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What might the public finances of an independent Scotland look like?

With higher levels of public spending but lower tax revenues than the UK average, Scotland would likely have a large budget deficit were it to become independent, which may make spending cuts or tax rises necessary. The long-term fiscal outlook would depend on the performance of the Scottish economy.

The state of Scotland’s public finances was a major issue in the 2014 referendum, with the UK government and Scottish government painting starkly different pictures, and producing very different projections for the future. Scotland’s public finances and the implications for independence remain contentious issues and will almost certainly be a significant point of discussion in any future referendum campaign.

Scotland’s public finances matter because they would have a key bearing on the tax and spending choices open to an independent Scotland. Scotland currently receives much higher levels of public spending but contributes slightly less tax revenues per person than the UK average. For example, during the period between 2014/15 and 2019/20, spending averaged £1,550 (or 12.3%) higher per person in Scotland than the UK average, while revenues were £325 (or 2.8%) lower per person. As a result, the implicit Scottish deficit – the gap between spending and revenues – averaged 9.2% of GDP, compared with 3.1% of GDP for the UK as a whole during this period.

This pattern looks set to persist and means that if Scotland were to become independent, it would likely be faced with the task of dealing with a large budget deficit, making spending cuts or tax increases necessary in its first five to ten years to get it down to more manageable levels. The longer-term outlook would depend crucially on how the post-independence Scottish economy performed – faster growth, while easier to promise than deliver, could in principle more than offset the loss of fiscal transfers from the rest of the UK.

What do we know about the current position of Scotland’s public finances?

Despite devolution, the majority of Scotland’s tax revenues and a hefty part of its public spending is pooled with the rest of the UK. This means that there is no overall Scottish budget deficit or surplus, or accumulated debt. Instead, both deficits and debts are subsumed within wider UK public sector deficits and debts, which taxpayers across the whole of the UK are responsible for servicing.

Nevertheless, estimates of Scotland’s deficit/surplus are produced by the Scottish government in its Government Expenditure and Revenue Scotland (GERS) publication. This uses both data on actual revenue and spending, where available, and estimates produced from various data sources, where not, to estimate the overall revenues raised in Scotland and public spending undertaken in or to benefit Scotland (Scottish Government, 2021). The latter includes a share of spending deemed to benefit the whole of the UK, including Scotland, such as defence spending, foreign affairs and aid spending, and servicing of the national debt.

From these revenue and spending estimates, figures for Scotland’s implicit budget deficit or surplus can be calculated and compared with those for the UK as a whole.

The latest publication covers the years up to 2020/21, the first year of the Covid-19 pandemic. This shows that for most of the period since devolution, Scotland’s implicit budget deficit has been a higher fraction of GDP than for the UK as a whole (see Figure 1).

This has been particularly true since 2014/15, since when a combination of lower prices and production and higher costs, as well as lower tax rates, has reduced North Sea oil and gas revenues (Office for Budget Responsibility (OBR), 2021). For example, in the period between 2014/15 and 2019/20, the implicit Scottish deficit averaged 9.2% of GDP, compared with 3.1% of GDP for the UK as a whole. In 2020/21, deficits are estimated to have peaked at 23.5% and 15.2% of GDP, respectively.

Figure 1: Net fiscal balance, Scotland and UK, 1998/99 to 2020/21

Source: GERS, 2020-21; OBR Economic and Fiscal Outlook, October 2021
Notes: Net fiscal balance for Scotland is based on a geographic share of North Sea oil and gas revenues. Figures for 2020/21 include estimates of the cost of writing off Covid-19 business loans, which were unavailable when the GERS report was being compiled, but were provided by the OBR in its October 2021 Economic and Fiscal Outlook report. The Figure allocates a population share of these loan write-offs to Scotland. Negative numbers are budget deficits, positive numbers budget surpluses.

Scotland’s higher implicit deficit is driven largely by public spending being higher than in the UK as a whole. For example, between 2014/15 and 2019/20, spending averaged £1,550 (or 12.3%) higher per person in Scotland than the UK average.

In turn, this was driven by the relatively generous funding the Scottish government receives via its block grant from the UK government to pay for devolved services such as health, education, local government, transport and housing. This is around 30% more than is spent on comparable services in England (Paun et al, 2021; Phillips, 2021a). Revenues averaged £325 (or 2.8%) lower per person than the UK average over the same period.  

Two further things are worthy of note:

First, Scotland is far from the only part of the UK with a large implicit budget deficit. Indeed, similar estimates from the Office for National Statistics (ONS) suggest that Wales, Northern Ireland and the North of England all have larger implicit budget deficits than Scotland. Fiscal transfers from areas with lower needs or higher revenue-raising capacity to areas with greater needs or lower revenue-raising capacity are normal within countries (Dougherty and Forman, 2021). Scotland does stand out from the other parts of the UK with large implicit budget deficits though: the other areas are poorer, with much more of their deficits explained by low revenues than in Scotland’s case (Phillips, 2021b).

Second, the figures are estimates and subject to both statistical margins of error, and more general conceptual criticism. On the former, there is little reason to believe errors would systematically bias estimates of Scotland’s deficit one way or the other. Building on the pioneering work of Jim and Margaret Cuthbert, significant improvements to the construction and transparency of estimates have been made (Cuthbert and Cuthbert, 2005; Roy and Spowage, 2021). In addition, the estimates’ status as National Statistics means they have been independently assessed as being based on sound methods and produced free from political interference.  

On a more conceptual level, some have criticised the ‘benefit’ approach taken, arguing that allocating Scotland a proportion of spending taking place elsewhere in the UK (for example to pay for the UK parliament in Westminster) or the world (such as defence and overseas aid) is inappropriate for assessing what the finances of an independent Scotland would be for two reasons.

First, different choices could and would be made on these areas of spending in an independent Scotland. Second, if more of that spending took place in Scotland, it would boost the economy and hence tax revenues, although even under generous assumptions such effects would not change the fundamental picture (Sustainable Growth Commission, 2018). But that is not the primary purpose of the GERS publication: instead, it is to estimate spending, revenue and Scotland’s implicit budget deficit under current institutional arrangements.

What would be the short-term position of the public finances for an independent Scotland?

There are two key steps to answering this question:

  • First, do the historic GERS figures provide a guide to how Scotland’s public finances may evolve in the future, at least in the short term?
  • And second, what implications would GERS-based figures have for an independent Scotland?

On the first question, the future is inherently uncertain, not least for the public finances, where forecasts even just two or three years out are subject to wide margins of error (OBR, 2021). But forecasts still provide a useful central prediction on which projections of the future evolution of Scotland’s public finances can be based.

Figure 2 shows the OBR’s forecasts for the deficit of the UK as a whole and projections for Scotland based on these forecasts and GERS figures, for the period 2021/22 to 2026/27. The Scottish projections assume revenues from North Sea oil and gas follow OBR forecasts, onshore revenues change at the same percentage rate per person, and spending changes at the same rate per person in either cash terms (for spending items that are largely devolved), or percentage terms (for other spending).  

Figure 2: Projected net fiscal balance, Scotland and UK, 2021/22 to 2026/27

Source: Author’s calculations using GERS 2020-21 and OBR, Economic and Fiscal Outlook, October 2021
Notes: Spending projections are made separately for spending items that are largely devolved (public and common services; public order and safety; agriculture, forestry and fisheries; transport; environmental protection; housing and community amenities; health; recreation, culture and religion; education and training; accounting adjustments) and other spending items (international services; public sector debt interest; defence; enterprise and economic development; science and technology; employment policies; social protection; European Union (EU) transactions). The former items are projected forward assuming the same change in spending per person as across the UK as a whole, but holding population fixed rather than accounting for projected population changes. This is akin to how the Barnett formula used to allocate spending to the devolved governments works (Cuthbert, 2020). The latter are projected forward at the same percentage rate per person, accounting for projected population changes.

The UK budget deficit is forecast to decline significantly (see Figure 2), as temporary Covid-19 related spending (such as the furlough scheme) ends, the economy bounces back from lockdowns, and a range of tax increases comes on stream (Emmerson, 2021).

If Scottish revenues and spending track these UK-wide forecasts, Scotland’s implicit budget deficit would also fall. But it would remain significantly higher than for the UK as a whole: 7.5% of GDP in 2026/27, compared with 1.5% for the UK as a whole. Scotland’s implicit deficit of £16.3 billion in that year would amount to around £2,975 per person, compared with a UK-wide figure of £640 per person (and a rest-of-the-UK figure of £440 per person).

What would these sorts of figures imply for Scotland if it were to become independent in the next few years?

To some extent this would depend on the ‘independence deal’ negotiated. As highlighted above, the GERS figures allocate a population-share of UK government debt interest payments to Scotland. The projections are therefore most relevant if Scotland were to be responsible for paying a population share of existing UK debt servicing costs post-independence.

The Sustainable Growth Commission set up by the Scottish National Party (SNP) thought that Scotland should make a contribution to servicing historic UK government debts, in order to secure co-operation from the UK government in other important areas needed for an orderly transition to independence (Sustainable Growth Commission, 2018).

The UK government made it clear that it would expect such a contribution and the Scottish government accepted this, at least in principle, in the 2014 independence referendum campaign (Scottish Government, 2013; HM Treasury, 2014). On the other hand, others have argued that because accrued debt would legally be the responsibility of the continuing UK government – and to reflect the large revenues generated for the UK government from North Sea oil and gas in the 1980s – Scotland should not contribute at all (Cuthbert and Cuthbert, 2014).

Even if we exclude all debt interest costs, Scotland’s deficit would still be around 6% of GDP in the middle of the 2020s, based on current forecasts. Continued deficits of that level – let alone the higher levels expected if Scotland had to contribute to existing UK debt servicing costs, as seems likely – would not be sustainable (Pope and Soter, 2021).

Reducing the deficit would require some combination of cuts to public spending or increases in taxation over the first decade of an independent Scotland. This was again recognised by the SNP’s Sustainable Growth Commission, which proposed cuts to defence spending, unspecified ‘efficiency savings’ and holding growth in other spending down to 1% less than growth in GDP for a decade. This would almost certainly imply cuts to some services, and difficult choices for many others (Sustainable Growth Commission, 2018; Phillips, 2018).

It is also worth noting that small, economically developed countries – which is what an independent Scotland would be – tend to run smaller budget deficits than larger countries (Emmerson and Stockton, 2019). This may reflect the fact that smaller countries are more exposed to external and sectoral shocks, and perhaps because of this and their smaller overall debt markets, generally pay higher rates of interest than bigger countries, making smaller deficits desirable (Pope and Soter, 2021; Armstrong and Ebell, 2013). This could mean that an independent Scotland would want to reduce its deficit further than assumed by the Sustainable Growth Commission, requiring further spending restraint or tax rises.

On the other hand, one might be tempted to conclude that low interest rates and experience during the pandemic mean than an independent Scotland need not be overly worried by a large budget deficit. But there is a difference between borrowing large amounts on a continuing basis, and borrowing temporarily to address a crisis, with plans to reduce that borrowing subsequently.

Interest rates would at some point rise without a credible plan to reduce the budget deficit. And one reason why interest rates in the UK and other developed countries have remained so low is that central banks have, in effect, bought much of the newly issued debt. Because an independent Scotland would take some time to set up and establish its own central bank and currency, this option would not be immediately available (Tetlow and Soter, 2021).   

What role could economic growth play in improving Scotland’s public finances?

One way to increase tax revenues and reduce Scotland’s budget deficit without cutting spending or putting up tax rates would be if the economy grew more quickly – with the added benefit that people would also get to keep more money to spend themselves. But how likely is it that faster growth would allow spending cuts or tax rises to be avoided?

Potential effects of independence on the economy are covered elsewhere in this series. It is clear, however, that independence would create a number of economic challenges in the short term that might have a negative effect on the economy, reducing rather than increasing tax revenues. For example, research suggests that the creation of a harder border between Scotland and the rest of the UK would reduce trade and in turn, GDP.

But the longer-term picture is less clear and would depend on how the Scottish economy and Scottish policy-makers responded to the challenges and opportunities presented by independence.

Trade could be re-oriented away from the rest of the UK and towards other trade partners, including in Europe, much as Ireland did in the late 20th and early 21st century. How feasible this would be and the scale of benefits that could be achieved is uncertain though, with one study suggesting that re-joining the European Union (EU) could only offset a small part of the reduction in trade with the rest of the UK (Huang et al, 2021).

Independence would give the Scottish government additional powers – currently held by the UK government – that could potentially help it to grow the economy by increasing the size of the working age population (most notably via immigration policy), boosting labour force participation and employment rates (for example, through welfare reforms), and improving productivity (for example, through changes in regulation).

Improving productivity would likely be the most important, as productivity growth is the main driver of long-term economic growth, and is where Scotland performs most poorly compared with the other small nations of north-western Europe (Tsoukalas, 2021).

Saying one would develop and implement policies that would boost growth is easier than doing so. And most of the policy ideas the Scottish government had at the time of the 2014 independence referendum entailed increasing spending or cutting taxes, which would increase the budget deficit even if they grew the size of the economy (Phillips and Tetlow, 2014).

But there are undoubtedly opportunities to improve policy in areas that are currently reserved to the UK government, or where interactions between devolved and UK-wide policy cause problems (Tsoukalas, 2021). A less obvious but not unimportant area is taxation, where the UK system is both unnecessarily complex and economically distorting. This is also an example of where the different geography and economy of Scotland implies that a different set of policies would be most suitable than in the rest of the UK (Adam et al, 2013).       

Whether an independent Scotland would be likely to implement growth-enhancing policies that would enable it to strengthen its public finances in the longer term is an open question. Surveys showing greater trust in the Scottish government may give it greater ability to take the sometimes politically difficult decisions that growth-enhancing reforms can require. Whether that trust would be sustained post-independence is unclear.

What is clear though is that to avoid higher taxes or lower spending continuing in the longer term, stronger growth would be needed post-independence to offset the loss of revenue transfers from the rest of the UK that Scottish residents currently benefit from.

Where can I find out more?

Who are experts on this question?                          

Author: David Phillips
Editors' note: This article is part of our series on Scottish independence - read more about the economic issues and the aims of this series here.
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