Scotland's fiscal position improves in 2013-14 but this is set to stall as oil price falls bite
11th March 2015
David Phillips, senior research economist at the Institute for Fiscal Studies writes for the Institute of Fiscal Studies.
Today, the Scottish Government published the latest version of its annual Government Expenditure and Revenues Scotland (GERS) publication covering 2013-14. In this observation we first discuss what the figures tell us about Scotland's notional fiscal position in that year. The key finding is that Scotland's overall budget deficit of 8.1% of GDP during 2013-14 was significantly higher than the UK wide deficit of 5.6% of GDP. This reflects the fact that disproportionately high oil revenues in Scotland are not sufficient to "pay for" higher public spending in Scotland.
We then project figures forward to 2015-16 over which period expected revenues from the North Sea have fallen further. Based on the OBR's December forecasts, we project Scotland's deficit in 2014-15 and 2015-16 to be 8.6% of GDP and 8.0% of GDP, respectively, compared to 5.0% and 4.0% for the UK as a whole. The gap would likely be even larger if oil prices remained at current levels – which are significantly below those used in the OBR's December forecasts – but could be smaller if oil prices or production rebound.
Finally, we place these figures in the context of the evolving constitutional debate – including the debate about whether Scotland should become "fully fiscally autonomous".
Excluding North Sea revenues, Scotland’s net fiscal balance was in deficit to the tune of 12.2% of GDP (or £16.4bn) in 2013–14. This represents a fairly sizeable reduction in the onshore fiscal deficit compared to the previous year, driven by government expenditure falling by 4.2% in real-terms.
Scotland’s onshore deficit is estimated to have fallen by more than that of the UK during 2013–14. This is despite the growth in onshore revenues being slower in Scotland than the UK as a whole; it instead reflects the fact the fall in government spending is estimated to have been larger in Scotland than in the rest of the UK. However, the level of the onshore deficit in Scotland remains around double that for the UK as a whole (6.0% of GDP) because government spending per person is much higher than the UK average, while onshore revenues are a little lower than the UK average.
Allocating a geographic share of North Sea revenues to Scotland unsurprisingly improves its fiscal position, although a large deficit of 8.1% of GDP remains. But these revenues did not help in as much in 2013–14 as in earlier years, as declines in oil and gas production took their toll. In the two years between 2011–12 and 2013–14, Scotland’s North Sea revenues fell by more than half from £9.7bn to £4.0bn. This has driven Scotland’s overall net fiscal balance from 5.9% of GDP in deficit in 2011–12 to 8.1% of GDP in deficit in 2013–14 – a period during which its onshore deficit shrank by a similar magnitude.
In contrast, the UK’s overall net fiscal deficit shrank from 6.9% to 5.6% of GDP over the same two year period. Of course, the decline in North Sea revenues was not helpful to the UK public finances either. But, because most North Sea revenues are estimated to come from the Scottish portion of the North Sea (84% in 2013–14), and because the onshore economy and tax-base of Scotland is much smaller than that of the UK as a whole, a fall in this revenue stream has a much larger impact on Scotland’s fiscal position.
Projecting Scotland’s fiscal position for 2014–15 and beyond
The falls in North Sea revenues have continued during the current financial year. The current low price of oil, if sustained, would also lead to further declines in revenue in future years. With this in mind it is worthwhile examining the impact ongoing weakness of North Sea revenues may have on Scotland’s public finances in 2014–15 and 2015–16. We do this by projecting the figures in GERS forward using official OBR forecasts for the UK as a whole, and a number of additional assumptions (see below for further details).
At the time the OBR made its forecasts, the oil price was $70 a barrel, and the OBR’s forecast was based on an assumed average price for 2015–16 of $83 a barrel. Since then, the oil price has fallen further, and futures markets currently have an average price of around $60 a barrel for oil to be delivered during 2015–16. Updated forecasts will be published next week alongside the UK government’s Budget but it seems likely that these oil price falls will result in lower revenues from the North Sea. For instance, a recent report by the UK parliament’s Scottish Affairs Committee suggests North Sea revenues for the UK as a whole may amount to £1.5 billion a year at an oil price of $60 a barrel. The direct effect of this would be to increase Scotland’s deficit in 2015–16 by around a further 0.3% of GDP; indirect effects on the wider economy in Scotland could be positive or negative.
The GERS figures in the context of the devolution debate
The figures described above represent Scotland’s notional fiscal position if it had to raise or borrow the money needed to pay for government spending undertaken in, or for the benefit of, Scotland. This is not the case at the moment though. Instead, most tax paid in Scotland goes to the UK government, which is responsible for defence, foreign affairs and for paying benefits and state pensions to those in Scotland. It also gives money as a block grant to the Scottish Government to pay for devolved services – like health and education. The size of this grant does not depend on how much tax revenue is raised in Scotland but is based on historic spending in Scotland, adjusted each year using the Barnett formula so that changes in spending broadly match changes in government spending in England. Scotland is therefore insulated from the fiscal implications of volatile North Sea revenues.
Under existing plans for further devolution, Scotland would be exposed to some revenue risks associated with its economy performing better or worse than that of the UK as a whole. This is because part of the Scottish Government’s block grant will be replaced with revenues from income tax raised in Scotland and a share of VAT raised in Scotland (and a number of smaller taxes). However, existing levels of funding would largely be maintained as the Barnett formula will remain in place, and as North Sea taxation is not being devolved, Scotland will remain insulated from the fiscal risk associated with these revenues.
It has been suggested that devolution could go much further, however, with the Scottish National Party calling for "full fiscal autonomy". Under such an arrangement, all taxes and the vast majority of spending would be devolved to Scotland – with the Scottish Government making transfers to the UK government to cover things like defence, foreign affairs, and Scotland’s share of the UK’s debt interest payments. In that case the notional fiscal position set out in GERS and our projections would have direct implications. The Scottish Government would have to borrow if its spending were greater than its revenues. It would also have to bear the risk of volatile North Sea and other tax revenues.
Our projections suggest that if Scotland were fiscally autonomous in 2015–16, its budget deficit would be around 4.0% of GDP higher than that of the UK as a whole. In cash terms, this is equivalent to a difference of around £6.6 billion. To put this in context, we project government spending in Scotland to be £68.8 billion in 2015–16, and onshore tax revenues to be £53.7 billion.
It has been suggested that the powers obtained under full fiscal autonomy would allow the Scottish Government to implement policies that would boost the growth rate of the Scottish economy, thereby improving its fiscal balance. This could be the case: full fiscal autonomy would give more freedom to pursue different, and perhaps better fiscal policy, and to undertake the radical, politically challenging reforms that could generate additional growth. There are undoubtedly areas where existing UK policy could be improved upon. But it is much easier to say things would be better if the economy grows more quickly than it is to develop and implement policies that would actually deliver that extra growth. The Scottish Government has previously suggested policies to boost growth – such as cuts to corporation tax and expanded childcare – but the immediate effect would be to weaken its finances; and it is not clear that even in the longer term the effects on growth would be enough to pay for such tax cuts and spending increases.
Today’s figures therefore illustrate that full fiscal autonomy would likely involve substantial spending cuts or tax rises in Scotland – unless oil revenues rebound and remain at consistently high levels, or credible policies to boost the growth of Scotland’s onshore economies and revenues can be developed.
