GERS, COVID and Scottish independence

The publication of the latest Government Expenditure and Revenue Scotland (GERS) report each year provokes an unedifying and often fruitless argument between proponents of Scottish independence and defenders of the Union of 1707, between those who think Scotland can overcome its debt/deficit problems on its own through borrowing on global markets like any other sovereign state and those who think the UK is the proven sole bulwark against penury.

Or, as Ben Wray of Source Direct, put it (very cutely): “GERS day is the geek term for the ultimate geeky day in Scottish politics, where a statistical publication is wielded like a constitutional axe, weaponised as the definitive financial statement of whether an independent Scotland is perfectly viable or a disaster waiting to happen, depending on your tastes.”

Some of these arguments and counter-arguments can be found in the links at the foot of the following analysis by John McLaren of Scottish Trends (often falsely written off as a “unionist” economist). But GERS also provides an opportunity to revisit, soberly, without wishful thinking, in line with our own non-partisan/sceptical stance, some of the key economic and fiscal (i.e. public finances position) arguments around Scottish independence, including what impact COVID-19 might have.

GERS 2020

The 2020 edition of GERS confirms that in 2019-20, i.e. prior to COVID-19, tax revenues in Scotland stood at around 37% of GDP, compared to public spending at 46% of GDP, leaving a 9% differential. By contrast the UK differential stood at around 3%. This higher Scottish differential (worth 6% of GDP) is equivalent to around £11 billion and is, in effect, the net fiscal benefit from Scotland’s being part of the UK’s shared public finances system. This equates to around 14% of total public sector spending in Scotland.

COVID-19

2019-2020 will be the last financial year for some time where fiscal balance figures are available that are not severely distorted by COVID-19 affected tax and spend patterns. For example, the UK’s fiscal deficit for 2020-21 is expected to be over 16% of GDP, rather than the 2.6% seen in 2019-20.

Examples of how the pandemic is likely to affect countries views on their economic future and their approach to public finances include:

• a shift from economic efficiency to economic resilience, with less emphasis on just in time and more on just in case;
• changes to trade links and supply chains;
• a move to a more environmentally friendly growth model;
• reducing income and workers rights inequalities;
• increased levels of preventative health and care home spending.

 Such changes greatly enhance the scope for a variety of new economic models to be put forward as the basis for how any post independence Scottish economy and public finance targets would work.

 An updated independence prospectus

Economic and fiscal changes since 2014, together with the current pandemic, will impact significantly on relevant arguments around a Second Referendum. In particular, Scotland’s fiscal position and its choice of economic model need to be re-appraised.

1) The Fiscal Position

Scotland’s fiscal position, as part of the UK, has worsened since the First Independence Referendum for two reasons. First, due to a fall in revenues from the North Sea – down from £4.6 billion in 2012-13 to £0.7 billion in 2019-20 and forecast to remain at this lower level. Second, due to an, unexplained, one-off fall in Scotland’s share of earnings related revenues between 2014-15 and 2015-16 – such that the Scottish/UK differential in onshore tax paid per head has risen from around £-120 to more than £-400.

This has left Scotland in the position of being a net beneficiary, to the tune of £11 billion, from the UK wide funding arrangement. The (SNP commissioned) Sustainable Growth Commission Report (SGCR) largely acknowledged the scale of this transfer as too have bodies like the Institute for Fiscal Studies (IFS).

The key question then, and one not addressed at the time of the last White Paper, is how adjust Scotland’s public finances in order to make them more sustainable, post independence.

Spending constraint adjustment

The SGCR’s main proposal for dealing with this situation was for a decade long transition period,  where public spending would grow by 0.5%, in real terms, a year, in order to allow the Scottish fiscal deficit to be brought down to a more manageable level. However, this would mean:

• if Health pressures grow at 3-5% above inflation (as predicted by IFS and others) and Social Security payments grow in line with RPI or wages, then all other public service budgets (50% of the total) would see annual cuts of around -1% for a decade;
• an annual 0.5% public spending growth figure is lower than that seen in UK public spending over the ‘austerity’ years, 2013-14 to 2019-20 and is well below the, pre COVID-19, 1.25% average growth rate forecast for total public spending growth at the UK level up to 2023-24.

The above observations suggest that such a public spending scenario – of on-going austerity for most public services – seems unlikely to be a popular one and may not be politically sustainable.

Tax raising adjustment

An alternative adjustment route, to raise taxes, could do away with the need for such a difficult and prolonged adjustment phase. This approach is at odds with the one taken in both the last White Paper and in the SGCR, i.e. that taxes do not need to rise in an independent Scotland. However, given the SGCR’s acceptance of the existence of a significant (negative) net fiscal transfer, as well as the evidence of higher tax raising levels in other small independent countries, then raising taxes at the point of independence may ultimately be a more politically fruitful way forward than attempting to restrain public spending for another decade.

2) The Economic Model

The willingness to look at a significantly different economic model to that followed in most ‘advanced’ economies, has been gaining ground for some time now and the pandemic will have only strengthened that appeal. Such a shift should hold attractions for pro-independence campaigners as it allows for a more unique ‘Scottish’ economic model to emerge. This might be seen as advantageous as, given the uncertainties and risks inherent in leaving the UK economic union then it is always going to be a difficult argument to convince voters of a ‘no harm’ outcome. However, by shifting the terms of the argument, by instead comparing two different economic models, such a disadvantage is, to some extent, overcome.

It is worthwhile therefore considering the economic growth model put forward by the SGCR and what alternatives might exist.

The SGCR highlighted aspects of the economies of Denmark, Finland and New Zealand for its own ‘Next Generation Economic Model’. However, the inclusion of New Zealand (with a ‘moderate’ level of taxation), deflected attention from the fact that most relevant examples fit into a higher tax, stronger social support, model, including: Netherlands; Belgium; Austria; and Iceland.

In general, countries with relatively small economies tend to exhibit: relatively high levels of tax (as a % of GDP); a Current Account surplus; and a government fiscal position near to balance. This might be explained in part by smaller economies tending to: be more open (i.e. have greater trade activity levels as their economies are less self contained); be more susceptible to boom and bust, due to being more concentrated around specific activities, and so government’s protect themselves by having a stronger fiscal balance position; lose out on economies of scale re provision of public services, especially as many have low population densities, which can increase the need for public spend per head.

The above analysis suggests that an independent Scotland is more likely to follow a higher tax model than it is the current UK one.

An alternative economic model?

Proposals put forward in the 2014 White Paper, and likely to merge in the next one, essentially suggest that Scotland would not diverge far from the UK economic model. The attractions of this ‘continuity’ model are obvious, it is easily recognisable and minimises the need for change to stable working practices, like the use of sterling. However, it has the drawback of being strongly associated with the alleged ‘failed’ UK economic model that Scotland needs to escape from and that has performed relatively poorly post the 2008 crisis.

While such a ‘continuity’ model may have been understandable at the time of the first Referendum, or even when the SGCR was being written (largely in late 2016), it is increasingly open to debate if this remains the best model to adopt now.

An alternative model could present Scotland as being a ‘first-mover’ that can then gain an economic advantage over other countries. Such arguments also have the upside of avoiding the ‘risks of separation’ threat by emphasising instead the risks of staying with an outmoded model, as opposed to moving forward to a new model.

One example of the kind of new thinking around growth involves a greater focus on reducing inequality as a way of improving well-being and the standard of living across the wider population. Economists like (Nobel Prize winners) Abhijit Banerjee & Esther Duflo (“Good Economics for Hard Times” (2019)) and Branko Milanovic (“Capitalism Alone” (2019)) highlight the economic and political drawbacks of the modern day ‘liberal meritocratic capitalism’.

The policy implications of moving to a more widely shared/owned form of capitalism (i.e. one where growth is important but so too is its distribution) include: tax incentives or regulations to encourage a wider holding of financial assets amongst the population; higher inheritance and/or marginal tax rates for the very rich; and improved free public education, particularly with respect to pre-school education. Overall, such models seek to achieve greater equality of assets (both financial and skills based) as opposed to using redistributive policies to rein in rising inequality, the current UK position.

The higher taxes proposition referred to earlier has obvious negative connotations in terms of voter appeal, but these might be more easily managed at a time of great upheaval, as now, and when the transition is to a new model and not to one more comparable with the existing UK model. However, it is difficult to make such an argument when few in the the SNP are actively involved in outlining, developing and proselytising such an alternative model.

3) Leadership

Even before the pandemic changed the ground-rules, the SNP’s approach to the economics of independence was uncertain. The Sustainable Growth Commission Report (SGCR) had received lukewarm support from the party as whole and parts of it were rejected or watered down with respect to currency, the economic model and the fiscal approach.

It can be argued that this uncertainty is the result of an on-going lack of economic leadership within the SNP, post Alex Salmond, towards any new post independence economic approach. Of those who advanced the SNP’s economic policy post devolution (i.e. Alex Salmond, Andrew Wilson, Jim Mather and Andrew Hughes-Hallet) only Andrew Wilson remains active, albeit at a distance given that he is no longer a politician. This lack of economic engagement by senior SNP Ministers remains a weakness for the independence message on the economy.

Such a policy vacuum in a key area of the independence debate may be manageable when minds are focussed elsewhere but if a Second Referendum were to become a reality then it would soon turn into a significant weak point in the pro-independence argument.

4) Avoiding another Brexit

In order to avoid the confusion and mis-information that dogged much of the economic debate around the First Independence Referendum and around Brexit then more trusted and authoritative channels of information need to be found. This is easier said than done and at present the lack of engagement and debate on such crucial, but complex, issues (witness the lack of reaction to the SGCR) bodes ill.

The general lack of interest and analysis in Scotland with respect to the economy – whether it be with respect to academics, journalists, think tanks or politicians – remains a concern and would have been a problem at the best of times but with a background including a recent/on-going pandemic and the early days of Brexit, then the potential for confusion and deliberate obfuscation of likely out-turns is considerable.

It is essential that the basic economic and fiscal principles and policies of any new beginning are clearly laid out and coherent. To avoid doing so, as with Brexit, is asking for trouble.

Read the full text of John McLaren’s analysis at Scottish Trends

Image of Kate Forbes via Wikimedia Commons/Flickr

Further reading: Richard Murphy, Tax Research UK, on GERSday, 26 August; Robin McAlpine of Common Weal on the Good news story; David Phillips, IFS, Scottish implicit deficit cd be 26-28% in 2020-2021, 27 August; Richard Murphy (again), Scotland’s problem: Low taxes, August 27; Tom Gordon, Herald, Forbes: growth will cut deficit, 26 August plus FAI elsewhere on this site (it puts the possible deficit peak at 21%). More generally: Laurie Macfarlane and Miriam Brett, A just sustainable recovery plan, Common Wealth, August 2020.