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

GERS 2014-15: Reasons to be Cheerful

Summary

The Government Expenditure & Revenue Scotland (GERS) figures for 2014-15 were published this morning¹. If you've followed Chokkablog then the figures will come as no surprise.

All figures quoted in this blog use the Scottish Government's preferred geographic share definition for allocating oil revenues (Scotland is shown keeping all of "our oil") and have been deflated (put in real £ 2014-15 terms) using the latest UK GDP deflator.

In summary:

• Scotland's total deficit was £14.9bn
• Scotland's deficit was 9.7% of GDP compared with the UK total deficit of 4.9% of GDP
• Scotland's deficit per capita was £2,800 compared with the UK total of £1,400

In simple terms: Scotland was running a deficit in 2014-15 that was twice as large as that we shared with the UK (whether you look at it on a per capita or % GDP basis).

On the basis that we take a population share of debt while we're in the UK, the difference between the amount of debt we accrued by being in the UK as opposed to being independent was £1,400 per capita (the difference between £2,800 and £1,400). Gross that up by our population of 5.3 million and the deficit gap versus the UK is £7.4bn.  For the avoidance of doubt: this is not our deficit, it is how much bigger our deficit would be if we were independent (than that we share by being within the United Kingdom).

These figures relate to April 2014 - March 2015 and include £1.8bn of oil revenue for Scotland - this means the onshore deficit gap (i.e. how much worse off we'd be if we didn't have any oil revenues) was £9.2bn.

Given that this year (15-16) oil revenues are predicted to be only c.£0.1bn we will (all else being equal) be looking at a deficit gap of c.£9bn.

It is now clear that, far from scaremongering, those of us who a year ago warned of an £8bn - £9bn annual deficit gap if we voted Yes were pretty much on the money. To put this in referendum propaganda terms: a vote for Yes was a vote to make us immediately £1,400 a year worse off for every man, woman and child in Scotland.

Of course as an independent country we would face a series of new challenges and opportunities that may make that situation better or worse. What's clear - now undeniable - is that the starting point (based on taxes we're used to paying and public spending we're used to receiving) would be £1,400 per person per year worse off than we are by remaining in the UK. That's £2,800 per tax payer.

To understand whether this would really matter - would we need to take drastic action or simply choose to fund this higher deficit with yet more debt? - we need to look at these deficit numbers in context.

Scotland's Deficit in Context

These 2014-15 figures would be the actual numbers we'd be using to negotiate any currency solution and the terms of (indeed the very existence of) our EU membership. One of the less intelligent comments thrown out during debates about the GERS figures and what they tell us about Scotland's deficit is the statement that "every country runs a deficit" as if the scale of the deficit is irrelevant.

Let's look first at the evolution of this deficit over time. The lower line is our onshore deficit (i.e. excluding any oil & gas income) and the upper line is our deficit including oil & gas.

This highlights a very important dynamic: although our overall deficit is worsening, our onshore (underlying) deficit position has been improving  since 2009. As oil declines the lines clearly converge.

Now let's put that in context with the total UK (the red lines)

We can see clearly that oil & gas has a relatively small impact on the UK's total deficit to GDP and that Scotland's onshore deficit (excluding oil & gas) is consistently worse than the UK's (for reasons readers of this blog will understand well, primarily higher expenditure per capita).

The improving trend in onshore (underlying) deficit to GDP tracks the improvement in the UK as a whole. Given the common fiscal approach this is unsurprising. Clearly we don't know what would happen under alternative economic plans, but the current path being pursued by the UK is undeniably leading to a reduction in the scale of the onshore deficit for both the UK and Scotland.

We'll explore the reason why Scotland's onshore deficit is so much worse than the UK's later in this blog, but first let's look at the scale of the deficits we're looking at in an EU context.

It's a bit of an over-kill graph but the following maps each EU country² against the figures for the UK and Scotland both with and without oil

It's a lot to take in but actually the overall picture is pretty clear;

• With oil, Scotland's deficit/GDP tracked the UK's pretty closely until 2011 ... but the subsequent decline in oil revenues predictably caused Scotland's deficit to worsen despite the UK's improving trend
• The "oil is just a bonus" argument is and always has been nonsense. Without oil the scale of Scotland's deficit would have been consistently the worst in Europe over this period ("beaten" only briefly by Ireland in peak financial crisis and Slovenia last year)
• On the most recent year's data, Scotland would have the worst deficit in the EU even with oil

Remember: not only would we be having to work out how to fund this excessive deficit, we'd be taking these figures to the negotiating table to try and renegotiate our EU membership if we'd voted Yes.

The rather gloriously named "corrective arm" of the EU Stability and Growth Pact "ensures that Member States adopt appropriate policy responses to correct excessive deficits by implementing the Excessive Deficit Procedure (EDP)" and defines an excessive deficit as 3% of GDP.

Let's just look at the most recent year's data from the graph above to put that in context

Let there be no doubt: if Scotland had voted Yes and we were facing independence, seeking a currency solution, incurring the costs of separation and negotiating EU membership ... we would be forced to take drastic fiscal steps to reduce this deficit. We would inevitably face tax rises and/or far deeper public spending cuts than we're currently experiencing.

As it is - as secured by the fiscal framework agreement - Scotland benefits from a fiscal transfer from the rest of the UK. On the generally accepted assumption that we incur only our population share of the UK's debt this means we are benefiting by about £8bn a year currently as a result of voting No. This is how pooling and sharing works - its the quid pro quo for the massive contribution Scotland made to the UK during the oil boom of the 1980's.


Understanding the Deficit Gap between Scotland and the rest of the UK

Anybody who has read FFA for Dummies will hopefully understand the following graph. Unlike the analysis above which compares Scotland on a % GDP basis with the UK as a whole, this analysis compares us on a per capita basis with the rest of the UK (i.e. the UK without Scotland). As explained in FFA for Dummies: Methodology this approach gives similar answers (particulalry now GDP/Capita is so similar between Scotland and the UK) but has the advantage of putting the numbers in a form people can relate to.

There are three lines:

• The green line shows how much less per capita we raise in taxes in Scotland than the rest of the UK (about £300)
• The black line shows how much more tax we raise per capita when you include oil revenues (in the most recent year this means our total tax generation is in fact at parity with the rest of the UK)
• The red line shows how much more per capita public expenditure we enjoy in Scotland than the rest of the UK (about £1,500)

The figures are almost identical to those we started this blog with: with the most recent year's data now available we see £7.6bn of the £9.2bn onshore deficit gap that exists between Scotland and the rest of the UK revealed by falling oil revenues.

This deficit gap is clearly mainly due the higher spend per capita in Scotland than the rest of the UK. As this blog has covered before (see FFA for Dummies) this is in large part due to Scotland's lower population density, remote communities and unique demographic challenges. None of these would miraculously go away if we were independent.

We really should be thankful we voted No.

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Experience tells me it's a good idea to include the following summary table here:

Notes:
1. 
As is the way with these things prior years' data have been restated. It's worth noting that there's a material change to TME in 2013-14 leading to a £1bn increase in the reported deficit for Scotland. The UK reported deficit increases by only £3.6bn so this implies an increase in the reported deficit gap between Scotland and the UK which is reflected in this blog. See GERS Appendix B for more detail.

2.
The EU works to calendar years, so our 2014-15 data is mapped here against 2014 EU AMECO data (which is generally the most recent actual year available as of today's date). The definition used for deficit by the EU is:

Excessive Deficit Procedure (EDP) Government surplus / deficit (net lending/borrowing under EDP
= net lending (+)/ net borrowing (-) of 'general government' (as defined in ESA 2010)
= National accounts (ESA 2010) net lending (+)/ net borrowing (-)
= total revenue less total expenditure

This maps closely with GERS/HMRC defined deficit but there are some technical as well as timing differences. I do not claim to have understood all the technical differences but the following graph comparing UK fiscal year data (from GERS) with EU AMECO data shows they match reasonably well

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What's £8bn Between Friends?

£8bn - Eight billion pounds - £8,000,000,000

It's meaningless isn't it? Just a big scary number that's bandied about among other big scary numbers. Except this particular big scary number (allowing for a bit of rounding here and there) is central to the ongoing Scottish constitutional debate.

Let's start with some historical actual figures. This blog has shown that - using the Scottish Government's own GERS figures and applying a range of possible methodologies - the onshore deficit gap between Scotland and the UK has historically consistently been between £8bn and £9bn.

It's worth being clear about what this number means: it's a measure (pro-rata on either population or GDP) showing how much worse Scotland's deficit would have been than that we share with the rest of the UK if we hadn't had North Sea oil.

This onshore deficit gap matters because it is revealed - it becomes real - as oil revenues decline. This is not to say that were Scotland to be independent this gap would remain; it might narrow, it might widen. It merely gives us an idea of the run-rate relative disadvantage we would be starting with if we sacrificed the benefits of UK-wide pooling and sharing (assuming the days of significant oil revenues are indeed behind us). If you like, it's the head-start we'd be giving to the rest of the UK.

For the avoidance of doubt: this is not Scotland's deficit without oil & gas; it is how much worse than our shared UK deficit Scotland's deficit would be without oil and gas.

So GERS figures show we've historically run an onshore deficit gap versus the UK of over £8bn pa.


When the IFS analysed the projected fiscal gap between Scotland and the UK they concluded that there would be a gap of £7.6bn in 2015-16. At that time they were assuming £0.6bn of oil revenue, so without oil revenue that shows an onshore deficit gap of £8.2bn.

So the IFS projected our onshore deficit gap versus the UK for 2015-16 would remain around £8bn pa.


The NIESR recently analysed the difference between the Scottish and UK economies using the generational accounting method (which among other factors models the net fiscal implications of different population age profiles over time). The NIESR used the latest OBR assumptions for oil & gas revenues, which in this context are effectively zero (£0.1 - 0.3bn pa. in coming years). Their conclusion was that in the long-term a fiscal gap exists of £9.5bn to £10.7bn pa.

So the NIESR highlighted structural reasons why the deficit gap between Scotland and the UK would widen over time to well over £8bn pa.


The Barnett Formula is the mechanism that currently allows Scotland to benefit from higher public spending per capita than the UK as a whole. It involves notoriously complex calculations and is increasingly complicated by increased devolution of revenue raising powers ... but if we want a simple indication of "what's Barnett worth to Scotland" we need only look at how much greater public public spending per capita Scotland receives than the rest of the UK. In the most recent available GERS figures Scotland received 11.6% higher expenditure per capita than the rest of the UK (table 5.7); in cash terms that works out at £7.7bn.

So the Barnett formula currently benefits Scotland to the tune of about £8bn pa.

The fact that this £8bn figure keeps recurring is not coincidental. The Barnett formula predates the 80's oil boom which is why it protects our public spending when oil revenues decline. It's worth c.£8bn to us because it fills the onshore deficit gap; that onshore deficit gap is largely caused by the higher spending that Barnett enables.

So hopefully it's becoming clear that this £8bn figure is central to the debate around independence (or indeed Full Fiscal Autonomy). Again: it's not how big our deficit would be; it's how much bigger our deficit would be (than the one we currently share with the rest of the UK) if oil revenues go and if we lose the Barnett formula delivered benefits of UK-wide pooling & sharing.

But of course it's only how much worse off we'd be if all else remained the same - if all else remained the same, what would be the point of independence?

I don't want to retread the well-worn path of why independence might in fact make things relatively worse (minor issues like what currency we'd use and within what fiscal constraints, business and capital flight etc.) or why some of the claims for why things might get better are - how can I put this? - somewhat less than logically compelling.

Instead let's simply look at the White Paper: "Scotland's Future: your guide to an independent Scotland" and consider how that dealt with the £8bn problem.

This 649 page document found room for just the one page of financial projections: an estimate of Scotland's financial position in 2016/17 "under current constitutional arrangements" (page 75). The figures used were basically a merging of GERS figures and OBR projections with a few choice adjustments.

Imagine putting this page together and having to defend these numbers. You want to be able to say "oil is just a bonus" but without admitting that without oil you've got an £8bn gap to fill.

The best you can cobble together through assumptions about "savings or increases in revenues" is £0.6bn a year (p.78). To get to this figure you've played your defence and security spending joker (the Trident card), you've had to accept that GERS figures already exclude expenditure that the Scottish Government judges we don't get any benefit from (Olympics, Crossrail, London Sewers etc.) and you've made some heroically optimistic assumptions about the costs that will be required to replace the administrative functions currently shared with the rest of the UK. And yet you've hardly dented the £8bn.

So you're back looking at oil. You've largely relied on the OBR for forecast figures (see White Paper notes 42 and 43) but they're forecasting only around £3bn for offshore receipts. So what do you do? You ignore the OBR oil forecasts and bung in assumptions for offshore revenue that range from £6.8bn to £7.9bn pa.

So the White Paper solved the £8bn problem by assuming oil revenues of up to c.£8bn.

Who'd have thunk it?

Anybody who doubts that the "oil is just a bonus" claims were rhetorical nonsense need look no further than the White Paper itself: if oil was just a bonus, why did the economic case for independence rely on it?

Of course some will argue that the existence of the £8bn onshore gap is somehow proof of the fact the the UK is failing Scotland. This overlooks the blindingly obvious fact that this gap is a result of higher public spending in Scotland far more than it is lower onshore tax generation (a topic covered in depth in the blog post FFA for Dummies).

So this £8bn figure really matters - and with the OBR now expecting oil revenues to be around £0.1bn - £0.3bn pa. it's a number that isn't going away anytime soon.

So £8bn isn't just another number being thrown around in the debate; it is in fact the crucial number in the debate. So it's worth getting our heads around what £8bn actually means;

• We have a population of 5.3 million: so £8bn is £1,500 every year for every man, woman & child in Scotland


• There are 2.7 million Scottish tax payers: so £8bn is £3,000 every year for every tax payer in Scotland


• Scottish Tax Payers pay £11bn income tax on £68.7bn of income: so to raise £8bn through income tax alone would require an additional 11.6% on everybody's income tax rates (or for those who prefer to present it this way: a 73% increase in our total national income tax bill).


• Our onshore GDP in 2013-14 was £135bn (£153bn including oil): so if we wanted to just carry that £8bn as higher deficit this alone would account for an additional deficit of 5.9% of GDP (that's in addition to any underlying deficit we would have by tracking the rest of the UK). To put that figure in context, the EU stability and growth pact sets a total deficit target of less than 3% of GDP.

Given the attacks of the vapors suffered by SNP MSPS's at Labour's suggestion that we might offset "Tory cuts" by raising a mere £0.5bn through income tax, you have to wonder how on earth they would have coped with the prospect of plugging the £8bn fiscal gap a Yes vote vote would have left us facing.

Fortunately we voted No and can reasonably argue that £8bn pa. isn't that much between friends ... when our friends are 10 times our size and we shared "our" oil revenues with them in the boom years. But if we continue to indulge in the politics of unjustified grievance, we might end up losing our friends and finding out the hard way quite how big a deal £8bn is.

Let's Talk About Growth

Watching the latest round of SNP politicians' media interviews (and hearing the echoes on social media) it's clear they're working off a crib-sheet that reads something like this;

If Scotland was able to run its own affairs - if we had control over the levers of growth - then we would grow our way out of the £8bn black-hole that we keep being told about. It might be true that Full Fiscal Autonomy now would be "tantamount to economic suicide" (SNP MP George Kerevan) - would be "a disaster" (SNP MP Tommy Sheppard) - but it's still a sensible medium term aim.

Saying we'd have an £8bn deficit as if that's something we'd have to get rid of overnight when all countries (including the UK) run deficits is simply scaremongering. Anyway these figures are all hugely uncertain and based on assumptions that the SNP don't necessarily agree with ... and who would argue that Scots wouldn't be better at running our own affairs than Westminster Tories?

If I could be bothered I could find plenty of direct quotes (from the likes of Stewart Hosie and Pete Wishart) to back me up on this - but I think most will agree this fairly paraphrases the SNP line at the moment.

So let's unpick it.


"We would grow our way out of the £8bn black-hole if we had full powers"

Putting aside the obvious point that the SNP have yet to make any concrete policy proposals that would lead us to believe that they would somehow achieve this superior growth, let's just concentrate on the magnitude of the challenge.

The numbers are easy: Scotland generates £50bn of onshore tax revenue, so to increase that by £8bn means growing it by 16%.  If we're to make this additional tax revenue through economic growth (as opposed to through increasing tax rates) then we'd need to grow GDP by 16%.  [For those who care about such things, Scottish onshore tax generation consistently runs at about 37% of GDP].

It's important to understand that this growth needs to be growth relative to the rest of the UK because that £8bn figure is the deficit gap (on which more later). It's what we need to generate to be paying our way within the UK, for us to be making Full Fiscal Autonomy work. See my post Full Fiscal Autonomy for Dummies if you need convincing.

To get an indication of the scale of this challenge we need look no further than the Scottish Government's own White Paper: Scotland's Future: Your Guide to an Independent Scotland. As you might expect they had a go at scaling how much faster an independent Scotland might grow when no longer shackled to the UK. In fact they were so pleased with their analysis that they quoted it five times (pp 23, 43, 88, 375, 619). Here's the wording from page 23;

"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"

I think we can safely assume that the countries and timescale used were selected to make the strongest possible case - after all, why stop at 2007 when more recent data was available? - and just in case you doubt if that is a cumulative 30 year figure, it's clarified on page 619:

"The average rate among small European countries was 2.61%, a gap of 0.12% each year. Over a 30 year period the compounded effect of this gap totals 3.8% of GDP"

So the Scottish Government's own attempt at scaling the economic growth benefits that "the bonus of being independent" might bring was 3.8% over 30 years. We're looking for 16.0% to grow our way out of the deficit gap. As one of my erstwhile American colleagues used to say: you do the math.

Frankly I could stop here. The assumptions required for the SNP's "levers of growth" argument to work are exposed as ludicrous by their own analysis.  But I'll carry on because this SNP Hydra has many heads ...


"The IFS say we'd have an £8bn deficit"

The £8bn (or £7.6bn) is consistently referred to by the SNP as the IFS forecast of Scotland's deficit. This is simply untrue.

I've blogged about this before and this simple table summarises the key figures

Scotland's deficit in 2013-14 per Scottish Government's own GERS analysis is £12.4bn and is forecast by the IFS to be £14.2bn in 2015-16. This is the net result of (largely know) oil revenue declines offsetting expected deficit reductions (as a result of UK-wide policies).

It shouldn't be beyond the wit of any half-decent politician to understand and remember these figures. If they're going to engage in this debate they really should know what Scotland's deficit is. If they're going to write a press release about it surely it would unforgivable to get this basic fact wrong?

Well here's the SNP's official press release (posted on Thursday 11/06 at 07:44) which includes these words:

"The IFS figures they cite suggest that Scotland would have a deficit of £7.6 billion in 2015-16. But over the five years to 2013-14, the UK’s cumulative deficit has been worth over £600 billion."

I (and many others I'm sure) jumped on this howler within minutes - the BBC picked up on it and contacted the SNP for a statement (see at 22:30 in this broadcast of BBC R4's More or Less) and yet still (13:50 on Saturday as I'm writing) the Press Release sits there uncorrected.

There are only two possible explanations for the SNP and their spokespeople making and repeating this error: either they don’t even know what our deficit is or they know full well but think they can get away with simply lying about it. I don’t know if they’re insulting our intelligence and actively trying to deceive the electorate or they’re just spectacularly incompetent. These are the people negotiating Scotland's economic future - god help us.

To compare this (wrong) annual figure with the cumulative 5 year UK figure really is so obviously ridiculous that I'll treat it as an aside.

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For fun let's work out the scale of this misrepresentation of data

1. Using the £7.6bn increase instead of the £14.2bn total is a 1.9-fold misrepresentation
2. Comparing a single year with a five year total figure is obviously a 5-fold misrepresentation
3. Comparing an absolute number spread across the whole of the UK with an absolute number shared across just 8.3% of the UK’s population is a 12-fold misrepresentation
4. Comparing UK figures from the past (when the deficit was worse) with a Scottish figure for the future (when the onshore deficit is forecast to decrease) is – as it happens -  a 1.6-fold misrepresentation

So that’s 1.9 x 5 x 12 x 1.6 = a 185-fold misrepresentation. Bravo!

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Of course the right comparison to make is that Scotland's deficit is forecast to be 8.6% of GDP compared to 4.0% for the UK: so more than twice as bad.


"Suggesting we'd have to get rid of the deficit overnight when all countries (including the UK) run deficits is simply scaremongering"

Under FFA we would still be sharing a currency and a national debt with the rest of the UK, so to be be paying our way we would simply need to be (over a sensible period of time) running a deficit at a similar rate to the rest of the UK. That's what the £8bn defines - the amount we'd need to find from more taxes or less spending to be holding our own within the UK.  If you like: it's the amount we'd need to find to get back to the position we're in now by pooling and sharing within the UK.

Nobody's saying that under FFA Scotland would have to eliminate its deficit.

As for "all countries run a deficit" - no they don't. To put it simply: those running deficits borrow their money from those running surpluses.   It's been pointed out this is an over-simplification which I'm happy to accept - suffice to say there are plenty of countries who run surpluses from time to time


As for "we'd have a deficit but so do lots of European countries" - it's rather silly to talk about having a deficit as if it's a binary thing (you either have one or you don't). Clearly the scale of the deficit matters, so let's put that forecast deficit of 8.6% in context.

The graph below shows European Commission data on net lending / (borrowing) by country as a percentage of GDP in 2015;

Stop drooling over Norway; it's unseemly.

I confess I'm not sure how Norway's sovereign wealth fund plays in these figures (although it's clear in 2014 Norway was running a considerable surplus) - but for other countries this is basically the same as surplus/(deficit).

Let's repeat the graph without Norway (just so it's easier to read) and add a line at -3% (which the European Commission's Stability & Growth Pact defines as the threshold for "excessive" deficits).

I don't think anybody can seriously argue that Scotland running a deficit of 8.6% of GDP would be "just like other European countries running deficits".  Our deficit would be considerably worse than any other European country, worse than Croatia, Serbia and Montenegro.

This would need to be addressed and it could only be addressed by yet more borrowing (if Scotland's borrowing capacity would allow it), higher taxes or lower spending.  To imagine how this would be playing out had we voted Yes and been renegotiating our position within the EU - while grappling with currency issues, transition costs and business flight - is quite terrifying.


"These figures are all hugely uncertain"

Actually they're not really. All the IFS assumptions do is extend the consistent long-term relative onshore tax and spend generation levels and factor in the known impact of oil revenue declines.

Of course these figures don't reflect what actions a Scottish Government would take if given FFA. That's precisely the point: maintaining the tax and spend status quo would be unsustainable under FFA. What we need to hear is how the SNP propose to close this gap. These analyses present the problem with FFA and - given they're the ones asking for it - it's right that the SNP should be asked to explain what their solution would be.

I think we've shown that just saying "we'll grow the economy" is not a good enough answer - so it becomes a question of which taxes will go up and which costs will be cut?  The SNP are very reluctant to answer this question.


"It's based on assumptions that the SNP don't necessarily agree with"

As we've seen the assumptions are hardly controversial and it is - as ever - really just all about oil. The latest OBR Fiscal Sustainability Report is very thorough on the topic. We can argue about future oil prices but two points are undeniable;

1. The profitability of North Sea production is in long term decline due to rising costs, not just falling oil prices.
2. The decline of North Sea production is not a surprise - it's been forecast for years, the only question has ever been one of timing

Unfortunately during the independence referendum it appears summit fever led the SNP to present hopelessly optimistic forecasts; they've not been too keen on producing forecasts since. But if they don't like the OBR and IFS forecasts, they really need to show us some of their own.


"Who would argue that Scots wouldn't be better at running our own affairs than Westminster Tories?"

This is always the payoff. When all else fails (and it does) accuse those who argue against FFA of talking down Scotland, of suggesting Scot's aren't capable.

It's true that the SNP seem hell-bent on demonstrating that they don't understand Scotland's economy, but let's not make the mistake of conflating the SNP's leaders with the Scots people.

The question is not one of competence or who happens to be in power in Westminster right now. It's about understanding and valuing the benefits of UK wide pooling and sharing. FFA means sacrificing that and for some of us that seems like a wildly reckless and self-destructive act.