Stephen Hay: How can Scotland improve its finances?

We now know that last year Scotland had a deficit of £13.3 billion; a celebration on the basis that for the previous year it was a whopping £14.5bn.

RSM's Stephen Hay says it's difficult to see how Scotland can make up its tax revenue shortfall. Picture: Andrew Milligan/PA Wire

However, the Scottish deficit, which is the gap between total expenditure and tax revenues raised, is now 8.3 per cent of GDP whereas the UK had an overall deficit of £46bn representing only 2.4 per cent of GDP.

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Taxpayers in Scotland raise some £300 less per person than those in the UK overall, whereas public spending in Scotland is £1,400 higher per person than the UK average – highlighting an unsustainable shortfall.

This news is compounded by CIPFA Scotland saying recently that, as a result of Brexit, Scottish GDP could be further reduced by £11bn with a reduction in tax revenue of at least £1.7bn per annum as Scotland receives 14 per cent of EU funding provided to the UK but only represents 8.3 per cent of the UK population. The suggested drop in tax revenue is a worrying thought, as the annual deficit could increase to £15bn.

Hypothetically, if all powers were devolved to Scotland tomorrow, how would Scotland manage its finances without the benefit of a block grant from the UK government operated under the beneficial calculation of the Barnett Formula?

If cutting services and increased borrowings are not high on the agenda to mitigate the deficit substantially, then taxation will be the prominent solution. Any withdrawal of a block grant to be replaced by devolved taxation is likely to increase the annual Scottish deficit by a further £5bn. That would mean that taxes would need to rise significantly, but how much exactly could Scotland raise in taxes?

If the biggest receipts are considered, then income tax (£12bn), national insurance (£9.5bn), VAT (£9.5bn) and onshore corporation tax (£3bn) would be the obvious targets. An increase of 1p on the basic rate of income tax and a 5p hike in the highest rate to take that to 50p will raise less than £700m. An increase in national insurance contributions to, say, 20 per cent would bring in another £600m and a VAT rise to 25 per cent about £500m. Corporation tax could increase from 20 per cent to 25 per cent but that would only add £150m.

So, at best, Scotland could raise no more than £2bn in tax revenue. Even with drastic measures on increased taxation, there would be insufficient receipts to balance the books and the deficit would still be about £11bn, not including any impact from Brexit or the loss of the block grant surplus.

Unless corporation tax payable by oil and gas companies (offshore) can increase back to the level of 2008-9 receipts of almost £10bn, it is difficult to see where this shortfall can be made up. In the meantime, Scotland should concentrate on further reducing the deficit and stimulating the economy before independence could be a fiscal and economic reality.

Stephen Hay is a tax partner at accountant and business adviser RSM