‘Move on, nothing to see here,” sums up the muted reaction to Scotland’s budget unveiled last week. Barring grumbles from higher rate taxpayers on freezing of the tax threshold, there was relief – and particularly over the upgrading of economic growth forecasts by the Scottish Fiscal Commission.
A quiet period ahead, then? No. Finance Minister Derek Mackay may have struggled for attention amid the deepening roar of the Brexit crisis and feverish speculation that a general election may not now be far off. And if there is anything more likely to impact even harder on business and household confidence, it is the prospect of a bitter and divisive political battle – and the prospect of a Jeremy Corbyn Labour government emerging from the carnage.
But there is something else that could overwhelm this modest budget package. For there is every sign that the UK political crisis is masking an economic one. Reassuring though the mildly more positive SFC forecasts may be, they could be blown off course by a gathering international slowdown, with talk of recession across both the US and the Eurozone. In a widespread world trade and investment downturn, Scotland would not be immune, particularly as that SFC forecast of higher near-term growth does not stem from an underlying improvement in our economic performance.
There is little that gives cheer in the SFC’s analysis. It is looking out on an economy that has barely any spring in its step. Average annual GDP growth since 2010 has been around one per cent, below the rate of GDP growth in earlier decades. Set in this context, its latest forecasts of 1.4 per cent growth his year, and 1.2 per cent next, while higher than its forecasts of a year ago, can hardly be hailed as a break-out from this low-growth performance. Indeed, it goes on to state that, even if we avoid a “hard” Brexit, it does not expect this stronger growth to be sustained beyond next year. It says growth will be subdued in the longer term, averaging just over one per cent over the next five years. This, it explains, is primarily the result of slow productivity growth that has been declining in Scotland since the early 2000s.
As if this in itself was not dispiriting enough, the reasons cited for the upgrading of its earlier forecasts are of equal concern.
That stronger than expected growth is the result of two developments. One is traced to the release of the new data and revisions to past GDP data – that is, an uplift that owes much to statistical corrections. One should not deny the statisticians their improved spectacles – and the brighter light they bring.
The second reason cited is that government expenditure in Scotland “is expected to grow significantly faster than we had previously forecast”. This has been driven primarily by increases in UK government spending in its budget in October. These increases, passed on to Scotland via the Block Grant, “also increases the budget for the Scottish government. We expect this,” says the SFC, “to support higher GDP growth over the next five years.”
The SNP administration would be most unlikely to advance this interpretation. Its line is that Scotland is still groaning under the yoke of Westminster austerity. But whichever side on this you take, there is a more troubling implication beneath: that what improvement in growth we may be enjoying is due to higher government spending, however it is disbursed, and productivity need not bother us much – just so long as that spending keeps growing.
But that leads us directly into trouble. Keep stoking the money furnaces of public expenditure and the economy – or more precisely those statistical measurements – will appear to glow with health. This is uncomfortably close to the model espoused for decades in state-dominated economies: the more the state directs and spends, the healthier and more prosperous the people – until, that is, the people, stripped of the ability to make their own choices, can stand it no longer.
For government expenditure to increase as this model requires, the greater the amount that the state must borrow, or the higher that tax revenues must be driven.
But this works only up to a point. People will seek a way to mitigate the ever-rising tax burden – the “behavioural response” that economists such as Professor David Bell have long warned about. People move, or seek reward in other forms, or seek protection in tax-sheltered pension saving, or are simply disinclined to work more. Whatever the response, it brings the risk that government tax revenues fall short of those linear statistical progressions.
The SFC now warns that we may be close to this tipping point and that the growing income tax gap with the rest of the UK could put some people off coming to work in Scotland.
The extra effective tax bite on Scotland’s higher earners in last week’s budget may seem modest enough: by not passing on a tax break for higher earners announced by the UK Chancellor in October, people earning £50,000 here will now find themselves paying £1,500 more income tax than elsewhere in the UK.
The SFC says this could make people “think twice” about working here. And it predicted it would also make others consider leaving Scotland or changing their residency status, and would have an impact on whether people go for a promotion or work more hours.
Overall, the SFC forecasts that this “behavioural change” will reduce income tax revenues in Scotland by about £6 million a year. But that is unlikely to cause Mr Mackay sleepless nights – after all, freezing the threshold for the higher rate of tax is estimated to raise an additional £68 million.
Meanwhile, the Scottish Government argues that the country has a fairer tax regime than the rest of the UK, with residents getting perks such as free university tuition and personal care that other parts of the UK do not offer.
But the more the state spends, the more functions and services it undertakes, the more it is at risk when the economy stalls and slows. When tax revenues decline and spending has to be cut, restraint by government in such a politicised environment becomes all the more difficult to enforce.
A quiet, “no change” budget may be the verdict for now. But it may have sown the seeds of mighty problems in the years to come.