UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 140-xi

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Scottish Affairs Committee

The Referendum on Separation for Scotland

Tuesday 10 December 2013

Paul Johnson, David Phillips and Gemma Tetlow

Evidence heard in Public Questions 3964 - 4041

USE OF THE TRANSCRIPT

1.

This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.

2.

Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.

3.

Members who receive this for the purpose of correcting questions addressed by them to witnesses are asked to send corrections to the Committee Assistant.

4.

Prospective witnesses may receive this in preparation for any written or oral evidence they may in due course give to the Committee.

Oral Evidence

Taken before the Scottish Affairs Committee

on Tuesday 10 December 2013

Members present:

Mr Ian Davidson (Chair)

Mike Crockart

Jim McGovern

Graeme Morrice

Pamela Nash

Lindsay Roy

________________

Examination of Witnesses

Witnesses: Paul Johnson, Director, David Phillips, Senior Research Economist, and Gemma Tetlow, Programme Director, Institute for Fiscal Studies, gave evidence.

Q3964 Chair: Welcome to this meeting of the Scottish Affairs Committee. As you are probably aware, we are undertaking an investigation into various aspects of separation. Obviously your best-selling report has been drawn to our attention, and we thought it was so significant that we would invite you along to speak to us.

Would you start off by introducing yourselves and giving us a brief background for the framework within which you have drawn up the report?

Paul Johnson: I am Paul Johnson, director of the IFS.

Gemma Tetlow: I am Gemma Tetlow, programme director for our work on pensions and public finances.

David Phillips: I am David Phillips, a senior research economist at the IFS. I have looked at public spending in Scotland as part of this work.

Paul Johnson: The background to this particular piece of work is as part of a big ESRC funded programme of work on Scottish independence. We were specifically looking at fiscal issues, building on a lot of work we have done in the UK on public spending, taxation and public finances. What was published a couple of weeks ago was the last part of that. We published some work a year or so ago on the immediate fiscal consequences. We then published a series of papers on welfare, taxation and spending in Scotland specifically. The most recent publication looked at long-run public finance consequences for an independent Scotland, very much in the same kind of way that the OBR does its long-run projections for the UK as a whole.

Q3965 Chair: Before we get into the meat of it, you are obviously aware that you, like everybody who raises any questions about separation, are being accused of talking Scotland down and being anti-Scottish. During the discussions we have about particular points, it would be helpful if you made us aware of any particular objections that have been made to the points you raised and gave us your response. Clearly we are working off the report. We have seen some of the press coverage and some of the comment that has been made on your report. Presumably, being sensitive authors, you have paid more attention to the responses that have been made than we have. If there is anything in particular where you think somebody has simply missed altogether the track of what you have been saying, or where you think upon reflection there may be a point that you omitted, it would be helpful for the Committee and for those who watch and read our deliberations to have it drawn to our attention.

You predicted that "a significant further fiscal tightening would be required in Scotland, on top of that already announced by the UK Government." Could you explain to us how you go about making your projections and why you have come to that conclusion?

Paul Johnson: I will start, and I am sure Gemma will fill in. What we did for this report was to try to look, essentially, at the mechanical effects of changes over a long period in the demographics of Scotland, in the same way, as I said, that the OBR does for the UK as a whole.

Feeding into the beginning of that is obviously a set of initial numbers about levels of spending and taxation per head in Scotland. Quite a lot of what follows all the way through, in terms of why Scotland looks different from the rest of the UK, is that those initial numbers are different. Spending per head in Scotland is rather more than in the rest of the UK. At the moment it is pretty much balanced by additional revenues from North sea oil. Our assumptions about North sea oil in the short run make quite a big difference to the position of Scotland in the long run, but essentially we have something which looks at the tax per head by age at the moment and the spending per head by age, for at least some kinds of spending, and projects that forward with a series of demographic assumptions into the future. It looks at how much tax is raised and how much spending will be spent on current policy. It is mostly constant as a proportion of earnings or national income going forward. That leaves you with a gap at the end.

It is worth saying that there is a significant gap at the end for the UK as a whole on these projections, largely driven by demographic change. What we see when we push this through for Scotland is a rather bigger gap at the end, largely driven by the bigger gap at the beginning, because spending per head is higher, but taxes, other than North sea oil, are much the same.

Gemma Tetlow: The only thing I would add is that this type of modelling is inherently dependent on the assumptions that you put into the beginning of it-for example, as Paul alluded to, how quickly you assume certain items of spending grow in the future. We assume that public service spending grows in line with average earnings in the economy. We have made an assumption about the profile of migration into Scotland and down into the rest of the UK in the future.

We therefore made an effort in the report to present a number of different scenarios to show the sensitivity of the exact final results to those assumptions. The big picture-that Scotland faces a more challenging fiscal challenge over the next 50 years compared with the UK as a whole-was rather robust to a number of alternative sensible assumptions you could make about some of those, including the medium-term outlook for revenues from the North sea and the longer-term position for revenues from that source.

David Phillips: I do not have much to add. I would emphasise that the short-term picture is still quite uncertain. As Gemma pointed out, the starting position in 2016-17 is still quite uncertain because there is uncertainty about oil revenues in the short term. In the longer term, under the various scenarios we look at, despite that uncertainty, they all point in the same general direction qualitatively. The quantitative findings are quite different, depending on the different scenarios you choose, but the qualitative picture looks more difficult in Scotland and stands out in all the different scenarios.

Q3966 Graeme Morrice: You mentioned that you used as a comparison the projections for the UK from the Office for Budget Responsibility. Have you done that on the basis that you agree with those projections?

Gemma Tetlow: We constructed our own model for the UK as a whole. In order to focus on what the difference is between the UK as a whole and Scotland specifically, we made the decision to try and replicate the OBR’s model as closely as possible. In doing so, we now understand much better what the OBR does. It is not perfect, and going forward we think there are ways you could improve that model, but almost deliberately we wanted to start from the position for the UK that was the familiar picture the OBR have set out for the last few years, and then talk about differences for Scotland and the UK on that basis.

Our model for the UK is slightly different from the OBR’s, but we have a slightly more optimistic outlook for the UK in our model than the OBR does. To the extent that our picture is worse for Scotland, it is not because we are starting from a more pessimistic outlook for the country as a whole.

Q3967 Graeme Morrice: Apparently, one of the responses to the projections of spending and taxation over so many decades is to brand them as largely fantasy. Indeed, the Scottish Government almost said as much about your report. How would you respond to that?

Paul Johnson: If they were predictions, they would be fantasy, but they are essentially a planning tool for understanding what might happen if nothing is done. Nobody is suggesting that either the UK or Scotland will end up in the position that these numbers look like in the long run, but what it does tell you is that if you carry on with current policies under a certain set of assumptions, that is where you are in danger of ending up.

One of the things that you see in these figures is that relatively small changes to policy in the short run can have quite a big effect on what the figures look like at the end. You should see it as a tool for understanding the consequences of inaction rather than in any sense a projection of anything that is likely to happen. What is really important here, as Gemma said, is to look at what these numbers look like under different sets of assumptions. We have run through quite a lot of those different sets of assumptions in the report.

The key message from the OBR report, for instance, is that, first of all, because the population is ageing, there is a fiscal challenge that will have to be dealt with. It is certainly dealable with. What our report shows is that qualitatively the same is also true in Scotland, but maybe it will be a bit bigger.

Q3968 Graeme Morrice: Would you suggest that the comment from the Scottish Government is perhaps a tad unfair?

Paul Johnson: It appears to start from an assumption that we are trying to do something that we are not. As I say, if we were trying to make predictions, it would be entirely fair to say that it is absurd to predict 50 years forward, but what we are saying is that this is a tool for helping you to understand the scale of the challenge.

Q3969 Graeme Morrice: How can you possibly make projections that far into the future with any kind of certainty at all?

Paul Johnson: I do not think it is with any great certainty. As I said, this is an illustration of what would happen under a reasonable set of assumptions, and showing what that looks like under different assumptions. It would be foolish to say that it encompasses any kind of certainty, but what it does encompass is a sensible set of judgments about how the world is developing, how demography is changing and what, with nothing else happening, that changing demography would do to the tax and spending situation. It is a tool for helping you realise that something will need to be done over the next, relatively small number of years in order to stop something nasty happening in the long run. It is not intended as an idea that this is certainly what will happen.

Q3970 Pamela Nash: I will not be the only person in this room who had a Yes Scotland campaign newspaper put through their door in recent weeks. Within that were lots of figures and information about revenue and how Scotland’s wealth compares with the rest of the UK. Even if you have not seen it, I am sure you are familiar with the figures that the Scottish Government are using. Can I ask you about the accuracy of those compared with your findings?

David Phillips: There are a number of different statistics that the Scottish Government have been using. First, they have been using the GERS figures-Government expenditure and revenue in Scotland-which cover the years 2011-12. Our own analysis of the taxation and Government spending picture in Scotland also makes use of those data. On the whole, we think the data are fairly reliable. In a number of areas you have to make certain assumptions about how to allocate certain taxes and spending to Scotland. Corporation tax is an example. It is quite hard to know how much of that comes from Scotland and how much comes from the rest of the UK. They use one method; HMRC has put out different statistics, which leads to a different method and comes out with different numbers. Both are imperfect measures, but neither looks particularly silly to use.

The underlying figures used on GERS look reasonably credible about the situation in Scotland in 2011-12. The figures produced on Scotland’s national income and GDP look to be reasonable as well. They are largely based on ONS data for the national accounts for the UK as a whole.

There have also been projections forward to 2016-17 as part of the Scottish Government’s White Paper. Whilst they are more optimistic than our basic case, which is based on the OBR’s projections for oil revenues from the March Budget, they are within the range of sensitivities we look at for the short term.

Gemma Tetlow: To add to what David said, we have assumed that the numbers that the Scottish Government are using for 2011-12-which suggest that more tax was raised per head in Scotland than in the rest of the UK and that although spending was higher, it was more than offset by the higher level of taxes that were raised-are the same numbers that we use in our long-run projections. The differences in the messages are that 2011-12 was an unusually bumper year for revenues from oil and gas.

Q3971 Pamela Nash: Could you explain why that is the case?

Gemma Tetlow: It is a very volatile revenue source. If you look back over time, it goes up and down a huge amount. In 2012, there was a major shutdown at one of the oil rigs, which substantially reduced production and therefore reduced the revenues that were raised. A very similar thing happened again in 2013, which led the OBR to revise their latest forecasts for oil revenues for this year down by £2 billion. It is just highlighting that this is quite a volatile revenue stream, which, at the UK level, is relatively small.

Q3972 Pamela Nash: Perhaps I should have used the word "appropriate" rather than "accurate". I am not saying that the figures are false, but are they the best measure to allow people to make the decision? You mentioned the volatility of the oil market. Are figures being made available-or do you have figures-that a lay person could average over a period of time to make it a better comparison, rather than just using the 2011-12 figures that have been used by the Scottish Government?

Gemma Tetlow: To do the full GERS analysis, which the Scottish Government will be doing early next year, is a reasonably large exercise. In the specific case of oil and gas revenues, we obviously already know what those generated last year. That is a known quantity. Taking that into account, the numbers in our report suggest that spending would have exceeded revenues in Scotland by a larger amount than in the rest of the UK in 2012-13, which does reverse the picture in 2011-12.

I think you are right: the much more important question is abstracting from that volatility, because there are obviously ways that you could manage that volatility by smoothing over time. One of the reasons, to answer the previous question, for taking a much longer-term view is that there is a huge amount of uncertainty about exactly how much revenue will be raised from oil and gas over even the next 10 or 20 years. Looking much further ahead, most projections would suggest that we will eventually deplete our oil and gas reserves; therefore, that is a longer-term challenge one needs to be prepared for, particularly in the context of an independent Scotland where that would start off as a very large revenue stream-a very large component of total revenues for Scotland.

David Phillips: The question is not about the accuracy of the figures, but the potential relevance of the figures. The figures for 2011-12 refer to the past, and already by 2012-13 there was a decline in oil revenues, which the OBR thinks is going to continue. The Scottish Government think it will rebound. The benefit of our work is that it is forward-looking rather than looking at past figures on the fiscal position.

Paul Johnson: The key point is that the fiscal policy needs to be robust to different possible outcomes. An independent Scotland might be lucky-they might get levels of oil revenues as they have been in the past, and that would be wonderful for them-but they might not. Fiscal policy needs to be robust to the "might not" bit.

Q3973 Pamela Nash: To sum up, would you say that the figures they are using would be an absolute best-case scenario for Scotland to calculate the revenue?

Paul Johnson: The White Paper figures are not quite as best-case as our best-case numbers, but they are pretty positive.

Gemma Tetlow: Certainly the OBR’s current central forecast for oil and gas revenues is well below the numbers that were used in the White Paper. Our best case in our reports uses the most optimistic scenario from the Scottish Government’s oil and gas bulletin earlier this year. They did not choose to use that most optimistic case in their recent White Paper; they used one of their more central scenarios, but it is still above the OBR’s estimate.

Q3974 Pamela Nash: Apart from differences in oil prices, are there any differences at all between the fiscal projections produced by the Scottish Government and your own?

Gemma Tetlow: We agreed entirely on most components, with the exception of debt interest spending. The White Paper presented a scenario where Scotland got a population share of debt and paid the same level of interest rate as the UK. They also presented a lower scenario for debt interest spending, which involved an independent Scotland taking a less-than-population share of debt. In our report we looked at a couple of different scenarios. Obviously that would be one area for negotiation between an independent Scotland and the rest of the UK.

In terms of debt interest borrowing rates, in our report we only looked at scenarios involving either the same level of interest rate as charged to the UK as a whole, or higher levels of interest. That was on the basis of some work that the National Institute for Economic and Social Research did, which suggested that a small independent country like Scotland would face some premium on their borrowing rate over the UK’s.

Chair: Could I stop you there? Unfortunately, we have a vote.

Sitting suspended for a Division in the House.

On resuming-

Q3975 Chair: We have a quorum so we can start again. Ms Tetlow, have you finished your points?

Gemma Tetlow: I have one final thing to add. There was a small difference between our forecasts for onshore revenues in 2016 and what was in the White Paper. Essentially, the White Paper assumed that Scotland would continue to generate the same share of aggregate revenues in 2016 as it does now. We instead incorporated the demographic projections for Scotland and the rest of the UK. Essentially, the Scottish population is projected to grow less quickly over the next five years. Therefore, we projected slightly lower revenues-£1 billion lower-generated by Scotland in 2016 than the White Paper did.

Q3976 Pamela Nash: You have already mentioned the fact that the forecasts you make are much longer term than those that have been created by the Scottish Government. Could you tell us about the model you use and what horizon scanning and forecasting you use? It is obviously an art and not just a science. Can you explain the process to us and to the lay people who might be looking at this evidence later, and tell us the impact of the difference between that and what the Scottish Government are saying at the moment and what their predictions might be?

Gemma Tetlow: Our model involves a bottom-up projection of different tax streams and different spending components year by year over the next 50 years. Our model produces a projection for all the numbers that the Scottish Government talk about as well, but the main motivation for doing our model is to understand where we will be in 50 years’ time rather than where we will be in 2016.

To be honest, we have done a very similar exercise to the way the Scottish Government came up with their numbers for 2016-17. However, given what is driving the pressures for Scotland-one is the long-run demographic pressures, which are quite similar in Scotland to the rest of the UK-spending is going to increase slightly more as a share of GDP according to our projections for Scotland than for the rest of the UK, because the average age of the population is getting a little bit older.

However, one of the major challenges over the next 50 years, according to our model, is what happens to revenues for Scotland from the North sea. If you look simply over the next five to 10 years, as I said before, there is a great deal of uncertainty about exactly at what level those revenues will be. You could have a long debate with different people who take different stances on the outlook for oil prices and for production in the North sea. Looking 50 years out, there is less uncertainty about the fact that you probably will not generate very much revenue from that source, which is where perhaps our bottom-line message sounds a bit different from what the Scottish Government would be saying when they are focusing on the picture in 2016. Their view is much more optimistic than the OBR’s view, for example, but there is inherent uncertainty about that.

Q3977 Pamela Nash: Thank you for that answer. As we look at these figures and the current situation and try to predict going forward, is there anything we have not thought of yet that would impact on this significantly? Is there a factor that might be different if Scotland was a separate country from the United Kingdom, which would be different from just comparing it with the figures as they stand today?

Gemma Tetlow: There are certainly a number of factors. First, one of the sensitivities that we look at in our report is sensitivity to alternative scenarios for migration. There have been some indications from the Scottish Government-

Chair: Could we leave migration to one side? We want to come back to it separately later on.

Gemma Tetlow: Obviously, if you were to radically change the tax system in Scotland in response to independence-for example, cutting the rate of corporation tax-that could reduce overall corporate tax revenues, unless it generates a sufficient behavioural response with companies moving into Scotland. Changes to economic policy could also possibly affect productivity growth in Scotland. We looked at a couple of different scenarios in our work for average productivity growth in Scotland.

Q3978 Chair: Could I come back on a couple of points to seek clarification? I was slightly confused by your reference to 2012. You were saying that the Scottish Government had based their account on the financial year 2011-12, but you then went on to mention how figures had fallen in 2012 and in 2013 because of a breakdown on a rig, and so on and so forth. Do I take it that that part of 2012 was the part of 2012 that was not part of the financial year 2011-12?

Gemma Tetlow: Yes; that is correct. The numbers that the Scottish Government have used, which they formalised in their latest Government expenditure and revenue in Scotland publication, were for the 2011-12 financial year. In the 2012-13 financial year, revenues from oil and gas declined substantially. That is a year that has not yet gone into a formal GERS publication, but that will come out next year. An assessment of that picture was included in our report.

Q3979 Chair: How professionally reasonable, if that is the right term, is it to take a single year in these circumstances? Unless I am mistaken, you are telling us that 2011-2012 was a particularly good year for oil revenues. In professional statistical terms, is a reasonable way to proceed to take the year that suits you best, or is it better to take several? What would be the norm in these circumstances? Would you normally take an average of five or an average of 10? Is there something that would be accepted in the profession as good practice?

Gemma Tetlow: The key question here is what you are using the number for. If you are using the number to try and illustrate how the public finance position of Scotland compares with that for the UK as a whole, using 2011-12 on its own presents a slightly misleading picture, because it was an unusually bumper year for oil and gas revenues. Drawing the conclusion that the higher level of spending in Scotland was more than matched by higher revenues in that year hides the fact that it would not be true were you to use the data from one year later.

The reason why that year has been used is that it is the last year for which comprehensive data are available. Obviously the 2012-13 data will be available, in probably March of next year. I would hope that they will get incorporated into the public debate as well, to take into account the fact that they highlight the volatility of that revenue stream.

Q3980 Chair: It strikes me that you are a very generous person. You are suggesting that they chose the 2011-12 year not because it was the year that suited their case best, but because it happened to be the most recent year, even though to take that year in isolation was effectively to distort the pattern.

Paul Johnson: I do not think it would be right for us to speculate why they chose it. It is the most recent year and it is the year they chose. In their White Paper they are also using their predictions, which are relatively optimistic, for 2016-17. They are not just using that 2011-12 number, but the relatively optimistic numbers they are using are based on projections. We will see. In a sense, the answer to your question will come in March, when the most recent year changes, and it will look less positive from that point of view.

Q3981 Chair: But am I right in thinking that the OBR produced more recent figures, which are not the full-year figures, which indicate that oil income is falling?

Paul Johnson: Yes.

Gemma Tetlow: We know the concrete outturn for oil and gas revenues in 2012-13. That is a published national statistic; a piece of data. The bit of the exercise that has not been done is the full exercise of allocating revenue streams and spending items across Scotland versus what happened in the rest of the UK. That is what will be done in the GERS publication. However, already at this stage, given that you know that most of those oil revenues accrued to Scotland, the picture that is going to come out is fairly obvious. The revenues per head from offshore receipts will be substantially lower in 2012-13, once that exercise has been done.

Q3982 Chair: If you were constructing the Scottish Government’s predictions in April, based on what by then would be the latest figure, would it be fair to say that they would give you a completely different version of the financial viability of a separate Scotland from the figures that the Scottish Government have actually produced?

Gemma Tetlow: I am not sure they would give you a different version of future viability, in the sense that I think you would already want to incorporate the importance, the volatility and the uncertainty about the oil and gas receipts into that picture. To the extent that the Scottish Government have presented the past as an indication of the viability of the future, yes, using a different year of data is going to change that presentation.

Paul Johnson: Presumably it will not change anything in their White Paper numbers for 2016-17.

Gemma Tetlow: I think there is a serious question. We have an independent body that forecasts the UK’s public finances that clearly is taking a very different view at the moment from what the Scottish Government are suggesting will be the picture in 2016-17. There is a very interesting question, to get those two organisations to explain why they take quite such a different view, and why the Scottish Government believe that their number is better than what is currently being projected by the OBR for the UK.

Q3983 Chair: There is no evidence, is there, that the OBR are fundamentally anti-Scottish and are interested in talking Scotland down? That is the usual accusation made to anybody that disagrees with the figures presented by the Scottish Government. Do they have a record in this matter of disagreeing with the Scottish Government?

Gemma Tetlow: I am not aware of them having entered into this debate at all. Obviously their job is to produce projections for the UK as a whole. If they are talking down revenues for Scotland, they are talking them down for the UK as a whole as well, and I think that would be outside their remit.

Q3984 Chair: If we wanted to have you back again-should this be such an enjoyable experience for us all that we want to repeat it-when would you be in a position to give us figures based on the latest year’s figures? How long would that take you? Basically you said that a lot of this work has been done; it is just the detailing of it and the allocation and so on.

Gemma Tetlow: We have already done our own estimate of that, which is included in our report. Obviously it may differ slightly; we have not spent as long as the GERS publication will spend trying to allocate it all, but we have had our own best guess at that and those numbers are in our report.

Q3985 Chair: I wanted to clarify whether, once the latest figures come out, you would revise what you said in this report, but I think you are saying that you have already taken account of that.

Paul Johnson: I do not think it will change our long-term figures in any significant way.

David Phillips: I want to add two things. First, on the point about choosing 2011-12, in a lot of the analysis they put forward they talked about averages over the last five years of data, from 2007-08 to 2011-12 in the Scottish Government’s case. Over that five-year period, it looks to be in a slightly stronger position than the UK as a whole. That is one point in defence of what they have been doing. If you chose five years before that, though, they would have been in a worse position than the UK, and five years after, from 2012-13 to 2017-18, again, on the OBR’s forecast, they would be in a worse position.

They are not always choosing just 2011-12; they have sometimes chosen a longer time period, perhaps in order to deflect that criticism. They chose five pretty good years for oil revenues in aggregate. The year 2008-09 was also a very good year for oil revenues, and 2010-11 was not bad either.

Q3986 Chair: Remind me again. What do all these years that they have chosen have in common?

David Phillips: They are the most recent five years of data.

Q3987 Chair: And they are all years that show the Scottish Government’s case to the best advantage. Is that a fair way of putting it?

David Phillips: I would say that they are the most recent years of the data they have chosen. It was designed to deflect criticism about choosing the one year that was most advantageous. Two of the other years in that period also look pretty good, and two of the years don’t look so good. It is trying to average things out.

Q3988 Lindsay Roy: I think you said the demographic picture was broadly similar between Scotland and the UK. Is that right? Are there any differences? If so, what are they and what implications are there for Scotland?

Gemma Tetlow: In our report we use the 2010-based ONS projections for Scottish and UK population growth. We have not incorporated the 2012-based estimates that were published only just before our report came out. Our basic model looked at the ONS low-migration scenario for Scottish and UK population growth, which the OBR argues is most consistent with current UK Government policy on migration.

The picture from that is that the Scottish population as a whole will grow less quickly than the UK population. In particular, Scotland will see declines in the number of people at working ages and a growth in the number of people over the age of 66, compared with a picture for the rest of the UK that is growth at all ages, but particularly high growth amongst the over-66 population.

Q3989 Lindsay Roy: What are the implications, given that scenario?

Gemma Tetlow: The implications are that old-age-related items of spending-particularly pensions, social care and health care-are projected to grow slightly more quickly as a share of national income for Scotland than the rest of the UK. The major point is that for both Scotland and the UK there is going to be a very large increase in those age-related items of spending over the next 50 years. The differences between the UK and Scotland are rather small in the context of that much bigger picture, which both nations face.

Q3990 Lindsay Roy: There will be a differential negative impact.

Gemma Tetlow: Yes; a slightly worse picture for Scotland.

Q3991 Lindsay Roy: Are you aware of the NIESR report? Do you have a view on what they said about demographic change in Scotland? It is different from yours.

Gemma Tetlow: I think some of the press coverage was misleading on the extent to which we differed in our projections from NIESR. As our report sets out, there is not a very big difference between our projections for the demographic pressures in Scotland and in the UK as a whole. That was broadly the conclusion of the NIESR report as well: demographics do not drive the differences between Scotland and the UK.

The conclusion in our report that Scotland faced a more challenging fiscal position over the next 50 years was largely as a result of what one assumes about revenues from the North sea, which the NIESR report did not take into account at all-they did not make any assumption about North sea revenues. It is also dependent on the starting level of spending in Scotland, which again was not a focus of the NIESR report. I do not think we differed very much from NIESR in terms of the demographics.

Q3992 Lindsay Roy: The Scottish Government have said that Scotland’s demographic position is more favourable than the UK’s. For example, Nicola Sturgeon described the idea that Scotland’s population was ageing more than England’s as a "myth". Was she right?

Paul Johnson: It does not sound like it.

Gemma Tetlow: Certainly on the basis of the ONS’s projections, the average age of the population in Scotland is projected to increase by more over the next 50 years than for the UK. To come back to the point that was raised earlier, that probably is something that would be sensitive to an alternative set of policies that could be pursued under independence. The average age of the population is very heavily dependent on the number of inward migrants you get and what age groups they are in.

Q3993 Lindsay Roy: But you are certain that your evidence is secure.

Gemma Tetlow: We have not devised our own projections for the population. However, we have used the officially recognised ONS demographic projections. Those central variants suggest that the Scottish population will age more rapidly.

David Phillips: We have also tested the sensitivity of our results, including the high migration scenario, which had migration of 26,000 per year instead of 9,000 per year into Scotland. We tested it to a no net migration scenario as well, to see how sensitive the results were. It obviously changed the quantitative findings, but the qualitative finding of a more difficult fiscal situation was robust with those differences in migration.

Q3994 Jim McGovern: First of all, thank you for coming along. I want to explain why everybody smiles every time you mention "GERS". I realise it is an acronym, but in Scotland it is very much an abbreviation for Glasgow Rangers Football Club.

On the subject of demographics, is it true to say that people in Scotland have a lower life expectancy than people in the rest of the UK?

Gemma Tetlow: I think that is the case. I am afraid I do not know quite what is assumed in the ONS projections about the different life expectancies of people in Scotland and the rest of the UK.

Jim McGovern: The chart we have here would seem to suggest that.

Gemma Tetlow: I think it is true at the moment.

David Phillips: At the moment, at least in the medium term, it is predicted to persist. I am not sure about the longer term, up to 2060. There is a substantial difference-about two years-at the moment, which I think in the medium term is forecast to persist. In the longer term, I am not sure.

Q3995 Chair: I want to pursue the quote that Lindsay referred to. We had the Deputy First Minister saying that "the number of people at state pension age will increase by 28 per cent in the UK and 26 per cent in Scotland." That seems to be contradicted by what you were saying. Can you clarify?

David Phillips: I do not think that is necessarily contradicting what we are saying. What matters for our projections is not the absolute increase in the number of old people; it is the increase relative to the rest of the population. One of the reasons why the older population is going up more in the UK as a whole-it is 28% rather than 26% in Scotland-is because the population in the UK as a whole is going up rather faster than in Scotland. When we say that Scotland is ageing more rapidly, it is not because the number of older people is going up more in absolute terms; it is that they are going up more, relative to the size of the rest of the population. In the projections for the UK as a whole, the working-age population is also projected to increase over the next 50 years, whereas in Scotland it is predicted to decrease slightly, under the ONS analysis.

Q3996 Chair: If the number of people over state pension age in the rest of the UK is rising more quickly, other things being equal, that is because people in Scotland are dying quicker, which should be a cause of concern for us.

Paul Johnson: I do not think that is the main thing driving it. It is just that the population of the UK as a whole is growing. They are getting older and getting to state pension age, and there are more of them, but the population of Scotland is not growing.

Q3997 Chair: I understand that these are in a sense two different things, but the point that Ms Sturgeon was making is not directly related to the question of percentages and a comparison of those who are above pension age and the ratio of those who are below-that is a different issue altogether. Leaving aside migration, if you have a population where the number of people at stage pension age is increasing by more in the UK than in Scotland, it is presumably an indication of a bulge just below pension age and also the fact that people in Scotland are dying sooner. Is that correct?

Gemma Tetlow: Possibly. On the numbers we have, it looks, in the scenarios we are using, like we are projecting higher percentage growth in the over-65 population in Scotland than in the UK, but similar-ish, or slightly higher-

Q3998 Chair: The Deputy First Minister and you cannot both be correct. You are saying different things.

David Phillips: When did the Deputy First Minister say this? We are using the 2010-based projections. There have been some changes in the 2012-based projections that came out-bad timing-about a week before our stuff came out. There could be a quantitative small change in the figures since our analysis was conducted. It would not change the core conclusions of our work, but it could be because she is using slightly more up-to-date figures from the ONS than we used.

Chair: We will obviously try and clarify that.

Q3999 Lindsay Roy: Can you say more about migration and the projection period over which you made the estimate-just to fill the gap in terms of age dependency?

Gemma Tetlow: We have used the ONS projections up to 2062. As David said, our basic model uses the ONS’s low migration scenario, which involves net inward migration of 9,000 a year on average to Scotland over that 50-year period. I am afraid I do not know the exact profile, but on average it is 9,000 a year.

We also looked at the high migration variant, which involved 26,000 a year average net migration into Scotland. It is obviously quite a big difference, which will change the demographic structure quite substantially.

Q4000 Lindsay Roy: A minimum of 450,000 over a 50-year period.

Gemma Tetlow: Yes.

Q4001 Lindsay Roy: That is more than the population of Fife. It seems quite a big number.

David Phillips: The lower case projections by the ONS will be a bit lower than has been the experience in Scotland over the last 10 years or so, but higher than the long-run average.

Paul Johnson: One thing I would say about inward migration in Scotland at the moment from outside the UK is that it is remarkably low for a rich part of the UK with a series of top-class universities and so on. It is much more like some of the much poorer parts of the UK and much less like London, the south-east and other of the rich parts of the UK. In a sense, there is scope economically for more inward migration, but as you say, even 9,000 a year is nearly 500,000 extra people over 50 years.

Q4002 Lindsay Roy: And it could be higher.

Paul Johnson: The high migration scenario is almost three times the size of that, yes.

Q4003 Chair: Could I clarify that? In terms of migration figures, you were talking about 500,000 and its being potentially triple that. That is three times the size of Glasgow as inward migrants in order to balance the difference in ageing populations. Is that correct?

David Phillips: No. The high migration scenario is not one we have chosen to balance the difference in ageing populations or to remove the more difficult fiscal situation; it is a scenario that the ONS produces based on a high estimate. I am not sure we have looked at the extent to which that would address the differential ageing. It is not enough to fill the fiscal hole; I know that.

Paul Johnson: It is worth saying that the high ONS migration projections for the UK as a whole are very substantial over long periods-I can’t remember the numbers-which would very substantially increase the size of the UK population and its composition. The same is true of Scotland if you take the higher projection.

Q4004 Chair: I want to be clear, inasmuch as we can be. Given the impact of ageing, given the need to have a larger number of younger workers to support those who are ageing and given the fact that, as I understand it, the Scottish population is ageing faster, we are trying to get some feel for the numbers of inward migrants that might be necessary in these circumstances. We have heard the half a million figure, which is greater than the population of Fife, or thrice that, which is three times the population of Glasgow over a period. Can you give us any better comparison that we could use, or any better figure?

Gemma Tetlow: It is worth saying that different patterns of migration bring a different set of challenges. If you have a higher number of migrants of working age, that means you will have more school-age children, for example, and that will push up items of education spending. While it addresses one issue of increasing your GDP and giving scope for spending on older people, it introduces a different set of issues.

To give some sense of that, one way we tried to quantify the scale of the challenge in our report was to quantify the fiscal gap. For example, say you want to aim for a 40% debt-to-GDP ratio at the end of the 50-year horizon, what scale of fiscal tightening do you need to do each year over that period to get you to that position? In our basic model, using the low migration scenario, we estimated that you would need to do a 4.1% of GDP fiscal tightening in Scotland. Using the high migration scenario-so the only change you make is from low to high migration-reduces that figure from 4.1% of GDP to 3% of GDP. In some sense, it addresses a quarter of the problem.

Q4005 Chair: To reduce it from 4% to 3%, what level of migration or immigration would be necessary?

Gemma Tetlow: That is going from 9,000 a year net migration to 26,000 a year net migration.

Q4006 Chair: Is that 26,000 a year every year?

Paul Johnson: Yes.

Q4007 Jim McGovern: You have done various analyses. How significant are they? Without being in any way complacent, even your most optimistic findings suggest that Scotland would still be under more fiscal pressure if it was separated from the UK.

Paul Johnson: That is correct.

Q4008 Jim McGovern: Thanks for your brevity. We understand that the main factors driving this are the loss of oil revenue and the demographic changes. Is that right, and could you explain the significance of each of them? I am sure that will elicit a longer answer.

Paul Johnson: The main factor driving the difference is, in a sense, the starting point, which you can either say is the loss of oil revenue relative to where we were at least in 2010-11 and 2011-12, or you could say-it is a very straightforward point-that onshore revenues per person are very similar in Scotland and the rest of the UK and spending is 12% or so higher per person in Scotland compared with the rest of the UK. That is a very significant difference. If it were the case that that was simply covered, roughly speaking, by oil revenues now and into the future, the difference between Scotland and the rest of the UK would be relatively small. But because it does not look like those oil revenues will be there, that will widen into a bigger and bigger gap over time.

The fundamental difference is about that starting point, in terms of revenues relative to spending. It is made a bit worse by the fact that the demography is a little less good for Scotland than the rest of the UK. It is the starting point that is driving most of this.

Q4009 Chair: Would I be reasonable or fair in comparing you to Private Frazer, who says, "We are all doomed"? This is not good news, is it, for those who are arguing for a separate Scotland. You are saying that under the most optimistic assumptions that you make, the fiscal position is worse for a separate Scotland than for the UK as a whole.

Paul Johnson: That is true. I do not think one should necessarily conclude from that that we are all doomed. You could conclude that we are all doomed-the UK and Scotland- because the scale of the changes is quite substantial, but I would not say that.

Chair: But you’re an economist.

Paul Johnson: If you look at the scale of the fiscal consolidational change that will be required, on our central numbers, it is less than is happening over the eight or 10-year period that we are going through at the moment. We are doing that with some pain over an eight-year period, and we are looking over a much longer period. There are clearly things that Governments can do to change this, in terms of increasing taxes, reducing spending and changing the way that public services work.

It is clearly the case that the UK as a whole, and an independent Scotland by itself, could deal with these pressures by changing the amount it raises in taxes or that it spends over a period of time, as we have in the UK adapted to an ageing population over the last 30 or 40 years or so. We are not all doomed, but we do have to make some serious choices. The choices that an independent Scotland would have to make would be somewhat more substantial than the choices that the UK as a whole would need to make, largely because it would be starting from a position of higher spending in the first place.

Q4010 Chair: So Private Frazer might adapt his position: it is not entirely doomed. A pattern of economic retrenchment is taking place at the moment. In the event of separation, there will require to be a combination of greater tax increases than the rest of the UK, bigger cuts in spending than the rest of the UK or a combination of both.

Paul Johnson: Yes, though in part you could say it was simply to take spending to the same kind of levels as in the rest of the UK. But, yes; you would have to do more on the tax and/or spending side than would be the case in the rest of the UK.

Q4011 Mike Crockart: You have dealt with my point to a certain extent. The difference is not really the starting point. You were saying that it is all about the starting point, and you have a different starting point from the Scottish Government, but it is really about the projections, isn’t it, and the statistical assumptions you make that everything else remains the same. The argument therefore is that if the Scottish Government chooses to do things differently, that can be dealt with in some other way. It is just being clear about what that other way means. You have alluded to that, but have you made any calculation of what size of extra tax or spending changes would need to happen to deal with the differences between what you and the Scottish Government are projecting?

Gemma Tetlow: To clarify what Paul was saying, it is not that there is a difference in the starting point between what we think and what the Scottish Government thinks, but that there is a difference in the starting point between spending per head on people in Scotland compared with spending per head on people in the rest of the UK. The former is 12% higher than the latter. That is what we mean by a difference in the starting point. Therefore, once you project forward and take into account that oil revenues, which are currently higher per head in Scotland-

Q4012 Mike Crockart: But surely that figure is agreed upon-the level of spending?

Gemma Tetlow: Yes; that is agreed upon. But that is what we mean by a difference in starting point. It is already the case that we all agree that spending per head is higher in Scotland. Looking forward, either that number will have to come down to the level that we currently see in the UK, or revenues would have to be raised elsewhere to put Scotland in the same position as the UK, which would still require a further fiscal tightening to deal with the long-run pressures that the UK has as a whole.

Q4013 Graeme Morrice: We won’t go into what Corporal Jones used to say on "Dad’s Army".

The Scottish Government said that oil revenues will be much more buoyant than the Office for Budget Responsibility predicts. Apparently last week the OBR forecasts showed a sharp drop on oil revenues. Given the uncertainty around these numbers, is it wise to try and predict them?

Paul Johnson: You need some kind of planning basis, but that comes back to one of my earlier answers. These numbers are clearly uncertain, and it is therefore clearly the case that if you were an independent Scotland, where this is a significant and important part of your revenues, you would want your fiscal situation to be somewhat invariant to what is going on with the oil revenue. You would not want to base your planning on an assumption of buoyant revenues. You would want your planning to be pretty robust to the different levels of revenue. Yes, we always need to have a best estimate of where we will be in the future, but we also need to understand where important elements of this are very uncertain, and then we need our planning to be robust to that uncertainty.

Q4014 Graeme Morrice: Would you say that the OBR predictions and the Scottish Government figures are assertions?

Paul Johnson: They are projections based on the information that they have. We have not looked in detail at why or how. We have looked at them to some extent, but we do not have a strong view about which of them is the right number.

Q4015 Graeme Morrice: It has been suggested that to control the fiscal gap identified by the new projections, taxpayers in Scotland would have to pay at least £1,000 a year more to plug that gap. Would you agree with that?

Gemma Tetlow: I will explain where the £1,000 number comes from and then describe whether I agree with it. The most optimistic scenario that we looked at in our report-which involved assuming the Scottish Government’s most optimistic case for oil revenues over the next five years, but projecting a decline from that point thereafter-assumed high migration and that Scotland would take a 40% debt-to-GDP ratio at the point of independence rather than taking a population share of debt, which would imply a higher number. Under that most optimistic collection of assumptions, our estimate was that Scotland would face a fiscal gap of 1.9% of GDP-the fiscal gap being trying to get to 40% of GDP-debt ratio by 2060. That was higher than the 0.8% that we estimate as the gap that the UK faces.

The £1,000 number comes from saying that if you want to do a fiscal tightening of 1.9% of GDP, to give you a sense of what that means, you could raise that sort of money by increasing the basic rate of income tax in Scotland by 8p. That is just an illustration. They almost certainly would not want to make an adjustment just on that margin, but that is the illustration.

What the Treasury did with that number was to estimate for the average basic rate taxpayer in Scotland what it implied in terms of pounds per year of extra income tax that they would pay. That is where the £1,000 number comes from. It is what would happen to the average basic rate income taxpayer in Scotland if you increased the basic rate from 20p to 28p.

It is a correct number in those terms. It relates to the entire fiscal tightening that an independent Scotland would have to do, as opposed to the amount by which that would be bigger than the fiscal tightening the rest of the UK would have to make. For the UK as a whole, there is 0.8% of GDP fiscal gap compared with 1.9% of GDP for Scotland. You would be talking about maybe £400 higher income tax for the UK on that same basis, compared with £1,000 for Scotland. It would be wrong to characterise the £1,000 as the extra that Scotland would have to pay compared with the UK. The UK would have to pay something as well.

Q4016 Chair: I followed all that until you got to the end, when you said it would be unfair to characterise £1,000 as the extra figure, because the UK would have to pay a figure as well. I thought the whole point of your explanation was that there were going to be cuts in the UK, but then there were going to be more cuts in Scotland, which would then equate to the equivalent of 8p in tax, which is the equivalent of £1,000 each. Where did I lose the thread?

Gemma Tetlow: Our most optimistic case suggests that Scotland would face a fiscal gap of 1.9% of GDP.

Chair: I got that bit.

Gemma Tetlow: That amounts to £1,000 per basic rate income taxpayer. The UK would face a fiscal gap of 0.8% of GDP, so perhaps more like £400 per basic rate income taxpayer. The extra challenge faced by Scotland is the difference between those two numbers, not the whole £1,000 number on its own.

Q4017 Chair: So it is only £600 extra.

Gemma Tetlow: Something of that order, yes.

Chair: I am sure that Private Frazer and indeed Corporal Jones will be greatly relieved to hear that.

Q4018 Graeme Morrice: Thank you, Captain Mainwaring.

You obviously make assumptions about greater economic growth. Indeed, the view of the Scottish Government is that the fiscal gap that you identify could be filled by greater economic growth in Scotland. It has been suggested that that would require Scotland to see economic growth that was double each year. What is your response to that assertion?

Gemma Tetlow: In most of the scenarios we have presented, we assumed that Scotland would experience 2.2% a year average labour productivity growth, which is the same assumption as the OBR makes for the UK as a whole. However, at the moment the offshore economy comprises a large fraction of the Scottish economy. Assuming that the whole Scottish economy grows at 2.2% a year-essentially, as the size of the offshore economy declines-you need to make that up in terms of the onshore economy. To that extent, assuming the same average growth rate for Scotland and the rest of the UK is a more optimistic assumption for Scotland, because it requires that the onshore economy grows more quickly than that. None of the research that we have done really gives us much insight into what will happen to the Scottish economy as the offshore economy depletes. It is clearly an open question, but it would be more challenging for Scotland to maintain that same average rate of growth, because of one sector of their economy declining at the same time.

Q4019 Graeme Morrice: Do you think it is doubtful that year on year Scotland could double its economic growth, and that that would be sustainable over a longer period?

Paul Johnson: There is a separate assumption underlying your question, which is about the impact of growth on the fiscal numbers that we are looking at. Clearly, any additional growth would make Scotland better off, and public services and so on would be better. The way the model is constructed means that additional economic growth does not help as much as you would expect in terms of the fiscal numbers. One assumes, for example, that increasing spending on health and so on increases in line with economic growth, so that health does not become a smaller and smaller part of the economy or doctors do not start getting paid less and less relative to everybody else. The actual impact on these numbers, in a slightly odd way, does not have that much effect. You would need extraordinary amounts of growth to fix these numbers. Obviously, Scotland would be a wonderful place if it did get that extraordinary amount of growth.

Q4020 Chair: The only comparable situation I can think of is when the Czechs and the Slovaks split. Was there any evidence that there was a sudden boost in productivity from either bit as a result of the division?

Gemma Tetlow: That is not something we have looked at, I am afraid.

Paul Johnson: We don’t know.

Chair: That has the merit of clarity as well. Thank you.

Q4021 Mike Crockart: If I were the First Minister in an independent Scotland coming out of an independence referendum, what would your recommendations be to me about what we would have to do to maintain long-term fiscal sustainability?

Paul Johnson: Repeating in a sense what I said before, the first thing I would do is make sure that my fiscal stance was robust to the vagaries of what might happen to oil. Because I would be a new country in the international markets, I would want to have some very robust and independently adjudicated fiscal rules. In order to achieve that, I would need a pretty clear plan for how I was going to get from where I started-which, more likely than not, would be a position of significant deficit, particularly if this was in 2016, because the UK as a whole would not have got through its deficit reduction programme. I would want to look at an appropriate combination of spending cuts and tax rises over a reasonably significant period-it would not have to happen all in year one-in order to meet a very clearly defined set of rules aiming at some kind of current structural balance in the medium term.

The initial position would probably be a little more difficult than that for the rest of the UK and I certainly would not suggest that we needed to do it the next year. It might be over a period of time, but it would be a difficult thing to avoid. If it then turned out that growth took off, you could adjust what you wanted to do in respect of the better position that that put you in. The last thing you would want to do is pretend that that was not there. That would be storing up more difficulties going forward.

Q4022 Mike Crockart: You led with that in some of your report. You said it was all about establishing a reputation among creditors. You would have to put in place fiscal rules, but what would those fiscal rules look like? What would it need to establish a good sense of reputation amongst investors that would bring down the borrowing costs?

Paul Johnson: Point one is that this is going to be very, very dependent on the amount of debt that is inherited. A Scotland that is inheriting debt at 75% of national income is going to be in a very different position from a Scotland that inherits debt at 40% of national income; 75% will look uncomfortable to start with. The rules are, as I suggested, likely to look to be achieving current balance in the medium run, excluding oil revenues, or certainly including only a very cautious estimate of oil revenues into the medium run; and a very clear view about the debt level that is being targeted. You need both of those.

Q4023 Mike Crockart: In your evidence, you talked about potentially excluding oil revenues from the fiscal rules. You would put the fiscal rules in place around borrowing, but in order to deal with the huge amount of changeability in oil revenues, they should probably be excluded from those rules.

Gemma Tetlow: There are two issues about the treatment of oil within the fiscal rules. First, you would want to aim for a target level of borrowing that excluded the revenues entirely, largely because an independent Scottish Government would have a fair amount of control over how much it raises in other types of taxes and how much it spends. It would be very open to the vagaries of oil production, oil prices and exactly how much revenue came from oil. An independent Scottish Government would want to be judged on the basis of a measure of the balance on its books that it has some control over, rather than being susceptible to the level of oil revenues. Exactly what target would you want to set for that level of borrowing? Do you want to aim for zero on that measure of borrowing and therefore take all the oil revenues as a sort of bonus on the side, or do you want to aim for some sort of deficit? That size of deficit may be the average amount of oil revenues you expect to receive over a long period of time. That would be a debate you would need to have. Exactly how tight a fiscal stance do you need to persuade creditors? You would want a measure that you would be judged on that excluded the revenues altogether.

Q4024 Mike Crockart: Allied to that is the debate around whether an oil fund would be something that would do the smoothing. If you had an oil fund, that would be the thing that equalised the volatility of oil prices over a longer period of time. How realistic is it that a newly independent Scottish Government would be able to start to put together an oil fund?

Gemma Tetlow: You would certainly have to get to a position where you had got non-oil borrowing down much closer to zero before you could credibly have an oil fund in any sense.

Q4025 Mike Crockart: Is this when, in your words, it becomes a bonus? It is only when it actually is a bonus, because you have the rest of the spending in balance, that you can then create the oil fund.

Gemma Tetlow: You could set up an oil fund even without having a genuine surplus on your borrowing, but you would need to get close to zero for that to be plausible; otherwise you are in a position where you are obviously borrowing money on the market and then having a notional oil fund that earns a return.

Q4026 Mike Crockart: This is what has been characterised as borrowing money on your credit card to invest in your ISA.

Gemma Tetlow: There might actually be good public management reasons to do that, in the sense that if you set the money aside it perhaps binds politicians’ hands more than if you simply say, "For the next few years we will pay down our debt and then we’ll start worrying about using these oil revenues for future funds." There might be a justification for trying to do something like that, for those reasons. Whatever happened, you would want an independent body giving its judgment on what is a credible, possibly cautious, forecast for oil revenues over the next few years, on which to make any judgment about the amount of spending that you can be funding from oil revenues, just to improve the credibility of your fiscal plans.

Q4027 Mike Crockart: When you say that you would need to have spending revenue broadly in balance before you could start to build up an oil fund, what does that mean? How different is that from the situation where we are at the moment?

Gemma Tetlow: Our projections suggested that an independent Scotland, at the point of independence, would still have quite a high level of borrowing. Our basic model suggested borrowing 5.1% of national income. It needs to be closer to zero than that number.

Mike Crockart: Five?

Gemma Tetlow: We are probably being deliberately vague.

Mike Crockart: I did notice.

Gemma Tetlow: It would almost certainly depend on a number of factors where we do not yet know the answer. For example, were Scotland in a currency union with the UK, that would limit their scope to use monetary policy to stabilise the economy, and would be another reason why they would want to be in a much stronger fiscal position so that they could deal with any shocks to their economy.

Q4028 Mike Crockart: Are you saying that the reduction in the borrowing would have to be greater?

Gemma Tetlow: Yes.

Q4029 Chair: Are you saying that if Scotland was in a monetary union with the United Kingdom, as the Scottish Government are suggesting, that would require them to make bigger cuts in their budget than would otherwise be the case?

Gemma Tetlow: I think there is probably a missing "all other things being equal" here. Being in a monetary union with the UK may make people more confident about other aspects of the Scottish economy. For example, if they took on a load of sterling-denominated debt, it would be easier for them to service if they also had their economy denominated in sterling. That would be a positive benefit.

However, all other things being equal, if you are in a currency union, with the Bank of England determining monetary policy on the basis of what makes sense for the UK, any idiosyncratic shocks that hit Scotland that don’t hit the rest of the UK would need to be accommodated through fiscal policy rather than monetary policy. For that reason, you would want to give yourself more scope on the fiscal side to deal with those shocks as they come along.

Q4030 Chair: I was under the impression from what you said earlier that in terms of wanting fiscal rules, an independent fiscal council and so on, in the event of monetary union with the UK, the Bank of England and the UK Government would do all that for them. In a sense, who then determines the fiscal rules is presumably the Bank of England and the UK Government, and that is part of the price of monetary union.

Gemma Tetlow: Yes, I guess we don’t know what the answer to that question would be. The eurozone is an example of a currency union that was set up with monetary co-ordination but not fiscal co-ordination. That is perhaps starting to change now, but clearly a very important question in negotiating monetary union would be what constraints, if any, you impose on fiscal policy, for exactly that reason.

Q4031 Chair: I was under the impression that it was being made clear that, in the event of monetary union, the Bank of England would want control of monetary policy and the UK Government would want control over both monetary and fiscal policy. There would obviously be flexibility within that.

Paul Johnson: I do not know whether the UK Government have said that or not, but I would certainly strongly presume that if there were to be any kind of formal monetary union, the UK Government would want a say over the fiscal policy of an independent Scotland, just as the EU wants a say over the fiscal policy of the members of the eurozone. There are very good economic reasons for wanting that. If you have a monetary union with no fiscal control over one part of that union, you have a recipe for a number of problems. In this very hypothetical world, given what the UK Government have said, you would clearly be looking for additional fiscal controls.

Q4032 Chair: But am I not right in thinking that it would not be rational for the UK to agree to monetary union with a separate Scotland unless it had monetary union across the whole of the UK and also had fiscal control? It would not be in the interests of the rest of the UK to make an agreement to support a separate Scotland financially without having fiscal controls?

Paul Johnson: I think you are saying very much the same as we are. If you are to have a monetary union, then you are very likely to want to have fiscal control, for exactly those reasons.

Q4033 Mike Crockart: You are likely to want fiscal controls, but those fiscal controls are likely to be common or very similar across the different parts of the monetary union.

David Phillips: You might still want different fiscal rules for Scotland because of the nature of the oil revenues. That is why you might still want to have some element of fiscal control at the UK level in such a circumstance, but Scotland might still have some discretion over the exact fiscal rules it has, because of the unique circumstances of the oil revenues. As Gemma was saying, you might want to target a measure of debt so that it excludes oil for Scotland, whereas it is a targeted measure of the total deficit for the rest of the UK. It is not inconsistent to have different rules for Scotland and the UK as a whole, and for the UK still to have some control over Scotland’s fiscal position.

Paul Johnson: It is worth saying in all of this that experience suggests it is very hard to enforce these kinds of rules, however you might draw them up.

Q4034 Chair: If it is very hard to enforce these kinds of rules, that’s an argument for not entering into that sort of arrangement, isn’t it?

Paul Johnson: I think that is the argument that the British Government are making.

Chair: I just wanted to hear you say it, to make sure that my understanding was also yours.

Q4035 Mike Crockart: There are a lot of hypotheticals in there, depending on monetary union and fiscal rules and everything else. Generally, what is this likely to mean for borrowing costs for an independent Scotland?

Gemma Tetlow: We have not really done our own analysis of that. As I said earlier, the National Institute for Economic and Social Research have done some work on this. Their approach was to look at other examples of small countries that looked a bit like Scotland, to try and get some sense of what the premium that might be charged on Government borrowing would be. They make the point that it would depend on the currency that Scotland adopted. As I said, their estimates are that the premium would be between 0.72 and 1.65 percentage points above the rate charged to the UK Government.

Q4036 Mike Crockart: The lower end being if it retains a sterling monetary union.

Gemma Tetlow: I think they simply have a range of historical international experience, and therefore they have come up with a range of estimates. There is a statistical uncertainty in that.

Q4037 Mike Crockart: I am trying to get the individual components that make up that calculation.

Gemma Tetlow: I do not think it was explicitly around sterling.

Paul Johnson: You are probably best asking them. I do not think that they did this in a bottom-up kind of way; I think they did it in an "estimating the differences between different nations with different characteristics" kind of way.

David Phillips: It is all in the context of a single currency. The EU has variations across Europe. In the eurozone, there can be different interest rates paid by different countries. It is all in the context of keeping the pound, effectively, but I would double-check that with Angus Armstrong at NIESR.

Q4038 Chair: If you did not keep the pound and you had your own currency, presumably the variation in the figures would be much higher.

Paul Johnson: You are best asking NIESR about that, quite honestly.

Chair: But you happen to be here, you see. That is why there is a great temptation to ask you in these circumstances.

Paul Johnson: I do not think we know the answer to that.

Q4039 Chair: Normal-real-people in my constituency are not necessarily obsessed by levels of Government borrowing, or interest rates. They would ask whether or not there was any read-across into their mortgage rates. Are these completely divorced one from the other, or does it have a read-across?

Paul Johnson: If this were part of the Bank of England with interest rates set in the Bank of England, there would not be that read-across, because that is where the interest rates would be set. Monetary policy is not our strong point.

Chair: There is another man or woman we should be speaking to about this then.

David Phillips: I think there could be a read-across on to public finances. A higher interest rate on debt would mean higher debt interest experienced by Government, which would mean higher borrowing, lower spending or higher taxes to pay for it. So there could be a read-across on that part, even if there is not a read-across in terms of higher mortgage rates.

Chair: These are the sorts of things that people will want to know-how much greater their mortgage costs will be under separation than they are at the moment.

Q4040 Mike Crockart: I have a final question. You are sitting there as the Institute of Fiscal Studies saying, "Well, we’re not the experts on monetary policy." This all gets very detailed and very niche. Many of the people who have to make the decision need this distilled into two or three sentences. There is the challenge for you. What is your report, distilled into two or three sentences?

Paul Johnson: In the end, I think it says something really rather straightforward. Under the current settlement, Scottish people are paying much the same in taxes as people in the rest of the UK, but rather more is being spent per head in Scotland than in the rest of the UK. If Scotland is independent, that clearly can’t keep going. There will need to be some rebalancing in order to pay for it. There is a lot of stuff around that, in terms of thinking about the long run, the demographics and the oil, but if it is distilled that is the very straightforward point.

Q4041 Chair: We have covered all the points that we want to raise. As I said before you came in, are there any answers you had prepared to questions that we have not asked? Is there anything that you feel you want to get off your chests or that you feel we have not given you the opportunity to explain to us?

Paul Johnson: I don’t think so. We feel unburdened of everything that we wanted to be unburdened of.

Chair: That is not necessarily our purpose. If anything occurs to you that you feel we have not adequately covered, or points of clarification that upon reflection you wish you had given us, perhaps you could get in touch. Similarly, if our staff or advisers want you to come back here, I hope you will feel able to respond.

Thank you very much for coming along to what has been an interesting, if complex, session.

Prepared 16th December 2013