The Deputy Director of the Institute for Fiscal Studies [IFS], Carl Emmerson, presented a perspective - Scottish independence: the fiscal context – to an Economic and Social Research Council [ESRC] seminar on Future of the UK and Scotland in the House of Commons on 12th June 2013.
His purpose was to look at the fiscal context within which Scotland sits and would sit as a member of the United Kingdom; and then to look at the position of a separate Scotland, the challenges and the options that would be open to it.
The UK fiscal picture
Mr Emmerson first looked at the current and future position of the UK as a whole, saying: ‘The UK faces significant fiscal challenges from both the recent financial crisis and longer term public finance trends’.
The picture he showed here is one of the UK budget’s primary balance propelled deeper into deficit by the financial crisis of 2008, reaching its nadir in 2010 at just over -9%. This means that, before interest payments on the national debt are added, the balance of income against expenditure is already in deficit of -9%. [Mr Emerson shows the UK primary budget pulled back to a deficit of around -6% this year.]
As well as affecting the primary balance of the budget, the impact of the collapse of the financial institutions in 2008 forced upwards the national debt, with Mr Emmerson predicting that debt to peak around 2015 at something like 86% of GDP – or of National Income, which is almost the same thing.
The respected Wall Street Journal sees the UK’s debt-to-GDP ratio peaking this year, at 87.4% and then slowly falling.
A debt-to-GDP ratio of below 50% is reckoned to be healthy. 90% is seen as the danger threshold, beyond which the cost of interest payments requires more expensive borrowing that drives up the total debt. At this point, a nation in such a position can only try to pull the situation back by hiking taxes or sharply cutting public spending – or both.
EU member states are supposed to keep their debt-to-GDP ratio to below 60%, although many do not and several are well above this level. This is a major factor of the suppressed concern for the survival of the eurozone and of the single currency.
The overall UK fiscal picture presented by Carl Emmerson a week ago is one of a primary budget in deficit alongside a rising debt-to-GDP ratio which will peak this year or within the next couple of years – at a point just below the danger level.
This scenario sees the UK primary balance moving towards equilibrium from now on – into surplus in 2018 – and with the debt-to-GDP ratio also falling back slowly after 2015.
Looking further into the future for the UK, with the impact of an ageing population on public spending, Carl Emmerson sees 2035 as a watershed, with the budget starting to fall back into progressive deficit and the debt-to-GDP ratio, by then pulled back to around 57%, starting to rise, hitting 90% of GDP in 2061.
As part of the UK, this scenario would be Scotland’s experience too.
The fiscal picture for an independent Scotland
Moving to an examination of the fiscal picture for an independent Scotland, Mr Emmerson says first that Scottish spending per capita is higher than that of the UK; and that Scotland’s per capita non-North Sea tax is similar to the UK’s.
This means that, taking no account of revenues from the oil and gas sector – and assuming that its public spending remained at the same level as currently, Scotland’s primary budget would be in increasing deficit, with per capita tax earnings the same as the UK’s and per capita spending higher.
Mr Emmerson then makes certain assumptions and shows what, historically – up to 2011 – the fiscal picture for Scotland would have been in these hypothetheses, compared to that of the UK.
He demonstrates that if Scotland had received a share of the UK oil and gas asset based on relative population, its primary budget would have been consistently in deficit below the level of the UK’s deficit.
Had Scotland received a geographic share of this resource – the fairest allocating principle [and it is inconceivable that Scotland would accept anything else], the revenues accruing from such a share would see the budget of an independent Scotland largely mirror that of the UK and, from 2010, perform better.
This demonstrates the accuracy of Mr Emmerson’s calculation that: ‘in recent years a geographic share of North Sea oil revenues would have been enough to finance the higher public spending per head in Scotland’.
However, this is relative. That ‘better than the UK’ performance would still have seen Scotland’s primary budget running at a deficit of -5% last year, 2012.
The deployment of the total revenues from the oil and gas sector to filling the gap of higher per capita public spending – and still producing a deficit – would see the country with scant, if any, resources to drive growth.
Then there is the issue Mr Emmerson does not address – and that is the addition to the primary budget of Scotland’s debt-to-GDP ratio and the interest payments accruing from this debt.
The stable estimate of an independent Scotland’s share of the UK national debt [running at £1.4 Trillion] is £140 BN. This would be inherited debt alone. No one knows the level of the debt that would be incurred from the substantial set-up costs for an independent Scotland, a matter whose component parts we have outlined before.
The First Minister, in the document, Scotland’s Economy, he presented at a media launch, gave the figure of £150BN as Scotland’s GDP, assuming a geographic share of the UK oil and gas asset.
With a minimum national debt of £140 BN, that would see an independent Scotland’s debt-to-GDP ratio at 93.3% – over the danger threshold from the outset and before the debt incurred from set-up costs was added.
The running fiscal challenges for an independent Scotland
Looking to a post-independence future, Carl Emmerson says: ‘More important is the longer term where the public finance challenges facing an independent Scotland if anything appear greater than those facing the rest of the UK’.
Here he is looking at factors affecting the twin budgetary forces of taxation and spending, revenues and outgoings.
On the positive side of the budget – and state earnings come from taxes of various kinds, Mr Emmerson says that an independent Scotland would have room to improve on the design of the UK tax system.
However, ‘improvement’ of tax systems, in the context of an endemic budget deficit, is about how to raise more money from taxes; and that will always more reliably come from ordinary people who have much of their taxes deducted at source in various ways.
Moreover, Mr Emmerson says that Scotland’s ‘very open economy may make it harder to raise revenue’.
An ‘open economy’ is one where there are economic activities between the domestic community and outside it, with people and businesses trading in goods and services with other people and businesses in the international community and with a flow of investment funds across the border in both directions.
The economist’s description of Scotland’s economy as ‘very open’ includes cognisance of the businesses and business sectors externally owned, with their profits exported.
There is pretty well no such thing as a closed economy in the 21st century but the degree of openness of a specific economy impacts upon its capacity to raise earnings through taxes.
Carl Emmerson’s scenario is one of limited potential for Scotland to earn more from taxes other than from its resident taxpayers.
On spending, he notes:
- ‘The Scottish population is older and is projected to age faster than rest of UK and has greater reliance on disability and sickness benefits at all ages’ – highlighting the likelihood of a widening gap between Scotland’s already higher per capita public spending and that of the UK; and a widening budgetary gap between what we can earn and what we must pay.
- ‘Careful choices would need to be made on basis of clear analysis of priorities over short and long term’ – most probably referring to choices on the level of spending on welfare and pensions.
He homes in on the issue of potential benefits arising from higher spending, asking: ‘should defence spending be higher than most other small countries’?
The issue here is that while strategic, judicious and controlled higher spending can fuel crucial growth, how and why would spending comparably more on defence contribute to that?
Much of defence procurement spending would inevitably leave the country, negatively affecting the balance of payments; and staffing costs would swell public sector spending even more. We do not currently pay a defence force.
It would make a lot more sense to look at higher public spending on infrastructure – on future-proofed roads, airports, interconnecting flights and fibreoptics to open up access to the regions, leaving it to the private sector to take advantage of the opportunities substantially improved access would create.
But here the choice would have to be made between spending to pour the foundations for growth or spending on current or enhanced welfare benefits. Oil revenues cannot cover both.
We are on the record as saying that the only realistic hope of economic sustainability for an independent Scotland would be to spend every single petrodollar on infrastructural development targeted on growth potential; and to cut our social costs to the cloth we can weave from an affordable tax regime to pay for them.
Tellingly, Mr Emmerson concluded his presentation at the ESRC seminar by repeating his sober assessment: ‘More important is the longer term where the public finance challenges facing an independent Scotland if anything appear greater than those facing the rest of the UK’.