vty ES The Scottish Parliament Parlamaid na h-Alba First Minister Nicola Sturgeon MSP St. Andrew's House Regent Road Edinburgh EH 3DG 26 March 2015 Dear First Minister, Today at First Minister's Questions | offered the opportunity to set the record straight on the figures behind the Scottish Government's economic plan for full fiscal autonomy within the UK, In particular, | put it to you that your Government's analysis of what it would mean to lose the money we get from Barnett, still included the benefits of Barnett. First Minister, today you stated on the record to Parliament: “Can I repeat what | said last week in this chamber; the modelling doesn’t simulate the continuation of the Barnett Formula.” Knowing that last week you wauld not knowingly have misled parliament, | offered the opportunity to correct the record. Yet your response simply repeated the position you asserted in the chamber last week: “The modelling does not simulate the continuation of the Barnett formula,” Going on to state: “As we know from past experience Presiding Officer, the Barnett formula is not part of the modelling framework.” | have now read the official response from the Scottish Government following today’s First Minister's questions and considered all of the evidence from impartial experts including Professor Brian Ashcroft and the Scottish Parliament Information Centre (SPICe). | am firmly of the view that you have now misled Parliament twice. F ‘The impartial experts at the Scottish Parliament information Centre (SPICe) have said the Scottish Government's analysis of full fiscal autonomy doesn’t appear to take into account that the economy would start from a different point. So either the SNP Government has included Barnett or failed to explain what spending cuts, tax rises or extra borrowing would be needed. Professor Brian Ashcroft of the Fraser of Allander Institute at the University of Strathclyde has described your analysis as “partial at best and dishonest at worst.” M107, The Scottish Parliament, Edinburgh EH99 1SP kezia.dugdale.msp@scottish.parliamentuk 0131 348 6894Faced with all the facts, the only conclusion that the public will reach on this is that you have lied. In saying that all the experts are wrong, you continue to assert that under full fiscal autonomy we can still benefit from the higher public spending that comes from the block grant. That's just not true. | include a copy of our correspondence with SPICe and the conclusions of Professor Ashcroft. It isa continued frustration that parliamentary procedures fail to offer an opportunity to hold the Scottish Government to account on an occasion that they mislead the Scottish Parliament. ‘The decision to pursue this matter and respond in this way Is not one | have taken lightly. I do so because this is an issue of exceptional importance to voters as we enter the General Election campaign. Following Alex Salmond’s announcement, you have been perfectly clear that fiscal autonomy within the UK {s your stated policy. This means the end of the benefits of Barnett to Scotland. | am equally clear that we will guarantee Barnett continues along with the stability of spending on public services it delivers. This goes beyond the day to day of party politics. It is about how we fund our NHS, schools and other vital services. The difference is | am open about our position and our figures. In contrast, the entire basis of the SNP’s economic plan is based on a fundamental untruth and is staggeringly dishonest. This matters because your plan would meen austerity max for Scotland. look forward to a straight response on this matter. Yours sincerely Kezia Dugdale Deputy Leader of Scottish Labour M1.07, The Scottish Parliament, Edinburgh BH99 1SP kezia.dugdale.msp@scottish.parliament.uk 0131 348 6894BRIAN ASHCROFT’S BLOGS HTTP: //WWW.SCOTTISHECONOMYWATCH.COM/ 15 MARCH 2015 Home Rule Fiscal Autonomy ‘Doesn’t Add Up’ ‘The news story in Scotland on Sunday about my article is here, The article itself does not appear to be on the Scotland on Sunday website yet, so here it is: On March 9th the Scottish Government published a news release “Greater gains from more fiscal control" The release claimed that " ... new Scottish Government analysis will demonstrate that if Scotland was able to retain and reinvest all the proceeds of improved economic performance, through holding greater economic powers, the overall positive impact on GDP, employment and tax revenue would be significantly increased." This analysis presumably by government economists in the Office of the Chief Economic Adviser (OCEA) was first released on March 3rd as a simulation exercise demonstrating how improvements in Scottish total factor productivity, investment and export performance could boost GDP employment and tax revenue. The March 9th version includes additional analysis. It first rebrands the original March 3rd analysis as a ‘first scenario’ which "reflects the situation under the Smith Commission powers where the majority of additional tax revenue generated by increased economic activity are retained by the UK Government and cannot be directly reinvested back into the Scottish economy." The March 9th paper adds a ‘second scenario’ where " 1. all additional tax revenue generated by the expansion in the economy are assumed to be retained in Scotland and reinvested back into Scotland's public finances and public services. This scenario is referred to in the paper as Full Revenue Retention”, No technical paper has been released by the OCEA to explain the nature of the modelling underiying the analysis. So we are forced to guess. In the absence of official information I suspect that the analysis has been produced by a Computer General Equilibrium (CGE) Model, which was originally developed by my colleagues in the Fraser of Allander Institute at the University of Strathclyde. The model was used in November 2011 to simulate the impact of a reduction in the corporation tax rate in Scotland. The model allows system-wide, or economy-wide, impacts of economic shocks/changes to be modelled and identified. ‘The OCEA and the Scottish Government should be applauded for using rigorous modelling to assess the impact of economic shocks such as policy changes. However, in this case the model has been used inappropriately to suggest political-economy outcomes that are fanciful and are lacking in economic rigour.Let me explain. What we can say is that the OCEA economists have brought together a general economic modelling approach with a very partial political-economy analysis. First, in the March 3rd paper reference is made to the new Scottish Government Economic Strategy, which has the objectives of "achieving a productive, cohesive and fairer Scotland," It seeks to achieve this through desiring to boost investment, innovation, internationalisation, and inclusive growth. Now since this is merely a wish-list the March 3rd paper simply offers an illustration of the consequences for Scottish GDP, employment and tax revenues of arbitrarily assumed small increases in total factor productivity, investment and exports, It is true that these increases relate in some sense to Scottish Government targets but as everyone knows you can have any target you like, the issue is how realistic is the target and the underlying policies adopted to achieve the targets. Not surprisingly the OCEA papers are silent on that, What must be understood at this stage is that simply having a target is obviously no guarantee of success. Secondly, in the March 9th paper, the March 3rd analysis has become what the situation would be under Smith Commission powers as stated in the second quote above. It is not at all made clear how in the modelling the Smith Commission powers lead to an increase in productivity by 0.1% per annum over 10 years, a narrowing in the gap in investment between Scotland and its international peers, and boosting exports by 50%. This is simply assumed. There is no rigorous analysis of how policy gets productivity, investment and exports to rise. It is fanciful. It is surely not the job of the Government Economic Service in Scotland to simply and unquestioningly affirm the dreams of Government politicians. Thirdly, and in many respects more damningly, the second scenario generates greater GDP, jobs and tax revenues because of the so-called ‘Full Revenue Retention’ concept, as all the tax revenues generated by growth are re-spent in Scotland, in contrast to the Smith ‘Commission powers, Full Revenue Retention” presumably means what it says - that the Scottish government would retain all the revenue from Scottish taxation and use it to pay for the public services that Scotland receives. This is just another phrase for the idea of Full Fiscal Autonomy, which is now the policy of Ministers, It is wholly unrealistic to imagine a policy in which in addition to the Barnett formula the Scottish government also received any increases in Scottish tax yield. So, the Scottish Government economists are in their second scenario effectively assuming full fiscal autonomy (FFA) plus Barnett. Yet, elementary political economy tells us that with FFA Barnett would be abolished and there would be no risk pooling or sharing of revenues between rest of the UK and Scotland, I noted in my post this week on GERS 2013-14 that nearly £4 billion would be withdrawn, through higher taxes and lower public spending from the Scottish economy if Scotland had had FFA in 2013-14 and had run the same deficit as the UK. Why doesn't the OCEA include that in its analysis, or the even larger withdrawal of £6.6 billion estimated by the IFS for 2014-15 by the IFS? It is not as if it is rocket science, On the Scottish Government website it states that one of the key aims of OCEA is to" ... provide high-quality analytical support for Ministers and colleagues across the Government on all aspects of the Scottish economy and public finances." Might I suggest that, on this occasion at least, that aim has not been met, 15 MARCH 2015 Government Economists And The Scottish Government More on the Scotland on Sunday news story and my article, which is also included in my last post. My paper criticises recent work by Scottish Government economists in the Office of the Chief Economic Adviser (OCEA), which purports to show that increased productivity, investment and exports will raise the growth of the Scottish economy and generate more tax revenues, That is unexceptional, However, the March 3" paper, which accompanied the Government's new Economic Strategy, has the implicit sub text that the new strategy will raise the rate of growth of productivity etc, The March 3" paper is careful to say that it is ‘illustrative’ but nowhere does the paper mention the difficulties of getting an effective growth policy, something that has eluded governments for years. Itis the March 9" paper, which I find most troubling. This is essentially the March 3"paper with anther scenario added to the analysis contained in that paper which is branded the first scenario and called the Smith Commission Scenario. The second scenario is branded the Full Revenue Retention Scenario, What I find particularly troubling with both scenarios is that they ignore the partial or complete loss of Barnett that would have to occur before either scenario could be implemented. The second scenario is simply full fiscal autonomy (FFA) in different words and so would only follow after the loss of Barnett. In the Scotland on Sunday news story the Scottish Government responds with: “Going forward, these figures illustrate once again the need for the Scottish Government to have full control of job-creating powers.” 1 suspect what they mean with the phrase "Going forward! is that from an initial ‘equilibrium state increased growth would generate more tax revenues for Scotland if Scotland had FFA. But this is the wrong counterfactual. The correct counterfactual must be taken into account, which is that in each period future public spending will be lower in Scotland because of the loss of Barnett. The counterfactual used in the OCEA model and in the quote above is that baseline public spending is unchanged. This would only be the correct counterfactual after FFA had been implemented and after the loss of Barnett. However, given that we currently benefit from Barnett, to undertake an analysis which does not acknowledge this loss is partial at best and dishonest at worst.1 fear that this is a further example of the politcisation of the Scottish civil service. One would have expected in the past that the OCEA would have resisted pressure, had it occurred, to produce such a partial analysis. This is an issue that clearly needs further discussion and debate.SPICE EMAILS Sent: 16 March 2015 14:39 Subject: Benefits of improved economic performance The Scottish Government responded today to confirm that the Scottish Government’s Computable General Equilibrium (CGE) framework was used for this modelling work. is is a version of the model which Brian Ashcroft cited in his blog yesterday. The CGE model uses a common starting point (equilibrium) point to test different scenarios. Both outcomes from the full fiscal retention and the Smith Commission scenarios are based on the marginal changes from a common starting point. But the latest edition of GERS shows public expenditure is higher than tax revenues in Scotland. The starting point for full fiscal retention doesn’t appear to take into account that the economy would look different from the economy under the Smith Commission proposals and the starting point would be different. Principally, either government spending would need to be lower, tax revenues would need to be higher or borrowing would need to be higher in order to balance expenditure and revenue in Scotland's economy. The implication is that the impact on government revenues (recycled in Scotland) might be higher under the full fiscal retention scenario but would start from a different baseline. We asked the Scottish Government what assumptions were made as to how much additional tax revenue is retained by the Scottish and UK governments under the Smith Commission scenario. They have said that “as income tax and 50% of VAT will be retained in Scotland, government spending in Scotland can only change with these revenues.” This does not appear to include the full range of taxes associated with the Smith Commission such as Air Passenger Duty and Aggregates Levy. This also appears to exclude taxes already devolved to Scotland such as business rates, council tax, land and buildings transactions tax and landfill tax. In the Smith Commission scenario the Scottish Government “assume the additional revenues flow back to Westminster.” No changes are made to the Scottish economy, the block grant or reserved spending as a result of this.No assumptions are made about what happens in the rest of the UK and the impacts on Scotland's economy are made in isolation. if the policy scenarios outlined by the Scottish Government were repeated for the rest of the UK (higher productivity, increased exports, business investment) then (assuming no changes in Scotland) this would be of a net benefit to Scotland. In addition, you mentioned the response | sent last week which emphasised: 1 The report does not say what policies would be used to increase business investment, exports and productivity. 2 In addition to the absence of specific policies, the report does not provide more general evidence on the broad drivers that can be used to achieve uplifts in business investment, exports and productivity and the likelihood of achieving these. 3 The report does not provide evidence that improvements in business investment, exports and productivity are linked to the degree of fiscal autonomy (the report says the difference between the two scenarios is that additional tax revenues are recycled in Scotland’s economy) Sent: 11 March 2015 09:47 Subject: Benefits of improved economic performance Further to our discussion earlier this morning, you asked for clarification on the Scottish Government report of the benefits of improved economic performance. The key points are as follows: Broad points 1 The report does not say what policies would be used to increase business investment, exports and productivity. 2 In addition to the absence of specific policies, the report does not provide more general evidence on the broad drivers that can be used to achieve uplifts in business investment, exports and productivity and the likelihood of achieving these. 3 The report does not provide evidence that improvements in business investment, exports and productivity are linked to the degree of fiscal autonomy (the report says 2the difference between the two scenarios is that additional tax revenues are recycled in Scotland's economy) 4a On the first page the report says “..the majority of additional tax revenue generated by increased economic activity are retained by the UK Government and cannot be directly reinvested back into the Scottish economy.” No further detail is provided on what assumptions have been made about the treatment of tax revenues under the Smith Commission scenario but “directly reinvested” suggests that the resources may be indirectly reinvested in Scotland via the UK Government. It is not clear whether or not this has been taken into account in the modelling. 4b It is also not clear what would happen to exports, investment and productivity in the rest of UK under the two scenarios and this will have implications for funding under the Smith Commission scenario. 5 The report does not provide any information about the model that was used, how the changes have been made in the model and it is not clear what assumptions are being made, 6 It would be useful to understand in more detail how funding and revenues are allocated to the Scottish Government under each devolution scenario and what additional revenues generated are spent on. The impact of government spending can vary depending on the nature of spend. 7 The report does not describe the types of tax revenue that may arise in each different scenario (income tax, corporation tax, VAT); itis therefore challenging to understand what exactly is behind the differences between the two constitutional scenarios, and why that varies. 8 The report does not show how sensitive the results are to changes in the scenarios. For example, it does not illustrate the impact of falling levels of productivity, investment and export performance on the Scottish economy under different devolution scenarios. 9 It is interesting to note that the difference between the economic impact under each devolution scenario varies for each change modelled. For example, when an increase in exports is modelled the economy (GDP) grows by 2.7% in the Smith Commission scenario and by 3.0% in the Full Revenue Retention scenario. Therefore 90% of the economic growth achieved under Full Revenue Retention is alsoachieved under the Smith Commission scenario. This ratio is different under the alternative scenarios presented. Points specific to the Impact of an increase in Total Factor Productivity (TFP) The report says “over the decade prior to the recession” TFP growth in the UK averaged 1.0% a year. The following ONS publication is referenced: fttp://ww jons/dcp171766_349616.pdf Ns.gOV. The relevant figure is Figure 1 on page 4. Up to 2007 the average annual growth is 41.0%. The growth in TFP modelled is described as “a small increase in Scotland’s TEP amounting to 0.1% a year over a 10 year period”. However, from 2008 up to the most recent year (2012} the average annual growth in TEP was -1.9%, shrinking by 5.8% in 2009. Evidently, increasing growth rates would have been more plausible for Scotland up to 2007 than they would be in more recent years. It is also difficult to assess how plausible this growth rate is given that there are currently no official TEP statistics available for Scotland (see SPICe briefing). Points specific to the impact of a rise in business investment Business investment is represented by Gross Fixed Capital Formation (GFCF). It is important to note that GFCF covers all fixed capital formation across Scotland's economy and will include capital investment by the government and households. For example, around one fifth of GFCF for the UK is in housing. If the Scottish Government has modelled an increase in GFCF then this does not just capture a rise in business investment, but also a rise in capital investment linked to the government and households. The latest Input-Output tables (2011) show GFCF for Scotland at 19.5% of Scotland’s ‘economy (GVA). Points specific to the impact of an increase in exports This scenario outlines the Scottish Government's target to boost exports by 50%. This is in nominal terms (including inflation) and it is not clear how the scenario was modelled, The specific nature of the increase in exports is likely to have a bearing on the magnitude of the impact.