Summary
A recent paper from the Institute for Fiscal Studies (IFS) points to an improvement in Scotland’s fiscal balance over the next few years, although this may only be temporary, resulting from high oil prices.
This raises the question of why Scotland has a fiscal deficit at all. The reason that tax revenues have fallen short of what is needed to pay for our public services is the slow rate of growth of the Scottish economy. Had the Scottish economy performed as well as the average small advanced economy in the last two decades it would have generated a fiscal surplus, even before taking oil revenues into account.
The Scottish economy grew so slowly because economic policy is reserved to Westminster and Scotland’s needs and opportunities are ignored. Due primarily to UK Government policy, the UK economy has grown significantly more slowly over the last two decades than other comparable economies.
The need for all economies to transition to Net Zero presents Scotland with considerable economic opportunities. It has great natural advantages including abundant renewable supplies of wind resources. Taking advantage of these resources over the next two decades should increase the rate of growth of the Scottish economy, and the total tax revenues generated.
Energy companies are beginning to invest some of the large profits they are earning from high energy prices into renewable resources like offshore wind. But in order that the maximum economic and social benefits can be realised by these investments they need to be carried out within a policy framework determined by Government.
Only a fully independent Scottish Government would have the range of powers required to design and execute the necessary policies. Under devolution, Scotland lacks these powers, while the UK Government has shown no interest in developing the Scottish economy.
The current high energy prices and Scotland’s renewable potential means that there is a historic opportunity to transform the Scottish economy. This opportunity will not be realised if Scotland remains part of the UK as the political constraints of the UK mean the necessary policies will not be implemented by a Westminster Government led by either of the main UK parties. Independence is required so that the economic policies required can be implemented.
Scotland’s Public Finances
The state of Scotland’s public finances has often been at the centre of the debate on the economics of Scottish independence. During the 2014 independence referendum campaign, the Yes campaign was able to point to evidence that showed that Scotland has made a net contribution
In more recent years, with a lower oil price and declining production, the tax revenues from North Sea oil have reduced and official estimates[1] suggest that Scotland in the UK has a public sector deficit. That is, public spending in Scotland plus an allocation of UK public spending exceeds the taxation revenues collected in Scotland. However, recently published analysis from the Institute for Fiscal Studies (IFS) shows how higher oil prices have transformed Scotland’s public finances. This suggests that next year Scotland’s underlying budget deficit could be similar to or even lower than that of the UK (see Graph 1), a “remarkably rosier picture” than previous projections showed.
Graph 1: Projected Scottish and UK Fiscal Balances (£/capita), 2021–22 to 2027–28
One of the factors behind this improved position is that the much of the UK revenues from oil and gas are from production in Scottish waters. Note that this does not mean that the volume of oil being produced has increased but its value has, due to the increased oil and gas prices. This means that oil producers are generating significant profits and these profits are taxed by the UK Government (from January 2023, with the increase in the Energy Profits Levy, the headline rate of tax on profits will be 75% [3]).
A second factor is the new tax on the profits of electricity generators. Because Scotland accounts for a significant share of the UK’s electricity generation capacity, the IFS estimates that (with 8% of the UK’s population), 25% from this tax will come from Scotland.
The IFS analysis focuses on net fiscal balance estimates, which take account of all public spending, whether on the delivery of public services or capital investment that will be expected to generate positive returns. In most circumstances, some government borrowing makes sense, particularly when it is to fund infrastructure and other strategic investments that will grow the economy, which generate higher taxation revenues in the future. There is a general consensus that a deficit of 3% of Gross Domestic Product (GDP) can be sustainable [4].
To translate this to £ per person (to be comparable with the IFS analysis), that would imply that a fiscal deficit of around £1,100 per person in 2027-28 could be sustainable. The IFS is projecting that it could be around £3,000 by then, if the short term benefits from high oil prices are not sustained. The IFS analysis is clear that this is a short term situation that creates a window of opportunity for an independent Scotland. It provides time for an independent Scotland to realise the significant economic opportunities that currently exist.
“..the long-term decline in North Sea output means that even if higher oil and gas prices are sustained, at best they would buy the government of an independent Scotland time to boost onshore economic growth and revenues.”
David Phillips, Institute for Fiscal Studies (December 2022)
Tax Gap
This raises the question of why Scotland has a fiscal deficit at all.
A previous article by The Bottom Line (https://thebottomline.scot/the-costs-of-dependency-the-tax-gap/) looked at the underlying drivers of Scotland’s public finances, highlighting the impact on Scotland of the underperformance of the UK economy, of which Scotland is a part. As well as levels of prosperity being lower than they would have been if the UK economy was performing well, the tax revenues collected by the government to fund public services and provide the infrastructure that an advanced economy needs to thrive are lower than they would have been.
This is the tax gap that arises from Scotland being tied to the UK economy – and is the underlying reason for a deficit in the public finances.
As The Bottom Line’s tax gap analysis showed, had Scotland matched the average performance for advanced economies (including both large and small advanced economies) in 2019 that could have added £16 billion in tax revenues. If Scotland had matched the average performance of small advanced economies in 2019 that would have added £26 billion tax revenues (Graph 2).
Graph 2: Tax Gap
The tax gap can can also be presented in terms of £ per person, so that it can be compared with the IFS analysis. The £16 billion tax gap is equivalent to £2,900 per person and the £26 billion gap with small advanced economies is equivalent to £4,800 per person.
Given that the IFS projections are for a fiscal deficit of around £3,000 per person by 2027-28, in the circumstances that the short term benefits from high oil prices are not sustained, to reduce this to a sustainable level (of around £1,100 per person), would not require Scotland to close the tax gap with the small success economies. It would require that only 40% of the gap would need to be closed.
This demonstrates that addressing any deficit that an independent Scotland inherited from the UK is eminently achievable. There will not be a need to cut public spending or increase taxes to ensure that Scotland’s public finances are sustainable. What will be necessary, will be to address the underlying cause, which is the underperformance of the UK economy, of which Scotland has been a part.
Had the Scottish economy performed as well as the average small advanced economy in the last two decades it would have generated a fiscal surplus, even before taking oil revenues into account.
The Scottish economy grew so slowly because economic policy is reserved to Westminster and Scotland’s needs and opportunities are ignored. UK Government policy has been responsible, in large part, for the UK economy growing significantly more slowly over the last two decades than other comparable economies. For more details on this, see this previous article from The Bottom Line: https://thebottomline.scot/economic-growth/.
Growth and Transition
The need for all economies to transition to Net Zero presents Scotland with considerable economic opportunities. Scotland has great natural advantages including abundant renewable supplies of wind resources. Taking advantage of these sustainable resources over the next two decades should increase the rate of growth of the Scottish economy and, as a result, the total tax revenues generated.
What is required to generate the economic growth that will transform the public finances was also the subject of a previous article from The Bottom Line (https://thebottomline.scot/agency-and-independence-needed-to-escape-the-uks-economic-crisis/). That post set out a number of available measures that are available that would immediately increase the rate of growth without imposing significant demands on the budget:
– Allow the immigration that the economy needs;
– Rejoin the European Single Market; and
– Incentivise innovation and entrepreneurialism to realise the huge economic potential in the transition to Net Zero, including the renewable energy opportunities.
These are examples of measures that have repeatedly been successful when implemented, including in the successful small advanced economies that have been outperforming the UK. These are all measures that focus on the opportunities and needs of the Scottish economy.
Energy companies are beginning to invest some of the large profits they are earning from high energy prices in renewable resources like offshore wind.
Scotland’s natural capital, particularly the weather, means that it has a huge competitive advantage in renewable energy. Scotland is, therefore, in a position to capture a very large share of this investment, perhaps the biggest opportunity to transform the Scottish economy since the industrial revolution. The scale of the opportunity was recently set out in a report by the global economic strategy consultancy Landfall Strategy Group [5].
However, in order that the maximum economic and social benefits can be realised by these investments they need to be carried out within a policy framework determined by Government which includes:
– ensuring that the regulations and consenting procedures are efficient and timely;
– investing in the supporting infrastructure (including ports and an upgraded grid network);
– ensuring the sites and factories required for manufacturing and fabrication can meet the demand;
– an education and skills system that ensures that people who already live here or decide to move here are equipped for the jobs that will be created;
– planning for the economic opportunities that arise (which could include hydrogen production to allow for the export of the energy produced, as well as new investments in the green economy that will utilise the low-cost, secure, renewable energy).
A few of these policy areas are devolved to the Scottish Government, including education and skills and planning. However, key policy areas such as overall energy policy and regulation are reserved, as are the borrowing powers that would be required to finance some the supporting investments required.
Agency, Independence and Economic Policies for Transformation and Transition
Only a fully independent Scottish Government would have the range of powers required to design and execute the necessary policies. Under devolution Scotland lacks these powers, while the UK Government has shown no interest in developing the Scottish economy.
The Bottom Line’s first article, published in August 2022 (https://thebottomline.scot/agency-and-helplessness-and-scotlands-future/), highlighted the importance of agency to the economy and set out how independence would stimulate a move to a society of agency.
The agency that would be realised with independence is in contrast to Scotland’s economic helplessness as part of the UK, without the control and responsibilities to address economic problems and pursue opportunities.
The current high energy prices and Scotland’s renewable potential means that there is a historic opportunity to transform the Scottish economy. This opportunity will not be realised if Scotland remains part of the UK as the political constraints of the UK mean the necessary policies will not be implemented by a Westminster Government led by either of the main UK parties. Independence is essential so that the economic policies required can be implemented.
Sources
[1] As set out in the annual publication from the Scottish Government, Government Expenditure and Revenue in Scotland
[2] Institute for Fiscal Studies (1 December 2022), Scotland’s relative public finance position is set to improve significantly, but only temporarily
[3] HM Revenue and Customs (21 November 2022), Policy paper: Energy (Oil and Gas) Profits Levy
[4] For example, the European Union’s Stability and Growth Pact, includes a requirement to maintain a budget deficit of 3% or less.
[5] Landfall Strategy Group (2022), the Economic Opportunity for Scotland from Renewable Energy and Green Technology
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