3. Scotland's Public Finances
3.1. The previous chapter provided an overview of the contribution the oil and gas sector makes to the Scottish economy. This chapter provides a summary of Scotland's public finances and additional context on how oil and gas revenues relate to Scotland's overall public finances.
Scotland's Public Finances
3.2. Government Expenditure and Revenue Scotland (GERS) is a National Statistics publication which provides estimates of Scotland's public finances under the current constitutional framework. In doing so, GERS captures estimates of all tax revenue generated from economic activity in Scotland and all public spending undertaken on behalf of Scotland, including a share of UK wide public spending such as defence and debt interest.
3.3. The Fiscal Commission Working Group's first report provided an overview of Scotland's public finances under the current constitutional framework.
3.4. It is important to note that as GERS takes the current constitutional framework as given, it is limited in what it can and cannot say about independence. Post-independence, not only will the fundamental structures of the Scottish economy (such as economic incentives and expectations) be subject to change, but the basic tax and spending choices of an independent nation may also differ. In addition, particular expenditure commitments - such as debt interest payments - may be subject to negotiation.
3.5. Despite these limitations, 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.
3.6. The most recent edition of GERS provided analysis of Scotland's public finances for the five years to 2011-12. The composition of Scottish tax receipts over this period is summarised in Figure 5 below. Since 2007-08, income tax has been the largest single source of taxation in Scotland, accounting for 20% of total tax receipts. This is followed by North Sea revenues, National Insurance and VAT which each account for between 15% and 16% of tax revenues. Collectively, these four taxes account for approximately two thirds of total tax revenue in Scotland.
Figure 5: Composition of Scottish Tax Receipts (2007-08 to 2011-12)
Source: Scottish Government - Government Expenditure & Revenue Scotland 2011-12
3.7. While oil and gas production makes an important contribution to the Scottish public finances, on an international basis it represents a smaller proportion of revenue than in some other major oil producing countries. For example, in Norway oil and gas production accounted for an average of 30% of public sector receipts over the decade to 2011-12, the majority of which was transferred to the country's oil fund. Likewise, among the major oil and gas producers in the Middle East, tax revenue stemming from resource extraction frequently accounts for between 50% and 90% of total tax revenue.
Scotland's Overall Fiscal Position
3.8. The strength of Scotland's overall fiscal position will determine the amount of revenue that the Scottish Government is able to deposit into a fund. This is considered in more detail in Chapter 5.
3.9. Government Expenditure and Revenue Scotland (GERS) provides a useful indication of the relative strength of Scotland's public finances under the current constitutional settlement. It shows that over the past five years, Scotland and the UK have both run a fiscal deficit (a shortfall between government revenue and expenditure). This is not unusual, of the 31 members of the OECD with reported data, 27 ran a budget deficit in 2012.
3.10. When oil and gas revenues are excluded, Scotland is estimated to have run a larger fiscal deficit than the UK as a whole over the past five years. However, when Scotland's fiscal deficit is estimated including a geographical share of North Sea revenues, Scotland is estimated to have run an average annual deficit equivalent to 5.9% of GDP between 2007-08 and 2011-12, whilst the UK deficit is estimated to have averaged 7.6% of GDP.
3.11. The relative financial positions of Scotland and the UK can be illustrated by analysing the difference in net fiscal balances as a share of GDP between the two countries. In 2011-12 Scotland's estimated deficit was 2.9 percentage points smaller, as a share of GDP, than the equivalent UK deficit. When expressed in cash terms, this relatively stronger fiscal position was equivalent to £4.4 billion over this period.
3.12. Despite its relatively stronger overall fiscal position than the UK over the past five years as a whole, Scotland is still estimated to be running a budget deficit. In the near term it would therefore have to use North Sea tax revenues to fund current public services and reduce public sector borrowing.
3.13. Therefore this report reiterates the Working Group's conclusion from its first report that a long-run objective of an independent Scotland should be to achieve some form of onshore budget balance, and to use at least a proportion of North Sea revenues to invest for the long-term. Chapter 5 sets out how an independent Scotland could establish a stabilisation fund and a longer-term savings fund immediately after independence. The structure of the chapter reflects the transition that may be required between the short and long term objectives of these funds.
3.14. Figure 6 provides estimates of Scotland's annual net fiscal balance since the 1980s, including an illustrative geographical share of North Sea revenue. The equivalent UK fiscal balance figures are also included for reference.
Figure 6: Historic Net Fiscal Balance: Scotland & UK 1980/81 to 2011/12
Source: Scottish Government, GERS historical ficsal balance.
3.15. For most of the 1980s, Scotland is estimated to have run a substantial net fiscal surplus, driven by significant growth in oil and gas revenues. This would have provided opportunities for Scotland to have established a significant savings fund over this period. Annex A discusses how a long-term savings fund could have hypothetically worked in Scotland since 1980-81 in more detail.
3.16. Scotland's fiscal position weakened through the 1990s and the country ran a slightly larger budget deficit than the UK (albeit very similar). Since 2001-02 Scotland's budget deficit has been broadly in line with that of the UK.
3.17. Like the UK, Scotland has run an overall budget deficit in most years since 1990. On this basis - and subject to the limitations set out above regarding the use of GERS as an indication of an independent Scotland's historical fiscal position - since 1990 a hypothetical independent Scottish Government (spending and raising the same revenue as the UK) would have therefore had only limited opportunities to invest surplus revenues into a long term savings fund during these years as North Sea revenues would have been required to help fund public services.
3.18. Given the need to restore the public finances to health following the substantial deficits of recent years, a strict surplus rule would mean that there would be relatively few opportunities to invest in an oil fund in future years. However, the Working Group believes that there is merit in the government of an independent Scotland investing a proportion of its North Sea revenues in an oil fund whilst in deficit. This is discussed further in Chapter 5.
3.19. North Sea revenue has accounted for 16% of Scottish tax revenue over the past five years. This is similar to the proportion of total receipts generated by VAT and national insurance. It is also smaller than the proportion of public sector revenues accounted for by oil and gas production in many other oil and gas producing countries.
3.20. Over the past five years Scotland's overall fiscal position has been stronger than the UK as a whole, when a geographical share of oil is included. However under the constitutional framework at that time, Scotland is estimated to have been in deficit in most years since the late 1980s, as have most other advanced economies (including the UK).
3.21. The remainder of this report discusses how the operation of a stabilisation fund and a long term savings fund could improve an independent Scotland's budget process, build in flexibility to respond to fluctuations in oil and gas tax revenues, and put in place a mechanism to promote long-run macroeconomic stability.
3.22. Subsequent chapters therefore consider the theory and international evidence underpinning stabilisation and savings funds and examine how an independent Scotland would benefit from adopting such a framework for the management of its natural resources.