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Calman Commission

The Scottish GovernmentLetter from Finance and Sustainable Growth Secretary John Swinney to Sir Kenneth Calman, Chairman of Commission on Scottish Devolution.

"I am delighted to enclose a copy of the Scottish Government's publication Fiscal Autonomy in Scotland: the case for change and options for reform which was published earlier this week as part of our ongoing National Conversation on Scotland's future.

"The view of the Scottish Government is clear - Scotland's interests would be best served by full fiscal autonomy in an independent Scotland.

"I also enclose a report for your information setting out our position on extending borrowing powers to the Scottish Parliament. This makes the undeniable economic case for Scotland to be granted similar powers to other governments both within the UK and in other countries.

"The inability to borrow when we are faced with considerable economic uncertainties or when faced with the prospect of having to fund a once in a generation infrastructure project, puts Scotland at a disadvantage in comparison to other countries. This is a view increasingly shared by many from across the political spectrum. Our inability to borrow is clearly an anomalous situation that must be addressed urgently."

JOHN SWINNEY



BORROWING POWERS: INFORMATION TO BE SHARED WITH THE CALMAN COMMISSION

Executive Summary



  • We believe that the Scottish Government should have extended legal powers to borrow and crucially increased spending power to utilise such borrowing.
  • The opportunity to borrow in a responsible manner would enable the Scottish Government to put forward an enhanced and better targeted stimulus package in times of economic need. Tailoring a fiscal stimulus to the specific challenges facing the Scottish economy would offer increased protection for Scottish households and businesses at a time when they are most vulnerable.
  • The ability to borrow would also give the Scottish Government greater influence over the pace and priorities of Scotland's capital expenditure programme. This would create further opportunities to address the clear infrastructure needs of Scotland more quickly, not least in enabling progress with critical projects such as the new Forth Crossing, by phasing funding in a way that is sensible, efficient and wholly appropriate to Scotland's circumstances.
  • It is not just the ability to borrow which is important but rather the ability to manage our finances effectively - borrowing in some years and being able to retain surpluses in others. It is a basic requirement for efficiency and accountability that Governments should have the opportunity to save money in good times but direct additional resources as and when economic pressures or infrastructure investment demands require. This is a responsible position for any government and parliament to be in, and would represent a significant step forward in devolution.
  • The inability to borrow when faced with considerable economic uncertainties or when faced with the prospect of having to fund a once in a generation infrastructure project, puts Scotland at a disadvantage in comparison to other countries. Indeed, other tiers of government in the UK, for example our own local authorities in Scotland and the devolved administration in Northern Ireland, have greater borrowing powers than are currently available to Scotland. This is clearly an anomalous situation that must be addressed urgently.
  • We recognise that a robust fiscal framework which ensures responsible management of government borrowing and financial planning, is vital to the long term sustainability of the public finances - a harsh lesson that the UK Government is now learning. We believe that this is now the ideal opportunity for the establishment of a revised fiscal framework. Until independence any such reform must be developed, agreed and when in operation, managed and monitored, jointly by the Scottish and UK Governments. In the interests of efficiency, accountability and transparency, any revised framework cannot be controlled solely by the UK Treasury.
  • Steps to provide greater borrowing powers and increased spending power to utilise such borrowing should be taken forward immediately.


1. Introduction

This paper sets out the case for greater borrowing powers for the Scottish Government within the broad context of the current fiscal and constitutional powers available to Scotland under the devolution settlement.

We are currently engaged in a National Conversation with the people of Scotland. This Conversation is debating the best environment for Scotland to flourish and the Scottish Government's economic responsibilities, including tax, spending and borrowing, are central to this.

We have recently set out the range of options for fiscal reform in our report, Fiscal Autonomy in Scotland: The case for change and options for reform. The view of the Scottish Government is clear - Scotland's interests would be best served by full fiscal autonomy in an independent Scotland.

However, we are committed to exploring avenues through which the current fiscal framework can be improved for the benefit of the Scottish economy and the people of Scotland.

In this regard and within the parameters of the current framework for fiscal policy in Scotland, extra borrowing powers would give the Scottish Government greater flexibility in budgetary management and greater control over the pace and priorities of Scotland's capital expenditure programme. This is something that is even more vital in times of economic difficulty. As the devolved government for Scotland, the Scottish Government is best placed to respond quickly and effectively to the economic circumstances of Scotland and to recognise and take forward the investment necessary to meet Scotland's infrastructure needs.

The current economic situation and the grave crisis which faces the UK Government's public finances, represents an ideal opportunity for the establishment of a revised and credible fiscal framework to manage fiscal policy across the UK public sector involving both the UK Government and devolved administrations.

The structure of this paper is as follows -

  • Section 2 outlines the benefits from an expansion of borrowing powers
  • Section 3 sets out the context for reform
  • Section 4 highlights the potential impact of limited borrowing powers
  • Section 5 concludes


2. The Benefits of Borrowing Autonomy

The borrowing powers of the Scottish Government are strictly limited. The Scotland Act provides for short term borrowing sufficient to cover 'a temporary excess of sums paid out of the Scottish Consolidated Fund over sums paid into that Fund' or for 'providing a working balance in the Fund'. Any such borrowings must only be from the UK Government.

In contrast, greater opportunities to borrow are available at the UK national and local authority level. Given that the Scottish Government is responsible for providing most public services in Scotland and significant infrastructure projects, such as investment in roads, schools and hospitals, this situation is a clear anomaly.

Increased borrowing autonomy, within the current framework, would provide greater flexibility in the Scottish Government Budget and would provide an alternative source of financing for major infrastructure projects as and when required.

2.1 Fiscal Flexibility

Borrowing autonomy would enable the Scottish Government to respond flexibly to changes in economic circumstance. For example, a degree of borrowing autonomy would increase the range of options and policy levers available to us to help stimulate the economy during times of economic necessity.

Scotland - in common with the rest of the world - faces significant challenges in responding to current economic conditions. We have already set out a wide range of actions as part of our Economic Recovery Programme, taking the steps available, within the current fiscal framework, to support businesses and households, to maximise jobs and investment and to ensure the Scottish economy is well positioned for recovery.

There is no doubt that more could be done if Scotland's Government had greater borrowing powers.

In recessions, temporary increases in government expenditure, particular concentrated in the sectors in which there is spare capacity (e.g. the construction sector) can act as an important stabilisation mechanism to the economy by supporting private sector consumption and investment levels that are falling below trend. Similarly, paying for targeted short run cuts in taxation through borrowing can help stimulate aggregate demand by increasing household take-home pay and/or reducing firms' after tax operating costs. Under the current fixed spending envelope, any attempt to reduce taxation, such as putting forward a temporary cut in the Scottish Variable Rate (SVR), would lead to an immediate reduction in government expenditure in Scotland.

Introduced in a timely and targeted manner, a fiscal stimulus can help mitigate the effects of a downturn and ensure that an economy is well placed to gain as and when the economy recovers. Fiscal stimulus packages, including additional borrowing, have been announced in all countries affected by the global downturn, including the US ($787bn), China ($600bn) and Germany (€32bn).

As an integrated part of the overall UK fiscal framework, the fiscal stimulus announced by the UK Government at the 2008 Pre-Budget Report has a direct impact in Scotland and therefore a degree of borrowing is already taking place on behalf of Scotland. However our ability to put in place our own stimulus package to complement that undertaken at the UK level is strictly limited. Furthermore, the Scottish Government have little opportunity to influence the contents of the UK fiscal stimulus package and other UK measures to stimulate the economy.
More generally, macroeconomic policy solely focussed on what is best for the people of Scotland may quite conceivably take a different path to that taken at the aggregate UK level.

The ability to borrow, coupled with greater fiscal autonomy in taxation, would significantly improve the options open to Scotland.

2.2 Investment in Infrastructure

In addition, or complementary, to providing a short-term boost to the economy when it is operating below trend, government borrowing can provide long-term economic benefits by funding increased levels of infrastructure investment. Such investment is an essential driver of productivity, competitiveness and long-term economic growth.

Within current capital expenditure limits the Scottish Government is investing up to £3.5 billion per annum in infrastructure. There is, however, a clear desire to do more, and the need for greater investment has been highlighted by the Council of Economic Advisors. With borrowing powers and the increased spending power to utilise such borrowing the Scottish Government would have more control over the pace and priorities of infrastructure investment in Scotland.

Funding large scale infrastructure projects through responsible borrowing has two important advantages -

  • infrastructure projects have to be paid for up-front, however the benefits that they provide accrue over the full lifetime of the asset. Funding a proportion of capital expenditure through borrowing ensures that the costs and benefits associated with a capital project are balanced across time. Future taxpayers, who will share in the benefit from today's spending on a particular project (e.g. a new road or school), will in effect contribute to their cost by repaying a share of associated borrowing required to pay for up front costs. This is important for ensuring inter-generational equity
  • large scale infrastructure projects are typically expensive (for example a new Forth Road Crossing). Funding a proportion of a project's cost through borrowing ensures that the costs of financing a once in a lifetime project can be spread over a number of years without resulting in a significant reduction in expenditure on other programmes and/or increases in taxation in the year in which the asset is purchased. This point assumes that any capital investment is matched by increased spending power from the existing capital Departmental Expenditure Limit


3. The Context for Reform

The Scottish Government's preferred option for fiscal reform is full fiscal autonomy in an independent Scotland as set out in Fiscal Autonomy in Scotland: The case for change and options for reform. Under independence the Scottish Government would have the full authority and flexibility to put in place the optimal choice of macroeconomic policies to ensure stability and to choose the best options for funding infrastructure projects.

As an independent nation, Scotland would be able to borrow responsibly in international capital markets subject to normal market disciplines by using the instruments of taxation and expenditure accordingly. Full fiscal autonomy would also enable us to establish a new fiscal framework for Scotland more generally, including the opportunity to establish an oil fund, where natural resource revenues invested over the long term could be used to provide a stimulus to the economy and to fund particular investment projects. Norway offers a useful example of the successful management of oil revenues by an independent country with resources as income generating collateral.

The Scottish Government will continue to argue that Scotland should be equipped with the full range of financial powers that would enable us to respond to the economic challenges that we face.

However, we believe that, within the general framework of the current devolution arrangements, the Scottish Government should have powers to borrow as and when necessary. We recognise that there is a balance between on the one hand flexibility and freedom to borrow and long run affordability and macroeconomic coordination. As such it is essential to have clearly defined principles outlining borrowing and long term affordability parameters.

Experiences elsewhere

The inability of the Scottish Parliament to support borrowing by the Scottish Government stands as a clear anomaly. Other levels of government within the UK, for example our own local authorities and the devolved administration in Northern Ireland, have greater borrowing powers than we currently have. Internationally, most governments with a similar remit to the Scottish Government have borrowing powers (Footnote 1).

Borrowing by UK Administrations

Scottish Local Authorities

Northern Ireland Executive

Able to borrow on private markets or via the Public Works Loan Board (PWLB) to fund capital expenditure

Regulated by Prudential Code under which local authorities determine the maximum amount affordable subject to a series of indicators such as affordability, prudence and sustainability

No explicit limits on the amount that can be borrowed, although HM Treasury retains the right to apply constraints in the future

Able to fund a proportion of its capital expenditure through borrowing from the PWLB.

Maximum limit of £200 million per annum (2.25 per cent of their total DEL Budget in 2008/09 (note 2)

Upper limit of £3 billion on the total level of debt that could be issued.



[1] PESA 2008 - Table 1.12 - Total Departmental Expenditure Limits, 2002-03 to 2010-11

Further afield, many countries operate 'internal' Growth and Stability Pacts which allow borrowing up to some pre-prescribed level and for particular purposes. This could be as a percentage of total expenditure or as a percentage of total GDP. Borrowing 1per cent of Scottish Government DEL would equate to approximately £300 million while 1 per cent of Scottish GDP would equate to approximately £1.2 billion (note 3).

In principle, extension of a prudential style regime or fixed limit on borrowing to the Scottish Government would represent a step forward in the fiscal framework for Scotland. However, a piecemeal reform would not allow the more substantial opportunities that could come from greater autonomy and it would not match our ambitions for Scotland nor the expectations of many in Scotland.

Elsewhere, there are clear examples of successful borrowing from private markets by governments from the issuing of rated bonds on the capital markets. Evidence from Transport for London and sub-national governments worldwide has shown that this approach can be successful in raising funds at competitive rates, guaranteed by future revenue streams arising from autonomous revenue streams. For example, Transport for London undertook three bond issues between 2004 and 2006, with borrowing costs only slightly higher than those incurred by the UK Government, to fund the modernisation of the transport system in London.

In the US both state and local governments can issue municipal bonds to raise money for major capital projects. Consequently, even States such as Wyoming and Rhode Island with populations of less than 1 million are able to borrow to fund infrastructure. Standard and Poor's have given most American states a credit rating of AAA or AA in January 2009 reflecting their low default risk. Similar levels of borrowing autonomy are also available to Canadian Provinces. The Basque Country's creditworthiness is reflected in its AAA credit rating from Standard and Poor's (note 4). This is the same rating given to UK Government debt and is higher than the rating on Spanish Federal Government debt.

A robust fiscal framework which ensures responsible management of government borrowing and financial planning is vital to the long term sustainability of the public finances. Until independence any such reform must be developed, agreed and when in operation, managed and monitored, jointly by the Scottish and UK Governments. In the interests of efficiency, accountability and transparency a revised framework cannot be controlled solely by the UK Treasury.

4. Economic Impact of Increased Borrowing Autonomy

To illustrate the potential implications from the transfer of limited borrowing powers to the Scottish Government we highlight the potential economic benefits which borrowing powers could provide, and the associated repayment costs of projects funded through borrowing.

4.1 Direct Stimulus Package

Due to the impact of the credit crunch and the significant fall in demand and private sector investment, additional infrastructure investment can be expected to employ or use existing (or unemployed) resources within the construction sector and economy more generally without displacing public or private sector investment which would have otherwise occurred. As such, the activity generated by the increase in investment can be considered additional to what would have otherwise occurred. Therefore, borrowing to fund such investment can generate positive short run economic effects (note 5).

The short run impact of an increase in Scottish Government investment when the Scottish economy is experiencing a sharp contraction in private sector demand can be estimated by considering the Scottish Government's Input-Output Model. Using this methodology, each £100 million increase in capital investment funded by borrowing is estimated to support approximately 1,000 jobs directly, with around 600 of these in the construction sector, with direct employment also supported in manufacturing and finance and business services. This is assuming that each £100 million of borrowing would be invested across a broad programme of capital accumulation as the government in Scotland currently spends, covering transport, education, health etc. This direct stimulus would further support an additional 500 jobs through indirect purchases by these sectors (supplies, materials, services, utilities etc).

4.2 Investment in Infrastructure

New borrowing and corresponding spending power would enable the Scottish Government to significantly expand its capital programme. Each £100 million in borrowing would be enough to build almost three new secondary schools. Alternatively, borrowing larger amounts such as £400 million a year over a four year period would enable the Scottish Government to fund the construction of the new Forth Replacement Crossing (from 2012-13 to 2015-16), without any impact on other capital budgets,.

These are illustrative examples based on borrowing to fund specific projects. Of course, cumulative borrowing over a period of years would enable larger suites of infrastructures projects to be undertaken. For example incremental borrowing of £200 million a year over an eight year period would enable the completion of the dualling of the A9 from Perth to Blair Atholl and the construction of the Glasgow Southern General Hospital.

4.3 Repayment Costs

The exact debt management process would depend on a number of factors including the form of borrowing undertaken, the time period over which the borrowing was to be repaid and the interest rates charged. For example, each £100 million borrowed at current levels of interest from the National Loans Fund over 25 years would incur an interest rate of around 4.2 per cent and would equate to annual costs of around £6.5 million (interest and principal). If new borrowing of £100 million was added each year to support continuous additional investment in infrastructure, with repayment including principal over 25 years, net borrowing would reach equilibrium (repayment of principal equalling new loans) after 25 years at an aggregate level of debt of around £1.25 billion and annual servicing costs (interest and principal) of around £165 million a year at current interest rates.

At present, the annual charges that have to be paid by the pubic sector on PPP/PFI schemes are met from revenue budgets in the same way as interest payments would.

It should be noted that as well as repaying the borrowings and associated interest charges, public bodies would need to meet depreciation charges on the assets, and cost of capital charges. Depreciation on buildings typically runs over 50 years and would cost about £2m a year for each £100 million of investment. Cost of capital would cost approximately a further £3.3m a year on the same investment.


5. Conclusions

The time is now right for a discussion about what fiscal framework is best for modern Scotland.

Independence and full fiscal autonomy would allow the maximum degree of policy discretion and accountability over fiscal and economic policy and is the arrangement chosen by similar nations around the world. Incentives for efficient policy delivery would also be maximised. Crucially, it would give the Scottish Government the full range of economic levers to deliver increased sustainable economic growth.

However, within the current fiscal framework there is clearly a growing consensus on the pressing need for extra borrowing powers for the Scottish Government. The ability to manage our own Budget responsibly is vital in ensuring that the Scottish Government is able to respond swiftly and effectively to changes in economic circumstances - something that is even more crucial in a time of economic difficulty - and in securing sufficient investment in infrastructure and development over the long term.

Borrowing powers could be put in place relatively easily and, until a period of greater fiscal autonomy, establishment of borrowing within a prudential style regime or within a revised rule based framework with the necessary increase in Scotland's spending power would represent a step forward and an improvement in the current devolution settlement.

Notes:

1. For a review of borrowing autonomy in other countries see Debrun et al., 2008, "Tied to the mast? National fiscal rules in the European Union", Economic Policy, Vol. 23, pp. 297 - 362 and Rodden J., 2002, "The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World," American Journal of Political Science Vol. 46, pp. 670 - 687.

2. PESA 2008 - Table 1.12 - Total Departmental Expenditure Limits, 2002-03 to 2010-11

3. In certain instances borrowing is constrained to be for certain purposes only. For example, in many cases, including Northern Ireland, borrowing is only permitted for capital expenditures - a framework consistent with the concept of a Golden Rule of public finance.

4. Standard and Poor's (January 30, 2009) - Spain's Basque Country Affirmed At 'AAA' And Off CreditWatch On Unique Fiscal Autonomy/Robust Finances; Outlook Stable

5. It is important to note that increased investment by the public sector when the economy is operating near trend is likely to lead to 'crowding out' of private sector demand rather than increases in output and employment.

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