Scotland’s fiscal position improves in 2013–14 but this is set to stall as oil price falls bite

In this observation, David Phillips of the IFS discusses what the GERS figures tell us about Scotland’s notional fiscal position in 2013-14.

On March 11th, the Scottish Government published the latest version of its annual Government Expenditure and Revenues Scotland (GERS) publication on Scotland’s public finances. Table 1 shows how Scotland and the UK’s net fiscal balance – which is the difference between government revenues and government spending (including investment spending) – evolved between 2009–10 and 2013–14 (the five year period GERS focuses on).

Table 1: Net fiscal balance (% of GDP), UK and Scotland, 2009–10 to 2013–14

Net fiscal balance

Source: GERS, 2013–14, and author’s calculations.

Excluding North Sea revenues, Scotland’s net fiscal balance was in deficit to the tune of 12.2% of GDP (or £16.4bn) in 2013–14. This represents a fairly sizeable reduction in the onshore fiscal deficit compared to the previous year, driven by government expenditure falling by 4.2% in real-terms. However, the level of the onshore deficit in Scotland remains around double that for the UK as a whole (6.0% of GDP) because government spending per person is much higher than the UK average, while onshore revenues are a little lower than the UK average.

Allocating a geographic share of North Sea revenues to Scotland unsurprisingly improves its fiscal position. But oil revenues did not help as much as in previous years. In the two years between 2011–12 and 2013–14, Scotland’s North Sea revenues fell by more than half from £9.7bn to £4.0bn. This drove Scotland’s overall net fiscal balance from 5.9% of GDP in deficit in 2011–12 to 8.1% of GDP in deficit in 2013–14 – a period during which its onshore deficit shrank.

In contrast, the UK’s overall net fiscal deficit shrank from 6.9% to 5.6% of GDP over the same two year period. Of course, the decline in North Sea revenues was not helpful to the UK public finances either. But, because most North Sea revenues are estimated to come from the Scottish portion of the North Sea (84% in 2013–14), and because the onshore economy and tax-base of Scotland is much smaller than that of the UK as a whole, a fall in this revenue stream has a much larger impact on Scotland’s fiscal position.

Projecting Scotland’s fiscal position for 2014–15 and beyond

Table 2 shows projections for Scotland and the UK’s net fiscal balance in 2014–15 and 2015–16 based on the latest OBR forecasts published in December 2014. This shows Scotland’s onshore budget deficit continuing to decline, from 12.2% of GDP to 10.3% of GDP in 2015–16 driven by growth in the economy and ongoing public spending cuts. However, under this projection, Scotland’s North Sea revenues would fall from around £4.0 billion in 2013–14 to around £1.8 billion in 2015–16. Such a decline in North Sea revenues would offset the projected improvement in the onshore fiscal balance, leaving Scotland’s overall fiscal deficit virtually the same in 2015–16 as in 2013–14 at 8.0% of GDP. In contrast, the UK’s overall fiscal deficit is forecast to decline from 5.6% of GDP to 4.0% of GDP during the same period.

Table 2: Net fiscal balance (% of GDP), UK and Scotland, 2013–14 to 2015–16

Net fiscal balance

Source: GERS, 2013–14, OBR December 2014 EFO and author’s calculations.

The OBRs forecasts on which these projections are based were made before the fall in oil prices was fully apparent. They assume, for instance, an average price of $83 a barrel during 2015–16; futures markets now have an average price of around $60 a barrel for oil to be delivered in the coming year. Updated forecasts will be published next week alongside the UK government’s Budget and it seems likely that these oil price falls will result in a downgrade in North Sea revenue forecasts. All else equal, this would likely increase Scotland’s deficit yet further, but might actually reduce the UK’s deficit as lower oil prices boost the proportionately much larger onshore economy.

The GERS figures in the context of the devolution debate

The figures described above represent Scotland’s notional fiscal position if it had to raise or borrow the money needed to pay for government spending undertaken in, or for the benefit of, Scotland. This is not the case at the moment though – the Scottish Government gets most of its money in the form of a block grant, and the UK government pays for things like welfare and defence. Under existing plans for further devolution, Scotland would be exposed to some revenue risks associated with its economy performing better or worse than that of the UK as a whole. This is because part of the Scottish Government’s block grant will be replaced with revenues from income tax raised in Scotland and a share of VAT raised in Scotland (and a number of smaller taxes). However, existing levels of funding would largely be maintained as the Barnett formula will remain in place, and as North Sea taxation is not being devolved, Scotland will remain insulated from the fiscal risk associated with these revenues. Does this mean these figures don’t actually matter then?

No. Because devolution could go much further, with the Scottish National Party calling for “full fiscal autonomy”. Under such an arrangement, all taxes and the vast majority of spending would be devolved to Scotland – with the Scottish Government making transfers to the UK government to cover things like defence, foreign affairs, and Scotland’s share of the UK’s debt interest payments. In that case the notional fiscal position set out in GERS and our projections would have direct implications. The Scottish Government would have to borrow if its spending were greater than its revenues. It would also have to bear the risk of volatile North Sea and other tax revenues.   

Our projections suggest that if Scotland were fiscally autonomous in 2015–16, its budget deficit would be around 4.0% of GDP (£6.6 billion) higher than that of the UK as a whole. Filling this hole would require tax rises or spending cuts, or some combination of the two, on top of those already planned by the UK government. A fiscally autonomous Scottish government could seek to borrow relatively more than the UK plans to. But that would increase debt and debt interest payments, pushing the budget deficit up further. Borrowing could therefore offer some breathing room – but fiscal sustainability would ultimately require higher revenue or lower spending. 

The Scottish Government argues this wouldn’t require explicit tax rises or spending cuts. Instead, the powers obtained under full fiscal autonomy would allow the implementation policies that would boost the growth rate of the Scottish economy, which would increase revenues, and reduce spending on means-tested benefits. Such an outcome is possible: full fiscal autonomy would give more freedom to pursue different, and perhaps better fiscal and economic policy. But it is much easier to say things would be better if the economy grows more quickly than it is to develop and implement policies that would actually deliver that extra growth. The Scottish Government has previously suggested policies to boost growth – such as cuts to corporation tax and expanded childcare – but the immediate effect would be to weaken its finances; and it is not clear that even in the longer term the effects of these policies on growth would be enough to pay for themselves, let alone contribute to deficit reduction.  

The full observation (including methodological notes) can be found on the IFS website

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David Phillips's picture
Guest post by David Phillips
The Institute for Fiscal Studies
16th March 2015
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