Finance and Public Administration Committee

Meeting date: Tuesday, March 28, 2023

Official Report 729KB pdf

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Scottish Fiscal Commission (Fiscal Sustainability Report)

The next item on our agenda is an evidence session with the Scottish Fiscal Commission on its “Fiscal Sustainability Report”, which was published last week. From the Scottish Fiscal Commission, I welcome Professor Graeme Roy, chair; Professor David Ulph, commissioner; and John Ireland, chief executive. I intend to allow around 75 minutes for the session. Before we move to questions from the committee members, I invite Professor Graeme Roy to make a short opening statement.

Good morning, and thank you for inviting us to give evidence on our “Fiscal Sustainability Report”, which was published last Wednesday. In the report, we project the Scottish Government’s spending and funding out to 2072-73, with a particular focus on demographics, trends and the cost of delivery of public services. The balance between spending and funding allows us to assess the long-term fiscal sustainability of the Scottish Government’s current tax and spending policies.

Importantly, many of the sustainability challenges that Scotland faces are common across the United Kingdom. Indeed, like Scotland’s, all high-income economies face pressures of rising costs of public service delivery and an ageing population. Moreover, the fiscal framework between the Scottish and UK Governments means that managing the challenge of fiscal sustainability in Scotland is a shared endeavour between the two Governments.

It is important to note that the challenges that we identify would exist under any constitutional settlement. However, under the current settlement, many of those challenges emerge through their impact at the UK level, which feeds through to the Scottish Government’s budget via the block grant. From a Scottish perspective, what also matters is where our outlook might differ from that at the UK level, and feed through either to higher spending pressures in certain areas or to relatively weaker devolved tax revenues.

If we look at that differential risk under current Scottish and UK fiscal policies, we project that, if public services in Scotland continue to be delivered as they are today, Scottish Government spending over the next 50 years will exceed, by an average of 1.7 per cent each year, the estimated funding that is available.

However, taking account of what the Office for Budget Responsibility says might need to happen across the UK in order to move towards a more sustainable position, we estimate that, over the next 50 years, the average budget gap for the Scottish Government would be 10.1 per cent of devolved spending each year.

Underpinning those calculations is detailed work, which uses projections for Scotland’s population and economic growth to develop our assessment of Scottish Government spending and funding. For example, our projections for Scotland’s population follow those that have been produced by the National Records of Scotland. In our central projection, the population of Scotland falls by approximately 400,000 over the next 50 years, driven largely by the low birth rate.

Our long-term economic projections are determined by the supply of labour and by productivity. To help with transparency, we have aligned our productivity assumptions with those of the OBR. We show that spending on public services will increase not only because of pressures from an ageing population but, crucially, because of evidence of the rising costs of delivery. Spending on health is projected to grow more quickly than that on other services, increasing from around a third of total devolved spending at present to about half in nearly 50 years’ time.

Finally, I thank the committee, and its predecessor in the previous parliamentary session, for their support as we have developed the project. As we look to future work, I refer you to the letter that I sent to the convener last Wednesday, which contains an overview of our thinking around next steps.

I am happy to take any questions.

You will be glad to know that there will be questions. Obviously, I am not going to hog things too much, because time will be against us today more than I had hoped.

My first question is about the fact that you intend to publish one of those reports every five years. The Office for Budget Responsibility first started producing such reports in 2011 and has been producing them every year. Given the fact that there can be significant changes within a five-year period—such as a change of Government, a pandemic or Brexit—do you think that, in the future, you will look at changing that frequency? Rather than the reports being produced on a set timeframe, might you produce them in response to specific events?

That is a really useful question and, in part, the answer is about the demand for that sort of work, whether people find it useful and where further or more regular insights can value to it.

Two things are worth considering. One is the areas that we have not covered in this report—which we have identified—that it might be useful for us to focus on. Climate change is an obvious area where some further work and insights would be helpful.

Secondly, you are right that our initial thinking was that we would do a big set-piece report like this every five years. However, clearly, things will change during that time. There could be changes of Government, priorities and economic conditions, so instead of doing a large, detailed, in-depth rebuilding of all our modelling, perhaps there is scope for us to think about how we can do updates more regularly.

11:15  

Returning to the first part of my answer, part of that is about whether there is a demand for it: would it be helpful in informing the debate around Scotland’s budget and public finances? I think that it would be, but that is slightly biased. However, if it would help to inform the work of committees and the Government, it would help us with both our internal resource conversations and our conversations with the Government to know that it adds value to the debate.

From a personal perspective, I think that that would be very healthy. I see that Liz Smith is nodding, which is probably because we both submitted questions on that topic for First Minister’s question time this Thursday. Liz beat me to it and was selected to ask one, which I hope to come in on the back of.

That is certainly a good starting point, you are right. The Organisation for Economic Co-operation and Development has reviewed it and also sees it as being very positive. It talks about other things being added. As well as climate change, which you mentioned, it suggests health and poverty. The OECD also looked at intergenerational fairness, which economists talk about a lot but perhaps not many other people do—certainly not as many as should.

I asked about the five-year situation because paragraph 2.15 of the SFC’s report says that, in August 2022, the forecast was that the Scottish population would fall to 4.6 million by 2072, yet only six months later the projection is that Scotland’s population will fall less, to 5.1 million, by that time. That is good news, but it is a dramatic change in six months, so one wonders how seriously the forecast should be taken, given that it is a 50-year projection. Who knows what bumps will come along the road? It is difficult to see whether the forecasts should be taken as seriously as—well, not quite tablets of stone, but it is hard to see how seriously they should be taken.

Those are very fair points. I will say a couple of things about them. One of the key messages that we want to get through is that we can play around with some of the assumptions but doing so does not alter the core message, which is about the relative scale of the challenge that we face. Another thing that I am keen to communicate is that, now and again, it is useful to take a break from the day-to-day discussions about budget to look at the very long-term challenges that we see coming down the line. Many of those challenges are resilient to the assumptions that we use in the report.

The second point that you made, about changes in assumptions, adds value to my point that there should be more regular updates rather than a full republication, because that would mean that, when the evidence changes, we could amend the reports and keep them as relevant as possible.

On the specific example around population, there is a technical reason why we made that amendment. We consulted to get people’s views on the report and we had some feedback about the relative population projections in it. However, the most important thing was that we were really keen to use the same broad assumptions as the OBR was using for its population projections, so that we were not talking about apples and oranges. When we published the first report in August 2022, before we did the numbers, the OBR had a much more a cautious forecast about what might happen to international migration in the UK, so we followed that. The OBR then became become a bit more optimistic about that, given recent evidence on international migration published by the Office for National Statistics, so, in essence, we aligned with that.

That explains one of the key reasons why we have a slightly more optimistic assumption about population, but it comes back to your point that, as things change—whether that be on key elements of our projections such as population, or a new fiscal strategy from the UK Government about what it might want to try and achieve in the long run—that is when it is probably useful to update the analysis and show how the messaging has potentially changed at the margin, although it will not change the overall story.

The overall story is critical, because it is quite clear that Governments need to look very seriously at what is likely to happen. One of the things that grabbed my attention was the fact that, over 50 years, we are looking at a 72 per cent increase in output but a 218 per cent increase in health expenditure. The good news is that we are all going to live longer, but the bad news is that it will be a lot more expensive to treat us because of new and more expensive treatments, the introduction of technology and so on. Governments north and south of the border have to take serious cognisance of those developments.

In the report, there is a very interesting graph that shows that there will be divergence in population numbers. Figure 2.4 shows that, over 25 years, there will be a 31 per cent increase in Midlothian’s population but a 16.2 per cent decrease in Inverclyde’s population. You say quite clearly that you did not look at population numbers by local authority, but it is interesting that National Records of Scotland is predicting a 2.5 per cent increase in the population over that period, whereas the SFC is predicting a 0.5 per cent increase. That is obviously a difference of more than 100,000 people across Scotland. Can you explain why there is a significant difference in the figures that have been produced by the SFC and National Records of Scotland?

I am just trying to find that bit of the report.

It is on page 19.

The first point to note is that our projection is slightly longer—it goes to 2072—so there is a slight difference in the timing that we used.

In order to be consistent with what the OBR does, we used slightly different assumptions about international migration. That means that there is a slight difference between our projections and the central projections from NRS.

However, that does not really change the overall story about the projections of weaker growth in Scotland’s population relative to the growth in the population of the rest of the UK, and, crucially, about Scotland’s ageing population.

I will build on your general question about potential population changes. In future reports, we might show that the range of projections on outcomes might depend on differences in our assumptions about population. We could show the relative differences in that regard, but that would not show the overall change in fiscal stance, which is our core message.

In paragraph 2.8, on page 16, you say that Scotland has a “projected net annual inflow” of about 19,000 people and that about 9,000 of those people will be from the rest of the UK. Over the months and years, I have said that a lot of the people who leave Scotland tend to be highly productive and educated people in their 20s and 30s and that a lot of the people who come from the UK retire to Argyll and Bute or to Arran, in my constituency, where they have a nice view over the Clyde to Skelmorlie and West Kilbride.

Overall economic performance will be impacted not just by the number of migrants. That goes back to the OECD’s point about intergenerational differences. Do you intend to take such issues into account more in the future?

I will give David Ulph a chance to come in in a moment.

On the general question, our projections on migration are drawn largely from long-term averages relating to migrants who have come to Scotland. We take into account our share of international migration into the UK, we use long-term averages relating to migration from across the rest of the UK into Scotland, and we use age profiles based on historical evidence. That all feeds into our modelling.

We then get into the questions that you are alluding to. What potential changes can be made in the long run to make Scotland a more attractive place for people to come to? How does that relate to relative economic performance? How does that relate to the delivery of public services and all those sorts of things?

Historically—for well over a century, until the past couple of decades—Scotland has been a net exporter of people, and a net exporter of younger people in particular. That is one of the dynamics that shapes our population projections for Scotland. We have not had the continual inflow of younger workers that other parts of the UK have had, and that is why our population is older, on average, than that of the rest of the UK. A lower birth rate feeds through to slightly slower population projections for Scotland relative to the UK. The question of how we attract more younger workers into our economy is one of the key policy implications of what the report is suggesting.

You should bear in mind that this is our first report on the subject. We are trying to paint a big picture of what is happening with population growth and other factors that are driving current policies. We have factored in the composition of migration. It is not covered in detail in the report, but it is in our thinking. If you think that we should bring that factor up more strongly in future reports, that is a useful steer to us. We can think about how we identify the factors and bring them out more clearly in the work that we do.

We are very conscious that there are many factors at work here. We wanted to produce a report that told as clear a message as possible, so we tried not to overcomplicate the story or give people the impression that we can get almost any number we want depending on the assumptions that we make.

I think that it is an excellent and thought-provoking report. I have to be honest with you. The things that we have discussed are just wee tweaks that would be helpful.

A key aspect that the committee has talked about over the years, including with the SFC, is productivity. You look at that primarily from a demographic perspective and you say that, under current projections, Scotland’s productivity level is likely to continue to be below that of the UK far into the future. What impact would an increase in productivity of just 0.1 per cent have? What role does policy have in increasing our productivity?

We do not have a back-of-an-envelope ready reckoner that says what we will get for every 0.1 per cent increase in productivity. We can look at that, but I emphasise as a really important caveat that it is important to understand how our modelling feeds through. We have aligned our assumptions on productivity with the OBR’s assumptions in order to get consistency, as Dave Ulph said. We are focusing on the big messages.

If we increase productivity and grow our economy, that will increase the tax revenues that we can raise and it will potentially encourage people to come and live in Scotland, but it will have another effect, too. If productivity rises, we would expect people’s wages to rise in the economy overall. In order for public services to keep pace, the wages in that sector will rise, and we would expect spending on the health service and education to rise as well, so the public sector will not shrink.

Having higher productivity in the economy is therefore not necessarily an exact win. It will not fully mitigate the challenges that we have with an ageing population, a potentially declining population and rising costs of delivery. It can help at the margins, but we assume in our modelling that, broadly, we will want to maintain the public sector’s relative share of the economy and continue to pay public sector workers in line with the broader growth rates in the economy.

Increasing productivity can have an impact and it can feed through to helping to deal with some of the challenges, but it is not a silver bullet. We cannot rely on it and hope that it will be a public policy magic wand. It will not fully mitigate the challenges that we have with an ageing population and rising costs of delivery.

What Graeme Roy says is true of many things in the report. There are often two sides, or facets, to a given issue. Although productivity is good from the point of view of growing gross domestic product and tax revenue, we make the assumption, as Graeme said, that rising productivity in the economy shows up in higher wage costs, and drives up spending, in the public sector. On the one hand, it increases the funding side, but on the other hand, it increases the spending side. It is important to look at the balance between the factors and how they play out on both the funding and the spending sides.

11:30  

Yes. I note that your projections do not incorporate the establishment of a national care service, but you predict that social care spending will grow by 135 per cent per person, which would be fuelled “by increased ... wages”.

I want to bring colleagues in, so I will not—you will be glad to know—go through the whole document. I will finish with a question on the annual budget gap, which is discussed in what is probably one of the most interesting and important parts of the report. At paragraph 5.8, you state:

“In the fiscal framework, the Scottish Government has more control over its spending than its funding.”

You talk about a funding gap that

“is equivalent to £1.5 billion in today’s prices”

and you say that, in order to address that,

“the Scottish Government ... have to consistently reduce spending or raise devolved taxes throughout the next 50 years.”

However, you say that the UK Government is able to fund its gap, which is also significant; you talk about the UK’s

“public sector net debt reaching”

an astonishing

“267 per cent of GDP in 2071-72.”

Will you talk us through the annual budget gap a wee bit and outline its implications for Scotland and the UK?

That is a important question, because it is crucial to understand what the budget gap means and how it is interpreted. The Scottish Government’s budget is quite different from that of most other fiscal authorities, which might think about fiscal sustainability from the perspective of an independent country that is issuing debt and borrowing on international markets. Typically, a fiscal sustainability report looks at how sustainable the debt position is over time, as the OBR does for the UK. I will come back to that point, because it is a crucial aspect that feeds through to the Scottish element.

We do not have that in Scotland. The Scottish Government has relatively modest borrowing powers and the Scotland reserve, but those mechanisms are not really about borrowing structurally over a long time—they are largely about day-to-day management of the budget process. The Scottish Government essentially has to run a balanced budget year on year.

At the SFC, we say, “If the Scottish Government and the UK Government continue with their current policies and we have an ageing population and rising costs, what will the average gap between spending and funding be over the next 50 years?” That is where the 1.7 per cent figure comes from—it is the £1.5 billion. It is clear that that gap would not actually arise, because the Scottish Government is not allowed to run such a gap. It would have to make the changes before then. That goes back to the point that we make about the adjustments that are needed year on year just to balance that.

Crucially, however, that is only one part of the equation. As you mention, the OBR says that, without corrective action, the UK’s fiscal approach will lead to debt rising to well above 250 per cent of GDP, that it is therefore not sustainable, and that the UK is going to have to make adjustments in order to become fiscally sustainable.

In the report, we say, “Let’s take the OBR analysis and assume that the UK becomes fiscally sustainable. How might that feed through to the block grant, and what would the implications be for the Scottish Government’s budget as a result?” That is where the 10 per cent figure comes in—it represents the average change that is needed over that time period.

The key point is that there is a shared risk, as many of the challenges that Scotland faces, such as an ageing population and rising healthcare delivery costs, are happening at the UK level too. When the UK makes those adjustments on behalf of the UK, that necessarily feeds through to the Scottish block grant and the Scottish budget. The 10.1 per cent figure is the really important one to focus on, because it represents the totality of the risk that is faced. The 1.7 per cent figure is essentially the differential risk that we estimate in the Scottish context.

David Ulph might want to add to that.

I will reiterate those points, because it is important to understand them.

First, as Graeme Roy said, many other countries that have fiscal sustainability reports can run debts—their Governments can borrow on the international markets—which means that many other studies use the debt to GDP ratio as the measure of sustainability. We could not do that here, so we had to come up with a measure that no other fiscal sustainability report uses. We decided to use the fiscal gap measure, which represents the annual gap between spending and funding. Essentially, that is what is behind the debt to GDP ratio. If funding is higher than spending, the ratio will go down. If spending is higher than funding, it will go up. The direction of change in the debt to GDP ratio will pick up the annual budget gap. However, we are the only people who use that as our primary measure of lack of sustainability. We cannot use the debt to GDP ratio as a measure of that.

There is an important corollary to that. Where countries use the debt to GDP ratio as their measure of sustainability, they have a choice, to some extent, about exactly when they address the sustainability challenge, because they can borrow on the international markets. As Scotland does not have that choice, policies will have to be initiated to address the budget gaps as they start to materialise, because Scotland has to run a balanced budget.

This is a central point. We were forced to use the budget gap measure because we cannot use the debt to GDP ratio. That has a powerful implication for future policy making, and it is important that Governments in Scotland grasp that nettle.

At paragraph 5.14 of the report, you say:

“The bulk of the sustainability risk is with the UK Government”.

At paragraph 5.15, you say that, in that scenario,

“the UK Government would have a deficit in its primary balance for almost all years of the projection. The deficit would gradually grow, reaching 11 per cent of GDP by 2071-72.”

The UK Government will clearly have to take corrective action, which will obviously impact on Scotland.

In short, yes. That is correct. Again, that comes through in a variety of channels. For example, the fact that the cost of pensions, which are reserved, will increase as people get older means that—all else being equal—other budgets will have to be squeezed to compensate for that.

The majority of the Scottish budget still comes through the Barnett block grant. As the UK faces pressures from the impact of the ageing population on healthcare and makes adjustments in that regard, other parts of public spending will be adjusted. In turn, that will feed through to Scotland via the block grant. There are direct effects through the block grant on devolved areas, but other pressures that arise from the ageing population and rising costs will indirectly impact on Scotland as well. That is why, in that context, the majority of the risk at the UK level.

Thank you. I will open up the session to members of the committee.

I echo the convener’s points about the usefulness and importance of the report. One of the interesting things about the timeframe is that 50 years gets us very close to the global inflection point at which deaths will start exceeding births—I think that the United Nations predicts that that will happen at some point in the 2080s. This is therefore a global issue and not just a European or a Scottish one.

You said that you have taken the assumption on productivity from the OBR. Is the gap between Scotland and the rest of the UK purely down to demographics?

The most interesting chart on that is probably figure 2.6, which shows what is happening to Scottish GDP and the driver for that. There are two key elements. Broadly speaking, our GDP grows in line with productivity and what is happening to our workforce. To try to simplify things, we have in essence followed the OBR assumption on productivity, with a differential assumption about what is happening to population and therefore the workforce. We can see that the 16-to-64 population is projected to decline, which acts as a drag on Scottish GDP growth. Because there is a bigger decline in Scotland than in the UK, there is more of a drag than in the UK.

There is an important question about whether we think that Scottish productivity might be higher or lower than the UK’s over time. There is an interesting question about potential interactions between the size of the workforce, the age of the workforce and productivity, and whether we think that the interaction is good or bad. For simplicity, we have set all of that aside and focused on the demographic element, which is the driver of the gap between Scotland and the UK.

Thank you for that helpful clarification.

I understand the points that you made in previous answers about productivity not being a silver bullet. However, on the basis of what you say in the report, is it fair to say that the key parameters are the level of spend; the level of taxation; immigration, and therefore net population growth; and productivity? It strikes me that we have quite good measures on the first three of those things, but do we have enough focus on and insight into the last one? In particular, do we need to focus much more carefully on productivity per capita and the distribution of that productivity both geographically and across the population?

I would not want to give the impression that productivity is not important in this context. Our modelling assumes that productivity leads to higher wages and that those wages will be shared between the private and public sectors. Clearly, you could depart from that and assume that some productivity growth just provides additional revenues that will, in turn, let you fund higher public spending without increasing wages in that context. One thing that greater productivity and prosperity does is to allow more flexibility to make some bigger choices.

The key point is that, with a potentially shrinking workforce, the only thing that is left around growing the economy is productivity. I will make the point again so that you fully understand what we are seeing. Faster productivity growth enables us to have higher public spending, higher wages for people in the public sector, and greater prosperity as a result of that. That will not necessarily close the gap, because more money will be spent on that but demand will also increase—spending and demand will both rise. However, faster productivity growth leads to a more prosperous economy, which in turn means that more can be spent on those things over time.

That gets us into the broader debate, which I know you have had in a number of evidence sessions, about how we turn the handle on productivity, the potential sector mix of productivity, the regional variations in productivity and how we can turn productivity around, given the puzzle whereby it has been growing much more slowly than it has grown historically in both Scotland and the UK.

The balance between private and public sector productivity is also key for exactly those reasons.

It strikes me that we are not alone, but that countries such as Japan and Finland have had a much sharper focus on the issues than we have had. Do we need to do more international comparisons, not only at the quantitative level but at the policy and qualitative levels, to better understand the challenge?

Your point is entirely right. If we look at other high-income economies that are like Scotland’s—for example, in Europe, North America and Japan—we see that they all face the same challenges with ageing populations and rising costs of delivery. We need to keep reminding ourselves that it is positive that we are living longer and can access greater technologies and healthcare, but it comes with a cost that we need to face up to and think about.

11:45  

For our purposes, we have looked at a lot of countries that have started to do fiscal sustainability reports and to think about how they might respond to the challenges. The phase in which we think about what we should do by way of policy responses is the really interesting one. In recent years, fiscal sustainability reports have had an impact on issues such as the pension outlook in particular. France, which is currently experiencing some interesting events, is considering some of those issues.

When we discuss fiscal sustainability, we often make the point that the numbers are so big and of such magnitude that there is no single silver bullet, such as putting an extra year on pensions—although that would push things out a bit and save some money. We need to look at a combination of everything that is happening in the economy, including choices about some public services relative to others and what we should do on pension age and prevention in the context of healthcare. Can anything be done to reduce healthcare costs over the long term? It is that balance and mix that is interesting.

It would be really helpful to look at what other countries are doing—countries that are perhaps ahead of us in focusing on and managing such pressures include Japan and European countries such as Finland—to see what lessons they are learning.

There are currently 8 million empty houses in Japan, and mid-range economic countries such as Bulgaria and other eastern European countries have huge out-migration, as well as massively falling birth rates, and they do not have the strong economies that we have, in relative terms.

There is an issue that I want to ask about before I bring in John Mason. When we discuss such matters, we keep talking about 16 to 64-year-olds. Why do we do that, given that the pension age is going to change and will be well above 65 for the bulk of the period that we are talking about?

That is just shorthand. In our work on fiscal sustainability, we take account of the fact that people over 64 participate in the labour force. We just use 16 to 64-year-olds as a convenient shorthand to let us get a handle on relative population movements.

Okay. It would be good to change the 64 figure to whatever the pension age is. Is it 67? I am trying not to think about that.

I want to pursue some of the areas that the convener has asked about. Paragraph 24 of your report, which is on page 7, under the heading “Fiscal Sustainability”, says:

“Based on the OBR’s suggested paths for reducing the projected UK Government deficit, we have modelled a scenario where the fiscal tightening is applied evenly across all areas of UK Government spending and taxation.”

What does that actually mean? Does it mean that half the gap will be met from spending and half will be met from taxation? Obviously, that would have an impact on us.

Yes, it would. What we do in that central scenario is relatively straightforward. We say, “This is the adjustment that is needed at the UK level. If half of it is made up of spending and half of it is made up of tax, what would the figure for Scotland be?”. In box 5.2 on page 50 of the report, we vary that assumption. If the UK Government puts all of it on tax, the negative hit to the Scottish Government is slightly less. If it puts all of it on spending, the hit to the Scottish budget is larger in that context.

The point that we are trying to make here is that it is still a very large negative number, irrespective of what the UK Government would do around spending and tax. We have made an assumption, but the actual story does not change the fact that the UK Government must make that adjustment, which will feed through to the Scottish budget.

An important issue here is not just whether it is spending or tax, but whether it is spending or tax in reserved or unreserved areas. We probably had more discussions about the diagram that Graeme Roy pointed you to than on almost anything else in the report. The question was, “How do we convey a message without complicating it too much and having lots of different lines for lots of different assumptions?”. Therefore, we went for a very simple message by just presenting the average across tax and spending, and the average across reserved and unreserved, and showing the picture for that case. We do not know what the UK Government is going to do. We just wanted to get a really clear message out.

As Graeme has said, the line based on 10.1 per cent is the one on which the committee and everybody else should be focusing—not the smaller, 1.7 per cent one.

You have kind of underlined what I was thinking. So, 1.7 per cent would be the absolute minimum or the best situation—however you want to look at it—whereas, as you say, 10.1 per cent is where we are more likely to be.

What would 1.7 per cent mean for us? I think that you gave us a figure, but what would we have to raise income tax or cut expenditure by to get 1.7 per cent?

Perhaps John Ireland can find the discussion that we have had about that, while I come back to the point that you made about 1.7 per cent being the best possible outcome. That would assume that the UK became fiscally unsustainable—that is the key point. It is a step in the process. We assume that, should the Scottish and UK Governments continue to spend as they do now, with changing demographics and rising costs, the Scottish Government will still face a gap of 1.7 per cent, because spending will run ahead of funding. However, that is based on the UK Government spending in an unsustainable manner, whereas we know that it will have to adjust.

That is why an easier way to think about the issue is to flip it around and say that the total fiscal risk that Scotland faces is the combination of Scottish Government risk and UK Government risk, which is the 10.1 per cent number. Of that total, the 1.7 per cent figure is, in essence, the differential risk that Scotland faces because of additional pressures—demographics and so on—that are relative to the UK as a whole.

I am emphasising the 1.7 per cent, because it would be, as you have just said, differential. In a sense, that is what we have to worry about and what we can make decisions on, because, if the UK cuts expenditure by 10.1 per cent, we will certainly all complain about it but we will not be able to do anything about it.

Yes. However, the point is that that cut would immediately feed through to the block grant, and the decision on how to allocate that sum and feed it through would suddenly land at the door of policy makers in this Parliament.

You can think about how you can potentially close the gap relative to the UK—that is the 1.7 per cent—but the full-on adjustment at UK level will still feed through to the choices that this Parliament has to make around prioritisation of spending.

So, we would have both the cut to the block grant, which we would have to put into practice, and the extra 1.7 per cent or whatever figure.

Exactly. I will let David Ulph come in in a second, but I want to make a really important point about language in this context. We are not talking about cuts in block grant. Public spending will still rise; it is just that it will not rise as quickly as the demand on spending will. We are projecting that the economy will grow and predicting that public spending will rise in real terms. It is just that the demand on spending will grow more quickly, which means that you will have to prioritise in other areas.

Another way of putting this is to say that 1.7 per cent is the figure that comes because Scotland is, on the whole, relatively insulated from some of the pressures that the UK is facing. As Graeme Roy said previously, pensions will fall entirely on the UK Government, and one of the big drivers of lack of sustainability that the OBR has identified is the loss of fuel duty as people switch to electric cars, which will have a big impact on revenue at UK level but will not affect Scotland. As Graeme also said, some factors are driving higher health spending in the UK, which has to be met from tax revenue, whereas we get Barnett consequentials for that spend in Scotland. Therefore, we get that spend coming through on both the funding and spending sides.

We are, to some extent, more insulated. The 1.7 per cent shows the position in Scotland, which is, on the whole, relatively protected from some of the factors that drive lack of sustainability across the UK, and the 10.1 per cent really reflects the long-term sustainability pressures that the whole of the UK, including Scotland, faces.

Right. Just to clarify again, on the 1.7 per cent, you say that we are relatively insulated.

Yes.

That is, the Scottish Government budget is insulated, but not the people of Scotland, because the people of Scotland will have to pay more VAT or some kind of electric car duty or something to help as part of the UK applying the 10.1 per cent.

Yes.

That is helpful—thank you.

On migration, we are getting less than 5 per cent of UK migration. Perhaps you are the wrong people to ask this, but why is that the case and can we do anything about it?

We use the average over time—it is a historical average, with Scotland getting a smaller share of migration. In part, it comes back to the point that the convener made about the inflow of people and where they locate. Particularly with international migration, people are looking for opportunities and, in that context, the pull of London is always a dominant factor in the UK economy. Turning that around, if you can get a higher share of the international migration that comes into the UK to locate in Scotland, and different parts of Scotland, that in turn will help you to boost the migration flow. However, we have not looked at what you could do; we have just looked at the evidence about where that number has come from.

I am sorry to go back, but I did not answer your previous question about the numbers. On page 49, we turn the percentages into actual raw cash terms, to give an idea of the scale of the adjustment.

That is helpful. I confess that I have not read every word in the report. I focused on certain chapters, so I will go back to the one that I have read. I am struggling with figure 4.2 on page 44, as some of it seems a little counterintuitive, so I want to ask you to explain some of that.

For example, the first paragraph under the chart says:

“Scottish tax revenues would grow by an additional 5 per cent by 2072-73 ... because of the larger pool of Scottish tax payers. But the BGAs would increase four times as rapidly due to the impact of greater population growth in Scotland”

relative to England and Northern Ireland. I am struggling to understand that.

This is really important. Perhaps the easiest chart to explain this is the one on page 43, because it gets to the heart of the fiscal framework and how it has been set up.

To again think about what we do, we in essence assume that there will be broadly the same earnings growth across Scotland and the UK—we assume that earnings will grow in the same way as they grow in the rest of the UK. If the rest of the UK has a growing population, total tax in the rest of the UK will run ahead of the growth of total tax in Scotland, simply because there are more people.

Remember that what really matters for the fiscal framework is the block grant adjustment, which is indexed deduction per capita, and it is the per capita bit that is important here. If you assume that people’s earnings are growing at the same rate as they are in the rest of the UK, but you have a falling population, in essence, the denominator in that calculation is going down, which means that the ratio is going up.

That is the protection in the fiscal framework that Scotland has in relation to declining or slower-growing population relative to the rest of the UK. In the example that we give, total tax grows faster, because the English and Northern Irish population grows more quickly than the population in Scotland but, because we have a falling population, the tax per capita essentially cancels that out—in the scenarios that we have in the report, it moves ahead ever so slightly in Scotland’s favour. That takes us into the whole debate around the fiscal framework and the protection that Scotland gets from the method of indexed deduction per capita.

Okay. My final point is, I think, linked to that to an extent. You say that you assume that

“the age distribution of income tax revenues remains constant”

and that

“an older tax payer base would partially offset the fall in tax revenues”.

12:00  

What we have done is to assume as neutral a position as possible in which earnings growth stays the same across the UK and Scotland. However, we know that older workers tend to earn more than younger workers, and because Scotland has slightly more older workers, particularly in the initial period, that leads to higher earnings in Scotland relative to the rest of the UK. For simplicity, we have made the assumption that earnings grow as people become older. Their pay increases, they move through increments and they have more experience, and that leads to higher earnings. It is important to think about whether that holds. There is the risk that, if you do not have the same level of growth or, potentially, you have sectors that are in decline in that context, you might face a squeeze in which older or more experienced workers do not get that pay premium—

They might be forced to take a lower-paid job.

Exactly, and that would start to feed through to our projections for income tax and so on. It is a really important debate. Coming back to David Ulph’s point, we assume, for simplicity, that it is the same as it is at the moment. If it changes, that is an additional factor or risk that could potentially feed through to that relative position.

We move to questions from Ross Greer, to be followed by Douglas Lumsden.

Thanks, convener. I should flag up that I have an event with the Presiding Officer at 25 past 12, so I will apologise now for having to slip out early if we run over a wee bit.

I should also caveat my question by saying that, like colleagues on the committee, I really appreciate the huge amount of work that has gone into the report. On the productivity projections, would you, for illustrative purposes, be able to project the impact on the deficit—the 1.7 per cent and 10 per cent figures—if our productivity, instead of running as currently projected, were to mirror the European Union average, the Organisation for Economic Co-operation and Development average and so on?

Going back to the convener’s point about policy choices, I know that everybody and their gran has, at some point, come up with a plan to boost productivity, and none of them has really worked. How much effort should we continue to put into that instead of trying to pull other policy levers to address the deficit?

As I have said, that is not something that we have done, but it can be done now that the modelling has been done. I am looking at John Ireland as I say that—and before he faints at having to deal with an additional request on top of preparing the medium-term financial strategy. It is certainly something that we can look at and write to the committee about.

However, even if it were relatively stylised—if we were to, say, rerun the model with slightly different productivity figures and say, “This is what the number would be”—we would still want to take a bit of time to interpret that. That is because, as I have said, the way in which we have set this up is to assume, essentially, that higher productivity is feeding through to greater prosperity—in other words, greater wages in the public sector and greater resources available for public spending.

To an extent, these things will largely cancel out, but, as Mr Johnson has said, a question then opens up about the relative balance between the public and private sectors in that context. It is certainly something that we can have a look at and get back to you on.

The thrust of your question is interesting, Mr Greer, because it is about where you, as a committee, should be trying to focus your efforts. If we could help you understand the effect of pushing on this or pushing on that, it might help the committee understand better where it should go on this.

Absolutely. Thanks very much.

In effect, that will probably happen after the May forecast.

Absolutely, John. Thanks.

The report notes that the growth in the block grant is largely going to be driven by increased health spending in England. If the assumption is that the consensus in Scottish politics continues and that health consequentials go straight into Scottish health spending, I presume that that will result in a relative deficit in non-health areas—that is, everything other than health—of Scottish Government spending and that they will be worse than the overall headline figure. Has any work been done on trying to disaggregate that to look at the sustainability of all of our non-health spending?

There are a couple of things to highlight. Page 36 of the report contains a bit of a discussion on the relative comparisons with health in England. Essentially, we assume no change in policy; we take the current position on health, with no change in policy, and push it forward, and we can see that Scottish spending on health per head is running slightly ahead of spending in England. In our spending projections, we assume that health spending will continue to grow in line with current policy.

What we do not do—because it starts to stray into the policy debate—is to consider how, if you face a funding gap, you might prioritise things in order to plug it. That gets us into questions about how you reprioritise from some areas to others—and if current policy is to prioritise health over other areas, that suggests that that is one thing that you would do—or about where taxes would potentially come from et cetera. However, we do not go into that, because we would then start to move into future Governments’ policy choices. We are simply saying that, if you keep the current health policy constant and then push forward, in the context of rising costs and an ageing population, that is the number that you will get in terms of spending pressures.

That is relevant to questions on preventative spend. We can keep launching more money into health, but it is not going to reduce demand. The challenge for us, then, is how we take money out of health and put it into prevention. That is politically challenging.

Finally, I want to ask about your projections for growth in local government tax revenue—and I accept that this will be more of a political question that you might want to avoid completely. It feels like we are relying far too little on local government tax, bearing in mind that in Scotland we rely too much on devolved income tax. Under our current powers, it is through local government tax that we can tax wealth, property and so on—in other words, we have more latitude with local government taxation—but the projected growth from local government tax is minimal and the overall share of tax revenue from local taxes relatively minimal. Do you have concerns that, given the overall issue of fiscal sustainability here, not enough discussion is being had about how to reform local taxation?

I will try to dodge some of that question, because it gets us into policy questions about what Government might do, but I can make a few general points. Maybe David Ulph, as ex-chief economist at HM Revenue and Customs, has some views on this, too.

What we do in the report, again for simplicity, is assume that, in essence, local government taxes grow in line with the rest of the economy. We are not taxing more in this context, because, again, it is all about policy neutrality. However, there is a funding gap, so the question is what you do about it. We have already talked about how you might prioritise within budgets such as health and education, which, as far as local government is concerned, might go down, because of demographics.

Then comes the big question of where you raise the revenue for the elements that you want to look at. How much can you actually tax income under Scotland’s fiscal framework? After all, it is just one element of the tax system; you can add pennies, adjust rates and bands and so on, but that will raise only hundreds of millions of pounds, as a maximum, when we have potentially billions of pounds of additional pressures coming down the line. The nature of the fiscal framework is such that you are constrained in your big revenue raiser, because, as simple arithmetic shows, there is only so much that you can do.

That starts to open up questions about where else you might raise revenue from. Some of that is a Scottish question relating to things such as local taxation and some of it is a UK question relating to the future of taxation in a world where there might be significantly different pressures on public spending than has been the case historically. That gets us into lots of questions, which I presume are being asked at a UK level, about things like carbon and wealth taxes.

I do not know whether David Ulph wants to add anything.

I can say two or three things. What we were trying to do in the report was look at fiscal sustainability at the aggregate level in Scotland, without trying to differentiate too much between local and central Government spending and funding. We thought that that was a useful starting point.

There is a problem with trying to think about what happens if we do this and what happens if we do that. It takes us into the area of trying to produce projections, rather than forecasts, on the basis of endless possible policies. We do not do that in our forecasting; all that we do is forecast for policies that have been formally announced. We did not want to complicate the message by thinking about all the different variants of doing this or doing that. We are trying to keep the central message clear and to paint a picture—it is up to politicians to think about what they will do about it. Once that turns into concrete policies, we can think about forecasting the likely consequences.

However, speculating endlessly about all the possible variants is a road that we do not want to go down. We want to give very clear messages instead of allowing people to pick any number that they want from a basket of numbers.

That is our job—we all pick the number that we want.

Yes.

Thanks very much. That is all from me, convener.

I call Douglas Lumsden, to be followed by Liz Smith.

I have a question about participation rates. I understand that the rate for the over-65s drops significantly, but has work been done on participation rates for those between 50 and 65? Where does Scotland stand in relation to the rest of the UK in respect of participation among that group? As Graeme Roy has said, they are probably the highest earners and the ones we want to keep feeding their tax income into the economy.

You are right. Indeed, we have discussed that issue in previous economic forecast reports, where we have seen a drop off in participation rates in Scotland relative to the rest of UK, particularly in the middle part of the age distribution. That is one of the key drivers of income tax revenues not being as high as they are in the rest of the UK. A big debate is happening at the UK level about what might have happened post pandemic in relation to the fall in participation rates in that crucial age group. It is the exact opposite of what we are saying in this report that we need, which is to get more people to participate in the economy for longer, given that life expectancy has gone up and they are the crucial earners that matter.

We know that participation rates across the UK have increased, because unemployment is now at a record low level—it is certainly at a record low in Scotland. However, it is the inactive bit that is crucial. We can make some changes to boost participation, particularly among older workers, and that will have a positive impact on the numbers, but it will not change the overall trend, which is ultimately driven by the ageing element and the rising costs in that respect.

When we get into policy questions about participation among older groups, there is some interesting stuff about dealing with not just an ageing workforce but people ageing in jobs, and the potential additional pressures, challenges and health conditions that we all experience as we get older. If we are going to try to encourage people to stay in the labour market, we have to consider how we make the workplace environment more conducive to people working there as they get older. That is crucial. Yes, we can boost population by migration, but we can also increase the impact by improving participation.

Has any work been done on how we are doing in relation to that age bracket compared with the rest of the UK? Are we better, worse or just the same?

I cannot recall. There might have been something about that in the last report.

There was something in the Scottish economic and fiscal forecast.

We can dig that out and send it to the committee. I recollect that the key point was that, across the working age, Scotland had not been doing as well recently when compared with the rest of the UK. That related in particular to the 30 to 40 age bracket. We can dig that table out.

I guess that that would not be explained by people retiring early—unless we were retiring really early.

It is early retirement and health conditions. It comes back to the point about prevention and healthcare; we know that we have slightly poorer than average health in Scotland compared with other parts of the UK and internationally, which means that, relative to other places, more people as they get into their 50s are leaving the labour force, because of ill health. That acts as a drag on the productive capacity of the workforce.

My other question—

Could I just add to that?

Of course.

12:15  

The other point to highlight is NHS waiting lists. We have quite good evidence that, because of the waiting lists in the NHS, people with relatively mild conditions who might have persevered in work are withdrawing from the labour force, because those conditions have become serious. Not only that, but people are then claiming certain types of disability benefits. Indeed, the rise in claims for disability benefits associated with increasing waiting lists in the NHS has been a phenomenon both in Scotland and in other parts of the UK. There is an interaction there; although we are spending huge amounts of money on health, waiting times in the NHS are still rising, with knock-on implications for participation and tax revenue and claims for disability benefits. It is quite a complex picture.

So, reducing our waiting lists and getting more people to participate will boost the economy in both ways.

Potentially, it would be a benefit.

In terms of the demographics, I think that Graeme Roy mentioned at the start of the session that what we are seeing in Scotland and the UK is not unique. How do we compare with other countries in Europe—France and Germany, for example? Has that work been done?

Yes. The broad picture is the same; an ageing population is common across European and high-income economies. A large part of that comes from the baby boomer generation and then the children of the baby boomer generation. That is easing out just now, with birth rates falling over the entire period. Essentially, then, we have had this bulge in the population, and now it is starting to ease off. That ageing in the population has been a big driver of that.

There are some countries that are ahead of us in this, and those are the countries where there might not have been significant in-migration through the second part of the 20th century. Japan and some of the Scandinavian countries, for example, have gone through that ageing of the population more rapidly. In that regard, Scotland is in a better place than some of those countries in terms of the relative ageing of the population and the population’s potential future decline.

However, the challenges are not different—this is not something that is unique to Scotland. Indeed, that is one of the key points that we are trying to make in the report: these challenges are not unique to Scotland. Nevertheless, they are challenges, and that is why we need to get ahead of them.

It is just that we often hear that our situation is much worse than everywhere else, because of Brexit. That does not seem to be the case.

Everything that we are talking about is long term. With, for example, the slight changes in migration assumptions—and this brings us back to the point that the convener made at the start—we assumed that there would be relatively low levels of migration. We have uplifted that figure, because we now think that we have more people coming in through migration. It does not really change the story, because this is all about the population stock changing over the long term, and there are also permanent increases in costs to take into account.

For example, in our report, we have assumed that, every year, about 10,000 people will come to Scotland through international migration, with 9,000 people coming from the rest of the UK. That is against a population stock of 5.5 million. From a fiscal sustainability point of view, that will not radically change the picture that we are getting. There is a broader question about what that means for productivity, skills and so on, but the big questions that we are talking about here are driven by structural dynamics in our economy that are not unique to Scotland. These things have been shaped over 100 or 150 years.

My last question is about the population of 16 to 64-year-olds. The figures for that age range in the rest of the UK seem quite constant, but we are dropping off quite considerably. Is that down to migration or is it down to the birth rate in the rest of the UK being higher than it is in Scotland?

There are a number of factors. The chart that you are referring to is on page 17 of our report. It is partly about our starting point. We have a slightly older population than the rest of the UK has. As you push that forward, you get that decline happening earlier. There is also a slightly lower birth rate on average in Scotland relative to the rest of the UK, which drives and pushes that decline forward.

As I have said, a lot of that stems from changes that have happened over decades to Scotland’s population relative to that of the rest of the UK. Apart from in the last decade of the 20th century, there was a net outflow of people from Scotland whereas, in the rest of the UK, there was an inflow of people from other countries. Scotland’s share of the UK population has gradually ticked down over the past 20 or 30 years as population growth has increased in the rest of the UK and population growth in Scotland has either been stable or has increased at a slower rate.

In essence, that is why, on the basis of the existing structure of the population, the projection for ageing and birth rate is relatively flat for England and a decline is projected for Scotland.

I guess that the Government should focus on that area to reduce the brain drain from Scotland and to try to attract more people from the rest of the UK to Scotland.

Yes. To be fair, the Scottish Parliament has probably spent a lot of time thinking about that since 1999. You will remember Jack McConnell and the fresh talent initiative and the pressures that we faced then. Actually, in the early period, Scotland did really well on attracting international migration because of the opening up of EU borders. That inflow has had a positive impact on Scotland’s population. In the late 1990s, there was talk of Scotland’s population potentially falling below 5 million within a few years, but it has increased because of that inflow. In turn, that has helped to boost the birth rate. The discussion about our population is really important, and it has been for the past 20 years.

Does David Ulph want to add to that?

I will go back to the point that the convener raised at the start of meeting. Just getting more people to come from the rest of the UK might not solve that problem, if we get retirees and we are still losing young people. The central question is how we get more younger people to come to Scotland. That is the question that we need to focus on.

Yes. I think that the convener has mentioned in previous meetings that, often, people leave Scotland to work and then come back to retire, which is something that we need to change.

Yes, indeed.

In your submission, you said that net in-migration of 19,000 a year is not that significant, but if only 48,000 babies are being born, that figure would be quite significant—it would be about 27 or 28 per cent of the total. The net figure for the number of people who left Scotland in the 50 years before devolution was 2 million, but we had a much higher birth rate then. That is why the population remained static. It is only because the birth rate has fallen so significantly that we have this situation. If we still had the out-migration that we had then, we would be in real bother.

You have referred in a number of your projections to the size of the increase in the health spend, which I think you are estimating will be just under 50 per cent of the change—it is about a third now. Obviously, there will also be an increase in the social security spend. Do you have any views on the scope for public sector reform in the economy to address the increase in the costs that we are having to cope with?

I have a couple of thoughts on that. There is an interesting chart on page 27 of the report that shows the drivers of health spend. Some of that is real earnings growth—productivity. We have spoken about the fact that, if you have a growing economy, you share that out and public sector wages grow with that.

The demographics are really important in the short term. In many ways, we are ageing—we are all ageing—and that will feed through, because we demand more public services as we get older. We face challenges, particularly in Scotland, in relation to demanding healthcare for longer because of issues around health inequalities and unhealthy life expectancy. Therefore, things that you do on that can lead to savings, which could be redirected. That gets us into the debate about prevention, the Christie commission and all those elements.

We talk about the pressures on health spending more generally. The costs come in at about 1 per cent over the long run. That is the rising cost of just delivering on healthcare. You could think about what reforms you could make to minimise that increase in costs—there are questions around productivity in the health service and the like. What is quite interesting is that we looked at a lot of international evidence on the pressures on health costs. Those pressures are not unique to the UK or to Scotland, and they are not unique to the delivery of healthcare in either the public sector or the private sector. They are essentially built into the way in which healthcare operates, given its unique nature.

In most sectors, as we improve and introduce technology, costs will fall, but in healthcare, that tends to increase costs. For example, if we have new ways of detecting illnesses or delivering procedures, there is greater demand; that is the nature of healthcare systems. As we develop new drugs to cure illnesses such as dementia, demand for those drugs goes up, so costs rise.

There are potential reforms that could be made to address that aspect, but we find that it will not be addressed through reform alone. Those pressures are built into the nature of how we deliver healthcare and the demand for it.

I do not think that there is much scope to be able to reduce costs. As you rightly say, if we want a world-class health service, costs are going to rise in that sector more than they will in the rest of the economy. That has been the nature of health service costs for a long time.

Is there scope for reform elsewhere, in the non-health, non-social security aspects of the economy, that could help us to make some savings?

We did not look at that area in the report because we were simply making projections. In the report, we essentially assumed, in order to come up with the totality, that the non-health elements and anything that is not really linked to demographics will grow largely in line with the economy. One exception is education, in which we pushed through a drop in the younger population, so there is less of a pressure in that context.

The general point—this starts to stray beyond the report—concerns the hope that the report will start a conversation about the fact that the systems that we have for public services, not only in Scotland but in the UK, were built around a structure and a cost base that will look quite different in the next 20, 30 or 40 years. Therefore, we need to have a conversation about how we can potentially reform those systems.

Some of that reform can come through efficiencies, but some of it will have to come through having debates—which are quite big debates for a country—about what we spend money on and what we prioritise, what our tax system looks like, and what the balance is between raising tax and spending. The system was built around the structure of our population, and that will—as you can see from our population projections—look radically different over the next few decades.

There might be more discussion about the whole issue of social care for the elderly and the balance between getting people out of beds in the NHS and into social care. That whole debate has been going on for decades, and Governments have kicked it down the road time and again. That is one area in which there might be some potential to get some control of some element of health costs. However, as Graeme Roy has said, the drivers of health costs are so fundamental that small reforms will not really get us very far.

Indeed.

On health, we need lifestyle changes, whether that involves tobacco, drink or the food that we eat. In North Ayrshire, where I live, the average age at which a person tips over from good health into bad health is 56. In the future, people may live 10 years longer but, for six or seven of those years, they might be in bad health. We need to ensure that, if people live 10 years longer, they actually live for 12 years in better health, so that we increase the healthy age even outwith the additional lifespan. That is where the prevention agenda comes in.

I thank everyone for their thought-provoking contributions. I apologise for the fact that some members have left—that is because they have been invited to lunch with the Moderator of the General Assembly of the Church of Scotland. It is unfortunate that this session coincided with that.

We have been trying to plug tomorrow’s seminar; I will give it another plug now. It will start at 8.30 tomorrow. There will be bacon rolls and an interesting presentation by Graeme Roy on the fiscal sustainability report. There will, no doubt, be many good questions from those who attend.

I thank the witnesses very much.

Before I close the meeting, I put on the public record my thanks to our colleagues from the Welsh Finance Committee, which hosted the second meeting of the interparliamentary finance committee forum on Friday. It was extremely interesting and valuable to hear about some of the common challenges that we face in undertaking scrutiny on a cross-party basis. I thank the clerks for their hard work and patience on the Thursday and the Friday; I think that they have aged significantly as a result of that trip. We have published a short statement on the meeting.

I close this meeting.

Meeting closed at 12:30.