• MammothWhale

Scotland is Not Subsidised by Taxpayers in the rest of the UK

Updated: Dec 19, 2021

By breaking down the UK monetary system, it is an indisputable accounting fact that Scotland is not subsidised by taxpayers in the rest of the UK. Here is why...

The release of the yearly Government Expenditure and Revenue Scotland (GERS) report is one of the most intensely debated topics within the Scottish constitutional question. The debate on this report exists in two parts. Firstly, on the methodology of the report itself and how accurately it represents the Scottish economy within the UK. Secondly, what the data suggests is what an independent Scotland’s fiscal balance could look like and what challenges this could entail.

These two debates lead to a healthy and largely informative discussion that introduce activists to new macroeconomic concepts. Alas, the debate also reinforces orthodox economic language and misleading claims that exist on both sides of the debate. This fundamentally comes from a misunderstanding how the macroeconomic system works in the UK today. Responding to these issues will be the main purpose of this article, whilst leaving room to discuss methodology in the future.

GERS functions as a positive advertisement for membership of the UK because its data suggests that Scotland is subsidised by other UK regions. As unionists argue, only thanks to fiscal transfers of taxpayers from other parts of the UK can Scotland be able to pay for programmes such as free education, zero prescription fees or our National Health Service. As the IFS describes in their GERS blog:

The UK government manages the overall public finances on behalf of whole country, and in effect, transfers revenues from those areas with surpluses (or smaller deficits) to the areas with (bigger) deficits.”

This orthodox language and economic framework used by the IFS is known as (TAB)S – taxing and borrowing precedes spending. The only way for an independent Scotland to increase its spending would be to increase taxation or to borrow savings. This is to suggest that government spending is like that of a normal household, in that we cannot spend beyond our means.

In his 2020 presentation at the These Islands conference, Kevin Hague takes the analogy further by comparing UK government spending to “going out to supper with the lads” – a questionable alternative of the household analogy. Further to this, Kevin Hague turns to regional data in the UK, to which he presents the following graph.

There are three important points of notice. First, the graph shown gives a perfect illustration of the extreme regional inequality that exists within the UK. Capital is heavily biased towards the South and Southeast of England, whilst other areas of the UK face serious resource and fiscal neglection. This inequality is a result of decades of inept, laissez faire governance.

Philip McCann, chair of Economic Geography at the University of Groningen offers a robust insight in his paper “Perceptions of regional inequality and the geography of discontent: insights from the UK” concluding:

the UK is one of the most inter-regionally unequal countries in the industrialised world. Wide-ranging evidence suggest that on many levels the UK economy is internally decoupling, dislocating and disconnecting, a reality which the UK’s highly centralised, top-down, largely space-blind and sectorally dominated governance system is almost uniquely ill-equipped to address.”

This level of inequality is made grimmer once you consider analysis from the House of Commons Library that the UK has the lowest wealth per head of every country in north west Europe for every year of the 21st century. IMF data shows that UK residents are £5,062 poorer compared to their North-West European neighbours, and £15,739 less wealthy compared to independent countries that are similarly sized to Scotland.

The South and Southeast does not protect the rest of the UK. Instead, it is a black hole that increasingly consumes wealth and income. If this growth model is to be socially and economically inclusive, this would require intense decentralisation and heavy investment into local economies. However, no such change seems to be a priority within the current UK political bubble.

Secondly, most of the discussion on GERS has consistently compared Scotland to the rest of the UK. This comparison is methodologically flawed as we are comparing an economic region with no monetary powers and limited fiscal levers to an entire unitary state that has full fiscal and monetary control - a point also accepted by the Fraser of Allender Institute. This accounting trick does not provide healthy analysis and nor should it be deployed by any serious economist or commentator.

Thirdly, it is adamantly wrong that Scotland receives fiscal transfers from taxpayers in the rest of the UK. To better understand why this is the case we can breakdown the accounting model of the UK exchequer to explain how the monetary system really works. I won't shy away from deep details - readers deserve a complex truth over an easy lie.

Government spending starts off in Westminster, where our politicians debate the allocating of money between each government department. Every government department holds their own account called a “Resource Account” with the Government Banking Service (GBS), where they receive their allocation of “Exchequer credits”. These credits represent how much each department can spend, so are neither commercial bank money nor central bank reserves. Exchequer credits are simply a ledger balance internal to HM Government.

After parliament has legislated its spending plans, HM Treasury is subsequently authorized to requisition sums of money from the Comptroller and Auditor General (C&AG). The C&AG will scrutinize HM Treasury’s requisitions and then contact the Bank of England to credit government departments – writing off the exchequer credits.

The Bankers' Automated Clearing System (BACS) are then contacted by the GBS to provide banking transmission services. The government department’s Resource Account acts just like a normal bank account. The government department will present its payment requirements to its GBS bank, which are then submitted into the BACS system for clearing and settlement.

The Bank of England then issues funds from the Consolidated Fund to credit the GBS Supply Account. Importantly, the Consolidated Fund begins each business day with a zero balance. No funds are drawn upon, as instead it goes overdrawn as the Bank of England extends intra-day credit. This credit is Bank of England Money, public money.

When settlement is required for payments, the GBS Supply Account feeds sums of Bank of England money into the GBS Drawing Account. Therefore, the GBS Drawing Accounting has a money balance to settle any required payments. After three days from the BACS submission, the clearing and settlement of the government payments occurs by both the GBS Resource Accounts of the government departments whilst the GBS Drawing Account is marked down. At the same time, Reserve Accounts at commercial banks held at the Bank of England and commercial bank deposit accounts of customers are marked up.

So where does Scotland fit into all of this? The Scottish government has its own Consolidated Fund Account within the GBS. Spending mechanisms for the Scottish government’s account is like that of other government departments, except its allocation of credit is determined by the Barnett Formula.

The key take away is that the money in these accounts is not taxpayer’s money from other parts of the UK, but rather credit that is transferred from the UK Consolidated Fund to devolved accounts - as long as parliament has authorised it.

Scotland is not subsidised by other regions of the UK – this is an indisputable accounting fact.

So where would the net flow of credit come from if Scotland became an independent country? It would be replaced by conditions and mechanisms created from a Scottish Reserve Bank. The basic model for a Scottish monetary system, based off how current mechanisms work, would work as followed:

An independent Scotland would not be financially constrained, as it is under devolution, to develop progressive policy that is desperately needed.

One of the major faults of macroeconomic discussion around GERS is the narrow focus on just one sector of the economy, that being the government sector. Political and economic commentators often ignore, intentionally or mistakenly, two other vital sectors that must be included in any serious analysis of Scotland’s fiscal position – the private and foreign sector. Ignoring these other sectors is the equivalent to describing a football match as “Celtic – 1” without any commentary on the other team. Therefore, the best accounting framework to analyse these sectors is the Stock-Flow Consistent (SFC) model by British economist Wynne Godley.

When considering all sectors of the economy, the SFC model presents an accurate and detailed account of all flows and stocks in the economy. This framework means the net sum of all equity of the economy is equal to zero (whilst equity remains). An example of a Sectoral Balance sheet is seen below.

Note that when the government sector is in a deficit, this means the private sector is in a surplus. Both sectors effectively mirror one another. A private sector surplus is a result of increased net-financial assets in our pockets from government spending. With this income we go on to spend it into other areas of the private sector. Our spending becomes the income of businesses, who use these net-financial assets to expand projects and production. This in turn can generate more jobs and economic growth. If our resources are being utilised, a private sector surplus creates a stable and functioning economy.

Government deficits are entirely normal and necessary to maintain a healthy and stable economy. This is the same conclusion reached by Economics Professor Eric Tymoigne, who writes in his paper “Debunking the Public Debt and Deficit Rhetoric”:

If a growing public debt is so concerning to some, it is because it is supposed to raise interest rates, slow economic growth, raise inflation, and raise tax rates. Even a casual look at the evidence shows that these concerns are not warranted and that prior beliefs should be reversed. Deficits help to stabilize the economy, deficits do not raise interest rates, deficits are not necessarily inflationary, and a rising public debt does not lead to higher tax rates. The public debt and fiscal deficits provide several benefits to the rest of the economy.

The argument that Scotland’s deficit must somehow shrink for arbitrary fiscal targets is not based on macroeconomic science. On the contrary, the evidence tells us that when governments attempt to “balancing the books” for arbitrary fiscal targets, this leads to increasing instability and economic recessions.

If the government wishes to run a small surplus, this will push the private sector into a deficit – reducing its size and suppressing economic activity. If a business or individual wants to spend beyond their income, they will either reduce their spending, sell their assets or borrow from commercial banks. Reducing spending will result in declining revenue streams for many within the private sector, whilst borrowing from commercial banks will result in growing private debt that will need to be paid by with interest. Prior to Covid-19, this was the path the UK economy was heading towards.

The GERS debate, whilst healthy and engaging, is still largely stuck in an endless loop that is framed within orthodox and illiterate economic language. Discussing economics with one eye shut leaves voters misinformed, when they deserve a more honest and robust analysis of our economic systems.