Observations

The SNP’s fiscal plans and Scotland’s fiscal position

Date: 30 May 2017
Authors:
Publisher: The IFS

Today the SNP published their manifesto for the upcoming UK parliamentary elections. In it they set out a target of balancing the current budget by 2021–22 and plans for an increase in public spending over the next five years of around £120 billion relative to those set out in the March 2017 Budget. They also state that if they win a majority of Scottish seats, they believe they will have a strong mandate for a second referendum on Scottish independence once the ‘final terms of the [Brexit] deal [between the UK and the EU] are known’, and on a timescale chosen by the Scottish Parliament. In this context, this observation examines the state of Scotland’s underlying public finances and how they might evolve over the next few years given current economic forecasts.

The SNP’s fiscal plans for the UK

Before that though, a little more about the changes the SNP would like to see to the UK’s fiscal plans.

Like Labour, the SNP would like a target of balancing the current budget (the difference between tax receipts and day-to-day spending) by 2021–22, stating they would support borrowing only for investment purposes from that year onwards. Overall the SNP say their plans would allow £120 billion of extra spending between 2017–18 and 2021–22. This increase in spending – and borrowing – would be consistent with falls in national debt as a share of GDP, but at a slower pace than under current plans.

The additional day-to-day spending on public services the SNP plans would allow is less than that set out in Labour’s manifesto. On welfare though, the SNP plan to go further than Labour in reversing planned benefit cuts – ending the cash-terms freeze to working age benefits and revoking restrictions on tax credits and universal credit to the first two children in a family, for instance. Their plans imply a net increase in taxes relative to current plans – including an increase in the top rate of income tax, an increase in the bank levy, a bankers’ bonus tax and the cancellation of further cuts to corporation tax – although there would be tax cuts targeted at SMEs. However, unlike Labour whose plans mean increases in day-to-day spending will be largely funded from (much larger) tax increases, the SNP’s plans imply most of the increase in spending would be funded by additional borrowing.

The 2.3% of GDP target for overall borrowing set out by the SNP is consistent with investment spending increasing in line with the plans set out in March 2017 and implies lower investment than under Labour’s plans (an additional £250 billion over 10 years).   

Scotland’s public finances: the medium-term outlook

As well as proposing changes to the UK’s fiscal policy, the SNP’s manifesto set out plans that could have big implications for the management of Scotland’s public finances: a second independence referendum once the terms of the Brexit deal are known.

The latest Government Expenditure and Revenue Scotland (GERS) figures for 2015–16 estimate that the “net fiscal balance” – that is the difference between overall revenues and spending – in Scotland was in deficit by 9.5% of GDP, compared to a deficit for the whole of the UK of 3.8% of GDP. This difference reflects the relatively high levels of public spending in Scotland (around 11% higher per person than in the UK as a whole in 2015–16) which are not matched by tax revenues (which were around 5% per person below the UK average in the same year), following major falls in revenues from North Sea oil and gas.

Table 1 shows our latest projections through to 2021–22, based on the OBR’s March 2017 forecasts and the current government’s tax and spending plans. Over this period Scotland’s deficit is projected to fall to 6.7% of GDP, while the UK deficit is forecast to fall to 0.7% of GDP on the same basis. So over the next few years the gap between the two is projected to increase slightly as a percentage of GDP.

Table 1: Projected Net Fiscal Balance, UK and Scotland, 2015–16 (outturn), 2016–17 to 2021–22 (projections), % of GDP unless otherwise stated

Net fiscal balance

2015-16

2016–17

2017–18

2018–19

2019–20

2020–21

2021–22

Scotland

-9.5%

-8.4%

-8.5%

-7.7%

-6.8%

-6.8%

-6.7%

UK

-3.8%

-2.6%

-2.9%

-1.9%

-1.0%

-0.9%

-0.7%

 

 

 

 

 

 

 

 

Difference

5.7%

5.8%

5.6%

5.7%

5.8%

5.9%

6.0%

Difference (£ bn)

8.9bn

9.4bn

9.5bn

10.0bn

10.4bn

11.0bn

11.7bn

Source: Author’s calculations using GERS 2015–16, and OBR EFO March 2017. Further details at end of observation.

Note: UK figures are taken from OBR EFO March 2017. Outturn figures for 2015–16 differ from those reported in GERS 2015–16 (at that stage the UK’s net fiscal balance was estimated to be in deficit by 4.0% of GDP in that year).

In 2017–18 the difference is projected to be 5.6% of national income (8.5% less 2.9%), which in cash terms is equivalent to about £9.5 billion, or around £1,750 per person in Scotland. That is the size of the Scottish deficit on top of its share of the overall UK deficit (which is £880 per person in the UK in the same year).

While large, this fiscal gap is actually somewhat smaller than under our last set of projections. This is because the forecasts for the UK budget deficit have been revised up by more than our projections of the Scottish budget deficit. In particular, upwards revisions to offshore revenues from North Sea oil and gas (driven by an increase in the sterling oil price) have offset more of the downward revisions to onshore revenues for Scotland than for the UK as a whole. However current projections for oil revenues of around £0.7 billion a year are still much lower than they were at the time of the last Scottish independence referendum when the OBR was projecting that revenues would be around £3 billion a year and the Scottish Government even higher (up to £8 billion a year).

It is also important to note that while changes to the overall levels of tax and spending in Westminster could lead to significant changes in headline deficit figures for the UK as a whole, they would have similar effects for Scotland: higher spending would feed through the Barnett formula into higher spending in Scotland, for instance. Therefore the fiscal gap would be little changed. What matters most for the gap is the performance of the economy and underlying tax revenues in Scotland relative to the rest of the UK.

Implications for an independent Scotland

Although under its new Fiscal Framework, the Scottish Government gains or loses if its devolved revenues grow by more or less than equivalent revenues in the rest of the UK, it does not bear responsibility for the pre-existing large fiscal gap. That is, under present constitutional arrangements, Scotland is largely insulated from the consequences of its higher implicit budget deficit. That would change though under independence.

A deficit of 6.7% of GDP, for instance, would be unsustainable as continuing to borrow that amount would lead to ballooning national debt. A newly independent country facing such a deficit would need to cut public spending or increase taxes to reduce the budget deficit to a more manageable level.

However, our projections are based on the Scottish Government’s official GERS publication, which allocates to Scotland a population-based share of spending on things like defence and interest payments on the UK’s national debt. The projections also assume Scotland’s onshore revenues and spending grow in line with those in the rest of the UK. With this in mind it is worth noting:

  • The Scottish Government might be able to negotiate a good deal on the share of the UK’s debt it took on at independence. Lower debt would mean lower debt interest payments and would therefore reduce the budget deficit. However, even if an independent Scotland inherited none of the UK’s net public debt, its projected budget deficit would still be substantial: around 5.2% of national income (rather than 6.7%) in 2021–22 holding all other elements of our projections fixed.
  • Without spending cuts or explicit tax rises, significantly faster growth in underlying revenues would be required to reduce the deficit to sustainable levels. For instance, to reach an overall deficit of 2.3% of GDP by 2021–22 – the SNP’s target for the UK as a whole in that year – would require Scottish revenues to grow by 4.0% a year in real terms, compared to a forecast 2.3% for the UK as a whole over the same period.

Looking further ahead, independence could also affect Scottish economic performance. A weaker performance would tend to push up Scotland’s deficit. But if, as the Scottish Government have previously claimed, independence would allow policies to grow the Scottish economy more quickly, such faster growth would tend to push up revenues and reduce Scotland’s deficit. During the last referendum campaign, however, the main growth-enhancing policies proposed were tax cuts or spending increases. In the near term at least, such policies would tend to increase rather than reduce Scotland’s budget deficit.

Finally there are significant issues raised by Brexit. This may mean independence would bring benefits that were not as relevant when the expectation was that the UK would remain in the EU. An independent Scotland could seek to rejoin the EU and/or the European single market, which would bring it the benefits of preferential access to European goods and services markets. If businesses responded to the UK’s exit from the single market by shifting investment or employment out of the country, an independent Scotland might be able to exploit its geographical, cultural and institutional proximity to the UK to attract a good chunk of that. But an independent Scotland in the single market might face bigger trade barriers with the rest of the UK. Given that Scotland’s trade with the rest of the UK is worth around four times as much as its trade with the rest of the EU, the costs of these sorts of barriers could outweigh the gains from better access to European markets. The impact of Brexit on the economic and fiscal impacts of Scottish independence is therefore far from clear.

What is clear though is that the future trading relationships between Europe, the UK, and a potentially independent Scotland, and businesses’ responses to these relationships, are an important issue for debates about the economic and fiscal implications of Scottish independence. If a second independence referendum is held, in-depth analysis of the options and their impacts would be a vital contribution to public debate.


Notes on methodology for projecting Scotland’s fiscal position beyond 2015–16

In order to project forward the GERS 2015–16 figures to the period covering 2016–17 to 2021–22 using figures from the OBR’s March 2017 EFO, the following method is used:

  • Spending is projected on the basis that government spending in Scotland remains the same proportion (9.1%) of UK-wide government spending as in 2015–16.
  • Onshore taxes are projected on the basis that the amount paid per person in Scotland grows in line with forecast growth in onshore revenues per person for the UK as a whole. This means onshore tax revenues per person in Scotland are projected to be 95.5% of the average for the UK as a whole, as in 2015–16.
  • Offshore (oil and gas) taxes are projected under the assumption that Scotland’s share of overall UK offshore tax revenues remains the same as in 2015–16 at 78.5%.
  • Figures for Scotland’s deficit if it inherited a 0% share of UK central government debt are calculated by subtracting estimates for Scotland’s population share of the UK’s government net debt interest payments from our baseline projections for Scotland’s public spending.

We have chosen the assumptions on the basis of their simplicity and as a reasonable baseline case. As with any economic or fiscal forecast or projection, the projections outlined in this observation will differ from eventual outturns. This includes the OBR forecasts for the UK as a whole; and trends in spending and government revenues in Scotland relative to the UK. There are some reasons to suggest that, if anything, the assumptions are more likely to lead us to under-estimate rather than over-estimate Scotland’s fiscal deficit relative to that of the UK as a whole. First, during periods of public spending restraint, the Barnett formula tends to lead to spending levels in Scotland increasing relative to those of the UK as a whole. Second, Scottish Government plans to borrow additional money to fund capital investment mean Scottish Government spending may fall less between 2015–16 and 2021–22 than equivalent spending in the rest of the UK. This would tend to increase Scotland’s share of overall UK government spending; in contrast, we have assumed this share would remain constant. Third, the OBR forecasts revenue growth to be particularly strong for taxes like capital gains tax, inheritance tax and stamp duties, which make up a relatively smaller share of Scottish revenues. All else equal, this would tend to suggest growth in revenues per person in Scotland would be lower than for the UK as a whole.

 

IFS Election 2017 analysis is being produced with funding from the Nuffield Foundation as part of its work to ensure public debate in the run-up to the general election is informed by independent and rigorous evidence. For more information, go to http://www.nuffieldfoundation.org.