Lower Oil And Gas Prices Hit Scotland's Underlying Public Finances In 2023-24
18th August 2024
The Institute for Fiscal Studies report (14 August 2024) shows how dwindling income from oil and gas is impacting on Scottish Government finances.
Scotland's notional fiscal deficit rose by £4.7 billion (2% of GDP) in 2023-24, as lower oil and gas prices hit North Sea revenues.
The Scottish Government has today published the latest version of its Government Expenditure and Revenue Scotland (GERS) report, covering the 2023-24 fiscal year. This provides an estimate of the total amount of government revenue raised in Scotland, the total amount of public spending benefiting Scotland (which includes both spending specifically for/in Scotland, and a share of spending on things such as debt interest, defence and foreign aid that are deemed to benefit the whole of the UK broadly equally on a per capita basis), and the gap between these two figures.
This gap is Scotland's net fiscal balance - and is, in effect, an estimate of the amount of borrowing the UK government is undertaking on behalf of Scotland as opposed to the rest of the UK.
Like nearly all economic statistics, GERS is subject to a degree of measurement error. The figures it contains are also backward- rather than forward-looking, and so do not, on their own, reflect how revenues and spending may evolve in future, or the different choices different governments could take.
However, their status as National Statistics means they have been independently assessed as being based on sound methods and being produced free from political interference. And they are widely recognised as a sensible starting point for assessing the kind of fiscal challenges and opportunities that an independent Scotland would initially face - for example by the Fraser of Allander Institute, and the SNP's Sustainable Growth Commission of 2016-18.
An increase in Scotland's notional deficit, driven by lower oil and gas prices
2023-24 saw the fiscal position of the UK as a whole improve slightly as the cost of energy bills support (such as the energy price guarantee capping average bills for households at £2,500 per year) fell from £28 billion to £4 billion. Debt interest payments also declined slightly. As a result of this, UK government borrowing declined from £128 billion in 2022-23 to £122 billion in 2023-24 – or from 5.0% of national income to 4.5%. However, if it were not for the reduction in the cost of energy bills support, UK government borrowing would have increased both in cash terms and (slightly) as a share of national income last year.
In contrast, GERS shows that Scotland's notional fiscal position weakened in 2023–24. This is because lower oil and especially gas prices that reduced the cost of support for households' and businesses' energy bills also reduced tax revenues from oil and gas production in the North Sea. These revenues halved from £9.9 billion to £4.9 billion. GERS estimates that around 80% of this revenue came from activities in Scottish waters. In contrast, Scotland's share of the benefit from reduced spending on energy bills support and debt interest was close to its population share (8%).
The disproportionate impact of the reduction in North Sea revenues on Scotland means that its notional fiscal deficit is estimated to have increased from £18.0 billion to £22.7 billion – or from 8.4% of Scottish national income to 10.4%. This deficit is substantially higher than the figure for the UK as a whole, with estimated borrowing per person being £2,357 higher than the figure for the UK as a whole (£4,164 versus £1,807).
Figure 1 shows that there is strong correlation between the extra borrowing on behalf of Scotland and the value of oil production in the North Sea: when the value of oil production is high, this fiscal ‘gap’ between Scotland and the UK as a whole is small, and vice versa. This clearly illustrates the sensitivity of Scotland’s public finances to oil (as well as gas) prices and production.
What explains Scotland’s large notional deficit?
While it was the decline in North Sea revenues that pushed up Scotland’s notional deficit relative to that of the UK as a whole in 2023–24, other factors explain the relatively high level of Scotland’s notional deficit.
The main reason why Scotland’s notional fiscal deficit is larger than that of the UK as a whole is higher public spending: overall government spending in 2023–24 is estimated to have been £2,417 (13%) higher for Scotland (£20,418) than for the UK as a whole (£18,001). Most of this difference is due to the much higher levels of funding the Scottish Government receives to pay for devolved public services than is spent on comparable services in England.
Scotland’s higher notional fiscal deficit also partly reflects lower onshore tax revenues (£15,527 per person versus £16,121 in the UK as a whole). But this is a much smaller factor than in the fiscal deficits of Northern Ireland, Wales, and the Midlands and North of England – as we have previously highlighted.
Offsetting the higher spending and lower onshore revenues is much higher oil and gas revenues – estimated at £727 per person, compared to £73 per person across the UK as a whole. This reflects the fact that, as mentioned above, the vast majority of oil and gas revenues relate to activity off the northern and eastern coasts of Scotland.
Does this matter?
The deficit in any given year matters less than the long-run picture. Figure 1 shows that Scotland’s higher notional deficit is not a short-term phenomenon: it has been higher than that of the UK as a whole every year since 2009–10. Moreover, projections based on the previous iteration of GERS and the UK’s March Budget suggest the ‘fiscal gap’ between Scotland and the UK will continue to grow over the next few years given forecasts for North Sea revenues. We will update these forward-looking projections following the UK government’s Budget in October (which may affect the path for revenues, spending, and hence the deficit for both Scotland and the UK).
However, as part of the UK, Scotland’s notional fiscal deficit is subsumed within the wider UK fiscal deficit. It is the responsibility of the UK government to borrow to fund this, not the Scottish Government. Under independence, that would change.
The Scottish Government’s Medium-Term Financial Strategy (and our analysis of that report and Scotland’s longer-term funding outlook) show that Scotland faces tricky decisions on tax and spending within the Union. These GERS-based projections remind us that independence would be no panacea for this issue. Indeed, Scotland’s much larger notional fiscal deficit means that unless North Sea revenues rebounded or economic growth and hence onshore tax revenues were boosted, tax rises or spending cuts would need to be even larger in the years ahead in an independent Scotland.
Faster growth is possible. And Scotland has previously experienced periods where growth in employment, earnings and the economy as a whole has consistently outpaced that of the UK as a whole – during the 2000s, for example, as our report last year highlighted – and could do so again in future, especially if longstanding issues with productivity and skills were tackled better in Scotland than in the rest of the UK.
Indeed, more recently, between mid 2022 and early 2024, earnings growth in Scotland outpaced earnings growth in the UK as a whole, as can be seen in Figure 2. This has helped drive an improvement in Scotland’s devolved income tax revenue performance over the last couple of years, with total income tax revenues up 27% since 2021–22, compared to 23% in the UK as a whole. The fact that these additional income tax revenues have been spent means they have not improved Scotland’s notional public finance position though. And as Figure 2 also shows, the recent increases in relative earnings followed several years of declining relative earnings (and weak income taxbase growth), driven in particular by a decline in earnings in the North East of Scotland, where the oil and gas industry is concentrated.
Looking ahead, it is also important to recognise that Scotland will also face tricky headwinds as declining oil and gas production hits onshore as well as offshore tax revenues, and more rapid ageing of the population puts more pressure on public services such as health and social care. Such issues are at the heart of debates about independence not just because they relate directly to people’s jobs and salaries, but because they also have an important bearing on Scotland’s public finances, and hence the taxes people could pay and the services they could expect to enjoy post-independence.
To read this IFS report with graphs and links go HERE
