North sea oil rig

Scotland’s underlying public finances are improving as oil and gas revenues rise – but long-term challenges remain

Published on 24 August 2022

Scotland’s implicit budget deficit is falling as oil and gas revenues rise but this wouldn’t prevent hard choices for an independent Scotland.

Today’s Government Expenditure and Revenue Scotland (GERS) publication suggests that Scotland’s underlying fiscal position recovered more strongly in 2021-22 than that of the UK as a whole. Scotland’s estimated budget deficit (‘net fiscal balance’) fell from 22.7% of GDP in 2020-21 to 12.3% of GDP in 2021-22: a reduction in the deficit relative to GDP of just over 10 percentage points. The UK’s deficit fell from 14.5% of GDP in 2020-21 to 6.1% of GDP: a reduction of just over 8 percentage points.

However, the bigger fall in Scotland’s deficit measured as a percentage of GDP was driven entirely by an increase in the value of North Sea oil and gas output and revenues. Scotland’s geographic share of North Sea oil and gas revenues are estimated to have increased almost 5-fold between 2020-21 and 2021-22: from £0.8 billion to £3.5 billion, the most since 2013-14. Excluding North Sea oil and gas revenues and output from the deficit calculations, Scotland’s deficit fell from 24.1% of GDP to 15.7%: a fall of just over 8 percentage points, in line with the UK as a whole.

This isn’t the entire story though. Measured in cash-terms (as opposed to as a percentage of GDP), the fall in the deficit in Scotland was smaller than for the UK as a whole. For example, even including Scotland’s growing North Sea oil and gas revenues, the estimated deficit per person is estimated to have fallen by £2,211 (from £6,541 to £4,330), compared to £2,471 (from £ 4,617 to £2,146) for the UK as a whole.

How then did Scotland’s deficit measured as a percentage of GDP fall by more but its deficit measured in cash-terms fall by less? It is because after shrinking more in 2020-21 at the height of the COVID-19 pandemic, the Scottish economy subsequently had further to rebound in 2021-22. This bigger increase in GDP means a bigger reduction in the deficit relative to GDP.

The smaller cash-terms fall in Scotland’s estimated deficit reflects what happened onshore. Despite a stronger rebound in the economy, revenues are estimated to have increased by 13% (or just over £1,500 per person) in Scotland, compared to 15% (or just under £1,800 per person) in the UK as a whole. Scottish onshore revenues per person are estimated to have been around £800 lower last year than in the UK as a whole, compared to around £500 lower, on average, over the previous five years, and broadly equal to those of the UK as a whole in the early 2010s.

Delving deeper, the shortfall in Scottish revenues appears to be driven by two main taxes: income tax and business rates. Income tax revenues are estimated to have grown by 14.3% in Scotland, as opposed to 16.5% in the UK as a whole, continuing a recent trend of relatively poor growth in the income tax base. The slower growth in business rates revenues likely reflects the more generous reliefs given to the retail, hospitality and leisure sectors last year and is likely to be reversed this year: most of the temporary COVID-19 reliefs were reduced in April and ended in June.  

As well as onshore revenues growing less quickly, public expenditure is estimated to have fallen less in Scotland last year: by around £200 per person, compared to just over £600 across the UK as a whole. A large part of the difference reflects capital expenditure, which is estimated to have increased by around 9% in Scotland but fallen by 5% across the UK as a whole. Current expenditure is estimated to have fallen by 2% compared to 4% across the UK as a whole. This may reflect the fact that temporary COVID-19 expenditure (such as the furlough scheme) represented a smaller fraction of public spending in Scotland, given its higher initial spending levels – the winding down of this spending would therefore cause a smaller fall in spending in Scotland. It may also reflect the fact that the Scottish Government (and the devolved governments of Wales and Northern Ireland) were able to carry forward more unspent funding from 2020-21 into 2021-22.

Implications of the GERS figures for the independence debate

Discussion of the GERS figures in recent years has focused less on these sorts of specifics though, and more on what the figures can and cannot tell us about the public finances of an independent Scotland. Pro-Union commentators have highlighted the large estimated deficits reported. On the other hand, some pro-Independence commentators have questioned the relevance of the figures by highlighting their backwards-looking nature, and the fact that they relate to Scotland’s position within the UK (including spending on UK-wide functions like defence, the UK parliament, and debt interest that is deemed to benefit Scotland). While this is true, and like any estimates they are subject to margins of error, they remain the best place to start for analysis of what an independent Scotland’s public finances would initially look like. They are produced by the Scottish Government to high standards, free of political interference, which is reflected by their National Statistics certification.

In previous years we have projected the latest GERS estimate of Scotland’s underlying budget deficit forward using the latest Office for Budget Responsibility (OBR) forecasts and the assumption that Scottish public spending and onshore revenues move in line with these UK-wide forecasts, and Scotland’s share of offshore oil and gas revenues remains fixed. However, such assumptions would not be appropriate for the next few years for a number of related reasons:

  • First, oil prices, and more recently gas prices, have exceeded the OBR’s March forecasts. For example, the OBR forecast that oil would cost an average of £70 per barrel in 2022, but increases in dollar prices and a weakening pound mean that the average so far is over £80 per barrel – although prices have recently fallen back from their June peak of almost £100 per barrel. While gas prices were slightly lower than forecast by the OBR through the spring and early summer they have now risen to around £2 per therm more than forecast, which could increase revenues by £7 billion. Higher prices will increase oil and gas revenues by even more than expected in March, particularly boosting Scottish revenues.
  • Second, the UK government has increased the tax rate on profits from oil and gas production by 25 percentage points, which in May it estimated could raise £5 billion in 2022-23, and which will likely raise more now given rises in gas prices. Again, given a large share of the UK’s oil and gas profits are generated in Scottish waters, this will particularly boost Scottish revenues.
  • Third, the UK government has announced a package of cash transfers to households to help them with rising energy bills, with more support measures highly likely to be announced in the autumn. This will increase spending across the UK, including in Scotland.
  • Fourth, increases in inflation as a result of higher energy prices will push up spending on debt interest and, from next year, benefits. In contrast, higher growth in nominal wages and incomes will push up revenues. However, a weaker economy, as forecast by the Bank of England, could also act to reduce revenues.  

The IFS published its assessment of how the combination of these various factors may affect the public finances of the UK as a whole last week. This found that borrowing is likely to be higher than previously forecast, particularly in 2023.

However, it is clear that the combination of factors driving this would be better for Scotland’s underlying public finances than those of the UK as a whole, given the concentration of oil and gas production and profits in its waters. This means a large part of the beneficial public finance effects are concentrated in Scotland, whereas the costs (in terms of higher spending) are spread across the UK as a whole.

Back of the envelope calculations suggest that Scotland’s implicit budget deficit this year could be close to that of the UK as a whole – for the first time since the early 2010s, when oil prices and taxation were last this high. If Scotland’s share of total UK oil and gas revenues were maintained at last year’s levels, oil and gas revenues would need to total around £14.5 billion this year across the UK as a whole in order for the Scottish implicit deficit per person to match that of the UK as a whole. Such a figure is plausible, and may be exceeded.

Updated OBR forecasts will be available this Autumn and again next Spring. GERS outturns data for the current financial year, 2022-23, will be published next August, just before the Scottish Government hopes to hold a second referendum on Scottish independence. The relatively rosy picture they are likely to show will be a welcome contrast to recent years’ figures for the ‘Yes’ campaign.

Remember though that the GERS figures are backwards looking – they are the place to start analysis from, not the final answer.  

If the much higher oil and gas revenues expected this year were sustained indefinitely in the future, an independent Scotland would likely still need to cut services or raise taxes in the years ahead to address the costs associated with an ageing population and rising healthcare spending. However, those service cuts or tax increases could be of a similar magnitude to those that the UK as a whole will likely need to make.

But that’s a big if. Even if high prices are sustained, oil and gas revenues will eventually fall away as production in the North Sea declines. And experience in the mid-2010s and mid-1980s shows that the fall in revenues could happen quickly if oil and gas prices fall. Indeed, market expectations are for them to fall back considerably over the next two to three years. Rather than solve an independent Scotland’s fiscal challenges, higher oil and gas revenues would therefore give more time to address those challenges.

High levels of spending and below-average levels of onshore tax revenues would still need to be brought into closer alignment in an independent Scotland – but the pace of adjustment might not have to be so rapid. That could give more time to plan tax rises and reforms and cuts to spending. It could also give more time to enact reforms that could increase the rate of economic growth in Scotland, potentially negating the need for tax rises and spending cuts. However, as has been highlighted before, new trade barriers with the rest of the UK, and the eventual decline in onshore activity associated with the North Sea will create tricky economic headwinds too.

Concluding remarks

Come next year then, the traditional annual debate on the GERS figures might be a little different to what we are used to, especially if a second referendum is looming. The ‘Yes’ side is likely to emphasise what will be a strong showing for Scotland’s public finances in 2022-23, while the ‘No’ side is likely to emphasise the backwards-looking nature of the figures.

As always, the truth is that GERS is backwards-looking, but it is the most sensible place to start for debates about what an independent Scotland’s public finances may look like. The near-term picture is better (and substantially so) than it looked just 9 months ago. However, higher oil and gas revenues are unlikely to be a panacea in the longer-term for the tough choices on tax and spending an independent Scotland would face without faster growth in its onshore economy. Higher oil and gas revenues may allow those choices to be deferred, but on their own, they are not enough to allow such choices to be avoided forever.