IFS: An independent Scotland would face a long term fiscal headache

A report by the Institute of Fiscal Studies in Edinburgh highlights the financial issues an independent Scotland would have to contend with.


The fiscal situation facing an independent Scotland would, in the short run, not look all that different to that faced by the UK has a whole, provided it takes a “geographical share” of North Sea oil and gas revenues.

That’s the conclusion of a new report (pdf) to be published by the Institute for Fiscal Studies in Edinburgh today, the first in a series of works to look at the fiscal implications of Scotland going it alone.

The report notes that whilst public spending per head remains higher in Scotland than the remainder of the UK, with oil and gas set aside, revenues per head are “close to the UK average”.

Adding such revenue, however, would mean total Scottish tax would, based on recent years, have been at a level to “slightly more than offset the higher levels of public spending”.

Crucially, though, the IFS study notes that in the long run, the likelihood of revenue from North Sea oil and gas falling would lead to Scotland facing a much more substantial fiscal adjustment that the rest of the UK.

The IFS explain:

If Scotland were to become independent in the second half of this decade it would do so following a long period of public spending cuts across the UK. Yet UK public sector net debt is projected still to be high by recent historical standards, still over 70% of GDP in 2017-18.

When you take account of North Sea oil, GDP per head is somewhat higher in Scotland than in the UK as a whole. So if UK debt were shared on a per capita basis then an independent Scotland might inherit a slightly smaller debt to GDP ratio than that faced by the UK. Even then debt would still likely be a good two thirds of GDP, much higher than the UK’s level of debt in the years prior to the recent financial crisis and associated recession.

The IFS goes on to warn that a new Scottish government would “need to put together a fiscal architecture which would set out a long term path to sustainability”.

The report also finds:

• Public spending per head is roughly £1,200 a year higher in Scotland than in the UK as a whole and is higher across most areas of government activity, despite the fact household disposable income per head in Scotland is similar to the UK average.

• Allocated on a geographic basis, North Sea oil and gas revenues would currently be “hugely important to the budget of an independent Scotland”. They would, the IFS suggests, have accounted for more than 15% of revenues in 2010-11 compared with just 1.6% for the UK as a whole.

• Oil and gas revenues remain volatile. On a geographic basis they were more than 20% of Scottish revenue in 2008-09 but just 12% in 2009-10. The report notes that in the mid-1980s they made up nearly half of all revenue, by just 3% in 1991-92.  Such volatility would, the IFS concludes, pose “challenges” for an independent Scotland.

• Taking oil and gas revenues out of the equation points to Scotland having seen a bigger gap between spending and tax receipts in recent years than the UK as a whole.

• The report notes that an independent Scottish government would have important decisions to make about whether, and if so, what, fiscal rules to establish.

The report continues:

An important decision would revolve around how to treat oil and gas revenues. One possibility would be to aim for budget balance, ignoring oil and gas revenues (as well as investment spending, as the UK Government currently does), several years down the road.

One of the report’s authors, David Phillips, senior research economist at the IFS, said of the findings:

“Independence would provide Scotland with an opportunity to set its own fiscal course. In common with all countries it would face constraints and would have to make, sometimes uncomfortable, choices. In the short run its higher public spending than the UK average could be covered by oil and gas revenues if these are assigned on a geographic basis.

“In the longer run the loss of these revenues would lead to tougher choices than those faced by the UK as a whole.”

The findings will once again raise questions about the viability of the SNP having a fiscal policy for an independent Scotland so strongly based on oil and gas revenues.

Launching Scotland’s oil and gas strategy for 2012-2020, the first minister, Alex Salmond, pointed to what he perceived to be the central role of such revenues to Scotland’s future, explaining:

“We will continue to work closely with the sector to deliver excellent services, drive growth and support the on-going success of an industry that has powered the economies of Scotland and the UK over the last 40 years, and which can continue to be a key driver of prosperity in these islands well into the middle of this century.”

The Fiscal Sustainability Report, published in July by the Office for Budget Responsibility, however, points (pdf, page 9) to significant falls in north sea revenues.

The OBR explained:

“Our latest projections suggest oil and gas revenues falling to around half the level we projected last year by 2040-41, but the reduction is small as a share of GDP – from 0.1 to 0.05 per cent. So our broad conclusion remains as last year: that these factors could reduce the revenue from these taxes by up to 2 per cent of GDP over the next 30 years.”

Unsurprisingly, both camps in the debate on Scottish independence have cherrypicked those bits of the report which support their particular point of view.

For the Yes Campaign, finance secretary John Swinney argued the report proved Scotland would be financially viable as an independent nation.

He explained:

“The IFS report confirms that Scotland is more than able to pay our way with public spending offset by revenues raised in Scotland and that with the appropriate share of North Sea revenues Scotland’s public finances  have been stronger than the UK’s in every year from 2006-07 to 2010-11 with an average fiscal deficit lower than the UK’s since 2000.

“With independence Scotland will be able to face the difficult financial choices ahead from a stronger position than in the UK and use the full range of economic levers to support growth, boost revenues and deliver public services.”

Speaking for the Better Together campaign, chair Alistair Darling concluded it showed that if Scotland became an independent nation its economy would remain uncertain given the volatility of north sea revenues.

He commented:

“The report sets out, in stark terms, just how exposed we would be under independence to one revenue stream. North Sea oil is notoriously volatile and, according to the report, the only way that we would even come close to balancing the books in future would be by ensuring that what oil we have left is sold at the highest possible price. An economy paid for at the petrol pump is not what Scotland wants or needs.

The report drives a train through the SNP’s claims that Scots would pay less tax, but receive higher public services than we do now under independence. There are difficult economic times ahead. Independence continues to be shown to be an inadequate response.”

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