Chapter 4: Scotland's Fiscal Position |
78. Independence would in principle allow the
Scottish Government to run its own policy on taxation and spending.
Mr John Swinney MSP, Cabinet Secretary for Finance, Employment
and Sustainable Growth in the Scottish Government, told us that
independence would create opportunities to "invest in growth",
"support key industries" and "tackle key social
issues" to "deliver the best results for Scotland".
This chapter addresses the question: to what extent would independence
in practice give a Scottish Government the scope to develop a
distinctive fiscal policy of its own?
79. Scotland's scope to develop a distinctive
fiscal policy after independence depends on both its choice of
currency and its share of current UK assets and liabilities. Since
the intention of the Scottish Government is to continue to use
sterling, as discussed in Chapter 3, the fiscal possibilities
are discussed in this context. The principles for dividing the
assets and liabilities were introduced in Chapter 2. North Sea
oil and the public sector debt are the most important asset and
liabilities and are discussed in more detail below.
North Sea oil and gas
80. The most important asset to be divided on
Scottish independence would be the oil and gas reserves under
the North Sea. The output is sold on world markets and the tax
revenues are currently collected centrally by HM Revenue and Customs
(HMRC). Over the past five years the average annual tax revenue
from oil and gas has been £9.4bn. This represents only 1.7%
of onshore tax revenues for the UK in 2011-12 but 20% of onshore
tax revenues for Scotland.
81. Professor Alex Kemp told us that the
median line would be the starting point for negotiations between
Scotland and the rest of the UK over division of North Sea oil
and gas reserves. He thought that "there would not be too
much controversy about that".
Most witnesses agreed that Scotland would gain approximately
90% of the oil and gas reserves.
82. The value of North Sea reserves depends on
future exploration, investment, oil price, tax policy and decommissioning
costs. Professor Kemp cited the most recent official estimates
of the remaining reserves in the North Sea as between 10.3bn and
33bn barrels of oil equivalent.
His calculation of the oil tax revenues which might have accrued
to Scotland from the UK Continental Shelf (UKCS) in past years
is shown in Figure 1.
Hypothetical Scottish Royalty and Tax
Revenues from the UKCS
(£m at 2009/10 prices)
Source: Professor Kemp written evidence
Professor Kemp's 'guesstimate' (to which we
referred in Chapter 2) is that net tax revenues in the Scottish
sector could range between £5bn and £10bn per year for
the next decade.
The revenue flows are large but volatile.
83. Volatility in the oil price translates into
volatility of tax revenues. For example, between 2008/09 and 2009/10
North Sea tax revenues halved from £12.9 billion to £6.5
billion. It is easier
for a large nation than a small nation to absorb the volatility
of oil revenues, as they constitute a very much smaller proportion
of total tax revenues. Professor David Bell noted that the
volatility of oil-based tax revenues makes "longer term planning
for public services
84. An independent Scottish Government would
need to ensure a seamless transition to a new framework of licensing,
taxation and health and safety provisions and so on for an industry
employing directly and indirectly almost 200,000 people. Professor Kemp
added that "investors and Government would have to think
about it much more".
85. An independent Scotland would benefit
substantially from tax revenues from a geographical share of North
Sea oil and gas reserves. But, as the revenue from North Sea oil
and gas would be a much larger proportion of total tax revenue
in an independent Scotland than in the UK, its volatility would
make it more difficult to conduct economic policy.
Public sector debt
86. Our witnesses agreed that the UK's public
sector debt should be shared by population. The most widely used
measure of public sector debt is the Public Sector Net Debt (PSND)
which was £1,104bn or 71.8% of UK GDP in the fiscal year
ending in March 2012.
Assuming that 8.4% of this debt is allocated to Scotland (so the
share is £93bn) and North Sea oil is allocated on a geographical
basis, the ratio of Scottish debt to GDP would be approximately
61.6%. The public
sector debt to GDP ratio for the rest of the UK would be approximately
87. But this measure of debt does not include
known future public sector liabilities. According to the Office
for Budget Responsibility (OBR) these future liabilities for the
fiscal year ending March 2011 include inter alia: £960bn
of UK public service pensions; £32bn of UK private finance
initiatives; and £108bn of other expected future liabilities
(e.g. decommissioning nuclear power stations).
Ms Johann Lamont MSP argued that some of these future liabilities
clearly relate to Scotland.
Assuming that these future liabilities are apportioned on the
same population basis as the public sector debt, the total liabilities
of an independent Scotland would double to £185.4bn or 123%
of GDP including a geographical share of North Sea oil.
The UK currently has all of these future liabilities.
88. The Scottish Government aims for independence
in March 2016. The OBR projects that the UK's public sector debt
(PSND) will then be significantly larger, at £1,502bn or
85.1% of GDP.
This suggests that the public sector debt to GDP ratios for both
an independent Scotland and the rest of the UK would be significantly
higher than the figures for the fiscal year ending 2012 referred
to above. If, however, economic growth were faster than projected,
this prospective debt burden would lighten.
89. We recommend that existing UK public sector
debt should be apportioned between an independent Scotland and
the rest of the UK by share of population. We also recommend that
the UK's known future liabilities, such as public sector pensions
and private finance initiatives, should be apportioned on the
same population basis unless they can be clearly identified as
applying to a particular nation only.
TRANSFER OF PUBLIC SECTOR DEBT
90. Transfer of an agreed share of the UK's public
sector debt to an independent Scotland would not be straightforward.
The terms on existing UK debt could not simply be altered to allow
some to be owed by Scotland. This would constitute a meaningful
change in contractual terms and would be a default. It would also
take a newly-independent Scotland some time to establish a credit
history successfully to issue enough debt to take on its share
of the UK's liabilities. As Sir Nicholas Macpherson, Permanent
Secretary of the UK Treasury, said: "Scotland will have to
go into the market [and] it will not have the track record of
the UK authorities, the sophistication of our debt management
operations, or the extraordinary length of our yield curve,
all of which means that it will face quite big risks."
Professor Bell noted that it was not clear how to assess
the credit-worthiness of an independent Scotland in the absence
of a credit history.
91. Transferring to an independent Scotland
its agreed share of UK liabilities would be fraught with difficulties.
Creditors might not agree to a straight transfer of public debt
from the UK to an independent Scotland on otherwise identical
terms. The Scottish Government should explain to voters before
the referendum how it would in practice take over its agreed share
of UK public sector debt and future liabilities on independence.
Scotland's 'separate' fiscal
92. The Government Expenditure and Revenue Scotland
2011-12 (GERS) report provides a sketch of Scotland's fiscal accounts.
The spending data mostly reflects actual spending in Scotland
whereas much of the revenue data is imputed from UK data. Public
sector spending per person, measured by total managed expenditure
(TME), has been on average £1,160 higher in Scotland than
the UK overall over the last five years. By contrast there has
been little difference in reported tax revenue raised per person.
This is shown in Figure 2 where the difference between the two
bars is the fiscal deficit per person. In 2011-12 the deficit
per person was £3,390 in Scotland and £2,052 in the
UK. This is before any re-categorisation of North Sea oil and
Public sector spending and taxation per
Source: Government Expenditure and Revenue Scotland
93. The GERS report also presents an approximate
fiscal balance for a separate Scotland. Without including any
tax revenues or output from North Sea oil and gas, Scotland's
separate fiscal deficit might be around £18.2bn or 14.6%
of GDP in 2011-12. If, however, North Sea oil and gas revenues
and output are apportioned on a geographic basis, as expected,
the deficit for a separate Scotland might be £7.6bn or 5.0%
of GDP in 2011-12. This is significantly lower than the OBR's
estimate of the fiscal deficit (PSNB) for the UK overall of 7.9%
of GDP in 2011-12. If the North Sea oil and gas output and tax
revenue had been allocated to Scotland the fiscal deficit of the
rest of the UK might be around 8.7% of GDP.
Alternative measures of Scotland's fiscal
|Public sector spending (TME), £bn
|Fiscal balance, £bn
|Fiscal balance, %GDP
|Fiscal balance incl. NS oil, £bn
|Fiscal balance incl. NS oil, %GDP
|UK PSNB, % GDP||-6.9%
Note: Where North Sea (NS) oil is included in
the table it is assumed that this is apportioned on a geographic
Sources: Government Expenditure and Revenue Scotland
94. As things stand, most of the tax revenue
is simply collected by HM Revenue and Customs (HMRC) and returned
to Scotland as a block grant. GERS data do not therefore, represent
amounts actually raised in Scotland. Instead they impute a large
part of the revenue figures to Scotland from UK totals using a
variety a methods. The Institute of Chartered Accounts of Scotland
(ICAS) stated: "Let no-one be misled, there are no official
statistics for tax paid by those in Scotland, simply because there
has never before been a need to measure them."
ICAS also reported to us that "to design and implement
an independent tax system in Scotland from scratch may realistically
take a decade if not two, shorter if a more limited devolution
of powers is involved".
If Scotland becomes independent the taxes paid in Scotland would
no longer transfer to HMRC but remain in Scotland. The block transfer
to Scotland would cease to exist. Professor John Kay said:
"There could be no continuing transfer of this kind [the
block grant] and Scotland would have to finance its activities
from its own revenues."
Whether this might involve tax increases or reductions can only
be determined once it becomes clear what the actual tax yield
is for Scotland.
95. Lack of data on the tax base in Scotland
impedes full understanding of the economics of independence. Although
there can be no certainty we recommend that the Scottish Government
and HMRC work together to make the best possible estimate of the
tax base in Scotland.
96. An important factor which will influence
an independent Scotland's fiscal sustainability is its future
demographic profile. The Chief Secretary to the Treasury told
us that Scotland's population is aging faster than for the UK
Figure 3 shows an old age dependency ratio defined as the
number of over 65 year olds relative to the working age population.
The public purse in Scotland will face higher demands as a result
of both the faster rise in the share of over 65 year olds relative
to the work force and the more generous public sector support
to retirees. Sir Nicholas Macpherson recalled that the newly-independent
Irish state had to cut the value of the state pension in Ireland
in 1924 to keep its public finances on track because of similar
Since Scotland's old age dependency ratio seems likely to worsen
in future years, investors may charge a higher cost of capital
before it materialises.
Old age dependency ratio projections (65+
year olds / 16-24 year olds)
Source: Office for National Statistics, 2010 projections
97. International investors will ultimately express
their confidence in the sustainability of the finances of an independent
Scotland through the cost of borrowing. Some small countries have
high credit ratings. Professor Gavin McCrone noted: "The
Swiss can run themselves perfectly satisfactorily and have very
low interest rates, and so can the Norwegians. So it can be done."
Four countries in Europe (Norway, Denmark, Switzerland and Sweden)
often cited as comparators of an independent Scotland all enjoy
the highest credit rating. Each of these countries, however, has
its own currency and in some cases a long track record of sound
finances and a low debt burden. Sir Nicholas Macpherson pointed
out, as already noted in paragraph 46:
"Even countries that are pursuing incredibly
tight fiscal policies, such as the Netherlands and Finland,
pay a premium on their debt compared to Germany. So even on day
one, if Scotland was pursuing a surplus, there would probably
be some sort of premium."
Fiscal Policy in a Currency Union
98. Witnesses were clear that fiscal problems
in an independent Scotland would have consequences for the rest
of the UK. Professor Jim Gallagher thought "good neighbourliness"
would require the rest of the UK to help as the UK helped Ireland
in 2010: "If I were sitting in the Treasury, I would say
that there is always a risk that the markets will think that we
will feel obliged to stand behind an independent Scotland, and
therefore the amount that it borrows is inevitably of interest."
99. The Bank of England might also have to provide
emergency liquidity support to Scottish banks, as discussed in
Chapter 3. Rt Hon Alistair Darling MP said that in a currency
union with the Bank of England providing full central bank services,
"we would presumably say 'okay, we're guaranteeing the Scottish
banks, so someone needs to guarantee that payment to us' in the
same way that currently the UK Government guarantee the Bank of
In the financial crisis of 2008, liquidity support from the Bank
of England was insufficient. The UK Government bought newly issued
shares to recapitalise the banks. Mr Darling reminded us
that the total support extended to RBS during the financial crisis
was equivalent to 211% of Scotland's GDP but only 21% of UK GDP.
While RBS was too big to fail for the UK it would have been too
big to save for an independent Scotland alone.
100. Almost all witnesses expected that the rest
of the UK would seek to impose limits on Scottish borrowing and
debt in the event of a formal currency or monetary union. The
Fiscal Commission Working Group acknowledged: "A common requirement
for countries in a monetary union is an agreement over the overall
fiscal position of each member (i.e. net debt and borrowing).
This is to ensure that the fiscal position of one member state
does not destabilise the monetary union."
101. Within a formal currency union, were there
to be one, the rest of the UK would clearly be the dominant partner.
There may be parallels with the dominant core of the Eurozone
and the policy coordination problems that arose with its weaker
member states. The rest of the UK's policies might take scant
account of an independent Scotland's interests. Mr Darling
reminded us: "It was actually France and Germany that drove
a coach and horses through that [the stability and growth pact],
who calls the shots in Europe."
102. Some witnesses thought an independent Scotland
would retain some room for manoeuvre over the composition of taxation.
Mr Jeremy Peat of the David Hume Institute said: "There
is a great deal of ability to vary individual taxes and indeed
to operate the public finances independently, subject to an overarching
constraint or two as to the overall fiscal position and the sustainability
of that position."
Mr Swinney made clear the Scottish Government's interest
in having the power to vary corporation tax as a means to promote
103. Professor Kay warned that within a
single market "there are some areas where competition
is destructive and corporation tax is one example".
Professor Gallagher agreed: "There is a general view
and understandable principle that varying any taxation is a distortion
of market activity. Varying tax across the territory is a greater
104. A monetary union as advocated by the
Scottish Government would require robust and credible limits on
borrowing and indebtedness by both member states. So far the Eurozone
has found this problem intractable. The Scottish and UK Governments
would need to reach agreement on detailed and credible fiscal
restraints, including sanctions for breaches, before the referendum
if Scottish voters are to make an informed choice. We believe
that it would be difficult for any such agreements to be made
binding in all circumstances.
105. Currency and fiscal unions offer scope for
risk sharing between the nations in the union. The British Academy
stated: "As is the case with federations such as the United
States, automatic stabilisers and risk sharing measures are part
of the UK's current fiscal system. In the event of a local shock,
tax revenue goes down and social security payments go up, thus
cushioning the shock. These would be lost by an independent Scotland,
and thought would have to be given to how they could be replaced."
106. Mr Alexander also drew attention to
the UK's automatic fiscal stabilisers, for example transfer payments
through the welfare system, which cushion regional impacts. He
said: "Those transfers would not be available in the context
of an independent Scotland.''
Dismantling the current fiscal union would result in
a loss of risk-sharing mechanisms between an independent Scotland
and the rest of the UK. This would be an adverse consequence for
the citizens of both states, but particularly for people in Scotland
given the relative size of the two countries.
107. With no track record of issuing debt
securities, the difficult mechanics of taking on a share of the
UK's public sector debt, volatile tax revenue and the loss of
risk-sharing with the rest of the UK, an independent Scotland
would face considerable fiscal challenges.
93 Q 864 Back
Government Expenditure and Revenue Scotland 2011-12, tables 4.1
and 2.3 and Office for Budget Responsibility, Economic and
Fiscal Outlook, table 4.6, December 2012 Back
Q 548 Back
Professor Kemp paragraph 17 Back
Q 553 Back
Government Expenditure and Revenue Scotland 2011-12, table 4.3 Back
Q 16 Back
Q 550 Back
It is the total issued financial liabilities (government bills
and gilts and National Savings debt) minus liquid assets (foreign
exchange reserves and cash deposits) measured on a cash basis
(so without accruals). This is an ONS statistic. Back
The Government Expenditure and Revenue Services report estimate
Scottish GDP for 2011/12 including a geographic share of North
Sea oil to be £150.9bn. Back
Office of Budget Responsibility (2012), Fiscal Sustainability
Ms Johann Lamont paragraph 6 Back
Negative net balances on working capital and other assets (i.e.
liabilities) may also have to be apportioned (depending on what
they were used for) which would increase the liability figure
Office for Budget Responsibility (March 2013), Economic and
Fiscal Outlook, Table 1.4 Back
Q 513 Back
Q 7 Back
Institute of Chartered Accounts of Scotland question 3 Back
ibid. question 6 Back
Q 65 Back
Q 503 Back
Q 503 Back
Q 164 Back
Q 512 Back
Q 634 Back
Q 624 Back
Q 570 Back
Q 570 Back
Fiscal Commission Working Group (February 2013), First Report
- Macroeconomic Framework, par 5.99 Back
Q 566 Back
Q 536 Back
Q 898 Back
Q 108 Back
Q 629 Back
British Academy paragraph 20 Back
Q 503 Back