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Scotland's Future

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Annex C Scotland's Public Finances

This annex provides detailed analysis of Scotland's public finances under the current constitutional framework. The analysis encompasses total public spending, public sector receipts, the overall budget balance and an implied share of UK public sector net debt.

It is clear that Scotland currently pays its way within the UK.

As we move to independence, our strong public finances will provide the foundations for policy decisions on taxation, growth and welfare.

This annex also therefore sets out forecasts for public sector expenditure and revenue for Scotland in 2016/17 based on a series of projections and plans for future expenditures and revenues.

Background

The National Statistics publication Government Expenditure and Revenue Scotland (GERS) published annually provides estimates of total public sector expenditure undertaken for Scotland, and total public sector revenue generated by economic activity in Scotland.

The analysis in GERS is based on the current constitutional framework. However, it 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. The most recent year figures are available for is 2011/12.

The analysis in this annex assigns Scotland an illustrative geographical share of both offshore oil and gas tax receipts and GDP.

Scotland's track record

Public sector spending

Public spending for Scotland was estimated to be £64.5 billion in 2011/12 - the most recent year for which figures are available.

This reflects spending undertaken for Scotland by every tier of government, including the UK Government, the Scottish Government and Scottish local authorities. It includes a share of UK wide public spending which cannot be easily identified as benefiting any one specific part of the country. For example, Scotland is assigned a per capita share of both UK defence and debt interest spending.

Responsibility for approximately 60 per cent of the public spending undertaken for Scotland is devolved to the Scottish Government and Scottish local authorities.

Whilst responsibility for such spending is devolved, responsibility for setting the overall budget for the Scottish Government is largely reserved to the Westminster Government and is determined by the Barnett Formula.

When comparing the level of aggregate public spending across countries or over time, the standard approach is to compare the ratio of public spending to GDP. This allows the size of the public sector to be compared whilst controlling for the size of the economy.

In 2011/12, estimated public spending was equivalent to 42.7 per cent of GDP in Scotland. This is estimated to be lower than in both the UK as a whole (45.5 per cent), and the majority of EU-15 countries.

Over the period 2007/08 to 2011/12 as a whole, the ratio of public spending to GDP was estimated to be 43.0 per cent in Scotland, compared to 45.0 per cent in the UK.

Public Spending as a share of GDP: Scotland and UK (2007/08 to 2011/12)
2007/08 2008/09 2009/10 2010/11 2011/12
Scotland 40.1% 41.7% 46.0% 44.5% 42.7%
UK 40.7% 44.4% 47.4% 46.8% 45.5%

Source: GERS 2011/12

Scottish tax receipts

Total tax revenue in Scotland was estimated to be £56.9 billion in 2011/12. This includes a geographical share of North Sea tax revenue, equivalent to £10.6 billion.

Income tax is estimated to be the largest onshore source of tax revenue in Scotland, raising £10.8 billion in 2011/12, 19 per cent of the Scottish total. VAT and National Insurance contributions were the second and third largest sources of onshore revenue, generating 17 per cent and 15 per cent of total estimated Scottish receipts respectively.

Total Scottish tax receipts in 2011/12 were estimated to be equivalent to £10,700 per head. This compares to a figure of £9,000 per head in the UK as a whole.

On a per head basis, total tax receipts in Scotland are estimated to have been higher than in the UK in every year since 1980/81. Over this period, total tax revenue per head in Scotland has been on average £800 a year higher than in the UK as a whole. Adjusted for inflation, the gap has averaged £1,350 over this period.

Total Tax Receipts Per Head: Scotland and UK (2007/08 to 2011/12)
2007/08 2008/09 2009/10 2010/11 2011/12
Scotland £10,000 £10,600 £9,100 £9,900 £10,700
UK £8,900 £8,600 £8,200 £8,800 £9,000

Source: GERS 2011/12 & Scottish Government Analysis

Whilst oil and gas receipts represent an important source of Scottish tax revenue, they account for a smaller proportion of revenue than in some other major oil and gas producing countries. The table below shows the proportion of total public sector revenue attributable to oil and gas production in Scotland and Norway, the largest oil and gas producer in Europe. As the table highlights oil and gas production accounts for a higher proportion of public sector receipts in Norway compared to Scotland.

Oil and Gas Receipts as a Share of Total Public Sector Revenue
2007/08 2008/09 2009/10 2010/11 2011/12
Scotland 14% 21% 12% 15% 19%
Norway 36% 27% 26% 27% 31%

Source: Scottish Parliament Information Centre - Share of total tax revenue derived from oil and gas: Scotland and Norway, and Scottish Government analysis

Scotland's overall budget balance

The budget balance measures the difference between public spending and tax revenue in a given year. It therefore determines the government's annual borrowing requirement.

The primary estimate of Scotland's overall annual budget balance is the net fiscal balance. The net fiscal balance measures the difference between total public sector expenditure and revenue. It is comparable to the estimates of UK public sector net borrowing published by the Office for National Statistics (ONS).

The table below provides estimates of Scotland's net fiscal balance between 2007/08 and 2011/12. The corresponding UK figures are also provided.

Over the five years to 2011/12 as a whole, whilst in deficit, Scotland was estimated to be in a relatively stronger fiscal position than the UK. Since 2007/08, Scotland has run an average net fiscal deficit of £8.3 billion (5.9 per cent of GDP). During the same period, the UK ran an average annual deficit of £111 billion, equivalent to 7.6 per cent of GDP.

Scotland's deficit has declined since its peak to 2009/10. 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 of GDP. In the same year the UK is estimated to have had a deficit of 7.9 per cent of GDP.

To put the above projections into context, the IMF report that the (weighted) average deficit across the G7 economies was 7.6 per cent of GDP in 2011, whilst the average deficit among the 35 advanced economies monitored by the IMF was 6.4 per cent of GDP.

Net Fiscal Balance: Scotland and UK (2007/08 to 2011/12) per cent GDP
2007/08 2008/09 2009/10 2010/11 2011/12
Scotland -2.9% -2.6% -10.7% -8.1% -5.0%
UK -2.6% -6.9% -11.2% -9.5% -7.9%

Source: GERS 2011/12

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. Between 1980 and 2014 there has been only one year when the 35 countries in the OECD as a whole have run an overall fiscal surplus. It is possible for a government to run an annual budget deficit (a shortfall between income and expenditure) in a manner which is sustainable. This is because if the economy is growing quicker than the rate of debt accumulation, the debt to GDP ratio will still fall. As such, the burden of the debt will be reduced, relative to the country's ability to service it.

An alternative measure of Scotland's fiscal position is the current budget balance, which is also published by the ONS for the UK. It measures the difference between current expenditure and current receipts.

The current budget balance excludes capital investment. It therefore captures the degree to which current taxpayers meet the cost of paying for the public services they consume today and a contribution to debt interest payments.

If a country is running a current budget balance or surplus it may still have to borrow to fund capital expenditure. However, such borrowing will be for long-term investment which can be expected to increase the economy's productive capacity in future years. In effect, no borrowing is being used to fund day-to-day government services.

The table opposite provides estimates of the current budget balance for Scotland and the UK between 2007/08 and 2011/12. In each year Scotland is estimated to have a relatively stronger current budget balance than the UK.

In 2007/08 and 2008/09 Scotland was either running a current budget surplus or a small deficit. In comparison, the UK was in deficit in both years. Looking at earlier years shows that Scotland also ran a current budget surplus in 2005/06 and 2006/07. In comparison, the UK has not run a current budget surplus since 2001/02.

Current Budget Balance: Scotland and UK (2007/08 to 2011/12) per cent GDP
2007/08 2008/09 2009/10 2010/11 2011/12
Scotland -0.3% 0.7% -7.2% -5.3% -2.3%
UK -0.5% -3.6% -7.8% -6.9% -6.0%

Source: GERS 2011/12

From 2009/10 onwards, the size of the current budget deficit in both Scotland and the UK increased. This reflects, in part, the impact of the financial crises and subsequent global recession which has had a significant impact on the public finances of many western economies. Scotland's public finances are expected to strengthen in the coming years as the economic recovery gathers momentum.

Scotland's national accounts on independence

To enable an informed assessment of the financial position of an independent Scotland, the Scottish Government has prepared projections of Scotland's public finances under the current constitutional framework in 2016/17, the year when Scotland will become independent. Such projections reflect the decisions and priorities of the Westminster Government.

In contrast, the strength of Scotland's public finances in the years after 2016/17 will depend on the economic and fiscal decisions of future Scottish governments and our ability to grow the economy.

The financial position that Scotland will inherit upon independence will depend in part on negotiations between the Scottish and Westminster Governments following a Yes vote. For example, the proportion of UK public sector debt which an independent Scotland will assume responsibility for.

To reflect the range of possible outcomes, the analysis here uses two scenarios for Scotland's share of UK public sector debt and annual interest payments.

  • Scotland's share of UK public sector net debt could be apportioned by reference to the historic balance of public spending and taxation since 1980/81. This provides a measure of our contribution to the UK's finances over the years.
  • Alternatively, Scotland could take responsibility for a population share of UK public sector net debt.

In addition, the following core projections are used:

  • Indicative total public receipts in Scotland 2016/17 of between £64 billion and £65 billion are projected. This is split £57 billion onshore and £7 to 8 billion offshore.
  • Onshore tax revenues in Scotland are projected to follow the path forecast for the UK as a whole and grow by approximately £5 billion (10 per cent) in real terms between 2011/12 and 2016/17. For each of the onshore revenue streams in GERS, the average ratio of Scottish to UK receipts in the three years to 2011/12 has been calculated and applied to the forecasts by the Office for Budget Responsibility (OBR) for the individual UK tax receipts in future years.
  • Forecasts for North Sea revenues are based on scenarios published in the Scottish Government Oil and Gas Analytical Bulletin.
  • Indicative non-debt interest total managed expenditure (TME - all public spending on behalf of Scotland based on the existing constitutional framework) is estimated at approximately £64 billion. This is based on the Westminster Government's current spending plans, which will see such spending fall by 4 per cent in real terms between 2011/12 and 2016/17. Scottish TME in future years has been estimated by applying the average share of UK TME undertaken for Scotland over the three years to 2011/12 to the totals for future UK TME. Spending on individual spending lines for Scotland have been estimated based on the projected growth in the corresponding UK totals.
  • Current devolved expenditure is estimated to be £37 billion, based on known expenditure plans. Estimates of reserved social protection (including welfare and pensions) are projected at £19 billion in 2016/17 based on existing OBR forecasts.
  • Of reserved expenditures, defence is estimated at £3 billion (a per person share of assumed UK spend of £36 billion in 2016/17).
  • The cash value of Scottish onshore GDP is assumed to grow in line with the OBR forecasts for UK GDP. Scottish offshore GDP has been estimated by projecting forward outturn data using the assumptions about future production and prices underpinning the forecasts for North Sea tax receipts.

Summary of Scotland's projected fiscal position

Table - Estimates of Scotland's financial position (2016/17) £ Billions - under current constitutional arrangements
Total Expenditure (Non-Debt Interest) £63.7
Currently Devolved £37.3
Defence £3.0
Reserved Social Protection £18.8
Other Reserved Spending £4.6
Public Sector Debt Interest1 £3.9 to £5.5
Total Public Sector Receipts £63.7 to £64.8
Onshore Receipts £56.9
Offshore Receipts £6.8 to £7.9
Net Fiscal Balance2
Including historical share of debt interest payments -£2.7 to -£4.0
As percentage of GDP -1.6 per cent to -2.4 per cent
Including population share of debt interest payments -£4.3 to -£5.5
As percentage of GDP -2.5 per cent to -3.2 per cent
UK Public Sector Net Borrowing3 -£61
As percentage of GDP -3.4 per cent
Figures are rounded to the nearest hundred million and therefore may not sum
1
Range based upon historical or population share
2 Scottish Government projections
3 Office for Budget Responsibility - March 2013 Economic and Fiscal Outlook

Scotland's deficit is forecast to fall to between 1.6 per cent and 2.4 per cent of GDP in 2016/17 with a historical share of UK debt and to be between 2.5 per cent and 3.2 per cent of GDP if we take on a population share of UK public sector debt. The OBR forecasts that the UK will run a deficit of 3.4 per cent of GDP in the same year. The IMF estimates that the average deficit across the G7 economies will be 3.2 per cent in 2016.

Scotland's current budget balance is also projected to improve in the coming years. Assuming a share of debt interest payments based upon Scotland's historical contribution to the UK public finances, Scotland's current budget balance is estimated to be between 0.1 per cent (i.e. a surplus) and -0.7 per cent of GDP in 2016/17. Assuming a per capita share of debt interest payments, Scotland's current budget balance in 2016/17 is projected to be between -0.8 per cent and -1.5 per cent of GDP. This compares to the OBR's forecast for the UK as a whole of -1.9 per cent.

These forecasts outline Scotland's potential fiscal position under the current constitutional framework. However, independence would provide the opportunity to implement a range of policies to reflect the preferences and needs of Scottish households and businesses. Such policy changes could have an impact on the public finances of an independent Scotland. Although in some cases their initial impact on 2016/17 would be limited with the full change not being observed on the public finances for a number of years.

Public sector net debt

When considering the sustainability of a country's public finances, it is important to consider the overall stock of debt, as well as the level of borrowing in a specific period.

Under the current fiscal framework, UK public sector net debt is incurred for the country as a whole, and not directly for Scotland or any other part of the UK.

As such, there are no outturn figures for the share of UK debt incurred on behalf of Scotland. Two approaches which can be used to allocate a notional share of UK net debt to Scotland are presented below.

Population share

GERS allocates Scotland a per head share of UK debt interest payments. The same approach could therefore be used to allocate Scotland a share of the corresponding debt.

UK public sector net debt at the end of 2016/17 is forecast to stand at £1.6 trillion. Scotland's per head share would be equivalent to approximately £130 billion (76 per cent of GDP). This would represent a lower debt to GDP ratio than for the UK as a whole (86 per cent), reflecting the fact that Scotland has a higher level of GDP per capita (including North Sea oil) than the UK.

Historical share

A country's public sector net debt can be viewed as the sum of its historic annual borrowing, minus any debt repayment. Therefore, an alternative way to calculate Scotland's notional share of UK public sector debt is to base it on Scotland's historical fiscal position.

During the early 1980s, Scotland ran a substantial net fiscal surplus, driven by the significant growth in North Sea revenues. Scotland's fiscal position weakened through the 1990s but since 2001/02 has been broadly in line with that of the UK.

As approximately 90 per cent of UK public sector net debt has been incurred since 1980, assessing Scotland's fiscal position over this period gives an indication of the amount of UK net debt which has been incurred on behalf of Scotland.

Between 1980/81 and 2016/17, Scotland is estimated to run a cumulative net fiscal deficit equivalent to approximately £85 billion. This means that over this period as a whole, total public spending for Scotland will exceed tax revenue by £85 billion. This equates to around 6 per cent of the cumulative UK deficit over the same period (£1,400 billion).

Applying this ratio to UK public sector net debt in 2016/17 would result in a notional share for Scotland of approximately £100 billion, this is equivalent to 55 per cent of Scottish GDP.