Finance and Constitution Committee

Meeting date: Wednesday, June 6, 2018

Official Report 808KB pdf

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Economic and Fiscal Forecasts (May 2018)

Good morning and welcome to the 18th meeting in 2018 of the Finance and Constitution Committee. The first item on our agenda is to consider the Scottish Fiscal Commission’s economic and fiscal forecasts, which were published last week to accompany the Scottish Government’s medium-term financial strategy. I welcome to the meeting Dame Susan Rice, who is the chair of the commission, David Wilson and Professor Alasdair Smith, who are commissioners, and John Ireland, who is the chief executive. I invite Dame Susan Rice to make an opening statement.

Good morning, and thank you for asking us back.

Last Thursday, we published our second report, which contains our economic and fiscal forecasts for the next five years. You might hear other numbers this morning, but five is the number to remember, because the report is five pages shorter than the previous report. For the avoidance of all doubt, I am not about to forecast a trend in the size of our reports.

With this report, we mark another milestone, as it is our first summer report—that is all part of the new budget process. Our winter forecast, as you know, will be used by the Government in preparing its budget, and our summer forecast can be taken as the first step in looking ahead to the next year’s budget, but it does not in itself affect the current year’s budget. “Winter forecast” and “summer forecast” are two new terms to remember, alongside the number five.

We will also continue to publish our forecast evaluation report every September, and we anticipate that the upcoming report this year will be especially interesting, as Her Majesty’s Revenue and Customs will publish its first full estimates of outturn income tax liabilities for Scotland over the summer. We will analyse that and incorporate it into our September report.

Turning to the current report, which lays out the central forecasts for use by the Government, all the forecast tables and charts, in spreadsheet form, are posted on our website, so all of you can go in and play with them in your spare time, if you would like to. I would like to highlight a few headlines from the report.

Last December, we described the outlook for growth as subdued. Our view now of the overall outlook is broadly unchanged from December. The economy is growing, but the rate of economic growth has been slower over the past decade than it has been, on average, historically. Our view remains that that pattern of slower growth is likely to persist over the next five years. Nevertheless, unemployment is expected to remain low, with employment continuing to increase over the same period.

Since our previous forecasts, we have done further analysis of wage growth in Scotland. Real wage growth has been weak over recent years, and real wages are now lower than they were a decade ago. As a result of that new analysis, we have revised down our outlook for real wage growth in Scotland. Real wages are anticipated to fall by 0.5 per cent this year, before gradually levelling off in 2019 and then starting to grow very slowly from 2020 onwards.

In line with that revision to the outlook for wages, our income tax forecast has also been revised down from our previous forecast by £209 million in 2018-19. That is about 1.7 per cent of total liabilities. Members should keep in mind that that is against an income tax intake of about £12 billion.

The report also contains detailed forecasts for tax receipts and devolved social security spending, including our first costing of the Scottish Government’s planned expansions in social security. The carers allowance supplement, which is now planned to increase in line with inflation, will cost £46 million by 2023-24. When the Scottish Government provides further details on other benefits that are to be devolved and expanded, we will cost those.

We have also been supporting the Scottish Parliament in its scrutiny of Scottish Government tax changes. Most recently, we published a costing of the change to group relief at the same time as the relevant secondary legislation, and we will continue to operate in that way.

Finally, the commission is also required to assess the reasonableness of the Government’s borrowing plans. On the basis of the information that the Government has provided to us, together with its projections, the plans are within the limits that are set out in the fiscal framework. However, we note in our report that the Government can continue to borrow at the rate that it has done only until 2022-23. Thereafter, the aggregate cap of £3 billion will be reached, which will limit future borrowing.

Those are our headlines. We are happy to take your questions.

Thank you very much for your opening statement.

We need to put some stuff on the record. We have heard the narrative on the substance of your report, but your income tax forecast for 2018-19 is now £209 million lower than it was in December, just four months ago. What has changed?

What has changed is that, for the December report, we spent a lot of time analysing productivity, which is one of the big factors that influence the economic forecast, and since then we have done a lot of analysis of wage growth. I mentioned some of the understanding from that analysis, which is that wage growth is really quite low. When that affects the overall economic forecast, it necessarily feeds into the income tax forecast, because if earnings are lower, less tax is paid—that is a simple way of putting it.

Can we get underneath that analysis a bit, so that we can understand a bit more clearly why the projection on wage growth is lower? What data drove the outcomes and judgments?

There are two main elements to this. One is that we have done further analysis of wage growth within the macroeconomic forecast, reflecting the fact that wage growth has been low since 2008 and is lower than one might expect. In our previous report, we put a lot of effort into discussing productivity. As we have looked further at real wage growth, we have observed that it has been low even relative to what one might expect in relation to productivity. The overall picture over the past 10 years is one of very low wage growth, and we have taken that more fully into account in this forecast than we had done previously.

The second major element is that, in the past year, real wage growth has been particularly low—indeed, it has been negative. For the next couple of years, that is our starting point.

Those are the two elements of further analysis and recent data that pushed us in the direction of expecting real wage growth to be lower than was anticipated in previous forecasts—not by a huge amount, as Susan Rice said, but sufficient to have that 1.7 per cent effect on the income tax forecast.

When you came before the committee after publishing your December report, I remember the committee asking about wage growth, because you had projected better wage growth in Scotland than in the rest of the United Kingdom, the overall impact of which was that Scotland was in almost the same position as the rest of the UK in terms of tax take. I still do not have a feel for what has changed between December and now in the data that you have been looking at. What analysis was done? I want to understand a bit more clearly what is going on, because although the difference is only £209 million out of £12 billion, it still represents £209 million of potential public expenditure in Scotland in the longer term.

Perhaps I can add a bit of detail. One of the issues that we face with wages in Scotland is data availability. There is no headline series for real wages, so we have to use a number of different sources. If you look at figure 2.3 in our main report, you will see that we have plotted some of that data for Scotland, using the two measures that are available for Scotland and two similar measures for the UK. It is a matter of interpreting two or three different sources of wage data. We also had new data—an additional data point—which we took into account.

However, the main thing that is driving the analysis is that we spent some time looking at how real wages have moved in relation to the standard things that drive real wages in economic theory, which are productivity and labour market slack. We have done work to look at how real wages respond to labour market slack or the extent of unemployment, and to productivity changes. We have also thought about whether there are other brakes on the evolution of real wages.

The work that we did to give us a sense of that allowed us to reconsider our forecast. If you look at the main report, you can see that figure 2.5 tries to capture that information.

I am looking at that now. I will bring in Murdo Fraser.

09:45  

In December, the Scottish Fiscal Commission said that it expected wage growth in Scotland to match that in the rest of the UK. The commission has now revised that view, because it has accepted that gross domestic product per capita and productivity will grow more slowly in Scotland than they will in the rest of the UK. That seems quite a radical change to make in quite a short space of time. Can you explain the reasons for that revised view in a bit more detail?

The simplest way to explain it is that we have analysed further the information to hand, and we have made judgments based on that information. A change has come about because we have more information and evidence on which to base our forecasts.

I understand that. However, the consequence of the revision downwards, combined with the revisions in the Office for Budget Responsibility figures, which affect the block grant adjustment, is that, in the current financial year, the Scottish Government’s budget faces a black hole of nearly £390 million, which is a substantial chunk of money. We know that that does not have to be met in this financial year, because there is the opportunity to defer it until the final figures are available. Nevertheless, that is a real challenge for the finance secretary, whom we will hear from shortly. Do you have any reflections on that process? What will it mean for the future of forecasting and its impact on budget decisions, given that such a large differential can appear in such a short space of time?

I will ask David Wilson to provide more detail, but that is the nature of forecasting: changes will be made up and down. That has happened in the OBR forecasts, and it will happen in our forecasts, too.

I will build on what Susan Rice said. In its most recent forecasts, the OBR amended its income tax forecast by about 2 per cent—we amended ours by 1.7 per cent. In most contexts, a revision of a forecast by 1, 2 or 3 per cent would not be a major or significant issue. In the Scottish context in which we are dealing with about £12 billion of income tax, a revision will inevitably have a significant headline number. We fully acknowledge that.

To respond more directly to Murdo Fraser’s question, we recognise that we have made a downwards revision to our income tax forecasts. As my colleagues have said, that very much reflects the further analysis that we have been able to do and our further understanding of the full implications of our wider economic assessments, including our GDP forecasts, and how those will affect our income tax forecasts. Further analysis, further data and improved assessment on our part have led to the downgrade.

On the specific issues to do with the budget, I should clarify the nature of our forecasts and of the medium-term financial strategy. They are the first stage in providing the setting for next year’s budget. In themselves, the forecasts will not affect the funding that is available to the cabinet secretary during the year, because the setting of budgets will be based on our next forecasts in December.

We fully acknowledge that we have downgraded our assessment. In doing so, we have taken into account better information to provide a more accurate and fuller assessment. It is not the case that the forecasts will mean that the Government needs to find additional money or adjust the budget, because the forecasts are part of the initial process in the new budget arrangements.

I completely understand that. However, if your forecasts are correct, when the outturn figures come out, there will be a reduction in the amount of money that is available of about £400 million, which is a chunky sum of money even in the context of the Scottish budget. Either this finance secretary or a future finance secretary will have the job of trying to address that problem.

Yes, but it is worth emphasising that the outturn figures for 2018-19 will not be available for two years. We have to be realistic. There will be further forecast revisions between now and then.

So it could get worse.

Or better.

As Susan Rice said in her introduction, we will have outturn figures for 2016-17 and 2017-18 before then, and they will feed into our forecasts. To pick up on what has been said, I hope that, if it turns out in two years’ time that the outturn is £200 million down, as we have forecast, you will congratulate us on being two years ahead of the game in alerting the Government to the fact that the forecast is a bit more negative than we previously thought.

I am still not totally clear about what has driven the change in the wages forecast. The cabinet secretary is in quite a serious situation. Although, as Mr Wilson has pointed out, that does not change the budget allocations for this year, if the figures turn out to be accurate, a combination of the income tax change plus the OBR forecasts means that, in effect, the cabinet secretary will be nearly £400 million down on where he started when he allocated his budget. It is therefore important that the forecasts are robust.

Table 2.5 in the report sets out four sources for the calculation of wage data. In effect, there are four surveys. Will you talk us through the changes in those sources that have driven the changes in your assumptions on wage growth?

I suspect that that is a question for John Ireland.

Yes—I was just thinking. Table 2.5 is key in illustrating the issue. We have four different sources of wage data, all of which collect data in different ways. They have different strengths and weaknesses, and they produce quite a divergent picture of wage growth. We could be quite simplistic, average those figures and come up with a number, or we could make a judgment.

We looked at the evolution of that data over a number of years. The data go back a long way—in some cases, to 2000 and prior to that. We looked at those four data sources and at how things have changed over a long period of time and over a shorter period of time, and we came to a judgment about the underlying change in real wages. That analysis, combined with our judgment, has led to our having an understanding of the evolution of real wages. As I explained earlier, we did further work that tried to link that to conditions in the economy—to how much demand there is for labour and to what extent that is bidding up the price of labour or real wages, to what extent productivity increases are driving the change in real wages, and to what extent other factors might be influencing real wages.

There is an awful lot of analysis. We have a lot of data in alternative data sources, and there is no definitive series of data. It is not like GDP, on which we can point our finger and say, “It’s that one.” We have to look at all the sources and reach a judgment and, in essence, that is what we have done.

I am still not clear about what new data has emerged in the past four months to change the forecast.

That is down to a combination of things. We have had new data from an extra quarterly observation. Such things come along at different frequencies. There is some new data, which has helped to inform what we think is going on, but the principal thing is that we have looked at existing data in much more detail. We have thought about productivity growth, which is the key factor that drives the Scottish economy. We examined that in December, and we spent a lot of time in the run-up to the December forecast looking at that. We have now changed our focus. Between December and now, we have put a lot of our effort into looking at the evolution of real growth. Therefore, a combination of new data and additional analysis is responsible for the change.

I will ask my question in a slightly different way. The four sources for wage growth data for 2017 vary from the labour force survey’s forecast of a reduction of 1.5 per cent to the forecast in the annual survey of hours and earnings of an increase of 3.2 per cent. That is quite a range. Your report says that your primary source of data, which I assume gets the priority in your modelling, is “Quarterly National Accounts Scotland”, which forecast an increase of 0.8 per cent in 2017. That is much less than the top two forecasts—from the ASHE, at 3.2 per cent, and the real-time information, at 2 per cent. Will you explain why you gave more weight to a more pessimistic view about wages?

If you want to use the optimistic or pessimistic flagging, I will talk about two data sources—the LFS and QNAS. Our judgment is that real wages declined in 2017 by about 1 percentage point. We gave more weight to the combination of LFS and QNAS than to the other two sources because our judgment is that LFS and QNAS capture what is going on better than the other two do.

I will reflect on an earlier reference by John Ireland. The strongest statistic to focus on is in figure 2.3, which uses several measures to show the pattern for real wages. The story is that real wages now are lower than they were in 2009. That is a virtually unprecedented economic picture. We should focus on the story that real wages have not increased for 10 years—they have not even been in line with productivity. That analysis drives the figures, rather than a focus on what happened in one year of statistics. What happened in the one year played some role, but the long-run story about real wages is the most important thing to focus on.

As Dame Susan Rice said in her opening remarks, the process is new for us all. As can be heard from the tenor of the questions, we are still trying—or struggling—to understand the great science of economic forecasting, and even whether it is a science at all. I am not an economist; I am a simple lawyer, so I will ask a simple lawyer’s question about what the witnesses just talked about with James Kelly and Murdo Fraser.

We are interested in what has changed since your previous forecast. Have the facts changed? Have you changed your mind about the existing facts? Have you realised that you spent an awful lot of time thinking about productivity and not enough time thinking about wage growth, so you are catching up with additional work that was not done last time? Which of those three is it? I hope that the question is not unfair; I am trying to understand how the forecasting process works.

It was a good lawyer’s question, which is fine. As John Ireland said, we had a few more data points, although not a lot, and they did not change the perspective.

You talked about the science of forecasting. It is part science and part imagination—I like to use that word because it partly involves judgment. We make a judgment at a particular point in time.

Since the committee previously had forecasts from us, we have seen what the OBR issued in the middle of March. What it says has an impact on our judgment in our forecasts, so that is new data in a more general sense. We are looking at no change in the rather uncomfortable numbers about wage growth—any new pieces of data about Scottish wage growth have not gone in a positive direction.

We use a combination of those aspects and not just one thing. It is not the case that we missed or forgot data that were out there. Back in December, the committee showed interest in real wages, which we are interested in, too, so we thought that it was worth doing a deeper and fuller analysis. The analysis was done by our colleagues in the commission and discussed at length with us as commissioners. The judgment is what we have come out with.

10:00  

What do you think is going on underneath the overall level of wage growth that you are forecasting? You have identified factors that suggest that, although we will see very low wage growth over the next few years, wage growth will rise from 2019-20. You said that higher public sector pay awards and increasing productivity, for example, will lead to stronger wage growth from then onwards. What is the reason for assuming that those factors will start to kick in at that point? I should have said that I am looking at page 55 of the main report.

We are learning as we go, to get a fuller and better understanding of what is a changing situation. We are conscious that what happened in 2015-16, which is coming through in the data, is one thing, and trying to interpret what is currently going on is another.

The core part of our forecasts is that the period of low real wage growth and subdued GDP that we have seen since the financial crash is continuing longer than anyone reasonably expected it to do and is expected to continue for a few years yet. At the core of our forecast is that once we get towards the second half of the five-year period of the forecast, we are forecasting increased productivity. When we look at some of the numbers inside our assessments we find quite a sharp increase in productivity, compared with what we have seen over the past few years, which will lead to real wage growth.

You asked why that is. Most people are coming to terms with the fact that economic growth has been disappointing for at least 10 years and we are not getting back to the rates of growth that we saw before the financial crash. Fundamentally, everyone who is in the business of forecasting thinks that things must get better than they have been; the debate is about whether and over what time period we will get back to earlier rates of growth.

Our assessment is perhaps a middling one for the latter part of the period. Whether we are talking about artificial intelligence, digital changes or boosts to and significant productivity improvements in manufacturing, there is a range of positive developments in the economy that are being hidden—in the context of the overall numbers—by the continuing overhang of what happened in the financial crash. We expect that to come through towards the latter half of the five-year period, and that is what is impacting on increased real wages and increased GDP at the end of the period.

I have not heard many people suggest that automation is a factor that should make us optimistic about wage growth.

It might well do. There are people who are creating the algorithms, manufacturing robots and so on. The distributional impact is a major issue, but technological change will lead to overall improvements in productivity, and that will impact on real wage growth at some point. That is what we expect to see.

I hope that the algorithms do not start making themselves.

I wanted to ask about distribution. On the same page, you suggest that there are factors that impact more or less at the higher or lower end of the income scale. In order to be able to link the wage growth projections to the income tax projections, you will have to have a fairly clear sense of what you think the distribution of incomes will be. Can you say any more about that? Can you publish any more information that would allow us to generate some projections on the impact on income inequality in Scotland?

Formally, we do not, at present, plan to publish a full assessment of the distributional implications of our forecasts, which would be a possibility. We must take the distribution of incomes into account, because it is a factor that has a material effect on our forecasts. We could certainly consider drawing that out in a further publication. We are not preparing such a document at the moment, but we could consider doing so.

If that is a factor that has to be taken into account, such an assessment must exist.

It is one of the many factors that are implicit and partly explicit in the modelling work that we put together. Over the five-year period that we are talking about, we would not expect the extent of any shift in the distribution of incomes and earnings returns to be a major factor, but we could do some further work on that, which we could share with the committee.

Thank you.

I want to stick with the issue of the wage growth forecasts. Are you saying that your forecast has been downgraded mainly because the LFS downgraded its forecast? I think that Mr Ireland said that greater weight was placed on that.

No. I said that we looked at all four measures in the table in question, and the two that we put greater weight on were the LFS and QNAS. It is much more a judgment of how all four have moved over time.

I am looking at the data that might be responsible for the downgrading of the LFS forecast. The Office for National Statistics has a table that shows that there has been a bit of volatility in the Scottish figures over the past year, but the ONS says that the LFS forecast is perhaps the least reliable of all the forecasts. It refers to the LFS data as being “self-reported by employees” rather than being reported by employers, which makes it a bit less reliable. In addition, the LFS data can be “supplied by proxy”, so it does not need to be supplied by employers or employees. The ONS says that the LFS forecast is probably less reliable than the others. Does that not call into question your judgment in using it as one of the major reasons for downgrading your forecast?

No. I have tried to make it clear that we look at all four of those surveys, each of which has different strengths and weaknesses. You have identified one of the weaknesses of the LFS, but it has strengths that are related to things such as sample size. All four have strengths and weaknesses, so it is a matter of looking at the evolution of all four of them.

The other important point to make is that it is not one quarter’s figure that is important, but how the figures have moved over time. Figure 2.3 looks at the evolution over time of the various measures of wages and the extent to which they have moved together or differently. We have looked at four very long data series; we have not looked only at one observation. We have looked at how all four of those have moved and the extent to which they have moved together or differently. That is how we reached our judgment. It is a case of using the data, which is imperfect. Each of the four sources has strengths and weaknesses, and we try to balance those out.

It just so happens that that was the ranking in the year that we were talking about, but it would be incorrect to say that that is a simple one quarter or one year thing. It is much more about the evolution of all four series over time.

A couple of members said that they wanted to ask supplementary questions. I thought that we might have exhausted this area, but that is not the case.

Oh no. I thank the panel for going through the report with us.

I would like to clarify a few points that have emerged in the discussion. I have a question about the data sets in table 2.5 and figure 2.3. Is it the case that that data is what the organisations in question thought that the outturn was, not the forecast, because we are talking about 2016 and 2017?

Sorry?

In terms of wage growth percentages, you have a table with different organisations and different percentages.

Do you mean the surveys?

Yes, the surveys.

Table 2.5 is actual end data.

Thanks; it is actual data. There may be some confusion there when we are talking about forecasts.

There are four surveys there talking about what they think has actually happened in the past, not what they think is going to happen in the future. Even so, the variation between what they think has actually happened is greater between the biggest and the smallest than the variation of 1.7 per cent that you are talking about in your forecast accuracy. Even looking at that, and saying what happened, we do not know what has happened looking backwards, never mind looking forwards.

It is important to notice that the surveys are not looking at the same variable. The real-time information series is looking at average annual earnings, ASHE is looking at gross hourly pay, and LFS is looking at gross weekly earnings for full-time workers only. Each of them is different. It is not that they are giving four different answers to the same question.

I understand that but, notwithstanding that, we are measuring wage growth only as a proxy, because what we really want to know is what the impact on income tax receipts will be, because that is what goes in the budget. Wage growth does not go in the budget; income tax receipts go in the budget. The only reason for measuring wage growth is so that we can figure out what income tax receipts will be.

It is one of the factors that impact the income tax forecast. As I said before, less earned, less tax paid.

Notwithstanding the fact that the surveys are all measuring something different, you have to find out the relationship between what each is measuring—they also all give a wide range of numbers—and what will happen in future. My point is that, given that lack of stability in what has happened in the past, it is not surprising that your forecast accuracy will have a variation of up to 1.7 per cent.

It is even more complicated than that.

We live in unprecedented times, so you cannot even rely on things that have happened in the past.

It goes to the data that we have on income tax and income tax payers. We have another data source—the tax records of individual taxpayers and the survey of personal incomes. That is the data that lies behind our income tax forecast. We have a lot of data on individual people. It is much less timely—the data is much older—and that is what we use to generate our income tax forecast. The data about real wage growth is used to update that rather old, but very detailed data, and that allows us to have a sense of where income tax is now. Then our forecasts of wage growth are used to project that individual, detailed microdata into the future.

There are a number of steps in the process. What gives me a greater degree of confidence is the fact that we have individual taxpayer data, dated though it be, and that allows us to get a better and richer understanding of income tax receipts. That also relates to some of the questions that Mr Harvie was asking earlier about the distributional effects. The important point on the data on wage growth is basically about how to project that individual data forward.

Given that we are struggling to know what happened in the past, it is not surprising that you are struggling to tell us what will happen in the future.

That is the science—or the art, or even the dark art—of forecasting.

The stack tolerances are even more difficult, because there are a number of different factors involved. Okay, that is clear.

Given that we are going to have unpredictability, the question then is how to deal with that. You said that 1.7 per cent is not unusual when talking about forecasting errors, and that the OBR had a 2 per cent error in the current time period. Is there something fundamentally different at UK level? Is the OBR just used to having to deal with that, so it manages it better, or does it have extra powers and the ability to deal with those shocks and forecast issues, compared with what is available to the Scottish Government?

The 2 per cent was 2 per cent up, and ours was 1.7 per cent down. Its error might be down the next time.

I understand that, but that is not the issue. The issue is that you will get variability, and sometimes it will be up and sometimes it will be down. The question is how you deal with it.

Everyone wants to speak now, but let us hear first from David Wilson.

10:15  

I will go first. It is clear that, at the UK level, there is much greater experience of undertaking budgets and managing and varying income and expenditure. The fiscal framework in Scotland is newer, and we are all learning as part of the process. I am grateful for your acknowledgment that the task is difficult, but that is the task that the Scottish Fiscal Commission was set up to do.

If it is not inappropriate to quote the Government’s numbers rather than ours, the uncertainty that it models in the medium-term financial strategy in respect of the potential highs and lows of income tax is clear. Our central estimate is used in that document. The Government says that net spending power could be between £400 million below and £1.4 billion above our central estimate. That is the range of uncertainty.

Whose data is that?

That is in the MTFS. Those are the Government’s figures. There is a significant range of potential income. Our role is to seek to give the best current estimate of that, and that is what we are trying to do.

I suppose that the question was—

We will have to move on a bit. You should make this question your last one.

Absolutely. The UK Government has more powers, a wider tax base to get different taxes coming in, more economic levers, and more borrowing powers. Is it therefore better able to deal with natural forecast variations than the Scottish Government, with its limited scope of borrowing powers?

The short answer to that is that the UK Government’s fiscal framework is different from Scotland’s for a number of reasons. The borrowing powers are one reason for that. If there are forecast errors for Scotland, the reconciliation is two or three years ahead, as opposed to its coming along at once. The frameworks are very different, and the Governments’ abilities to adjust to changes in income tax are different as a result.

If hourly earnings are slowing, but there is still strong growth in the number of hours worked, what does that say about living standards? Can we assume that there has been a relative reduction in living standards?

We have stated that real wages are lower than they were a decade ago. Real wages are what is left to spend once inflation has been stripped out. You can draw a conclusion from that.

However, there is a partial upside. Employment is very strong—in fact, it is growing—and unemployment is decreasing. There seem to be jobs out there for people who are willing and able to work. It is conceivable that, if employment is even fuller, wages may rise, as there will be pressure there.

The downside of having high employment and lowering unemployment is to do with capacity. If there was a lot of investment and a need for more new jobs, which would ultimately improve wage growth, people would be needed to take those jobs.

My question is not directly related to wages. Paragraph 24 of the summary document deals with real household disposable income. Obviously, there is a challenge in that area in the early years of the forecast. A couple of weeks ago, the governor of the Bank of England, Mark Carney, suggested that, as a result of the vote on Brexit, household incomes were already £900 less than they had been. I do not want to make things worse and be even more pessimistic, but has that sort of description been built into the forecasts since the Brexit vote? We do not yet know what the final deal will look like, but there has been a £900 reduction in spending power per household since the Brexit vote. Was that factored into your material?

We looked at Brexit as one of the background factors in the economy forecast. We have made some general judgments, but we can incorporate information only when we have specific policies and data to hand. There is a lot of uncertainty.

The impact of Brexit is that there is a lot of uncertainty, which might lead to less confidence in business investment. We have not picked up the figure that the governor stated—I do not know the basis for it, or whether colleagues do. Brexit is a background factor that is creating a bit of drag on future investment.

I do not imagine that the governor of the Bank of England would have made his statement if the bank had not done some analysis.

The bank’s role is different from ours. We have not made and would not make an assessment that was based on Brexit versus a no-Brexit counterfactual. We do not do such calculations. However, broadly speaking, it might be worth looking at table 2.2, which is on page 42. That sets out our estimates of household consumption as a result of our modelling work. As with real wages, the figures show limited increases over the forecast period, which is exactly what would be expected given the overall assessment—there are pressures on household consumption as well as wages.

I am not thinking about what is coming; the governor’s comments were about what has happened. I assume that your forecast in December will look at Brexit in more depth.

As we expect to have a lot more information about how Brexit is likely to unfold, we intend to incorporate in the December forecast a much fuller analysis of the effects of Brexit. We assume that we will have a much clearer picture then.

We need to move on.

We have spent quite a bit of time on talking about the impact of wages on the public finances. That is underpinned by the working-age population. The proportion of the population who are of working age is important in economic terms, and that group is not growing as quickly in Scotland as it is in the rest of the UK. Your report says that that

“places a ... drag on growth in GDP in Scotland.”

It is difficult not to conclude that it might be beneficial, at least economically, for Scotland to control migration, but I do not expect you to comment on that.

Your report says that, for your calculations, you

“use the 50 per cent net EU migration variant of the ONS 2016-based population projections for Scotland, whereas the OBR has continued to use the principal projection for the UK.”

What is the difference between the projections and why did you use the variant that you chose?

We use the main ONS and National Records of Scotland population projections, but they produce a variety of variants of their projections, and we chose to use the 50 per cent EU version. The forecasts are not ours; we chose one of the variants.

The background is that Scotland’s population has not grown as quickly as that of the rest of the UK. In 2017, we tipped into a period of natural decrease in the population—in simple language, there were more deaths than births. The population is important to our forecasts, and Scotland has some differences.

The key factor that has driven faster population growth in the UK than in Scotland is different levels of in-migration. I looked back at the numbers. Back in 1997, there was a net outflow of about 7,000 people from Scotland. In 2006, there was a net inflow of about 30,000. We now have significant levels of in-migration.

You asked me to explain our choice of forecast. The principal projection for Scotland from the ONS and NRS assumes average net in-migration of 15,000 people, on the basis of recent historical trends. Given the Brexit vote, it is possible that there will be a change in behaviours and a tighter immigration regime. Only part of that 15,000 figure is due to EU migration. The assumption is that that portion that is due to EU in-migration and EU out-migration will be halved. That is where the 50 per cent comes from. It is not the case that there will be no EU in-migration or out-migration, but there will be a significant reduction in the changes. That means that, instead of a net in-migration of 15,000 per annum, there will be a net in-migration of 9,000 per annum, and that works through the numbers going forward.

We felt that that was a recognition of the downside risks for Scotland’s population of the vote to leave the EU. We put that in our December forecasts, and we have not changed our view on that in the forecasts that we are discussing today. The situation might turn out differently, but that is the forecast that we use at the moment.

You mentioned the so-called “working-age population”, which is people aged 16 to 64. People are working beyond that, but the people in that group are the primary wage earners. That population is beginning to shrink—it will start to shrink a little this year and we envisage that shrinkage continuing a little way into the future. That, too, has an overall impact. On top of that, our birth rate is not high enough to compensate for what is happening at the other end. There are various factors that affect population.

I refer to my entry in the register of interests in relation to house building.

I have a few questions about land and buildings transaction tax. There has been a modest increase in the revenue from that, but there are a couple of anomalies. There has been a huge increase in sales of properties with a value of more than £325,000. Some commentators attribute that to the result of the UK general election, which they concluded gave some people greater confidence, because the prospect of indyref 2 was diminished. Another anomaly is the fact that just four postcodes in Edinburgh account for nearly 20 per cent of all LBTT receipts. However, the overall trend has been that the number of transactions has dropped, contrary to the Fiscal Commission’s prediction.

Against a backdrop of stagnating wages growth and the continuing fall in gross weekly earnings that is revealed in figure 2.3, why do you persist in forecasting an increase in the number of transactions, albeit a slightly smaller increase than the one in your original forecast?

I am sorry—I thought that your question was going in a different direction, so I do not have an answer to that. Perhaps someone else would like to pick that up. In the numbers, we reflect the fact that there have been more higher-value transactions, which seemed to be rather muted in the recent past. There has been an increase in the number of those transactions, which has increased the tax revenue that has come in, although there have been fewer transactions at the lower end of the housing market. Those things might even out over time.

Professor Smith might have a better answer.

I do not have a better answer, but I will supplement that by saying that the housing market is inherently volatile and difficult to forecast, which means that LBTT is difficult to forecast. One forecasts it by looking at a mixture of long-run averages or trends and short-run behaviour. When we get new information that says that the housing market has behaved unexpectedly—prices have been unexpectedly high, the number of transactions has been unexpectedly low or the number of transactions at the top end of the market has been unexpectedly high—that will feed into the forecast, because it would be foolish to ignore that and to assume that what happened in 2017 was a one-off. It would be natural to think that it might well continue in 2018. However, at the same time, we do not throw away the long-run information. New information shifts the forecast for the next period, but one year of new information does not have a big impact on the long-run forecast.

To pick up what Alexander Burnett said about transactions, we are not going to completely change our view of what a sensible forecast is for transactions because of one year’s data. That shifts the forecast, as has been reflected, but we still give a lot of weight to the long-run averages of both prices and transactions. That is the way that such statistical modelling works.

10:30  

So you are not seeing a relationship between transactions and earnings.

Not in a formal sense. I am looking to John Ireland to correct me if what I am saying is not right or to add to it. The housing market model is essentially a self-contained one that is driven by data in the housing market. There is not a big feed into it from the rest of the economy.

That is right.

Good morning, everybody. I am interested in the landfill tax. I am aware that that is an environmental tax that is intended to incentivise the reduction of waste disposal in landfill sites. Your report shows that for all taxes, with the exception of the landfill tax, the take is supposed to increase. I know that there is not just a standard rate for waste disposal—it is not as simple as that—and that incineration is involved in your forecast. Will you clarify whether the landfill tax take will continue to reduce?

We believe that it will continue to reduce. One of the key factors that influence that is the rate of development of incineration in Scotland. Incineration takes a lot of what would have gone to landfill in the past. That development means building kit. There is a construction project for each incinerator, which involves time, construction, planning and so on. Therefore, the trajectory is not absolutely certain.

The other issue is the ban on biodegradable municipal waste going to landfill. That is bound to have some effect. That waste is mainly from households. All the councils have to find a way to avoid putting BMW—I suppose that that has another meaning—into landfill. Various things can happen if the incineration facilities are not ready. That waste can be exported, for example. If the incineration facilities are ready, it can go there.

Therefore, there are some uncertain factors and uncertain timings, but we believe that that take will go down over time. That is what we want, of course.

To build on what Susan Rice said, the report shows that the landfill tax is working very effectively in reducing the waste numbers. However, there is a bit of a decline in the rate of the fall—I hope that saying that does not confuse things—because of a delay in developing incineration facilities. However, the overall trend is quite strongly downwards.

We have not yet made a specific judgment on the further reductions that will result from the BMW ban; we will do that once the full regulatory framework to put that ban into place is set out and we have all the information about that. We hope that that will be in our December report and that it will show significant further reductions.

I thank the panellists very much for coming to the meeting. I do not envy their job. Forecasting is not an easy thing to do, particularly when a new process is being dealt with. It is inevitable that there will be unintended consequences. We have a fiscal framework that has a significant reliance on forecasting from two different bodies, and it is inevitable that that will produce a lot more risk and turbulence. At some stage, we will need to have a risk analysis of the process rather than the numbers. Maybe the committee will need to think about that for the longer term.

I suspend the meeting for five minutes.

10:34 Meeting suspended.  

10:39 On resuming—