Finance and Constitution Committee

Meeting date: Wednesday, November 30, 2016

Official Report 657KB pdf

---

United Kingdom Autumn Statement and Scotland’s Budget

Agenda item 2 is evidence from Professor Graeme Roy, director of the Fraser of Allander institute, on the United Kingdom autumn statement and Scotland’s budget. Members have received copies of Professor Roy’s slides from the briefing that he conducted last week. I am sorry that I could not be at your briefing, Professor Roy, but I know that some members were there. I warmly welcome you to this morning’s meeting. You may wish to make an opening statement.

Yes, please. Thank you for the invitation to come back to the committee and give our thoughts on the autumn statement and the potential implications for Scotland.

A number of things in last week’s statement were quite interesting. First, there were the Office for Budget Responsibility’s revisions to growth for the next couple of years. The OBR forecast that the economy would slow slightly next year, to about 1.4 per cent, going back up to 1.7 per cent the year after. In relative terms that is a significant slowing but, in comparison with other forecasts, it was slightly more on the optimistic side. Crucially, the OBR expects that, at the end of the years of the forecast period, growth will return to being close to trend.

Obviously, there is a lot of uncertainty about that. There is quite a lot of variation among the different forecasts for the next couple of years and that has implications for the public finances. The big thing is what will happen to the public finances, with a significant increase in borrowing over the next few years relative to what George Osborne predicted back in March.

I guess that the big number to take away is the increase in borrowing of £120 billion. There are a couple of interesting points with regard to that figure. About half of it is expected to come from the weakening of the economy from Brexit, and some will come from classification changes. However, in addition, a slightly poorer performance from tax receipts this year, even before the Brexit situation, has had an impact on the overall public finances. Tracing that through, the chancellor then faced a decision about what to do with public spending in the next few years. What we saw, particularly on the revenue side, was a decision to wait and see and continue largely with George Osborne’s departmental resource spending plans. The Scottish budget is therefore expected to fall about 3 per cent in real terms, assuming that Scotland matches UK tax revenues over the next few years.

The big difference was on capital, because there was quite a significant stimulus to capital investment, which means £800 million coming to the Scottish budget cumulatively over the next few years. We can look at that either as the glass being half full or as it being half empty. On the one hand, it is quite a significant increase from where we are just now. If we add the new borrowing powers to the additional £800 million, that is a further real-terms increase in capital borrowing. The full amount of capital that the Scottish Government could have in 2020-21, relative to 2010-11, is slightly higher in real terms when we add the full amount of capital borrowing, which is interesting. On the other hand, it is still relatively low in comparison to 2010-11 purely on the capital departmental expenditure limits, so it is down in real terms.

As I said, we can look at the situation in two different ways. However, there are obviously implications for what happens with the Scottish budget, and we will see the details of that in the next couple of weeks.

Murdo Fraser has a question.

Good morning, Professor Roy. Before I come to my question, I want to pick up on your last point about the overall envelope of capital spending, which is quite interesting. What restrictions does the Scottish Government have on how it can borrow for capital projects?

Under the new fiscal framework, Scotland can borrow from largely two sources if it wants to: the private market or the Public Works Loan Board, where it can get the same rate as the UK. The sum of £450 million additional capital borrowing at the end of the period is quite significant, given the additional money that is coming as well.

Thank you. I want to ask about the overall size of the budget. Figures that we got from the Scottish Parliament information centre tell us that, in real terms, the budget for 2017-18 will be up £130 million on that for 2016-17. As far as I can work it out, that splits as £23 million up on resource DEL and £106 million up on capital DEL. Are those figures in line with your assessment?

Yes. There are two numbers that are quite interesting, one of which is for what happens between this year and next year; the other is for what happens towards the end of the forecast period. The budget between 2016-17 and 2017-18 is pretty much flat, but there is a small real-terms increase in revenue terms. One of the reasons for that is how the deflators have changed on, for example, imputed rent. I will not go into a big discussion about imputed rent, but there was a change in the methodology for using it. The deflators have therefore changed and have become slightly lower, and some in-year adjustments to budgets have lowered the cash-terms figure for 2016-17 and increased that for 2017-18, relative to where it was. There is therefore a modest real-terms increase between 2016-17 and 2017-18, then additional cuts coming on the back of that. That is slightly different from what was planned earlier this year.

I wonder into what context that puts all the discussions that we had prior to the autumn statement. You might remember when you came to the committee previously that we talked about the potential for cuts in the resource budget and the impact that that would have on the Scottish Government’s planning. The expectation that there might be further reductions was, of course, the justification for the Cabinet Secretary for Finance and the Constitution delaying publication of his budget. However, such reductions have not happened, so Scotland could perhaps have seen its budget much earlier.

The first thing is that the plans have remained largely unchanged from those of George Osborne. As I said, there has been the slight change in methodology for the deflator, which changes whether it is increasing or decreasing from one year to the next, but that involves relatively small numbers. However, in the run-up to the autumn statement, the big question was what would actually happen.

As we said in the September report, there was a lot of uncertainty about, and the scenarios that we had potentially had a stimulus this year—an actual, genuine, real-terms cash and real-terms increase from this year into next—or additional consolidation. I guess that the chancellor faced that difficult balancing act between further consolidation or a stimulus, and in the end he has almost decided to wait and see. To be fair to the Scottish Government in that context, things were going to turn out one way or the other; there was a lot of uncertainty, and I think that the Government’s position was a justifiable one to take.

Where things get slightly more interesting is what happens in the future. This year, the budget potentially being flat in real terms almost hides, in a sense, some of the challenges that are coming down the line—some of the difficult choices that will come in years 2, 3 and 4. That moves into the issues about whether a one-year budget is appropriate or whether the Government needs to set out spending plans going towards the end of the parliamentary session.

Thank you.

It is interesting to see the front page of The Scotsman this morning and some of the projections that are being made—I do not know whether Professor Roy has had a chance to see it. I do not know whether your resource plans and the historical context slide in the material that you provided to the committee reflect exactly the same numbers, but they seem to reflect the same direction.

Can you talk us through the longer term? If any cabinet secretary is setting their budget for the next financial year, they will obviously need to consider the longer-term issues.

In essence, we have the budget increasing very slightly in real terms this year into next—a £20 million real-terms increase, depending on which adjustment is made for inflation. However, our projections up to 2020-21 show around an £800 million real-terms decrease between 2016-17 and the end of that period. That works out at about a 3 per cent real-terms cut.

With regard to the number today that is slightly higher than that, we have to be careful to avoid double-counting. In essence, that figure adds in the implications of some of the commitments that the Scottish Government has made, such as for health and childcare, which means that other non-protected areas face a cut of closer to £1.2 billion to £1.3 billion. I guess that that is a discretionary choice by the Scottish Government. It is not the budget being cut by £800 million; it is a decision to prioritise some areas over others, which then means that those other areas have to take a larger real-terms cut.

In our presentation, depending upon which assumptions we use about growth, that works in anywhere between a 10 to 13 per cent real-terms cut in the unprotected areas. The crucial point is that that is part of a discretionary choice by the Scottish Government to make those commitments in those areas. You need to watch for slight double-counting there.

Okay. That leads us neatly to James Kelly.

You describe a situation in which the budget for next year will be almost flat—a small real-terms increase—and then there is cumulatively an £800 million decrease over a period of time. You also paint a picture in which the UK economy will be smaller, unemployment will rise, inflation will rise and wages will not rise at the same rate as inflation. How will those other factors that result in a smaller-sized UK economy—such as inflation, lower growth, rising unemployment, wages not rising as high as inflation—impact on the Scottish budget?

I offer one point of clarification. The £800 million cut in real terms is not cumulative; it is just the difference between 2016-17 and 2020-21, so the cumulative figure will be bigger. That figure is the difference from one year to the next. There are the cuts in 2017-18 and 2018-19 as well, so the cumulative number will be bigger than £800 million.

What do you project them to be?

I could add them up for you.

Your wider point gets into the overall outlook for the UK economy. The Office for Budget Responsibility revised down its forecasts for the UK economy over the next couple of years, and what was really quite interesting with its forecasts—without going into too much detail—was what it assumes about productivity. Weak productivity growth is one of the key challenges that we have faced since the financial crisis, and it is projected to continue for at least the next couple of years. That will drive what happens to earnings, for example—we expect that earnings will grow much more slowly than had originally been predicted. With inflation projected to rise, that will lead to lower real incomes for households.

09:45  

There is a balance between an economy that is slightly slower, which feeds through in real household incomes and higher inflation, and continued consolidation on the public finances side. There is a mix of pressure on households and continued consolidation on the Government side. That means that there will be less resources to pay for public expenditure in real terms and, at the same time, there will be a squeeze on households.

The key challenge—I guess that the chancellor was wrestling with this—is how we grow our economy out of that. If productivity growth is weak, what can we do to boost productivity and restore the public finances to health? Growing revenues in the long run is crucial, which partly explains the new investment that the chancellor announced through the productivity plan, new support for research and development and so on. The next couple of years, on both the household side and the public spending side, will be quite challenging, and it will be interesting to see what happens.

To return once again to the overall size of the budget, looking further down the line where there are cuts of £800 million for the year that is specified followed by further cuts, what are the taxation options to mitigate those cuts?

We have seen one view this morning in the Institute for Public Policy Research report, which suggests that a 3p tax rise is necessary to mitigate the cuts. What are the potential options? How much would different taxation policies raise in various scenarios?

We now get into the question of what the Scottish Government could do with the new tax levers that are being devolved from April. On paper, the Scottish Government will have quite a bit of discretionary power to do things differently. For example, 1p on income tax will raise approximately £500 million, so if it is facing an £800 million cut, an increase of 1, 1.5 or 2 per cent in income tax would, in real terms, be sufficient to compensate for that.

Whether the Government wants to do that is ultimately a political choice. Obviously, that needs to be balanced with the outlook for the economy. If the economy is going to be slightly more fragile, the Scottish Government will face challenges from the potential economic impacts of increasing income tax. There is a lot of uncertainty in that respect—we genuinely do not know what the implications of using those devolved powers will be for the economy. On one hand, there would be concerns that that could lead to a slower economy relative to the rest of the UK, which would have implications. On the other hand, it might be a way of increasing revenue, which could then be spent on public services and would bring its own positive boost for the economy. What to do is a difficult choice, and ultimately a political choice, but the choice is now there—that is the key point. The Scottish Government now has an opportunity to take different tax decisions if it wants to in order to make up for some or all of the drop.

The chancellor mentioned that he wants the UK economy to be match fit, and there was a real focus on productivity growth in his autumn statement. Productivity is also a priority for the Scottish Government. As things stand, Scotland remains in the third quartile for productivity, roughly 25 per cent behind Ireland, Denmark and some other countries. With an additional £800 million capital spend coming to Scotland, how do you recommend that should be spent to boost productivity? What other policy steps could the Scottish Government take to boost productivity in the short and medium term?

Far be it from me to give a policy prescription for what the Scottish Government should do. There are a few points in there. To return to my point about the importance of productivity, it is crucial for what happens to future tax revenues not only in the UK but in Scotland. One of the reasons why the UK public finances have been disappointing and not as healthy as the OBR has consistently predicted over the years is not because the Government has not made the spending cuts—although it has not delivered in some areas of welfare and has moved back on that, it has actually delivered most of the spending cuts by department—but because tax revenues have been a lot lower than would have been expected, and that comes through productivity. For more than 10 years now, we have not had productivity growth at the long-term average that underpins the OBR’s forecast going forward—it assumes that we will get back to that point, but we have not been there for 10 years.

One of the key risks in the forecasts, which the OBR acknowledges, is that if productivity does not get back to where it was, the deficit will be a lot worse. That is one of the things that is motivating the chancellor to make investments in those areas. We know that our productivity performance in Scotland has been a challenge for a number of years. We have caught up, in part, with the rest of the UK, but the UK lags behind everybody else, so we need to do more. The new capital investment provides an opportunity to that. You have got an £800 million cumulative increase in capital investment, plus the £450 million per year additional capital that you can now put into investment from the new borrowing powers. You have an opportunity, particularly on the infrastructure side, to look at how you can increase that expenditure and therefore boost the economy.

The UK Government said in the autumn statement that it wanted to achieve a step change in productivity, but it matched that with an investment of 0.2 per cent of gross domestic product. Is it possible to get a step change in productivity with such a small investment?

We worked it out and it was about 0.25 per cent, which is essentially the value of the national productivity investment fund divided by the share of the economy. If we consider that UK productivity is about 20 per cent lower than some of our key competitors, that puts it into context. In that regard, it is a relatively small stimulus to tackling the issue.

On the other hand, public sector investment is up to a relatively high level in historical terms, so it is a bit of a mixed bag in that regard. Much will come down to how the investment is delivered—we await some of the detail behind that. Last week, we heard about ambitions by the UK Government to spend an extra £2 billion on R and D by 2020-21. We do not know what that would look like and how much of that will be to replace potential European funding that is lost. Is it net additional money? The ambition and the rhetoric are there; the question is, what will be delivered and whether the measures will have an impact.

I should caution that some of the numbers that have been included in the national productivity investment fund are for things such as housing. Again, that number could be slightly inflated because there is some evidence that housing, better access and better links to work and so on improve productivity but the link is more indirect than in other areas, such as R and D and infrastructure.

In an answer to Dean Lockhart you said that the UK is seriously lagging behind in investment. Is that just because we spend less on it? Could you put that in a European context? What percentage of GDP would an average European country be spending?

It varies. You have to be slightly careful about making direct comparisons, because people measure things slightly differently. The UK has typically spent less on investment than most of our competitors, on both the public and the private side. We have good-quality infrastructure, but we tend not have a lot of it. That is particularly an issue around transport, for example. I will avoid saying anything about trains.

With Brexit happening, we think that the headwind will be there. Most people, whether they think that the headwind will be really strong or slightly less strong, would accept that Brexit will be a challenge, at least in the short run. There is a valid debate about the scale of that challenge.

The solution to that is what we do about productivity. As I mentioned, the UK’s productivity performance in the past few years has been quite dire. Long-term productivity through the second half of the 20th century was round about 2.5 per cent, whereas last year’s productivity was about 0.8 per cent and the year before it was about 0.7 per cent. It is really quite weak, so the key thing will be how we can tackle that and boost it, which in turn will feed through into growth.

You said that the main focus of the UK Government’s productivity investment fund was housing, transport, telecoms and R and D. Following on from Dean Lockhart’s question, could you say whether there any areas that the Scottish Government focus on in passing on any Barnett or capital spending consequentials? Should we look for a different balance in any of those expenditures? We have recently heard from Professor Anton Muscatelli about the need to increase R and D expenditure and from others about the importance of all those areas.

There are a number of areas that I think the Government will be looking at over the next few years. In particular, it will look at innovation and what more can be done to stimulate R and D in a Scottish context—especially links with universities and how we can increase interaction between the university sector and business. We know that transport infrastructure has strong links to productivity. With this additional money, I am sure that the Government will be looking hard at what issues that are unique to Scotland need to be addressed and where the potential real benefits will come from. I guess that that is the benefit of devolution. With this additional money, we now have the opportunity to identify the priorities in Scotland and to see where the key elements come from that.

Some of the interesting things will be around digital—we have been there before. We know that that is going to be crucial in the long run. It will be crucial for the Government to think about how it delivers its digital plans, whether it needs to tweak those, and whether any additional money can go into them. Given the priorities that the UK Government has set out around productivity and making that its flagship element, it will be interesting to see what the Scottish Government does with the additional money that is coming for capital spending. Either it will follow suit or it will take a different path.

Could I ask a very quick supplementary question on that? It may be an unfair question, but what do you mean by “infrastructure”? In an answer a few minutes ago, you seemed to imply that housing was different from infrastructure, yet it is often rolled up into that. Do you mean roads, or digital connectivity, or something else?

What I meant was that infrastructure classifies a broad area from housing through to transport. My point was that we know that some areas of infrastructure have a much more direct causal relationship to the economy than some other areas do, and the impact between investment in those areas and boosting the economy happens over a much shorter time period. For example, something like housing has more of an indirect but very much a long-term impact on the economy—particularly around inclusive growth and boosting the productivity of households and so on. Ultimately, the Government will face the choice of investing in infrastructure that has a more immediate, direct link with the economy, or in something that has a longer-term, more indirect effect. I was making the point that, within that classification of national productivity, there are a lot of things that capture both direct and indirect effects.

It is a very interesting area. What about energy efficiency measures, which can help those at the lower end of the social spectrum and have an impact on growth?

Very much so. With such measures, there is a capital element, a boosting growth element and a direct effect. There are also long-term effects from greater efficiency. When the Government publishes the budget and when it makes those choices, it will be useful if it sets out exactly how it believes that it is impacting both the economy and inclusive growth, so that we have the full justification for what it is doing.

What we had last week from the UK Government was quite a lot of ambition, and some numbers attached to it, but, understandably, less yet on the specifics and about how it would implement that. That is where it would be interesting to see what the Scottish Government does, too. It could be on energy efficiency, on housing, or on transport, but that setting out of where the choices are will be crucial.

There are a couple of things that I want to explore a wee bit further. I will perhaps take a step back. We are talking about numbers that are based on OBR forecasts, but clearly the OBR forecasts are based on assumptions, and I want first to explore some points about those.

We are talking about an extra £120 billion of borrowing, but then you say that that is potentially optimistic, compared with some of the other forecasts, and that the OBR has clearly made some assumptions on the type of Brexit and other matters. What is your understanding of the information that the OBR had in making those decisions? What kind of ranges are there? If we have a different type of Brexit, how much worse could things be?

10:00  

There are two points to make on that. One is about the OBR’s forecast in the short run and the other is about what might happen in the slightly longer term.

The OBR, in pretty much the same way as most other forecasters, has assumed that next year the economy will slow down in relative terms, because business investment is likely to be lower as a result of the potential uncertainty around Brexit, and because consumption will fall as a result of higher inflation feeding through to real incomes. That will lead to slower growth relative to others over the next couple of years. The OBR forecasts growth of about 1.4 per cent next year, 1.7 per cent the following year and then back up to 2.1 per cent the year after that. To put that in context, the Bank of England is forecasting 1.4 per cent next year, but only 1.5 per cent the year after and then only 1.6 per cent the year after that, so there is a significant difference between the OBR and the Bank of England. Ultimately, there is a lot of uncertainty about the forecasts but, if the Bank of England forecast were to turn out to be correct, that would obviously lead to weaker growth, higher unemployment and weaker public finances, and therefore the OBR will have to address that.

That is the position in the short term. There is a really interesting part in the OBR report, buried away in one of the annexes, where it models what might happen under different scenarios of productivity performance. As I mentioned, the OBR assumes that productivity will return to trend by the end of the decade and into the 2020s. It assumes that productivity will grow by around 2 per cent, and that is the number that drives the reduction in net borrowing over the next few years, taking public sector net borrowing to about £20 billion. Interestingly, the OBR also runs a scenario for what happens if productivity does not rise but stays the same as it was last year. Under that scenario, instead of borrowing about £20 billion, we would be borrowing £50 billion. The crucial point there is how the economy does. If the economy does not perform as well as the OBR hopes, it has a scenario in which borrowing rises to £50 billion. Of course, productivity could return and could be slightly higher. We could get a bounce back and the economy could grow significantly over the next few years. Under that scenario, the OBR believes that the deficit will be eliminated and we will actually be running a surplus.

There are two crucial points. One is about the outlook for the economy in the short term. There is a lot of uncertainty about that and about who is right—the OBR, independent forecasters or the Bank of England. Setting that aside, there is an issue about the long-term trajectory for the UK economy. That is the key thing that will drive the public finances in the medium to long term, and it is arguably the most important thing to focus on.

Yes but, even in the short term, it looks as though the forecast could be optimistic, given some of the other ones that are out there.

The OBR has been clear that it is more optimistic than the Bank of England and slightly more optimistic than the average of independent forecasts. To be fair, most forecasters have been revising up their forecasts, particularly for 2016, so there is a lot of uncertainty. It is based on assumptions and a judgment call on what assumptions to put into the forecasts. The OBR is clear on what it does and does not model around Brexit. In essence, it just takes what is in the public statements of the UK Government and models that up. It assumes that the UK leaves in 2019, and that that has an impact in the period up to then, but it does not assume anything beyond that about future trading relationships. Clearly, that will have an impact on future growth and public finances.

I also want to explore population assumptions, which I am a wee bit confused about. The UK population has been growing, with net migration at 350,000 a year or thereabouts, which is about 0.5 per cent of the population and which is a fairly chunky number. A big part of the vote for Brexit was on the assumption that that population growth and migration would be brought “under control”—to use others’ words—and would reduce to the low tens of thousands. If we assume that that is true, we cannot also assume that we will return to a 2 per cent plus GDP growth rate and that productivity will stay at the current low levels, because those cannot all be true. Either the population growth is going to stay at the current level—in which case, what was the point of voting for Brexit?—or the GDP growth numbers are overoptimistic by at least 0.5 per cent, or something is going to happen in productivity over the next few years that will be magicked out of nowhere. What is your comment on that?

The OBR assumes that there will be a hit to productivity over the next couple of years but that it will return to the long-term trend towards the end of the forecast period.

The OBR had been planning to increase its forecast for migration towards the end of the forecast period relative to what it had forecast in March, because migration had been much higher than previously. The OBR now assumes that, because of Brexit, that increase will not happen. Migration into the UK is still built into the OBR’s scenario planning, but the OBR has reduced the forecast. However, it still assumes that there will be positive net migration into the UK.

At a similar level to just now.

Yes.

But not increasing, as it might have done otherwise.

Yes. Migration had been higher, so the OBR was planning to increase its forecast. However, it is not doing that now but is keeping the forecast the same as the previous forecast. The OBR is therefore still forecasting positive net migration, but it is not as high as it would have been if the UK were remaining in the EU. The OBR also increased the forecast for productivity back up to 2 per cent at the end of the period. Those migration and productivity forecasts are the key drivers that influence the OBR’s GDP forecasts.

If migration were to drop to the numbers that Brexiteers have assumed—the low tens of thousands—the OBR’s numbers would not hold up.

Yes. If we changed the migration assumptions by lowering them, that would naturally reduce the GDP forecast. However, to be fair to the OBR, it has tried to be as neutral and balanced as possible about the things that are driving the forecast, so it has not assumed changes in migration, changes in trade relationships or changes in how those trade relationships feed through to productivity. When the Brexit deal is finalised, the OBR will ultimately have to change its forecasts. One of the key points for the forecasts for both the economy and the public finances is the highly significant level of uncertainty in all of this.

Am I right to say that, under the most pessimistic forecast, there could be £220 billion of additional debt by 2020 from a hard Brexit? I think that that was the figure that the OBR gave.

Yes, but within that there are a couple of numbers flying around that are slightly confusing. On its current assumptions, the OBR is forecasting that there will be £120 billion of additional borrowing over the next few years. Some of the forecast increase in debt of over £200 billion comes from classification changes, such as some of the money that the Bank of England uses being reclassified as public sector money, which adds about £100 billion to the debt. Therefore, one of the reasons for the net debt figure increasing significantly between the current forecast and the previous one is a classification change. However, the key number to focus on is the £120 billion, which is the additional borrowing relative to what had been planned over the next few years.

All of this will have to be revisited, though, because the OBR has not made a long-term forecast for what Brexit might look like. Whether there is a hard Brexit, soft Brexit or middle Brexit, the OBR will have to look at its forecasts again.

Oh, boy. [Laughter.] Willie, do you want to ask a supplementary question?

Aye, just on the general borrowing and forecasting stuff. Professor Roy, one of the slides in your submission to the committee has some key messages. One of them is that £120 billion of additional borrowing is forecast, of which only £23 billion is due to policy announcements. My arithmetic tells me that that is £97 billion of additional borrowing and that a substantial portion of that is attributable to Brexit. Can you give us a wee flavour of what that borrowing is for? Why are we borrowing that amount of money? What kind of impact will it have on the overall national debt?

The £120 billion of additional borrowing is the cumulative borrowing between now and 2021, relative to what the chancellor had forecast in his budget back in March. You are right: the OBR has attributed £60 billion of that to Brexit effects, and £23 billion to £25 billion of it relates to policy. Interestingly, around a further £25 billion of it is just for a general weakness in the economy beforehand. Tax revenues have been disappointing in 2016-17, and the OBR expects that to continue. Even before Brexit, borrowing was going to rise relative to what had been planned, and the remainder is a difference between classifications about borrowing and where it comes from.

Essentially, the OBR has set out where it thinks that additional £60 billion will come from—where the different sources of that kick through. The two key points to look at are what the OBR thinks will happen to tax revenues because of business investment leading to lower growth in the economy, which in turn leads to lower long-term growth in revenue from corporation tax, national insurance, income tax and so on and, crucially, the forecast of lower consumption in future, which in turn feeds through to lower tax revenues. Cumulatively, the OBR has revised down its income tax revenue forecasts by around £66 billion. That is quite a significant downward revision to tax revenues.

Essentially, the key driver of the £60 billion increase in borrowing is a slower economy, leading to slower growth in tax revenues, which, in turn, leads to higher levels of borrowing.

The slide refers to a

“Substantial deterioration in public finances”,

with an implication of

“lower wages, employment and living standards”,

as well as

“Significant downward revisions to forecast economic growth”.

Another slide says that, of

“12 fiscal rules since 1997”,

there are

“10 broken or abandoned”.

That is hardly an encouraging picture for Scotland on St Andrew’s day, is it? Am I right in saying that the overall national debt is heading towards the heady total of £2 trillion?

Thankfully, those numbers are not my numbers today, so I am not the one giving you the gloomy news.

The previous chancellor had a plan to restore the public finances back to balance. There was obviously a debate about whether that was the right or wrong thing to do. That was going to be tougher in any case, because tax revenues were not performing as well as had been planned even before Brexit. We now add in the downward revisions that have been made to the economy—to living standards and earnings—as a result of the referendum outcome. That means that meeting those public finance targets becomes much more challenging. There is an increase in borrowing. Instead of running a surplus of £10 billion, the chancellor is now running a deficit of £20 billion.

Debt is now higher. It is rising towards 90 per cent of GDP. In turn, that means that the fiscal rules have been broken—again. Quite a number of fiscal rules have been broken. The chancellor now has a new set of fiscal rules. Rather than constraining public spending, they are more about giving him some headroom to do that. He has left about £26 billion of additional stimulus that he could use if the economy slows worse than he expects. Ultimately, that has led to a set of weaker public finances.

It is a matter of the budget continuing to be cut up to 2021. Even then, the repair job is probably not likely to have been completed, and there will potentially be further cuts or consolidations into the 2020s as the Government tries to restore the public finances back to balance. That is what it said its overall objective would be: to run a balanced budget at some point in the next Parliament. There is a debate about whether that is a good thing to do, but that is what the Government plans to do. That would imply further real-terms cuts to public spending.

Is there any good news anywhere on the horizon? Even one bit?

10:15  

The big thing, to be fair, is that the economy has held up much better than expected in 2016 compared with what most forecasters had predicted. There were three key things about how Brexit could have an impact on the economy. One was the potential for a short, sharp impact on uncertainty that could come from a shock result. In the couple of months after Brexit, there was a quite significant risk that the economy could slow down really quickly in 2016. There would then be the adjustment phase as we travel to the new world; even the people who supported Brexit said that there would be some challenges as we go through that adjustment phase. There is much more debate about the potential longer-term impacts on trade from Brexit; the people who supported Brexit see it as an opportunity.

The positive bit comes in the first part; the level of uncertainty feeding through to the economy—at least in the immediate term—has not been as significant as it could have been. That showed that the economy had slightly more momentum through the start of 2016, and that the economy was slightly more resilient, than had been thought. The sharp drop and depreciation in sterling has also fed through to some positive impacts on exporters. Those are the key positive things that I focus on.

Now we have got past I M Jolly, I call Patrick Harvie—not that he will be any worse. [Laughter.]

To be honest, I think that Willie Coffey’s voice sums up the way that a lot of people feel about everything that 2016 has already thrown at us.

Good morning, Professor Roy. A few members want to discuss distributional and social justice impacts. I want to try to link to those from the discussion that we have had about debt and productivity. If we assume that, at some point, the UK Government gets to a surplus and starts reducing public debt—you have acknowledged that there is a debate about whether that is advisable in principle—is it fair to say that, if there has not also been a significant increase in productivity, a reduction in public debt can only lead to increased levels of private debt in the economy?

Yes—unless the Government continues to cut through public expenditure or increases tax revenue. The way to reduce debt is either through growing more quickly on the productivity side or continuing to cut. Where does the growth come from to reduce that overall debt? It comes from becoming richer and being able to pay off more, or it comes from either further cuts or increases in debt somewhere else—and that could be higher levels of private sector debt.

The story that we have seen since the financial crash is a significant increase in household consumer debt. By one estimate, it has gone up by 65 per cent since pre-crash levels, and a lot of those affected are the people who have been hit by austerity decisions on pay levels, meeting basic needs or welfare cuts. That private debt is also more expensive than public debt.

Can the Fraser of Allander institute do anything to give a clearer picture of the impact that any further increases in private debt will have on social justice arguments and the condition of the economy? We often think about that distributional impact purely in terms of direct changes in tax and welfare rates, but when we push people further into desperation, we also push them further into private debt and that will be more expensive for them in the long run.

That is a very good point and we would definitely be keen to look at that issue. It is probably a weakness in much of the discussion about the outlook for public finances that it focuses on the public finances and not on the wider implications for the economy. Some of the unintended consequences of that are that debt is pushed off balance sheet and then comes back on to balance sheet; for example, the Bank of England’s asset purchase facility is now coming on to the public sector balance sheet. That adds about 10 per cent to GDP.

There is a whole debate about what is genuinely the ultimate debt of the economy. At the moment, we tend to focus on the public finances. I think the point is really well made; it is about looking at the debt not just on the public sector side, but on the private sector side.

By any estimate, private debt is much larger than public debt.

Oh aye—by a massive amount. We then get to a really crucial point. One of the implications of the autumn statement was that slower growth is coming through lower productivity, which in turn leads to lower earnings. With higher inflation, that creates a dangerous cocktail: relatively slow growth in real earnings, which feeds through to relatively low levels of household income, which puts pressure on households and—you are right to say—potentially leads to higher levels of private sector debt. All those things are essentially ignored in the type of analysis that we currently produce and elsewhere.

You make a good suggestion that we need to link all the elements with what is happening on the private sector side with regard to the distributional impact and the debt impact. We will look at that.

Thank you.

Moving on to the way in which the impacts from the direct changes in the autumn budget statement are distributed throughout society, I have a couple of charts in front of me. The first chart, which is from the Scottish women’s budget group, demonstrates not only that the impact is more severe on the poorest third and least severe on the richest third, but that at every level throughout the income distribution, the impact is more severe on women than on men.

The second chart, which is from the Resolution Foundation, shows the distributional impact of the 2016 budget in comparison with the impact of the changes proposed in the autumn statement. It is clear that the changes in the autumn statement are marginal in comparison with the hit that people were already taking from tax and benefit policies as a result of the 2016 budget. Admittedly, people in the top decile were a little bit worse off following the previous budget, but only by a tiny proportion of their actual income, while the rest of the top half of the population were significantly better off and the deepest cuts were hitting the poorest third of society.

Do you recognise and endorse the Resolution Foundation’s assessment? The ultimate question is, what can we do about that with the choices that are available to us through the Scottish budget? Is it possible for Scotland to change that line at all and make a more significant impact in protecting those who have been hit so hard by UK Government decisions?

I do not have those specific charts in front of me, but I recognise the various bits of analysis that people have done. Obviously, it depends on what the starting point is and who wins and who loses and so on. For example, would you start from the beginning of the consolidation period or from the autumn statement?

You are right to say that the autumn statement did not contain many new measures for changes in welfare or taxation that would have an impact on the people and households on the lowest part of the income distribution scale. However, the freeze to working-age benefits, which we knew would be crucial going forward, is the key driver in the challenge for people in that part of the income distribution scale over the next few years. Higher inflation will make that challenge even harder. If we add to that the fact that earnings are now predicted to be slightly lower than they would have been, and that inflation is eroding those earnings, we see quite a pinch point over the next few years for people in that group in society, who are facing the full impact of higher inflation on their earnings and in the freeze on working-age benefits that is coming through.

There was a great deal of speculation that the chancellor might do something to address that. What he did was to make a minor change to the taper rate for universal credit. It is a relatively minor change in comparison with all the other changes that had been planned to save some money, and it does not kick in until quite a bit further down the line. We know that the roll-out of universal credit keeps on being delayed, so any changes to it are not likely to have an immediate impact on the vast majority of people who receive working-age benefits until towards the end of the forecast period.

I do not have the charts to which you refer in front of me, but that kind of analysis is consistent with our conclusions. We then get into the question of what policies the Scottish Government can implement to mitigate the impact. There is a lot of debate about what it can do around the personal allowance, such as whether it can set a 0 per cent rate on top of that to increase the personal allowance.

To be honest, that is not a tax policy that impacts on people at the lowest part of the income distribution. Most people there are not paying income tax because of the various deductions. It would have much less of a blunt effect than expected. People in different parts of the income distribution use certain types of public services more often than others. That is potentially where to look for mitigating action that can be taken to support people at different parts of the income distribution.

Local government is crucial, because it picks up quite a lot of the anti-poverty measures and the implications in terms of education. There are potential mechanisms in those areas that the Government might want to look at, for example offsetting some impact by directing resources at the public services that the Scottish Parliament controls.

It is interesting that you mention the personal allowance as one option. The next graph in the Resolution Foundation report demonstrates that 85 per cent of the benefit of the change to personal allowance goes to the richest half of the population. The notion that increasing the personal allowance is a socially progressive measure does not stand up to much scrutiny. Would we be able to have a more positive impact on the curve of who benefits and who carries the greatest burden if we were willing to look at the tax rates rather than the allowances and thresholds? We could reduce the rates for those on a below-average income and increase them for those who can afford to pay more.

You are right: the personal allowance essentially benefits individuals and does not impact on a household basis. The vast majority of the impact is at the higher parts of the income distribution. You are talking about what you might do with the rates to raise income and feed that through to use of public services. That is one way to do it.

Whether you could cut rates, for example, to boost the incomes of marginal households comes back to the point about the personal allowance. Cutting tax rates is not likely to make an impact on the households that are most impacted by the welfare cuts and in the first few deciles of the income distribution. If you cut the basic rate, that benefits everybody. You have to be careful about how the rates are used as well.

That is assuming that we have only one basic rate, as it stands at the moment.

Exactly.

Which is not required under the new powers.

It is not. My point is that, if you focus on the households in the first few parts of the income distribution, cutting the rates or changing the allowances is not likely to have much of a direct impact. Targeting public spending on such households could be the most crucial action.

I am sorry that it has taken a while to get to Maree Todd.

Professor Roy has covered much of what I was going to ask very well.

The Finance and Constitution Committee’s job is to scrutinise the Scottish Government. We try to match up policy aims with spending and see how that works. It is not our job to scrutinise the UK Government, but I was struck by what you said about how the hardest hit will be the poorest in society—working-class families and those on low incomes. How does that match up with the promise to be a Government that delivers for working-class families?

I do not want to comment too much on UK Government policy. The UK Government would be able to articulate a strong answer on that. The chancellor faces a difficult balancing act on growing the economy, and the UK Government’s view will be that a faster-growing economy that has stable public finances will, in the long run, be the most important for boosting growth. That is a political argument and, whether you agree or disagree with it, it is ultimately a choice that the Government will make. Our focus will be on the analysis about the autumn statement—for example, who is impacted most. Whether the decisions are right or wrong, and whether they represent the right or the wrong way to do things, are ultimately political choices.

10:30  

Clearly, some people will be impacted severely next year when inflation peaks.

Yes. That is the big thing that is pretty much guaranteed. Obviously, lots of things about the forecast are quite uncertain, but when there is a 15 per cent depreciation in the currency, that will feed through to higher import prices, which in turn will feed through to higher inflation, which will impact on different households. Therefore, when the choice was made to freeze working-age benefits, because inflation will be higher, that will impact on more people than would otherwise have been the case. Pensioners, on the other hand, are more protected, because pensions are linked to overall inflation. There will be differences in distributional impacts but, ultimately, it comes down to what you want to do with the choices.

Dean Lockhart has a supplementary.

It is on a related but slightly different point. The chancellor has said that he will look at the measure of budget deficit as a percentage of GDP. At UK level, that is 4 per cent, and the target is to reduce it to below 1 per cent by the end of the UK parliamentary term.

The latest “Government Expenditure and Revenue Scotland” figures show a notional budget deficit in Scotland of about 9 per cent. What impact will the budget deficit and the additional borrowing powers that are coming to Scotland have on that notional budget deficit level? Do you expect that 9 per cent number to increase or decrease over time?

I always love a question on GERS. Essentially, GERS assigns expenditure and an estimate of revenues in Scotland, as well as a share of equivalent UK expenditures. Any up or down movement in the UK deficit will feed through to the Scottish budget and make it move up or down. If the UK Government continues to cut the fiscal deficit, we would expect the Scottish fiscal deficit to decline, too. Within that is the debate about relative shares of oil and what might happen with all that other stuff. However, if we just take the onshore economy, if the UK deficit is falling, the Scottish deficit will fall as well.

But that would be subject to additional borrowing by the Scottish Government, if it were to use its new powers to do that.

The number that you are talking about in GERS—the 9 per cent and so on—is the notional Scottish position within the UK context. It does not have too much to do with the Scottish position under the fiscal framework.

If the Scottish Government were to increase capital borrowing, that would add to the overall public expenditure. However, it is slightly irrelevant in the GERS context because, ultimately, the Scottish Government does not run a deficit; it has a balanced budget. GERS is a slightly different concept of what a fiscal position might be overall.

I will change the focus from the chancellor’s budget and how we might deal with it in the Scottish context to more of a focus on how the committee and the Parliament deal with budgets. That is crucial, because the autumn statement included an announcement that the UK budget—the main fiscal event—will move to the autumn. Dealing with the ramifications of the timescale change will put significant pressure not just on the Scottish Government, but on the Scottish Parliament. We were talking about big changes under the budget review group, but a radical change will be needed to deal with the new timescales.

The fact that the main budget statement will be in the autumn is, in some ways, helpful in that regard, because there will no longer be a situation in which the Scottish budget is set, it goes through the process in January or February and then the UK Government can make major fiscal changes in March, less than a month away from when the Scottish budget kicks in. That is a positive.

However, the challenge relates to when in autumn the budget statement will be. The definition of autumn in the civil service seems to range between July and December. The date will be the crucial point. I would not expect it to be that early in the autumn. The UK Parliament returns later than the Scottish Parliament and there is then the UK party conference season, which is around October. The budget statement might not happen until sometime in November, which immediately means that there will be challenges around when the Scottish budget will be and the Parliament’s ability to scrutinise it.

If the major budget event is going to be in the autumn, it would probably make sense for the Scottish budget to come after that, given that that is when the block grant adjustment will be. However, I caveat that with a number of points. First, a lot of information could be provided in advance of the finalisation of the budgets. A lot of detail could be provided in the run-up to whenever the Scottish budget is done. Secondly, the timing of the scrutiny is important but for me the key thing is the quality of the scrutiny. That is the sort of stuff that the budget review group is looking at. I think that I am coming to speak to the group about that in the next couple of weeks.

What is the level of information that underpins the Scottish budget? How transparent are the assumptions that go into it? How transparent are the various elements of portfolio spending? If the budget scrutiny period is slightly shorter than it has been in the past, how can we improve the level of scrutiny without trying to find lots of different material from different places? Some quite significant issues arise not just about the timing, but about the quality of the scrutiny. If the scrutiny is going to be constrained by the timing, we need to improve the quality.

The Auditor General suggested the need for a medium-term financial strategy from the Scottish Government. If that was to become a feature of the process in Scotland, what level of information would there need to be in that financial strategy to allow that scrutiny to be undertaken at an appropriate level?

There are two points to consider around that. One is that you have to move beyond one-year budgets. Murdo Fraser made the point that the budget next year will rise in real terms. In a sense, there is a danger that that pushes back some of the difficult decisions that have to be made, because if only a one-year budget is published, those difficult decisions are hidden to an extent.

At the very least, you need to be setting out budgets up to the end of the parliamentary session. The OBR has a rolling forecast period—every time that it comes to an update, it adds on an extra year. That is crucial. You should be looking at forecasts for five years out, not just on your spending elements but on your revenue elements. There will be uncertainties about that but there is an advantage in being up front about the uncertainties, which the OBR has done this time, and being clear about where the various expenditure pressures will be. Acceptance that we need to have multiyear budgets to help with planning and so on is where we need to move to in the budget process.

The second point is about what we do about the medium to long-term challenges around the budget. The Auditor General is quite right in that we know that things such as demographics in particular will start to have quite a significant impact on pressures on certain elements of public spending over the next few years.

The OBR says that the deficit will be about 0.8 percentage points higher in the mid-2020s because of demographic pressures. That is quite a significant increase in spending that we need to get to. It would be really helpful when you are making commitments to protect the health budget in real terms, for example, to think about what that means in the context of an ageing population. How can you forecast that need? What might the pressures be further down the line from medium to long-term implications?

Professor Roy, thank you for coming along—it has been a very interesting session.

10:38 Meeting suspended.  

10:44 On resuming—