Peter Jones: Swinney’s slant on swingeing Tory cuts

North Sea oil could receive a boost much greater than any decision by Osborne or Swinney if the Fed increases rates. Picture: Contributed

Two big money-related announcements are due tomorrow. One – finance secretary John Swinney setting the Scottish government budget for 2016-17 – will grab most of Scotland’s attention, but the other – the US Federal Reserve’s decision on whether to raise US interest rates or not – while it may barely register here, is potentially rather more important for the Scottish economy.

The pre-budget SNP noise has been cacophonous. Scottish Government leaks have warned of dire cuts to local council spending and other disastrously tough choices having to be faced. The blame for this, of course, has been laid firmly at the door of Chancellor George Osborne and the UK Treasury.

This is all political smoke and mirrors. Mr Swinney’s choices are not as tough as he makes out. Yes, Mr Osborne is cutting public spending and Scotland does have to take a share. But as the International Monetary Fund observed last week, his overall strategy seems to be working – Britain’s growth has outstripped other major economies, unemployment has fallen, employment is at a high, the fiscal deficit has been reduced, and financial sector resilience has increased.

That is surely good news for the yield from income tax which will start to become a big chunk – nearly 5 per cent - of the Scottish Government’s total spending from next April as HMRC letters have been reminding taxpayers recently.

But, of course, SNP ministers prefer to rage about cuts claimed to be 6 per cent. This sounds big, but Scotland is getting off lightly with only a third of the 18 per cent which Mr Osborne has lopped from some UK ministries such as the Home Office.

This 6 per cent, moreover, is spread over four years. If you start with the Treasury block grant to Scotland of £25.9 billion in 2015-16, then for the block grant to remain exactly the same in real terms by the end of this spending review period, it would have to rise in cash terms to £28 billion by 2019-20 to compensate for expected inflation.

However, the Treasury says it will be only £26.5bn. The difference of £1.5bn is the 6 per cent Mr Swinney will be complaining about tomorrow. (Note that these sums are notional as part of the £26.5bn will actually be coming from the new devolved taxes, mainly income tax, that the Scottish Government is getting control of over the next few years).

Just how much of a cut this actually turns out to be depends, however, on whether inflation turns out as forecast by the Office for Budget Responsibility – 1.4 per cent this year rising to 2.1 per cent in 2019-20.

For the 2015-16 Treasury grant of £25.9bn to be the same in real terms next year, it should be 1.4 per cent or £300 million higher at £26.2bn. But it will be £26.1bn, a real terms cut of £100m, perhaps close to £200m to allow for big number rounding.

Actually, there may not be any cut at all if the inflation index used in government accounting, the GDP deflator, turns out to be 0.7 per cent. This is possible because Consumer Price Index inflation, which the GDP deflator normally tracks fairly closely, was negative at -0.1 per cent up to October this year.

Even if inflation is as forecast (and to be fair, Mr Swinney has to assume it will be), he has other tricks he can pull. His total planned spending (excluding pension payments) in 2015-16 is £30.4bn. Some of this £5bn over and above the Treasury grant is capital spending, financed by borrowing, and the rest is raised by taxes he controls, mainly council tax and business rates.

Just as George Osborne has done to plug his budget holes, he could raise more from taxes (business rates income was projected to rise by £150m last year). Or, since Mr Osborne has raised Mr Swinney’s capital spending allocation by £200m (4.5 per cent in real terms), he could put back some or all of the £300m he diverted from services spending in last year’s budget into capital spending. By borrowing a bit more, he can easily maintain capital spending at present levels.

The third and likeliest option is that he could use some of the money that should have been spent on services this year but won’t have been because of lower than expected inflation to plug any hole. This could be a big sum; the Auditor General found that the government underspent its 2013-14 budget by £347 million.

So, tough choices? No, not really. But by building up doom-laden expectations and then delivering a not-too-bad budget, Mr Swinney will be hailed as a genius (at least by his own party) and the SNP can hope for thanks from an electorate grateful to be spared from Mr Osborne’s cuts which, in reality, are less then swingeing.

None of this will much affect the Scottish economy. But tomorrow’s decision by the US Federal Reserve could, particularly if it raises its base rate from 0.25 to an expected 0.5 per cent. This would strengthen the US dollar – bad news if you habitually holiday in the US but good news for North Sea oil producers.

As crude oil’s value is denominated in dollars, the stronger the dollar gets, the more pounds are available to pay wage and other bills. At $40 per barrel, a difference of 5p for every dollar of oil sold (the variation in exchange rates over the last year) translates at current North Sea production levels of roughly 800,000 barrels a day to £580m a year.

That’s pure gold in today’s depressed conditions and could make the difference between survival and shutdown to a lot of producers. With thousands of Scottish jobs (and therefore income tax revenues) dependent on oil, Mr Swinney should be just as interested in the Fed’s decision as are oil executives.

And he certainly should be thankful that he isn’t having to prepare a budget for an independent Scotland when the cuts he would be having to make because of vanished oil revenues, rather than just blame on Mr Osborne, would be in the billions, not the millions.