Last week the Scottish Government released their annual Government Expenditure and Revenue Scotland (GERS) report, the most intensely discussed set of statistics in the country's constitutional debate. The report produces data surrounding Scotland's fiscal position in the UK, mainly the difference between what Scotland returns in the form of taxation and what it receives in government spending.
What are the headline figures?
The most recent GERS report shows that for the period of 2021/2022 Scotland had a government deficit of £23.7 billion, which is the equivalent to 12.3% of GDP. In contrast, the UK's deficit sat at 6.1%.
Above: graph from GERS 2022
Overall Scottish expenditure was the equivalent to £17,793 per head of population, compared to the UK with £15,830 per head. In terms of tax returns, Scots raised £13,463 per head of population. This is in comparison to the rest of the UK with £13,684.
If the shift away from Covid-19 spending continues, then Scotland may return to historic deficit levels around the £15 billion (roughly 8% of GDP).
What is the response?
Despite the updated figures, the arguments surrounding GERS have changed very little.
For many anti-independence groups, GERS functions as a positive advertisement for membership of the UK because its data suggests that Scotland is subsidised by other UK regions. The argument that follows is that Scotland’s notional deficit could only have been achieved from the spending of the UK Treasury.
The Scottish Conservatives produced a graphic claiming that Scotland's position in the UK meant that is benefited from a "union dividend" of £2,184.
Whilst Scottish Labour did not promote the figures on their social media, finance spokesperson Daniel Johnson said: “The focus of every politician in Scotland must be on tackling the cost of living crisis and today's GERS statistics plainly show how the people of Scotland benefit financially from our United Kingdom.
“The figures confirm, yet again, that Scotland has an increased level of public spend relative to its tax base. That gives fiscal room that is vitally needed as we tackle the cost of living crisis. Independence would require tax increases or spending cuts at a time when these actions would shatter households as their bills spiral.
“The devolution benefit of £2,184 per person in Scotland compared to the rest of the UK is vital in maintaining the public services upon which we all rely."
On the pro-independence side, the Scottish National Party argued the figures were welcomed news due to the speed in which Scotland's government deficit was falling, and the amount of tax revenue that matched spending on devolved areas and reserved social security spending.
The Scottish Greens echoed a similar point to the SNP, with Green MSP Ross Greer adding: "With the powers of independence, Scotland could make better choices and take the action that is needed to build a fairer, greener and better recovery that works for people and the planet.
"Basic powers, like the ability to raise the minimum wage and make corporations pay their fair share of tax, would finally sit with the Scottish Government rather than cruel, incompetent and unaccountable Westminster governments that we did not vote for and cannot remove."
What does GERS tell us about independence?
The main takeaway from GERS is to understand where the Scottish economy has been inside the UK - the report does not predict where the economy is heading. If an independent Scotland were to take a different economic policy positions from the UK, then future GERS reports will look much different (whilst also offering better data collection in specific areas).
Secondly, using GERS to compare Scotland and the rest of the UK is methodologically flawed. Comparing an economic region with no monetary powers and limited fiscal levers to an entire unitary state that has full fiscal and monetary control does not provide fair or healthy analysis.
When considering wider economic regions within the UK, Scotland is not an outlier. ONS data shows that all regions beyond London and bordering regions run fiscal deficits. This point was previously demonstrated by Kevin Hague, Chair of the anti-independence think tank These Islands.
Whilst anti-independence activists will praise this as "pooling and sharing resources", this actually demonstrates huge regional inequality. When comparing the top percentage of regions to the lowest regions, whilst looking at various factors such as research and development, gross value added estimates, and GDP per capita, we find that the UK is one of the most regionally unequal countries in the industrialised world. This largely comes down to how centralised the UK economy is surrounding London, with resources disproportionately extracted and invested in the South.
Would independence end the "union dividend"?
The strongest argument from anti-independence activists on GERS is that independence would result in Scotland losing a fiscal transfer from the rest of the UK .The Institute of Fiscal Studies laid out this logic more clearly in an older GERS blog, writing:
“The UK government manages the overall public finances on behalf of whole country, and in effect, transfers revenues from those areas with surpluses (or smaller deficits) to the areas with (bigger) deficits.”
This framework is known as (TAB)s - taxation and borrowing precede spending. This framework argues that there is only three options for the state to increase its spending; to tax the population more, to borrow our savings, or to simply create new money. This framework suggests that a government’s budget is like that of a household or private business
Above: Three-source view of public finance process (UCL, 2022)
This framework is inaccurate, as it does not accurately follow the accounting practices of spending and taxation in the UK. For a more accurate description of where Scotland currently receives its funds from, we need to look at economic research from UCL Institute for Innovation and Public Purpose and the Gower Initiative of Modern Money Studies (GIMMS).
Above: Public sector accounting of the expenditure process in the UK
Above: Public sector accounting of the taxation process in the UK
When the UK government spends money, it is drawing on a sovereign line of credit from the core legal and accounting structure called the Consolidated Fund. The Consolidated Fund does not draw credit from other accounts, it is newly spent currency. The UK finance ministry directs the Bank of England to debit the Consolidated Fund's account at the Bank and credits other accounts at the Bank held by government entities. The Scottish government has its own Consolidated Fund account, like that of other government departments. The only difference is the Scottish government's allocation of credit is determined by the Barnett Formula. When government departments spend public money, it is done so through commercial banks and into the real economy. A more accurate visual is presented below.
Above: One-source view of public finance process (UCL, 2022)
Rather than Scotland receiving a "union dividend" in the form of taxpayers money, it is receiving a "central bank dividend" in the form of public money. An independent Scotland could replace the conditions and mechanisms of the Bank of England with its very own central bank and continue to meet its public spending commitments with public money. Austerity and tax rises are not inevitable for an independent Scotland, but rather a policy choice.
Does Scotland's revenue match devolved expenditure and reserved social security?
Whilst it is true that Scotland's onshore revenue (£70.3 billion) covers all devolved spending and areas of reserved social security (£70.2 billion), this still leaves out large areas of spending, such as foreign aid, defence, administrative costs and more. It also leaves out capital investment of £8 billion, which is devolved to Holyrood.
When pro-independence activists work within a (TAB)S framework - which does not apply to the UK - then it leads to odd statements such as these. If an independent Scotland were to establish a central bank with similar accounting to the Bank of England, then spending would be in the form of public money. It would not draw from other accounts and thus there would be no direct link to government tax revenues.
Further, whilst Scotland's tax returns are technically the "largest on record", this is not because of any new policy programme from either Holyrood or Westminster. This is because economic activity is returning to pre-Covid levels. So this statement is somewhat exaggerated.
If the Scottish Government wanted to achieve real record tax returns, then this would require large policy shifts. Currently Scotland's tax-to-GDP ratio stands around 38% (£73 billion/£192 billion), which is somewhat lower compared to its Nordic neighbours (or other European countries such as France and Italy), who sit between 42% to 46%. Assuming an independent Scotland wanted to mirror a similar ratio, then the country could see increased tax returns between £3 billion to £6 billion. Excluding offshore revenue, this would take Scotland's tax-to-GDP at 42%, so to match similar proposed tax returns with north sea revenue Scottish tax-to-GDP would need to be around 46% to 50%.
This would need to be balanced through various reformed and progressive tax streams, such as income tax, corporation tax, wealth tax, land value tax, capital gains tax, financial transaction taxes, carbon taxes and more.
Yet the simple introduction of new taxes and shifting rates will not be enough. Wider government policy will be required to tackle labour market bottlenecks that have resulted in lower productivity rates and higher inequality rates compared to Nordic countries (which can largely be solved with a Job Guarantee programme either equal or above a living wage). This is a topic MMS will analyse in the coming weeks.
When considering income tax, areas of Scotland's labour markets are found to be offering employment below that of the living wage, and thus reducing the potential for tax returns. According to data from the DWP around one third of all Scottish job opportunities online offer less than the real living wage. This figure increases to over 50% for part time jobs. Further research uncovered job opportunities that were advertised far below the legal minimum wage, with companies such as Pizza Express, Burger King, McColl’s Retail Group, and Farmfoods offering wages around £6 per hour. The increased spending through a living wage via lower income households will add to Scotland's overall tax returns, whilst further increasing Scotland's economic activity.
Higher tax returns for a monetarily sovereign Scotland is goods news, but not because of the governments ability to spend. Instead these returns would be indicators of behavioural changes, equity, domestic currency demand, and increasing economic activity.
Is Scotland's falling government deficit goods news?
It is of little surprise that Scotland's government deficit has drastically declined, with government policy and spending moving away from Covid-19 protections. Tax returns from Scotland's oil have also largely increased, which will likely have played a roll in the large decrease in Scotland's government deficit. However, the keen attitude of both anti-independence and pro-independence activists who want to see the government deficit vanish is misjudged.
The discourse around GERS places too much focus on just one sector of the economy, that being the government sector. Any analysis must also include the private and foreign sector. Ignoring these other sectors is the equivalent a football commentator only talking about one team and completely ignoring the rest of the game. Therefore, the best accounting framework to analyse these sectors is the Stock-Flow Consistent (SFC) model by British economist Wynne Godley.
When considering all sectors of the economy, the SFC model presents an accurate and detailed account of all flows and stocks in the economy. This framework means the net sum of all equity of the economy is equal to zero (whilst equity remains).
Above: Historic Sectoral Balances of the UK
The Scottish government deficit (in an independent Scotland) means the private sector is in a surplus. A Scottish government deficit adds net-financial assets to other parts of the economy. This in turn increases our income, which is spent into the private sector. Our spending becomes the income of businesses in, who in turn can then afford to expand projects and production, and generate more growth and jobs. By increasing our productive output and further utilising our resources, we create a stable and functioning economy. This is completely normal and necessary in order to run a healthy economy. It is wrong to for any economic discourse to push back against government deficits - unless in very specific contexts.
When the government aims to reduce the government deficit or achieve a surplus, which is what the UK government aims to do, then this will likely push the private sector into a deficit – reducing its size and suppressing economic activity. This will pressure us to either reduce our spending, sell our assets or borrow from commercial banks. Reducing spending will result in declining revenue streams for many within the private sector, whilst borrowing from commercial banks will result in growing private debt that will need to be paid by with interest.
Former UK chancellor George Osborne implemented some of the worst austerity levels in all of Europe, and yet only reduced the UK deficit to just under 3% after six years. Yet in those six years Scotland saw a rise in food banks, child poverty, deteriorating physical and mental health, failing infrastructure, growing crime, and increasing mortality.
So whilst Scotland's falling government deficit makes sense in the current context, we should be wary of calls of further reduction when there is still room for investment. Scotland's spending should not be limited to ratio targets, but by real resources (labour, skills, physical capital, technology and natural resources) to avoid high inflation.
Scotland's government deficit is a public surplus, the opposite of austerity driven by UK government. This is something we should all embrace.
The Real Challenge
Whilst the discourse around GERS has typically focussed on debates around government fiscal deficits, the real challenge for an independent Scotland would be tackling the current cost-of-living crisis. Between October 2021 and October 2022, the price of energy will have increased by 178% - taking the price cap to £3,549. This 35 times faster than wage growth and 57 times faster than standard benefit payments. When comparing the months of winter between 2021 and 2022, the price increase is 418%, with wider inflation predicated to reach 18% in January. On these numbers, it is predicated that three-quarters of Scots will be in fuel poverty. It is worth noting that the price cap is not a literal cap, but an average result of the new per-unit cap. For those who use more energy above average, in particular those who are disabled and/or consume energy for medical equipment, these hikes will burden them with increasing private debt. Many will also attempt to make cuts elsewhere, including dietary needs and heating, with disability justice activists predicting deaths in the coming months. On top of all this, the Bank of England is predicting a year long recession in 2023.
The UK's current inflation rate is one of the highest of all developed countries in Europe, ahead by a few percentage points compared to the likes of Norway, Switzerland, France, Finland, Italy, Denmark, Sweden, Luxembourg, Germany, and more. Yet this is despite the fact the UK disproportionately does not heavily rely on oil and gas from Russia compared to the rest of Europe. The largest factors behind UK's high inflation rate are disrupted supply-lines through Brexit and profit-fuelled price increase from large corporations with pricing power.
Whilst the UK government has indicated little policy movement to tackle these problems, an independent Scotland could take more direct action. We previously covered these policy solutions, which include a living wage, a Job Guarantee, price regulations and/or nationalisation, progressive tax brackets, a Foreign Investment Review Board, increased immigration and a central bank committee analyse output gaps & price stability in the economy.
Modern Money Scotland will present further comments and analysis in the coming weeks. For now, GERS once again provides a healthy platform of discussion in the debate on Scottish independence and economics. However, the dominance of orthodox language and frameworks leaves macroeconomic discourse with one eye shut, and still largely results with misinformed voters.
Whilst easy soundbites are useful for political activists, a more complex truth is better for democracy.