Scotland's Future

Chapter 2 Scotland's Finances

• Scotland is a wealthy country and can afford to be independent
• Our public finances are healthier than those of the UK as a whole
• Tax receipts per head in Scotland are estimated to have been higher than in the UK as a whole in each and every year since 1980/81
• In 2011/12, Scottish tax receipts were equivalent to £10,700 per head - £1,700 higher than the equivalent UK figure
• Over the last five years, Scotland's public finances have been stronger than the UK as a whole by a total of £12.6 billion - almost £2,400 per head
• Projections set out here demonstrate that Scotland's public finances are expected to strengthen over the next few years
• Independence will provide us with the opportunity to manage our public finances more securely and to create a more vibrant and resilient economy

Why we need a new approach

The strength of a country's public finances depends on the balance between public spending, revenues and the stock of government debt.

These in turn depend upon the health of the economy and choices around the level and composition of taxes and provision of public services.

This chapter sets out Scotland's public finances and demonstrates that Scotland has the financial foundations to be a successful independent country.

It also provides an overview of the financial position that the Scottish Government expects an independent Scotland to inherit and this Government's early priorities for public spending and revenue.

The starting point for this analysis is the National Statistics publication, Government Expenditure and Revenue Scotland (GERS). GERS is the authoritative publication on Scotland's public finances.

GERS provides estimates of the tax revenue generated in Scotland and the public spending undertaken for Scotland within the current constitutional framework^[23].

The facts are as follows:

• even when oil and gas revenues are excluded, estimated tax receipts per head in Scotland are broadly equivalent to the UK figure^[24]. When Scotland's oil and gas receipts are added, tax revenue per head in Scotland is nearly 20 per cent higher than the UK average
• in 2011/12, the most recent year for which information is available, Scotland generated £10,700 of tax revenues per head compared to £9,000 per head for the UK as a whole^{[25], [26]}
• indeed, in every year from 1980/81 to 2011/12, Scottish tax receipts per head are estimated to have been higher than in the UK as a whole
• some decisions on taxes are already devolved to Scotland, notably on council tax and local business rates. However, together these taxes account for just 7 per cent of total Scottish tax receipts^[27]
• changes included in the Scotland Act 2012, due to come into effect over the next one to two years, will give the Scottish Parliament control over two additional taxes which together raise about £400 million per year, and some limited control over a proportion of income tax. These changes will still only give Scotland responsibility for 15 per cent of Scottish receipts. Decisions on the overwhelming majorityof Scottish taxes will remain at Westminster^[28]
• total public spending for Scotland was worth an estimated £64 billion in 2011/12^[29]. This includes all spending undertaken for the benefit of Scotland by every tier of government in the UK
• relative to the size of the economy, public spending is estimated to be lower in Scotland than in the UK as a whole. In 2011/12, total public sector expenditure for Scotland was estimated to be equivalent to 42.7 per cent of GDP. In comparison, UK public spending was 45.5 per cent of GDP in the same year^[30]
• as a share of GDP, public spending in Scotland is also lower than in the majority of EU-15 countries^[31]

The overall level of public spending for Scotland is primarily decided by the Westminster Government.

In terms of reserved programmes affecting Scotland, the Westminster Government sets levels of spending on matters such as welfare payments and defence. This covers around 40 per cent of all spending for Scotland.

For devolved programmes such as health, education and transport, the total budget is set by the Westminster Government using the Barnett Formula. The Barnett Formula uses the size of Scotland's population relative to other parts of the UK to calculate changes in the budget available for devolved services, depending on decisions taken about funding levels for Whitehall departments.

Public spending in Scotland is therefore set without reference to the needs or preferences of Scottish households or businesses. Nor does it directly reflect the substantial contribution that Scotland makes to UK tax receipts.

Taking revenues and expenditures together provides a picture of the overall health of the public finances.

The facts show that, over the last five years, Scotland's public finances, despite being in deficit, are estimated to have been relatively stronger than the UK as a whole by a total of £12.6 billion - almost £2,400 per head^[32].

This relatively stronger fiscal position is consistent with a longer-term trend.

The Fiscal Commission Working Group ("the Fiscal Commission")^[33] has estimated, that since 1980/81, Scotland has run an average annual net fiscal surplus of 0.2 per cent of GDP, compared to an average annual deficit for the UK of around 3 per cent of GDP.

The Fiscal Commission has also illustrated that, had Scotland had control of our own resources, and assuming no change in tax revenues or spending priorities, our relatively stronger fiscal position from 1980/81 would have allowed us to not only eliminate a per head share of UK net debt, but actually accumulate assets worth between £82 billion and £116 billion by 2011/12^[34].

This would have equated to an asset of between £15,500 and £22,000 per head. In contrast, by the end of 2011/12, the UK had accumulated net debt of over £1.1 trillion, equivalent to a liability of £17,500 per head.

The opportunities available to Scotland

Despite these underlying strengths, Scotland is disadvantaged by not being independent.

Scotland does not have full control of our economy or public finances.

The Scottish Parliament is unable to determine the level and composition of taxation or the overall value of public spending.

It is not possible to realise the financial benefits of successful economic policies - such as increased revenues or reduced welfare payments. Under current arrangements, these benefits are passed straight to the Westminster Government. For example, because Scotland has proportionately more social housing, spending on housing benefit is lower, but the benefit of this goes to the Westminster Government not the Scottish Government.

Without independence, Scotland is also exposed to the approach that successive Westminster governments have taken to managing the public finances.

Between 2001/02 and 2007/08, the then Labour Westminster Government increased debt year on year, despite strong economic growth^[35]. As a result, just as the recession hit, the UK had the third highest structural deficit in the OECD^[36].

In surveying the UK's public finances, the Fiscal Commission concluded that:

the decision not to manage government borrowing more prudently during the years prior to the financial crisis weakened the resilience of the public finances and meant that they were not well placed to respond to the sharp drop in tax revenues, and increase in government spending, which occurred with the onset of the recession in 2008^[37].

This position has since been compounded by the current Westminster Government's decision to cut public expenditure too quickly - especially public sector capital investment - and before the recovery had gained momentum. This damaged economic growth, depressed tax revenues and resulted in borrowing exceeding forecasts.

In contrast, the Scottish Government has developed a reputation for sound financial management. In the areas that we control, we have taken tough decisions, delivered significant efficiencies and prioritised spend to the areas which have the most significant economic impact and offer the greatest protection for those who rely on public services.

Independence will provide the opportunity to safeguard Scotland's financial sustainability more effectively and ensure that our public finances are managed to reflect the needs of Scotland's economy.

Scotland's public finances on independence

It is clear that Scotland currently pays our way within the UK.

As we move to independence, our strong public finances will provide the foundations for policy decisions on taxation, growth and welfare.

As with most developed countries - including the UK - Scotland is currently running an estimated fiscal deficit, which means that the revenues from taxation fall short of public spending^[38]. Of the 31 members of the OECD for which data are available, 27 are estimated to have been in deficit during 2012^[39].

As a result of the recession, Scotland will inherit challenging fiscal position that will require careful stewardship in the years immediately following independence. The first Government of an independent Scotland will need to make decisions based on the prevailing conditions.

To enable an informed assessment of the financial position of an independent Scotland, the Scottish Government has prepared projections of Scotland's public finances under the current constitutional framework to 2016/17, the year when Scotland will become independent^[40]. Such projections reflect the decisions and priorities of the Westminster Government. In contrast, the strength of Scotland's public finances in the years after 2016/17 will depend on the economic and fiscal decisions of future Scottish governments and our ability to grow the economy.

Scotland's public finances are forecast to improve as the economy continues to strengthen.

The financial position that Scotland will inherit on independence will also reflect, in part, negotiations between the Scottish and Westminster Governments following a Yes vote. For example, the proportion of UK public sector debt which an independent Scotland will assume responsibility for will have implications for our annual debt interest payments. Negotiations will enable phasing and the financial consequences of the transition to be agreed, planned and managed by all parties.

To reflect the range of possible outcomes, the analysis in this guide uses two scenarios for Scotland's share of UK public sector debt and annual interest payments:

• Scotland's share of UK public sector net debt could be apportioned by reference to the historical balance of public spending and taxation since 1980/81, the earliest year for which figures are available. This provides a measure of our contribution to the UK's finances over the years. As Scotland has been in a relatively stronger position than the UK over this period, a historical share of public sector debt would be lower than a population share^[41]
• Alternatively, Scotland could take responsibility for a population share of UK public sector net debt

Under either outcome, Scotland's projected debt to GDP ratio would be smaller than the UK's. Negotiations will also take into account the degree to which Scotland's share of UK public sector debt, and in turn its annual debt interest payments, could be reduced in return for forgoing rights to certain UK assets (see Part 4).

Based on the Westminster Government's current spending plans, public spending excluding debt interest payments for Scotland is forecast to fall by 4 per cent in real terms between 2011/12 and 2016/17.

UK debt interest payments are projected to rise by over 20 per cent in real terms between 2011/12 and 2016/17, reflecting higher levels of UK borrowing in recent years^[42]. Based on such figures, Scotland's historical share of UK debt interest is projected to be £3.9 billion in 2016/17 or £5.5 billion based on a per head share.

Assuming onshore tax revenues in Scotland follow the path forecast for the UK as a whole, they are projected to grow by approximately £5 billion (10 per cent) in real terms between 2011/12 and 2016/17^[43].

Tax revenues from oil and gas production will depend on a range of different factors, including future production in the North Sea, wholesale oil and gas prices and profitability. The Fiscal Commission has set out proposals for how such revenues could be managed successfully in an independent Scotland.

The Scottish Government has published forecasts for North Sea tax receipts under a range of scenarios^[44]. Two scenarios are used here.

In the first, production is assumed to remain unchanged at current levels, whilst oil prices are assumed to remain unchanged in cash terms at their average level over the two years to March 2013. Under such a scenario, Scottish oil and gas receipts are forecast to generate £6.8 billion in tax revenue in 2016/17.

In the second scenario, production is forecast to increase more in line with industry forecasts, although at a lower level of profitability. Under this scenario, oil and gas receipts could reach £7.9 billion in 2016/17.

The table below provides forecasts of key elements of public sector expenditure and revenue for Scotland in 2016/17 based on the above scenarios and projections.

Table - Estimates of Scotland's financial position (2016/17) £ billions - under current constitutional arrangements
Total Expenditure (Non-Debt Interest)	£63.7
Currently Devolved	£37.3
Defence	£3.0
Reserved Social Protection	£18.8
Other Reserved Spending	£4.6
Public Sector Debt Interest1	£3.9 to £5.5
Total Public Sector Receipts	£63.7 to £64.8
Onshore Receipts	£56.9
Offshore Receipts	£6.8-£7.9
Net Fiscal Balance2
Including historical share of debt interest payments	-£2.7 to -£4.0
As percentage of GDP	-1.6 per cent to -2.4 per cent
Including population share of debt interest payments	-£4.3 to -£5.5
As percentage of GDP	-2.5 per cent to -3.2 per cent
UK Public Sector Net Borrowing3	-£61
As percentage of GDP	-3.4 per cent
Figures are rounded to the nearest hundred million and therefore may not sum 1 Range based upon historical or population share 2 Scottish Government projections 3 Office for Budget Responsibility - March 2013 Economic and Fiscal Outlook

Scotland's deficit is forecast to fall to between 1.6 per cent and 2.4 per cent of GDP in 2016/17 with a historical share of UK debt and to be between 2.5 per cent and 3.2 per cent of GDP if we take on a population share of UK public sector debt. The Office for Budget Responsibility forecasts that the UK will run a deficit of 3.4 per cent of GDP in the same year^[45]. The IMF estimates that the average deficit across the G7 economies will be 3.2 per cent in 2016^[46]. Based on this approach, the net fiscal balance for an independent Scotland in 2016/17 is therefore forecast to be better than for the UK as a whole.

When assessing a country's finances, an important figure to consider is the current budget balance. This measures the degree to which current taxpayers meet the cost of paying for the public services they consume today and includes a contribution to debt interest payments. If a country is running near to a current budget balance or surplus, it may still have to borrow to fund capital expenditure. However, such borrowing will be for long-term investment which can be expected to increase the economy's productive capacity in future years. Such borrowing can therefore be part of a sustainable approach to managing the public finances.

Assuming a share of debt interest payments based upon Scotland's historical contribution to the UK public finances, Scotland's current budget balance is estimated to be between 0.1 per cent (i.e. a surplus) and -0.7 per cent of GDP in 2016/17. Assuming a population share of debt interest payments, Scotland's current budget balance in 2016/17 is projected to be between -0.8 per cent and -1.5 per cent of GDP. This compares to a forecast for the UK as a whole of -1.9 per cent.

Given this expected starting point, the following section sets out the early tax and expenditure priorities that the current Scottish Government would take forward following independence.

We recognise that, as with any financial projection, revenues and expenditure may be higher or lower than projected at this stage. As a responsible government, we will make plans for transition and contingency.

Early priorities for action within sound public finances

Robust public finances are an important prerequisite for delivering sustainable economic growth. The sharp increase in Westminster borrowing, and resulting austerity, highlights the significant implications for household incomes and the economy of not managing the public finances responsibly.

This Government will ensure that Scotland has stable and sustainable public finances, underpinned by the discipline of a framework designed to ensure that Scotland's finances are appropriate for the country's economy, and able to withstand changes in economic circumstances.

To support this, this Government will put in place an effective fiscal framework, including: the creation of an independent Scottish Fiscal Commission; fiscal rules; and an Energy Fund to manage oil revenues^[47]. This will provide future Scottish governments with a sound basis on which to make appropriate choices about tax rates, spending levels, debt and borrowing.

Sound public finances will be an important part of the agreements underpinning a Sterling Area arrangement with the rest of the UK and for demonstrating our credibility to financial markets^[48]. The record of Scotland's public finances, and the projections provided here, give us confidence that Scotland will be able to meet these requirements.

In an independent Scotland, the elected government will have control over all tax revenues and expenditure in Scotland. This will provide an opportunity to redirect currently reserved expenditure to reflect Scottish priorities and also to use key tax and regulatory powers to improve the Scottish economy - for example, by better linking our welfare and tax system.

This Government intends to raise revenue and reduce spending by:

• reducing defence and security spending to £2.5 billion per year (which is still more than Westminster spends on defence in Scotland)
• ending the married couples tax allowance, planned for introduction in 2015
• cancelling the Westminster Government's Shares for Rights scheme in Scotland
• providing for a streamlined system of overseas representation focused on Scottish citizens and priority business sectors

There will also be savings from no longer having to fund the Westminster Parliament.

We expect these changes to deliver savings or increases in revenue totalling around £600 million in a full year.

This will provide scope to take action in the first budget of an independent Scotland to create a fairer and more successful country. The priorities of the current Scottish Government for that first budget will be to:

• maintain a commitment to protecting free personal care, free prescriptions, free higher education tuition for Scottish students and free concessionary travel
• abolish the "bedroom tax"
• extend the period of the triple lock for uprating of state pensions
• reduce energy bills by moving the cost of the Energy Company Obligation and Warm Home Discount Scheme to the Scottish Government
• provide 600 hours of childcare to around half of two year olds, as part of a longer term plan to deliver a transformational expansion in childcare
• equalise the earnings disregard between first and second earners for those already in receipt of Universal Credit
• increase tax allowances, tax credits and benefits in line with inflation
• meet international commitments to spend 0.7 per cent of Gross National Income on international aid

We expect these commitments to cost around £500-600 million per year in total to deliver.

Over the course of the first term of an independent Scottish Parliament, the Scottish Government proposes to work with Scotland's tax authority, Revenue Scotland, to simplify the tax system to reduce compliance costs, streamline reliefs and help to reduce tax avoidance, with a target revenue gain of £250 million per year by the end of the first term.

Alongside simplification, this Government plans for Revenue Scotland to deploy modern digital collection technologies to help ensure that all taxpayers pay their fair share of taxes, bearing down on the amount of revenues which are lost to error, avoidance and evasion.

Within our framework for robust and sustainable public finances, we propose to deliver the following measures to boost Scotland's competitiveness within the first term of an independent Scottish Parliament:

• provide childcare for 30 hours per week for 38 weeks per year - equivalent to primary school hours - for every three and four year old and vulnerable two year old, as part of a longer-term commitment to provide this level of provision to all children from age one until they start school
• cut Air Passenger Duty by 50 per cent, with a view to eventually abolishing it
• provide a clear timetable for cutting corporation tax by up to three percentage points for businesses paying tax in Scotland

We will also examine an increase in the National Insurance Employment Allowance to help small businesses, and will commence negotiations to return Royal Mail in Scotland to public ownership.