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Economics focus: Tax revenues and Scottish independence

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Tax is always a hot political issue but the tax revenues from North Sea oil and gas will be very important in the Scottish referendum on 18 September. Scotland needs North Sea taxes to close the gap between other revenues and spending. The latest evidence suggests that prospects for these revenues are significantly poorer than was hoped

Tax often features prominently in election campaigns. Who can forget Labour’s 1979 claim that the Conservatives would double VAT (which they almost did), or later efforts such as ‘Labour’s tax bombshell’ or ‘Labour’s double whammy’? If there is a pattern to these things, it is usually that Labour focuses on planned spending cuts by the Conservatives, while the Tories highlight what they say are Labour’s likely tax hikes. We may see more of this as the election approaches, with Ed Miliband committed to raising the top rate of income tax to 50% and said to be mulling over a tax hike targeted at increasing NHS spending. These things matter, though voters tend to take pre-election claims by political parties, particularly about their opponents’ intentions, with a pinch of salt.

Sometimes, however, tax matters a very great deal, and it matters hugely as far as the Scottish referendum vote is concerned. The Scottish campaign, ahead of the vote on 18 September, is clearly important for Scotland, and the rest of the UK. A few days ago, the Treasury released figures showing that corporation tax revenues from North Sea oil and gas production fell from £4.4bn in 2012/13 to £3.6bn in 2013/14. They were, said Danny Alexander, the Treasury chief secretary, ‘another body blow to Alex Salmond’s credibility on the economy and public services’.

That may be overstating it. But those North Sea oil and gas revenues, of which corporation tax receipts are only a part, are hugely important for Scotland. Let me set out the figures, taken from the Scottish government’s Government expenditure and revenue Scotland publication. The figures only go up to 2012/13 – the next scheduled publication is in March 2015 – but they tell the story well. In 2012/13, Scotland’s non-North Sea revenues, its so-called onshore revenues, totalled £47.6bn. Scotland’s public expenditure in that same year was £65.2bn, nearly 40% more.

The UK as a whole spends more than it generates in tax, but onshore Scotland does so dramatically. Without North Sea revenues, its budget deficit in 2012/13 would have been 14% of gross domestic product, almost double the overall UK deficit of 7.3% of GDP. Scotland, however, does have oil, and on the basis of a so-called geographic share of North Sea production (Scotland gets the revenues from what would be in its territorial waters), oil and gas taxation helps close the budgetary gap. But those taxes only raised £5.6bn in 2012/13, leaving Scottish tax revenues still well short of its expenditure. It would, in fact, have a budget deficit of 8.3% of GDP, still larger than the overall UK deficit of 7.3%. 2012/13 was a bad year and, though we do not yet have a breakdown of the full figures, it seems likely that the total North Sea revenues in 2013/14, and thus the amount that an independent Scotland could get, will be even lower.

The independence vote is thus being held at a time when North Sea revenues, which are very important for Scotland, are very weak. North Sea oil and gas production is running at around a third of its peak, which was reached 15 years ago in 1999. Oil prices remain quite high, at close to $100 a barrel, but production costs have risen sharply. The result is that the North Sea has ceased to be a cash cow, and is highly unlikely to be one in the foreseeable future.

Looking ahead

According to the Office for Budget Responsibility (OBR), total North Sea revenues will be £3.7bn in 2014/15, followed by £3.8bn, £3.2bn, £3.4bn and £3.5bn in the following four years. An independent Scotland’s share of that will average out to a little over £3bn a year, not much more than half of its 2012/13 revenues. Scotland, as noted, has a big gap between its onshore tax revenues and its public spending. North Sea taxes will not contribute much to closing that gap. If the Scots do vote ‘yes’, it will be in the hope that the weakness in North Sea revenues is only temporary and that a wave of investment will push up production and revenues in future.

That, however, looks highly unlikely, given the sharp trend decline in North Sea production and the fact that the easier oil – from the big fields – was extracted in the past. Again, the OBR had something important to say on this when it published its recent Fiscal sustainability report, which looks at Britain’s long-term public finances. This really was a body blow to the economics of independence and Robert Chote, the OBR chairman, wrote to the Scottish Parliament to explain the new findings.

He noted that North Sea revenues had consistently come in below forecasts and that North Sea production has declined by an average of 7.8% a year since 1999. Accepting that this fall would level off over the next few years, before resuming its decline at a slower average rate of 5% a year, the OBR estimates North Sea revenues over the period 2019/20 to 2040/41 to be £39.3bn, £13.6bn lower than it expected in its long-term projections a year earlier.

The new forecasts brought predictable accusations of a political fix from Scottish nationalists. Only time will tell whether the OBR has got it right. But think about these numbers. The OBR’s new numbers suggest oil and gas revenues of less than £2bn a year, but even the old forecast would have meant only £2.5bn a year. An independent Scotland cannot rely on the North Sea to fill the gap between its taxation and spending. It is not clear what will fill that gap.