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An independent Scotland would have a big hole in its public finances

An independent Scotland would have a big hole in its public finances

This is the first episode of an FT series asking if the UK is in favor of a break. Follow UK policy and policy myFT to warn when new parts are published.

An independent Scotland would inherit a huge hole in its public finances, lower than projected tax revenues, as Brexit and the coronavirus crisis have widened the country’s budget deficit, according to an analysis by the Financial Times.

The country’s significant deterioration in Scotland’s fiscal situation since its independence referendum in 2014 suggests that it will have a permanent deficit of almost 10% of its gross domestic product – well ahead of international standards – if it wants to leave the UK in the middle of the UK. decade.

Based on the previous assumptions of the Scottish Nationalist Independence Party, this means that Scotland needs to raise taxes or reduce public spending by £ 1,765 a year per person to leave the UK and then reduce the deficit to sustainable levels.

This, in turn, highlights how it would be more difficult for Scotland to move to a stable and advanced economy compared to when the 2014 referendum was held.

Nicola Sturgeon, the Scottish Prime Minister and leader of the SNP, aims to get a full majority in the Scottish parliamentary elections on 6 May, and then demand that the UK Prime Minister Boris Johnson allow another vote of independence. Scots rejected independence between 55 and 45 per cent in 2014, but polls suggest people are now evenly divided.

The FT estimates that Scotland’s deficit would be 10% of GDP means that the tax increases or spending cuts needed to lower public debt to manage lending have doubled in 2018 compared to the narrow spending limits proposed by an SNP economic committee. During the 2014 plebiscite, the SNP said there was no need to reduce the deficit because the country could rely on North Sea oil revenues.

As Scotland’s fiscal situation is much weaker today, a new independent nation would present a difficult set of options. It could lead to many years or higher taxes to reduce spending, or a bet that the financial markets would be willing to lend to a new sovereign loan with a large and permanent deficit at very low interest rates.

Neil Shearing, an economist at Capital Economics, said an independent Scotland would “need a major fiscal adjustment and that its government should communicate its intentions in a clear and credible manner to the markets”.

Nicola Sturgeon
Nicola Sturgeon, Scottish Prime Minister, in Glasgow last month. Aims to win a full majority in the Scottish Parliamentary elections on 6 May © Andy Buchanan / Pool / Getty

Few economists thought that an advanced economy the size of Scotland was uniquely viable, but warned that it would be a difficult transition to stable public finances, as well as major challenges in terms of currency and trade arrangements.

Thomas Sampson, an associate professor at the London School of Economics, said Ireland had shown that long-term prosperity and independence for the UK was possible for Scotland, “but in the short to medium term, there would be many problems”.

Public finances are now a much bigger challenge for Scotland than they were in 2014, mainly due to the fall in oil prices.

Scotland received 1,633 pounds more in public spending per person per year than the UK average in 2019-20, according to the latest data from the Scottish government. The country generates £ 308 less than the UK average if it includes the geographical share of North Sea oil revenues per person in tax revenue.

This leaves a significant lack of funding for an independent Scotland that did not exist in 2014. The SNP then said that data on geographically fragmented North Sea oil revenues showed a deficit of 1.6% of GDP for 2016-17. .

But shortly after the 2014 referendum, the price of oil fell and tax revenues were never recovered. The Scottish government estimated Scotland’s deficit at 8.3% of GDP in 2016-17, at a time when UK debt was falling.

North Sea oil platform
At the time of the 2014 independence vote, the SNP said there was no need to reduce the deficit because Scotland could rely on North Sea oil revenues © Andy Buchanan / Pool / Getty

The end of the possibility of funding oil for Scotland’s independent intentions The SNP set up a commission in 2018 to devise a new economic strategy.

Led by economist Andrew Wilson and a former member of the Scottish Parliament’s SNP, the sustainable growth committee said a plan had to be made to reduce the country’s deficit to 3% of GDP in order to manage it.

The UK government is on par with the stable level of debt as part of the economy in the medium term, and would comply with most international standards for a manageable deficit.

The Wilson Commission proposed lower defense and savings from other UK distribution costs, a “solidarity payment” to cover part of the UK’s Scottish debt, and said there was hope for further improvements in UK public finances from 2016-17. This means that Scotland’s deficit will fall to 5.9% of GDP.

When Wilson sought to reduce the deficit to 3% of GDP, it was supposed to close the 2.9 percent tax gap, so he advocated a five- to six-year spending control plan to achieve the goal.

Although there were many hypotheses that Wilson would question from the UK government, his report was described as “unbelievable” by the Institute for Fiscal Research, an influential think tank.

From the Wilson commission, however, according to the Scottish government, revenues from income tax, national insurance and value added tax have been lower than expected.

And between the Brexit and the Covid-19 pandemic, the UK government has abandoned plans to balance the books, so an independent Scotland would not be able to assume that it would inherit a better fiscal situation.

Using the same assumptions as the Wilson Commission, and once the UK economy is fully recovered from the pandemic, the FT believes that an independent Scotland will run a 9.9% GDP deficit by the middle of this decade. It would be reduced to 8.7% of GDP with lower defense and other shared spending in the UK.

But reducing the deficit to 3% of GDP requires closing the 5.7 per cent tax gap, which would mean annual tax increases or spending cuts such as £ 1,765 per person.

Graph of waterfalls showing how Scottish public finances have deteriorated since 2014.  The 2021-26 funding gap for 2025-26 is now 5.7% of GDP, equivalent to £ 1,765 per person.

Wilson said the fiscal and economic starting point for an independent Scotland has been more difficult since its commission reported, but like other small advanced economies, it will be able to achieve sustainable public finances.

“The way the UK is run and run will reflect its very significant economic and regional disparities – it’s a reason to change, not to stay the same,” Wilson added. “There is no doubt that Brexit has made the starting point difficult. Once again that is the reason to change, not to continue the same.”

The SNP, which currently has no specific economic prospect for an independent Scotland, has not responded in detail to the FT’s calculations and has repeated the Wilson Commission’s calculations.

“Prior to Covid, it was estimated that Scotland’s tax revenue would cover all day-to-day expenditure on public services (such as the NHS and schools) as well as pensions and all social security.

“The whole point of independence is to give the Scottish Parliament all the economic leverage it needs to grow our economy and the public spending that best suits Scottish interests.”

Scottish Parliament
Scottish Parliament in Edinburgh. An independent Scotland would greatly improve its economic performance to avoid tight control of spending or higher taxes © Daniel Tomlinson / Getty

Global interest rates with historical lows could be an alternative to spending cuts or higher taxes to seek external financing to keep debt close to 10% of GDP.

Investors in sovereign bonds have warned against relying too much on cheap credit.

David Riley, BlueBay Asset Management’s main investment strategy, Bond Investor, said “Investors seeking diversification and profit will benefit an independent Scotland … but investors would like to make sure the government has a credible macroeconomic policy framework, a plan to reduce its budget deficit. including critically ”.

Another complication of indebtedness is related to future currency arrangements in Scotland.

The Wilson Commission advised an independent Scotland to continue using sterling until it was ready to take its currency. But relying on sterling would increase the need for reliable fiscal policies, as they would like to ensure that bond investors return.

Shearing at Capital Economics said it did not believe Scotland’s fiscal stance was “necessarily a disaster” but that it should be managed with caution within a credible economic strategy.

“The nightmare scenario is an unbelievable fiscal plan, issued in an unbelievable currency, on top of a relatively large stock of existing debt and with much higher global returns in the future,” he added.

Is the UK going to break up?

Ahead of the May 6 Scottish and Welsh parliamentary elections, the FT is examining whether the four UK nations will stick together.

Part 1: What is the economic cost of Scottish independence and can the country pay for it?

Part 2: Does Boris Johnson plan to save the UK from rupture?

Part 3: What is the future form of government as interest in Welsh independence increases?

Part 4: Is Northern Ireland on the same path to a united Ireland?

With high debt lending unsuccessful, an independent Scotland would greatly improve its economic performance to avoid tight spending control or higher taxes.

But Brexit raises doubts about its border with England, which could pose a new threat to Scotland’s hopes for higher GDP.

The SNP wants an independent Scotland to join the EU, and being a member of the bloc’s customs union and single market would increase its chances of a tough border with England, its largest market.

A study published by the LSE in February said that border problems caused by Scotland leaving the UK would make up for Brexit losses and it is estimated that Scottish revenues are likely to be 6.3% and 8.7% lower over the long term. no events occur.

Lower oil prices, lower Scottish tax revenues, Brexit and coronavirus have increased the costs of independence for Scotland. IFS Associate Director David Phillips, considering the tough chances of tackling the deficit, said: “Of course, Scotland is a rich country, it can be independent. It’s just a matter of matching the size of the cloth bag.”

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