Academic journal article National Institute Economic Review

Fiscal Challenges and Opportunities for an Independent Scotland

Academic journal article National Institute Economic Review

Fiscal Challenges and Opportunities for an Independent Scotland

Article excerpt

This paper looks at some of the key fiscal questions related to Scottish independence, drawing on detailed analysis of household survey data, official data on public spending and revenues, and using a model of the UK and Scotland's public finances over the next half a century. We examine how and why public spending on, and revenues raised from, Scotland differ from the average across the UK, and how Scotland's fiscal position might be expected to evolve over the next 50 years under current policies.

Keywords: Scottish independence; fiscal policy; generational accounting

JEL Classifications: E62; H62

I. Introduction

Independence would bring both opportunities and challenges for Scotland. This paper examines a key fiscal question: How would Scotland's fiscal position evolve over the next 50 years under current policies? The answer to this depends importantly on the ways in which Scotland currently differs from the rest of the UK in terms of the level and distribution of private incomes and public spending and the amount that is raised from different taxes.

Our long-run projections for Scotland's public finances are derived from a model constructed using a similar methodology to Cardarelli, Sefton and Kotlikoff (2000). The main objective of models of this type is to illustrate the future evolution of revenues and spending driven by changes in the size and demographic composition of the population. However, other drivers of changes in revenues and spending can also be incorporated into the model. For Scotland, it is particularly important to allow for the future evolution of revenues from oil and gas production; these revenues will not be driven by demographic changes but rather by the availability of oil and gas reserves, the technology available to exploit them and global demand for this source of energy.

The results of our model are sensitive to a number of underlying assumptions. However, the broad conclusion of our modelling is that Scotland would face a tougher fiscal challenge over the next 50 years than the UK as a whole. This conclusion is largely the result of two factors. Scotland currently enjoys higher levels of public spending per person than are experienced on average across the UK. In 2011-12, this higher spending was more than matched by higher tax revenues, if one allows for a geographic share of revenues from offshore production to be allocated to Scotland. However, over the next 50 years, reserves of oil and gas are likely to be depleted and thus revenues from this source are likely to dwindle. These higher levels of spending and declining revenues will put pressure on Scotland's fiscal position; this will happen to a far greater extent for Scotland than it would for the UK as a whole, since oil and gas revenues, while not insignificant, are a far smaller share of total UK government revenues. Scotland's population is also forecast to age more rapidly than that of the UK as a whole, which would tend to put upward pressure on Scotland's public spending. However, our model suggests that, while population ageing will increase public spending quite substantially in both Scotland and the UK as a whole, the difference between the size of this effect in Scotland and the UK will be quite small. This is a very similar conclusion to that reached by Lisenkova and Merette (2014) using a different methodology.

The remainder of this paper is structured as follows. Section 2 describes how income levels in, and the population structure of, Scotland compared to that of the UK in 2011-12, which is the last year for which a detailed analysis of the distribution of public spending and revenues between Scotland and the rest of the UK was available at the time of writing. Section 3 describes the construction of a model of the long-run public finances of Scotland and the UK. Section 4 then discusses how a number of assumptions about the evolution of the Scottish population and economy affect the outlook for Scotland's public finances over the next 50 years and--bearing in mind the uncertainties around any assumptions made--draws out the key conclusions about the fiscal outlook for an independent Scotland and how this would compare to the outlook for the UK as a whole. …

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