage exploration in the basin. Swinney also wants the government to make it easier for companies to access tax relief for decommissioning projects, and consider non-fiscal support such as government loan guarantees.

Possibly you recall the words of the SNP's 2017 manifesto which stated:

Only after pressure from SNP MPs did the Tory Chancellor abolish the petroleum revenue tax and halve the supplementary charge to 10 per cent.

Maybe you read the Independence White Paper and remember that even before the oil price crash the Yes campaign wasn't arguing for more aggressive taxation of the oil industry:

"We have no plans to increase the overall tax burden on the industry on independence [...] Post-independence decommissioning relief will be provided in the manner and at the rate currently provided through the current fiscal regime" - p304

Surely BfS can't be arguing that cutting tax for an embattled oil industry to help protect Scottish jobs was a bad thing, they can't be saying the SNP was wrong to argue to maintain tax relief for decommissioning projects, to call for and celebrate tax cuts in response to the oil price crash? Well hold on to your hats, because I'm afraid that's precisely what they are doing. Here's another direct quote from the Herald piece:

BFS also claimed Westminster had squandered resources on tax advantages for oil corporations [...] 

The article goes on to say:

BFS claimed that Westminster gave tax rebates to large oil companies to decommission rigs and to explore for new oil fields.

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As an aside: Claimed? An observation of widely known and well documented fact described as a "claim"? Presumably this is to make it seem like some shocking revelation to the casual reader - it's truly feeble stuff

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I have to apologise for failing to maintain a clear logical through-line here (the "critiquing Alphabetti Spaghetti" problem) but there's a line in the article that doesn't fit any logical flow but explains why this piece has been pushed now: there's bad news coming and a distraction - however desperate - is needed

The GERS figures will on Wednesday probably show Scotland as part of the UK running a bigger deficit that the rest of the UK

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As another aside: Probably? The figures are published tomorrow and anybody with even a passing understanding of Scotland's economy within the UK knows that Scotland will definitely be shown to be running a bigger deficit that the rest of the UK. Look at this graph of historical actual data:

We know oil & gas income is effectively zero now, we know spending in Scotland hasn't been dramatically cut relative to the rest of the UK and that there hasn't been a history-making jump in Scotland's onshore economy ... so the GERS report will definitely show Scotland running a deficit (on a per capita or percentage GDP basis) far larger than the rest of the UK. The deficit gap that some of us warned about in 2014 is very much a reality.

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But back to the core argument being put forward by BfS and that Sunday Herald front-page splash.

At this point you're probably thinking "not even BfS could just look at the tax revenue generated by one country's highly profitable oil industry and suggest a country whose oil industry is on its knees should be expected to generate the same level of tax"? Well tighten the grip on your head:

[BfS said] It would not be unreasonable to add Norway’s £11bn revenues and state that would have been possible as an independent nation.

Yep, you read that right. The article explicitly states that it would "not be unreasonable" to add the tax revenues generated by another country's oil industry to Scotland's fiscal balance.

I fear I'm insulting my own readers' intelligence by explaining why that is not only an unreasonable thing to do, it's frankly a bat-shit crazy sentence to commit to print. To be clear:

• North Sea revenues are generated by taxing production profits
• While it's true that both Norway and the UK are exposed to the same oil market prices, the costs of production are very different, as are the production volumes³
• This means that the Norwegian oil industry generates a lot of profit, which in turn generates tax (and dividend) income.
• Compared to Norway, the UK industry has higher extraction-cost reserves and is now incurring decommissioning costs - there simply isn't the same profit there to tax

It's really not very complicated.

There's more. The article offers this incredible statement as part of their "Business for Scotland concludes" quote:

UK Government policy has deliberately removed one of Scotland's key revenue streams

If your brain is still able to function after trying to follow BfS "logic", I encourage you to think long and hard about this statement. This isn't an argument about revenue allocation: the suggestion is that the UK Government could have generated billions for the UK economy in the last few years if they'd wanted to - could have lessened the need for UK-wide austerity - but instead they deliberately chose not to so as to make Scotland look bad. I'm genuinely lost for words.

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Now look back at that Herald front page and the words used to describe the report within the article. There is nothing "revealed", there is no "big oil lie", the oil price isn't being "falsely used to attack the case for independence", there is no evidence based on "detailed oil price research", nobody has "contrasted the tax regimes" (they've merely observed the different tax revenues and leapt to a fantastical conclusion), there is no "in-depth analysis".

If your stomach can cope with the mixed metaphor, here's the cherry on the cake (of Alphabetti Spaghetti - I'm sorry)

This - this - is what a high profile SNP MP judges to be "excellent research"?

I just can't ...

I'm done.

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Notes

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1.  For evidence of BfS's track-record as a misleading think tank (aka Gordon Macintyre-Kemp's track-record of writing economically illiterate nonsense), see "Who do Business for Scotland Represent"; "Business for Scotland and the SNP",  "£8.3bn Better Off?", "Response to Independence & The Economy - The Facts", "Stop Getting GERS Wrong", etc.

2. Even if we did have a time machine, creating an oil fund would have required us not to spend the money when we did and instead adopt tax and spend policies more like those in Norway where - for example - healthcare is not free at point of use. I don't see the SNP championing that policy

3. In broad terms the cost (hence profit, hence government tax income) differences are are explained by geology (size and accessibility) and maturity of reserves

Here's Oil & Gas UK’s chief executive, Malcolm Webb (quoted in 2015)

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

Or if you like see this thread by Fraser White or this thread by the University of Strathclyde's Stuart McIntyre. .. or just google he question, there's swathes of stuff out there on this topic

Richard Murphy: The Outlier

Well, I appear to have caused quite a stir by understanding and defending the historical economic data compiled and published by the Scottish Government. Who would have thought that doing such a thing would be so controversial?

My Twitter timeline has been over-loaded with notifications (of both abusive and supportive mentions) and I'm even told I was briefly a "trending topic". Go me.

An SNP MP has been quoting me as having "conceded" something I've consistently been very clear about, the cybernats have created a meme about me and others have created counter-memes¹.

Now I even see an article ostensibly about my views [Kevin Hague thinks Scotland should know its place ...] is currently the National's "most popular²".  I know not many people read the National³, but it's not every day you find yourself in the eye of the storm, even if it is just one in a tea-cup.

The cause of all this is a spat (first online, then on radio, now in print) between a Professor Richard Murphy and me about the trustworthiness of the Scottish Government's GERS figures (GERS being the report which, quite explicitly, "estimates the contribution of revenue raised in Scotland towards the goods and services provided for the benefit of Scottish residents under the current constitutional arrangements").

I recommend you listen to the radio debate if you have time (it's about 20 minutes long): John Beattie Show.


Summary (tl;dr)

Last August, the National published an article co-authored by Ian Dommett, former Marketing Director of Yes Scotland, headlined "11 lessons the Yes campaign must learn to win a second referendum". Tacitly accepting that the economic case for independence lies in tatters, it resorted to appealing for people to discredit the Scottish Government's own figures.

As the months passed, it seemed nobody with even the thinnest veneer of credibility would respond to this clarion call. Then, just a few weeks ago, a Professor Murphy entered the Scottish Independence debate. His contribution was to assert that the National Statistics published by our Scottish government are nonsense, that we practically know nothing about the Scottish economy and that what figures exist can't be trusted and are probably rigged by Westminster.

Having since discovered he hadn't understood the methodologies and assumptions used (and that these are chosen by the Scottish Government themselves) Murphy seems to have backed down, now saying he's merely suggesting that the accuracy of the data could be improved.

That he has implicitly retracted some of his more swivel-eyed claims is a good thing. That the GERS-denying wing of the pro-independence movement will ensure his initial wildly inaccurate and ill-informed assertions will echo on social media for years to come is as predictable as it is depressing.

His apparently more measured calls for better data still make little sense. In fact he's merely exposed the fact that he doesn't understand the nature of data we do have and appears ignorant of the law of diminishing returns.

The issue is not that we're not allowed access to data, it's that the data he thinks we need isn't currently gathered.  To address this, he appears to champion introducing intra-UK border posts so that we can have more accurate import/export data. He implies that companies should face a four-fold increase in their reporting burden by forcing them to file separate profit and loss accounts and VAT returns for each devolved UK region they trade in.

Better data comes at a cost, a cost which would damage our economy but wouldn't materially change the debate about an independent Scotland's economic challenges.

The financial uncertainties we have to deal with when considering the possibility of independence are measured in billions.  The oil forecasts used in the White Paper were out by £6.8 - 7.9bn. We have no idea what currency we'd be using and how that would be supported. Battling to improve the accuracy of historic figures by a £100m here or there would be a pointless exercise given the latest GERS deficit is a whopping £14.8bn.

Focusing on improving the GERS data is less like rearranging the deck chairs on the Titanic, more like hearing the Titanic is heading towards an ice-berg at 15 knots and complaining that we actually only know that the speed is somewhere between 14.5 and15.5 knots  - and arguing that simply isn't good enough information on which to act.

It gets worse. Just in the last week Murphy showed his own hypocrisy by applauding analysis using the same data sources which showed - before taking our public spending into account - that Scotland "is doing just fine" as a UK region. This reinforces a point many of us have been making for years, namely that the issue with Scotland's economy is less on the revenue generating side and more on the spending side: GERS shows the Scottish onshore economy consistently raises only £400/capita less in taxes than the rest of the UK, but that we spend an eye-watering £1,300/capita more⁴.

It's telling that Murphy avoids engaging on the spending side of the GERS figures, despite this being the biggest issue GERS reveals. That's probably because the £1,300/capita higher spend is not based on estimates or surveys or per capita allocations of shared costs: it's nearly all explained by the Scottish Government's own budget and by actual welfare and pensions data from the DWP.  Nobody with any credibility denies that Scotland simply spends far more per capita on public services than the rest of the UK.

So to conclude: GERS data shows - to an acceptable degree of accuracy - that the tax revenues our Scottish economy currently generates are insufficient to sustain the level of public spending we are currently used to receiving. Many pro-independence campaigners rightly recognise this and are trying to find ways to credibly address the challenge.

Denying the validity of the GERS data, as Murphy has attempted to do, is simply not a credible stance to adopt.

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The Tedious Audit-Trailed Detail

Let's unpick this by starting with Richard Murphy's latest slight strange article in the National.

His article starts by saying ..

"LESS than a month ago, I admit I had not heard of the political commentator Kevin Hague [...] Then I wrote a blog explaining why, in my opinion, that data was unsuitable for decision-making in Scotland".

.. and concludes with

"If only Kevin Hague realised that all change for the better is dependent upon someone, somewhere sticking their head above the parapet and saying that things aren’t good enough and could be improved, he’d have something much more useful to say. I’m happy to play that role of the person seeking change in this case"

So he's positioning himself as somebody who's merely said the data is "unsuitable for decision making" and "could be improved".  He is now, apparently, merely an agent of change. This is a climb-down to rival that achieved by Sir Edmund Hillary and Sherpa Tenzing after they'd conquered Everest.

In the last month or so he's written several blogs, tweeted extensively and written a column for The National on the topic. Here are some selected quotes for those who may not be aware what he actually said:

• Twitter, 13th March: "Three numbers Scots should not trust: Scottish GDP, tax take and total government spending. All easily rigged by Westminster"
• Blog, 14th March
• "forget Scottish GDP data: we just don’t know what it is"
• "Let’s be blunt: no one has a clue what crosses the borders from Scotland to England and Northern Ireland. These numbers are literally made up in that case."
• "Westminster could pretty much manipulate this data at will [..] the last thing [the SNP] should do is trust that from London"
• "it's nonsense data ..."
• "But there is no data ..."
• Blog, 15th March
• "it could be manipulated"
• "based on estimates provided from what I called London, which was a euphemism for the whole Westminster controlled machinery of government"

I could go on, but I think you get the picture by now.

For those who care, I carefully corrected his more obvious misunderstandings in my blog at the time: Richard Murphy: GERS denier. There was also an excellent blog from the University of Stratchlyde's Fraser of Allander Institute which made similar points, albeit using more diplomatic language.

Suffice to say that he strongly implied the data was "rigged" and "manipulated" by Westminster. He wrongly (and ridiculously) asserted that because some estimates are used, there is actually "no data" and that what data there is is "nonsense" (and comes from London so can't be trusted anyway). This is full-on fact-denial, and has rightly been treated with disdain by respected economists⁵.

When it was pointed out to him that the data isn't "made in London", he hinted at a wider conspiracy involving the Office For National Statistics (ONS):

Here's how the ONS describe themselves: "We are independent of ministers and instead report through the UK Statistics Authority to Parliament and the devolved administrations of Scotland, Wales and Northern Ireland."

I'm sure Richard would point out it's naive to believe they're independent just because they're constituted to be so. It's clear he doesn't trust the ONS.

Or does he? I was amused to notice that just in the last week he was applauding analysis by Robin McAlpine of the Common Weal, saying: "What he quite effectively showed – using ONS and House of Commons data – was that Scotland is doing just fine as a UK region [..] I endorse [..] the analysis". 

I haven't checked the analysis, but at least in terms of economic activity as measured by GVA⁶ (i.e. the revenue generation side of the equation, before we consider spending) I agree "Scotland is doing just fine". I have consistently pointed out that the revenue generation of our onshore economy in Scotland is broadly in line with the rest of the UK. But then I do trust ONS data - it seems Richard only trusts it when he likes the answer.

He went on to use his platform in the National to make some even more ridiculous claims ("Why you can't rely on GERS figures to judge Scotland's financial state" - National, 21st March 2017)

• "The chance that Scotland makes a deficit of the scale it suggests is remote. It is exceptionally unlikely that eight per cent of the population make 17 per cent of the UK deficit"

This is a genuinely extraordinary statement - he either doesn't understand maths or thinks the readers of the National are dribbling fools. What is exceptionally unlikely is that the Scottish Government would consistently make the mistake of over-stating our share of the UK's deficit.

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To illustrate: imagine a retailer has two stores, one large store with many employees and one small store with fewer. Both stores make similar sales per employee, but the small one pays its staff slightly more*. The big store is break-even, the smaller store loses money. The smaller store would therefore be responsible for 100% of the retailer's losses. There's nothing "exceptionally unlikely" about that. Now if 8% of the population was responsible for 17% of our revenue or 17% of our public spending, that might be surprising - but that's not the case.

*This analogy is not a bad one: Scotland and the rest of the UK generate similar revenue per capita (sales/employee) but Scotland has higher public spending per capita (cost per employee).

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His initial National column continued

• "it would be England that would owe Scotland money if there was independence"

Heaven knows I've heard some bizarre assertions during Scottish Independence debates, but this one's a doozy. It is of course offered with no justification - it seems Richard just feels like it should be the case. Incredible.

He concluded

• "[the economic debate could be improved] if GERS and all the nonsense that goes with it is dismissed as another example of Westminster’s contemptible attitude to all things Scottish"

It seems Richard still hadn't grasped that GERS has nothing to do with "Westminster's attitude" to anything, because it's the sole responsibility of the devolved Scottish Government.

In an effort to put this misunderstanding to bed once and for all, I made a Freedom of Information request. The Scottish Government replied with the following (full Q&A in notes below⁷)

"The Scottish Government statisticians and economists who produce the report are responsible for the methodologies and assumptions it contains. [..] The revenue and expenditure statistics in GERS are produced in the Office of the Chief Economic Adviser, in St Andrews House, Edinburgh." - Scottish Government

The most charitable interpretation I can offer is that Richard waded in without doing his homework. Like a late arrival to a bar-room brawl, he charged in swinging blindly and didn't realise he was actually punching the Scottish Government's own economists and statisticians. In the face. Repeatedly.

Maybe he thought he was being helpful by responding to an explicit call for help that was voiced in the National last August:

"The opponents of independence have already shown their hand by focussing on and repeating the GERs figures [..] How can these be discredited, recalculated or reframed?" - co-authored by Ian Dommett, former Marketing Director, Yes Scotland

Let's be charitable: as someone who is new to this debate⁸ he's had a lot of catching up to do; we should maybe allow him to re-position himself from full-on "GERS denier" to someone who merely argues that the data "could be improved".

So let's continue by just looking at what he's now saying in his latest National column.

He makes three points. His first and second points are basically that GERS used to be fine but "times have changed" so it needs to be improved, we need better data.

This ignores the fact that GERS is already being continually improved. The 12 civil servants and the 16 external members who sit on the Scottish Economic Statistics Consultancy Group (SESCG) - including those independent consultants beloved by the Nationalists, Jim and Margaret Cuthbert - will I'm sure be very keen to hear some detail from Professor Murphy as to what they're missing.

The SESCG is meeting again later this month: who wants to run a book on the likelihood of Professor Murphy making the effort to be there? Will he have constructive suggestions to make to back up his bellicose rhetoric?

It's clear that Murphy has little or no idea of the amount of work that goes into continually revising and improving the GERS methodology. If he did he might bit a bit less cavalier with his insults towards the full-time dedicated team of Scottish Government economists and statisticians who compile them.

Let's be clear about one thing: as various Freedom of Information requests^7,9 have confirmed, no data is "denied" Scotland by Westminster. The issue - as argued cogently by Neil Lovat on his blog here - is whether it is worth incurring the expense and disruption of gathering additional information to make the GERS figures more accurate.

I was heartened to read a sober and sensible perspective offered by (independence supporting) Marco Biagi in the National a couple of days ago, which tacitly accepted that the data is fit-for-purpose

"Are GERS estimates perfect? No. Significant uncertainties exist around them. Anyone who treats GERS figures as sacrosanct to 10 decimal places can safely be disregarded with your preferred euphemism for idiot. But substantial changes to how they are collected have already taken place. The methodology was substantially interrogated in 2007 after the SNP came to office: nearly every revenue estimate was revised. [..] The real question is what an independent Scotland would do with its economy. GERS represents, with some imperfection, Scotland-in-the-UK, not an independent Scotland. But Scotland-in-the-UK is the starting point for the journey."

But back to Murphy. He certainly hasn't made any practical suggestions as to how GERS should be improved, but he has given some examples where he thinks the data isn't good enough, so let's look at those.

In his first blog on this topic, one of his many goofs was to assert that "no one has a clue what crosses the borders from Scotland to England and Northern Ireland". As I pointed out at the time, Richard clearly hadn't looked at Export Statistics Scotland (ESS), which is where that information comes from. This is data compiled by the Scottish Government, primarily using the Global Connections Survey run by the Scottish Government. Like so many economic statistics, it's an estimate - but one triangulated with other sources and which qualifies for National Statistics designation.

What would Murphy need before he is satisfied that the data is good enough? Well his 21/03 National article actually tells us. He states:

"It’s the same with imports and exports: no-one knows what these are because there are no border posts at Carlisle, Berwick-on-Tweed or Stranraer."

Interesting huh? He's not suggesting something practical (like, say, that the survey needs to be more widely completed by putting greater pressure on more businesses to complete it). No, he explains that no-one knows because there are no intra-UK border posts. The implication is clear: to satisfy his desire for better data we need to put border posts up between Scotland and England. It's a ludicrous suggestion - and of course the data still wouldn't be perfect, not least because most of our rUK exports are services.

He also complains that "Revenue Scotland is still struggling to work out which people are tax resident in Scotland". There will be some issues at the margin here for sure (issues that would exist even if Scotland were independent), but the materiality of this problem might be contested by the 300,000 Scots who are affected by the lower higher-rate taxation threshold in Scotland. HMRC seems to be finding us without too much difficulty.

He also moans that the Scottish Government  "has no clue at all on what corporation tax, VAT [raised in Scotland actually is]" .

Had Murphy done his homework, he'd have known that corporation tax and VAT are in fact good examples where the economists who compile GERS have been willing to over-ride HMRC assumptions to move the figures in Scotland's favour:

• In 2013, HMRC estimated Scotland's share of onshore corporation tax revenues at £2.5bn but the GERS figures used a different methodology and so assumed £3.0bn. Similarly, GERS assumed £1.3bn more North Seal oil revenues should be attributed to Scotland than HMRC did¹⁰
• In the most recent revenue figures, GERS assumptions differ from HMRC's in four areas (Corporation Tax, VAT, PRT and Shares) - in all cases GERS assumes higher revenues attributable to Scotland than HMRC¹¹

If the GERS figures have any bias, it's likely be in Scotland's favour.

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With VAT and other consumption taxes, the current methodology rather neatly uses consumer spending data to attribute these to Scotland. On this basis it's worth noting that Scotland gets attributed more per capita income than the rest of the UK for VAT as well as tobacco, alcohol and gambling duties¹² - so the GERS figures benefit from this approach compared to crude per-capita allocations.

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What is Richard's proposed better methodology? Again his article gives us the answer - we don't know the right figures "because no-one has to declare those taxes separately for Scotland".

It's clear Prof Murphy is an academic and not a real-world businessman. He seem to think that imposing additional reporting burdens on UK businesses would be a worthwhile price to pay to tighten the accuracy of the GERS data. Is he seriously suggesting we get all businesses that trade UK-wide to file four VAT returns every quarter, one for each devolved UK region? Does he want to enforce the (frankly meaningless) burden of regional profit reporting in audited accounts?

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Corporation Tax is a special case worthy of an aside. The only way we could get better data here would be by forcing companies to report profit for each area of the UK in which they trade. This would not only be an onerous task but a spectacularly pointless one. If Scotland were to become independent, many things would change (not least, depending on corporation tax rates, where companies would choose to base themselves and report their profits). Nobody can know which jurisdiction companies would choose to report their profits in were Scotland to become independent. We can't make the historical data meaningfully "more accurate" if what we want to know is what would an independent Scotland's corporation tax take be - there are so many variables the best we can do is allocate UK corporation tax based on economic activity levels. Which is precisely what GERS does.

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Standard statistical analysis tells us that the survey based revenue allocations in GERS are accurate to +/-£0.6bn¹³. Is it really worthwhile to introduce more administrative costs and tie businesses up with the burden of four-fold additional reporting requirements to improve accuracy further? In a word: no.

To illustrate with two examples:

• The current GERS deficit is £14.8bn. If it was £14.2bn or £15.4bn it frankly wouldn't make a jot of difference to the economic narrative around independence
• The White Paper oil forecasts were out by £6.8 - 7.9bn. What's the point in mithering about a hundred million here or there in our historical actual figures when the forecast uncertainties are measured in billions?

His third "point" is that apparently recent events have vindicated his position

"in the last couple of weeks the UK Office for National Statistics has said data of the sort I have suggested, based on real tax income, should now be used for UK-wide decision-making. So why should that not be the case in Scotland as well, I argued."

He's relying on the fact that readers of the National will take that assertion at face value and not check what was actually said. On his blog he points to this FT article as his source. Here's what the ONS were actually saying:

"statisticians have found that the forecasting techniques used for the initial GDP estimates — which are published one month after the end of each quarter — “struggle to pick up turning points” when the economy lurches downwards or up. [..] VAT data will increasingly be used as the primary source of initial estimates of the size and growth of the economy" 

It's very clear that the issue here relates to data used for initial estimates, not the data used for the actual figures (which are published later). It's frankly pretty desperate for Muprhy to suggest this somehow vindicates his position.

So we've covered what he's said, but the astute reader will maybe have noticed that all of this recent talk has been about revenue allocations in GERS and there's nothing being said about cost. During our radio debate [listen here] he asserted that when it came to decisions about how we spend in Scotland "the variations are relatively small". I wasn't given a chance to respond to that statement, but it's absolute nonsense.

GERS shows that Scotland overall spends £1,324 more per capita than the rest of the UK. The one thing we can be absolutely sure of is this has nothing to do with Defence, Debt Interest and International Affairs costs which are allocated on a per capita basis (because the per capita difference in these cases will necessarily be zero, obviously).

In fact this higher spend is almost all accounted for by Scotland's own devolved budget areas (health, education, etc.) or by non-devolved social protection spend (primarily pensions) where the information comes directly from the DWP (and is known, not estimated). I was amused that in the radio debate Murphy suggested that those DWP costs are "dumped" on Scotland - that's an extraordinary way to describe pensions and other welfare payments. This higher per capita spending in pretty much every public service area has been consistently true for years¹⁴.

This is the core issue - Scotland is a high cost-to-serve country, we are used to a level of spending on public services that our onshore economy's tax generation simply could not sustain. All of Murphy's attempts at obfuscation and fact-denial have been aimed at distracting people from that simple point. [The fact that this blog has been so long suggests that in that regard at least he can claim some qualified success.]

Let me finish by recalling how the radio debate concluded [listen here]. When the presenter/moderator John Beattie suggested that there's a problem if half the country don't believe GERS is good data, I pointed out this wasn't the case, that Richard was in fact very much an outlier.

At the time Richard responded "oh come off it [...] I'm not an outlier." You will perhaps forgive me, therefore, if I allowed myself a small chuckle when I read in his latest National column that he now embraces that term (as I suggested he would): "I happen to think being an outlier is a virtue, not a failing".

It's a good job he embraces being an outlier, because when it comes to rubbishing the GERS data, he definitely is

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NOTES

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1. Meme and counter-meme

2. The National's "Most Popular" (13/04/2017)

3. The National quotes a print Circulation of just under 8.5k - for what it's worth, I confidently predict that this blog post will be read by more than twice that number of people

4. Real terms revenue and spend/capita data from GERS

5. Responses to Murphy's initial assertions:

“All economic statistics involve sampling and estimates. But when the UK Statistics Authority designate figures as ‘National Statistics’ that’s hugely significant. This is a kite-mark showing they meet international statistical standards. Anybody who says these figures are “easily rigged” or “nonsense data” frankly doesn’t deserve to be taken seriously. The people who work to create these statistics are honest, hard-working and dedicated public servants who aren’t allowed to answer back to defend themselves. Anyone who questions our national statisticians’ honesty and integrity should take a hard look at themselves.”

- Professor Angus Armstrong, Director of Macroeconomics at the National Institute of Economic and Social Research (NIESR) 

 "It is important to note that that GERS is a national Statistics publication and assessed by the independent UK Statistics Authority. The statistics are produced by civil servants, and not by a partisan group, and are best practice in the sense that they meet the Code of Practice for Official Statistics, a code that is consistent with the European Statistics Code of Practice. As in practically any statistical exercise the GERS statistics depend on estimates and there is nothing unusual about that. In that regard it is noteworthy that the statistics produced and reported in GERS come with standard confidence intervals indicating the uncertainty with which the central estimates are held. An examination of these confidence bounds demonstrates that the generally accepted position on Scotland’s fiscal and trade positions are unchanged. This is why mainstream economists, statisticians and commentators will continue to use these statistics in their work."

- Professor Ronald MacDonald, Research Professor in Macroeconomics and International Finance at the Adam Smith Business School 

"These are the sorts of questions we should be debating. Questioning the integrity and robustness of National Statistics is not one of them. "

- Dr Graeme Roy, Director, Fraser of Allander Institute 

6. NUTS1 regional GVA

7. Freedom of Information request detail

8. Late Arrival: Richard is a prolific blogger, but during the first independence referendum he appears to have only blogged on the topic once, to ask what we'd call the rest of the UK if Scotland left

9. Has Scotland been denied data by HMRC?  An FoI request via Neil Lovatt

10. GERS vs HMRC assumptions: 2013

11. HMRC vs GERS revenue methodology differences: HMRC, October 2016

12. Income/capita

13. Survey based allocations: confidence intervals (GERS 2015-16)

14. Scotland's higher public spend/capita, by cost area over time