 Good morning, and welcome to the 22nd meeting in 2017 of the Finance and Constitution Committee. The usual story, as far as our mobile phones are concerned, folks. The first item on our agenda is to take evidence on the outlook for the UK public finances from Paul Johnson, the director of Institute for Fiscal Studies, and I welcome Paul to this meeting. I'm very grateful for him being here. I thank him for providing the slide that you've given us in advance of this session. Paul, do you want to make any opening statement at this stage, any particular opening line that you'd like to give us? Well, just very briefly to remind the committee, to some extent, of the background to the public finances. Obviously, we've had now seven years of pretty tight spending control following the financial crisis and the very big deficit that we have back in 2010. The deficit is now down to less than 3 per cent of national income, which is a big change over the last seven years, but that's clearly come at the cost of some historically unprecedented levels of spending cuts across much of the public services. Looking forward, the expectation on current policies that that deficit gets down to 1 per cent of national income by the end of the decade against the Chancellor's self-imposed target of 2 per cent—that looks like he's got a bit of wiggle room—but we've also got an unprecedented level of uncertainty about what might happen to the economy over the next two or three years, given how little we know about the shape of any Brexit deal and how that might play out. The Chancellor's got quite a lot of difficult decisions to make at the moment, how much, if any, he used to make of his fiscal room for manoeuvre, how much to worry about the debt, which is now well over 80 per cent of national income, how seriously is he taking his target to get to budget balance in the mid 2020s, and all against the background of very poor productivity performance and very, very low increases in living standards and, indeed, following recent inflation, probably falling living standards again over this year. Lots of issues on the spending and public finance side, and then some issues on the tax side in particular. I'm sure that the Chancellor would like to bring back his proposals to bring taxation of self-employment and employment more into line that he didn't get through in the last budget, but my guess is the parliamentary arithmetic will make that even more difficult than it was earlier in the year. Murdo Fraser, you were going to ask some questions around borrowing OBR forecasts and fiscal policy, I think. Thank you. Good morning, Mr Johnson. I can maybe just pick up the point that you've just made about the Chancellor's wriggle room in terms of any policy choices that he might make. The OBR's latest forecast, which was from March, suggested that the Chancellor was on course to meet his borrowing target with some room to spare. Do you think that the economic and fiscal outlook has changed in any way since March? If so, what does that mean for the Chancellor's choices coming up to the budget? My guess is that the economic outlook won't have changed very much in the views of the OBR. The economic news this year hasn't been terribly different from what might have been expected. As I said in my opening statement, the overwhelming fact is the uncertainty about where the economy might go over the next three or four years. Whilst it looks like there's quite a lot of room for manoeuvre up to 2020, as the OBR also said, I can't remember the numbers. There's something like at least a one-in-three chance, even given that £20 billion or so apparent room for manoeuvre that, on current policy, we would still breach the 2 per cent target because the economy may well end up doing less well or tax receipts may well end up coming in less strongly than expected. That probability is just based on historic mistakes in forecasting. As I said, the chances are that the uncertainty in either direction is probably greater than normal this time round, so it may actually be a worse than more than one-in-three chance that that will be breached because of the higher level of uncertainty. I think that that's the balancing act that the Chancellor has to do—how much weight to give to strongly bad outcomes in three or four years and how much weight to give to the central forecast. If he gives a lot of weight to the central forecast, he may feel he's got more room for manoeuvre than if he's putting a lot of weight on the uncertainty. In light of what you've said, how likely do you think it is that the Chancellor and the Budget will announce some loosening of fiscal policy or do you think he'll just want to keep the ship sailing in the same direction? I wouldn't want to put a probability on it, but I think the things that he's weighing up are, on the one side, as I said, the uncertainty and the need potentially just to keep some fiscal firepower back for what may turn out to be some bad news around whatever the Brexit deal turns out to be. On the other hand, he's got this apparent room for manoeuvre and there are clear pressures on public services, so a couple of years ago you I think you could reasonably have said that all of that public spending cuts hadn't really started pushing through into very obvious problems with public services. It's much harder to make that case now. If you remember back last autumn, the Chancellor found more money for prisons because there was clearly a big issue in terms of what was happening in prisons at the time. Back in March, he found more money partly through increased council tax for social care in England. This time round, it's pretty clear that social care is still an issue that waiting lists and so on in the national health service are growing. Local government is beginning to show significant signs of strain, and of course we've got big cuts in welfare benefits just starting. There's quite a lot of pressure on him also to find a bit of money for those public services, and it's that balance between leaving himself some room for manoeuvre later on and responding to some of those pressures, including the public pay pressures that he's going to have to take. My guess is that if it's going to move anywhere, it'll move towards a loosening, but how big a loosening I don't know. Willie Coffey. Thank you. Thank you very much. Can I just talk about this potential room for manoeuvre? In your paper, you speculated that there could be a further £3.5 billion budget cut by the UK Government, so does this room for manoeuvre assume that that's going to take place or that might not happen? There are a set of spending plans laid out in the budget, and that includes some significant increases in investment spending and then relative to national income at least, some pretty significant reductions in day-to-day spending. That's where the plans are to get from a 2% or nearly 3% deficit to a 1% deficit. That is a tightening. That's a fall in the size of state intervention over that time. This goes back to the choice we were just describing. The Chancellor could decide that he's happy with the deficit roughly where it is at 2.5-3% of national income. That gives him a lot of room for manoeuvre, and the debt could probably bear a few years of 2.5-3% deficits. That will be a very different path to the path that he's currently planning just to get down to 1%, and that's the big choice that he's going to have to make. What do you think would be the proportion of that £3.5 billion cut that might impact on the Scottish budget? I'm afraid I don't know exactly what the Barnett consequentials of that will be. The OBR also said that, even though the economy has been poor for 10 years, there's no capacity on it to expand. The OBR also said that that means that they can't rely on above normal levels of growth to help bring the deficit down further, since that just pointers and edges more towards more cuts being the only solution to bring us back into line. That's a desperately depressing conclusion that the OBR have drawn. We've had seven years of very poor growth in terms of national income ahead. We're barely above where we were back in 2008, so we've had a decade with no growth, essentially, in national income ahead. The UK economy is something like £300 billion smaller than we might reasonably have expected back in 2008 on the basis of historic trends, and yet the OBR judges that there's no room for growth because we are basically at the new trend. If the OBR is right, that means that, for example, there's a little scope for a fiscal expansion in the Keynesian sense driving additional growth because we're already at capacity if they're corrected. It also means that, in the long run, additional spending will have to be paid for through additional tax because, again, if they're right in the long run, there's no scope for above-trend growth. That's a very different place from one where we might have been a few years ago, where we had a big deficit poor growth and at least a general acceptance that the economy wasn't at trend, being at trend if it's right. It creates a much bigger constraint on government. Thank you. Can I just ask you if you think the OBR are right about that? You caveated all of that by saying, if the OBR are right, what's your professional judgment as to whether the OBR are correct about these assumptions that they're making? This is an incredibly difficult judgment. The Bank of England is in a reasonably similar place. There is quite a wide range of views among the macro forecasting community, of which I'm not a part happily. If you look at particularly employment levels, which is one of the key inputs into the OBR calculations, it's hard to believe that there's a lot of scope for additional employment at record levels of employment. The flip side of that is that we've had very poor levels of productivity and earnings growth, but that's part of the judgment that all of that up till now has just been lost, that there's no additional scope for that. That's partly because investment has not been terribly strong in recent years, which reduces the capacity for that. It's also actually in the OBR numbers, it's partly down to immigration. If immigration falls off a bit then that also reduces scope for economic growth across the economy. I don't know whether they're dead right. It may be that there's a little bit of spare capacity, but I don't think that there's many people who believe that there's a lot of spare capacity out there, which would allow big differences in terms of judgments. Can I ask a couple of supplementaries to that as well? You just mentioned the migration issue, obviously, and the discussions that are going around Brexit, as far as that particular component in EU nationals are concerned. Do you like to expand a bit more about that in terms of the room in the economy for growth, with the challenge that we're now going to have in terms of the number of people who are going to be around as a pool for us effectively from EU nationals? There's a number of parts of that. First, there's again a lot of uncertainty about what this might do to levels of immigration. The judgment that the OBR has taken is that there'll be a significant fall in net migration and that that will hit the public finances reasonably hard. Their view is that tax revenues will be about £6 billion down relative to what they otherwise would have been. If, in addition, the Government gets to its stated target of getting net migration down to below £100,000, that's an additional £6 billion hit to the public finances through lower tax revenues. The unknown here is the scale of potential return movement by European workers. Clearly, the UK economy looks very different to what it would have looked like had we not had this net influx of something like 2 million European workers over the last decade and a half. It's important to distinguish two things. One is that net immigration may go down and that will have a relatively gradual effect on the economy. Another possibility is that large numbers of people might decide to leave and you may actually get a net emigration at least of some classes of workers and some classes of nationalities. That would make certain parts of the economy very difficult to maintain and may, in the longer run, change the structure of the economy. I think that brought that alive to me this week. I was talking to a construction company in my constituency who were already beginning to see some hemorrhaging of people leaving the United Kingdom and are taking quite rightly aggressive approaches around potential recruitment of apprentices for the future, just to ensure themselves. If they are doing that in the construction industry and all the other construction industry people are reacting in the same way and they are out there quite rightly from their perspective aggressively trying to find different types of recruitment, it might leave some of the public sector a bit more vulnerable because it's not going to respond in that way because it just won't because it's the nature of the beast to try to begin to look at where they're going to get their people to work in the public sector in the future. That balance about how the private sector is now responding against the public sector did worry me when I heard that. I'm not criticising them because they're doing the right thing for themselves. Do you think there's a potential problem there just in terms of the balance of the economy and enough people to be able to work in these areas in the future? Again, there are different parts of the economy. There are some bits of agriculture, for example, where historically the UK is dependent on migrant labour to do quite a large fraction of the work. Now, in a world in which that labour is simply not available, my guess is that some of that business will just stop. If you can't get people to pick your strawberries or have you at an appropriate wage, then we will have made a decision that it's better that our economy doesn't support that kind of work. It's interesting what you say about taking on apprentices and so on in the construction industry. It's very hard to find any economic research that suggests that net migration has had that kind of impact in terms of reducing opportunities for training and higher wages among the native borne. The way in which a lot of that research is done makes it quite difficult to be confident about that when you've had such a big change over such a prolonged period. It is possible, at least, that one of the effects of this will be to increase training opportunities available to British-born workers. As I say, the economic research doesn't show that, but it seems to me at least possible. On the other hand, it is very clear that it won't increase the total number of jobs available. As far as the public sector is concerned, there are clearly hotspots as it were there. Nurses in London and the south-east, for example, have a very high fraction of European and foreign-born staff. It's clear that, already, there has been an effect there, and it takes quite a long time to train some of these groups. That said, again, there is an over-demand still, despite the end of the nursing bursary, there is still an over-demand for places at universities that train in this kind of way, but it will cost us more to train more. Thanks, convener, and explore a bit more around about immigration numbers, Paul, if that's okay. It's interesting to hear what you said there, the six-billion already baked in. What assumption does that place on where net immigration would be? I don't know the number, but that's the difference. That's based on the difference between the numbers coming in over the next three or four years relative to what the OBR would have expected had we not had the Brexit vote. I'm afraid I don't know if I had the precise numbers. The numbers that have been up in, what, £309,000, I think? Gross. Up to now, yeah, yeah, okay. Then there's another six billion hit to the tax take if it drops below 100,000. Yes. Okay, so that number somewhere between 100,000 and 300,000 then there is shaman going forward. In terms of the net immigration, I mean certainly my own anecdotal experience talking to Eastern Europeans here and in Eastern Europe is that there's quite a large potential for that, accelerated also by the exchange route situation which makes it far less attractive for people to be working here and sending money home if they can earn more than working in one of the other EU countries. But that hasn't been factored in at all, and I think that there was some data recently that suggested that in terms of Eastern European we were actually starting to move towards an immigration situation. If you get any assessment of where we would be if there was a further hit then to the immigration in terms, I was happy to see a significant net immigration to back to Eastern Europe. Yeah, so I mean I think to some extent I mean you're exactly right about what might happen and what's driving it and the you know the thing that will make the 100,000 or less target attainable is that we just make ourselves very unattractive to people to come and live and work here irrespective of any policies that we pursue and it may be that there is some tipping point at which this view starts to change very quickly. Now I don't think we're you know we're not there yet and we're still looking at a position of significant net immigration but you know if we're losing six billion now and we've lost another six billion if we've got below 100,000 then clearly if we've got to a net immigration point then we'd be losing you know at least that much at least that much again in terms of in terms of tax receipts. It's also important to think about the composition of this and I mean these net numbers can be quite misleading because if you clearly the net number might not go down so much if given uncertainty about their rights we get a lot of British pensioners for example who are currently living in the rest of Europe coming back the net number might not go down so much but clearly we'll be swapping as it were working age people paying tax for pension age people who are in receipt of benefits. Yeah okay now that's that's clear and when you talk about those numbers to put it in context six billion another six billion maybe another six billion that starts to have a material impact on the deficit and the debt as a percentage of GDP because I think you've got 15 billions probably close to 1% or thereabouts is it? Yeah about 18 billion is about 1% yeah so that begins to have a yeah I mean that does begin to have a significant impact and again actually if you look back at previous OBR reports you'll see one of the things which has helped the public finances in the past has been that immigration has come in above their previous expectations it's one of the things that's kind of dug the chancellor out of a hole once or twice over the last six or seven over the last six or seven years so yes it does add up a matter it is worth saying on the other side of this we're looking at the sort of you know the gross impact on tax receipts as a whole clearly there are local areas where the impact on public services goes in the other direction that you know the impact on local health or education services that tends to be very concentrated whereas the the tax receipts are sort of beneficial across the piece and one of the things that I think arguably particularly of the way with local the way in which local government has been funded in England over the last seven or eight years has not compensated adequately for increased population when that's come about okay and I mean clearly the difference in Ireland Scotland where we're much closer to net immigration number has traditionally been lower anyway so this would have a much bigger impact potentially in Scotland as well in terms of the growth rate is there any assessment what those reduced immigration numbers across the UK would have on the UK's growth rate? um to a to a first approximation the evidence suggests it wouldn't have any effect on growth rate per capita so the you know the the evidence is not particularly that having more immigration has a big impact on the growth rate per person but on the overall growth rate it would be essentially proportional to the to the population so if you've got the population one percent smaller than the economy would would itself be one percent smaller okay okay thanks very much I don't just want some clarity around the six billion figure yeah thank you I know it's not your figure um it's the OBR's figure but can you just I mean this six billion figures is an annual figure so it's a loss to the economy of six billion pounds every year it's a loss to tax revenues of six billion pounds a year by I think 2020 or 2021 so it's a cumulative effect of a smaller number of people so few people come in this year next year the year after the year after the calculation is that the uh cute that that in 2021 the revenue coming to the x jack will be six billion less than it would have been had net immigration continued at its previous level okay thanks but as a figure as you just said I think in response to Mr McKee that it is a figure that talks only about loss of revenues it doesn't take into account reduced expenditure in public services in areas where you have you know quite dense immigration that that that's correct is that is is there a kind of figure that puts those those two things together so that we have a complete picture of them just one side of the coin um the uh well I mean there's two ways of answering that one is that as I say um the public find the public spending hasn't tended to reflect the increase in the number of um peoples there isn't a direct one-to-one correlation there and I think that's probably been one of the problems that actually the way that local government in England particularly has been financed has not reflected increases in number of people so that would leave spending per person higher than it otherwise would have done whether it has much effect on total spending I think is more questionable so for example benefit spending which is clearly very directly linked to individuals is very very low on on immigrants there's clearly more spending on on health and education it's it's a fraction it's some fraction of the six billion it's less than six billion but it's it's probably a couple of billion but that's that that's a bit of a guess right thank you very much forget the sorry forgive this brain for needing a wee bit more information on this six billion figure I'm assuming it'll go something like so 2021 four billion five billion six billion over the financial years it wouldn't be these exact numbers but after 2021 it'll stick it's it might potentially go up or down from that six billion figure relatively it's always against a counterfactual and I suppose one of the issues is whether it is reasonable to think there is a counterfactual in which net immigration continues at the very high levels that it has been um in the past uh so you know if the counterfactual is that we had net immigration of 300 000 a year ad infinitum um then you might you might reasonably ask whether that's actually a sensible counterfactual and whether it would have to have sort of tailed off in any case okay um Marie thank you convener I wanted to ask i mean I know there's a general challenge on the public purse because of inflation but is there a specific challenge because of the uh sterling crash so anecdotally I'm told that see where the NHS goes to buy an MRI scanner it's often in a different currency so is there a specific impact on the of what's happened with the currency on some of our public spending um I'm afraid I don't know the details of uh NHS spending in in in that sense but clearly um where you're buying big things from foreign providers and I think the ministry of defence does quite a lot of that um uh that's going to have a big impact on the prices that you are paying as well as of course the need to you know I suspect the biggest impact is on public sector workers where you know 1 cap might be manageable if inflations at one one or two percent but if inflation is at three or four percent because of the um uh devaluation uh then uh then that's an even harder thing to manage and because we spend 180 billion pounds a year on public sector pay an extra one or two percent on that probably dwarfs any um any of the other impacts okay thank you um Ash give me a round of external factors and you wanted issues about the single market and we'll I think we'll come to you next then and because polls introduced already the public sector pay issue I'll come to you after that okay thank you morning um I was I saw your twitter and yet I'll just read the tweet out to you um stunned both main party support leaving the single market this guarantees to make living standards worse would you like to expand on that any I'm sure I didn't tweet stunned um so uh you know if if you're um if you leave the single market um uh I mean that will clearly reduce living standards relative to world in which you stay in it and it's a you know in a sense it's a very simple proposition the um European Union is by far our biggest closest and richest trading partner we do about half of our trade with them and if we make that trade more expensive that will on average um make us uh that will on average make us worse off I mean that the I mean the the single market is particularly important for the services industries because it is through the single market that uh they have pretty free access to the rest of the EU and very few free trade agreements if any provide anything like the kind of integration that the single market gives for um for service industries clearly the customs union is the thing that's crucial for um more more crucial for manufacturing where it's border checks that uh and non-tariff barriers that create uh the biggest issue so again if you make that trade more difficult um you will you will make us worse off now part of what the sterling depreciation was about was about an expectation that um this will become more difficult but UK goods and services abroad will become more expensive and therefore um and therefore sterling depreciates an expectation of that my guess is if um if this became if we ended up with a a bad trade deal then sterling would go down again in uh partly in compensation for uh for that expectation and as we know the first impact of that is to increase prices and that's just making us worse off so what impact do you think leaving the single market and possibly the customs union as well would have on the public finances either for the UK and then the knock-on effect on the on Scotland uh well the um I mean the the public finance impact the um the the OBR has made some fairly modest assumptions about the impact of um of leaving the EU on on the economy and therefore the public finances I mean it's one thing um I've got the number there somewhere but it makes a difference of something like 20 billion I think to the public finances in the early 2020s on that basis for the UK and the big question the real big question so let me let me let me let me take this in three chunks so the first thing is that in terms of the public finances we we spend gross about 15 billion on EU membership that's about 8 billion net and one of the things actually in the public finance numbers is that that that that that 8 billion difference so the 8 billion net that we spend hasn't been allocated so actually in that sense there is an extra relative to the current baseline there's an extra 8 billion to spend but the OBR numbers are suggesting a a loss to an overall loss to the public finances because of lower growth so there's not an extra it's a relative to the sort of status quo anti there is a sort of a something like minus 8 billion to spend I can't remember the precise numbers I'm afraid um uh and and but the there is then secondly the question of the so-called divorce settlement now uh I don't know what number that will be but it sounds like it'll be somewhere between 20 and 50 billion now in a sense that's I mean obviously 20 or 50 billion is a big number but one should think of it as a one-off number which will increase the debt but not increase the deficit in each year going forward and in that sense is a much smaller number than 10 billion a year obviously I mean 10 billion a year kind of cumulates to an awful lot over a period and then the third the third question is not just what the public finance will impact will be in year one it's really what is the impact on economic growth in the UK each year going forward and then even even if it has affected only 0.1 a year that dwarfs all of the other numbers because within 20 years that adds up to a very large number and if you look at some of the work that has been done at the London School of Economics and the University of Warwick their view is that um the size of the UK economy would be between 5 and 10 smaller um after 20 or 30 years than it would have been had we stayed in the single market and so on and that economy that's 5 or 10 smaller is is much poorer in terms of its capacity to manage the public finances. So just briefly to go back to living standards you know you've said is guaranteed to make living standards worse would you be able to put a percentage on that you've just said the economy could be 5 to 10 smaller could you then apply that to living standards could they be 5 to 10 percent worse? Well if that's the effect on the economy then that would be the effect on average on on living standards now there is you know whilst I think there is genuinely no uncertainty about the direction of the impact the scale of the impact is very difficult to know. Neil? Yeah just in terms of the public sector pay cap in Scotland's a higher percentage of public sector workers in the rest of the UK it's around 21% in Scotland 17% across the whole of the UK. If the UK government was to relax the pay cap what would be the impact in terms of UK departmental spend and then the knock-on impact in terms of the Scottish budget and would it be fair to say that lifting the pay cap across the UK would disproportionately benefit Scotland of the Scottish budget because of the the higher sector public sector workers that there are in Scotland? I think the big the big the big question here for the government and the chancellor is what he means by lifting the public pay cap so you could as we've seen with two recent announcements on police and prison officers you could say that we're going to pay them more but without giving the services any more money and that you know that in then you know obviously doesn't flow across into the Scottish budget at all because there's the same amount of money going in so you could imagine the chancellor saying in the budget that he's no longer going to ask pay review bodies to keep within a 1 cap and he'll take note of their recommendations. It's very interesting looking at the NHS pay review body this year with the 1% pay cap and they say in their introduction because they have to take account of all of the pressures on the NHS and how much pay should rise in the context of all the other pressures. They say very very starkly in the introductory part of what they say we thought very hard about recommending zero because in their judgment it was pretty finely balanced whether that you billion and a half pounds or whatever the 1% pay cost in their judgment very finely judged as whether extra pay was the best way of spending that so it's quite possible that the chancellor would say we'll get rid of the pay cap we're not going to give any more money and then the NHS pay review body for example will come back with 1% anyway. Now as I say in that context it doesn't have any impact on the Scottish budget. Now it's also possible that the chancellor will say we want to get rid of this 1% pay cap and as a result will give a certain amount of money to each of the key departments who are responsible for these services and then the pay review bodies need to take a judgment as to how much of that to spend on pay and if there's more money for the services then that clearly has a knock-on effect on Scotland. The last thing I'd say on this is clearly there are significant differences by region and by you know what kind of work that they are in the public sector but if you look put the whole lot together it's not just the politics that are pushing for higher pay now we've actually we've got pay in the public sector now which is about back where it was in 2008 relative to pay in the private sector so if you carry on with that 1% pay limit then pay in the public sector quite rapidly falls relative to pay in the private sector historically quite low levels so I think we're probably going to have to do something about public sector pay certainly within the next couple of years but that point about it public pay now being about where it was in relative to private pay in 2008 is quite important because we tend to talk about these things separately we talk about living standards having done and earnings having done really badly and then completely separately we talk about public pay having done really badly actually public sector workers and private sector workers have gone in lock step pretty much since you know they've gone different got got there in a different way but public sector workers have not done any worse than private sector workers over that period on average. In the short term you're saying there might not be a disproportionate impact on the Scottish budget in the longer term due to the higher number of public sector workers in Scotland and the fact that raising revenues in Scotland is now vital to the Scottish budget and economic growth would you accept in the longer term that a public sector pay cap would be lifted would help the Scottish economy and the Scottish budget? Well it depends how you fund it but clearly if it results in more barnic consequentials coming to Scotland because more money is being spent in England then that's clearly helpful to the Scottish budget. The fact that you have a higher fraction means though that the knock-on effect would probably be higher than the barnic consequential would necessarily fund but clearly it's a more important part of the as you say if it's a higher fraction of the Scottish workforce then it's a more important part of the Scottish economy. Can I just obviously the public sector pay cap will cost money I know in your evidence you say to give one example that the government could choose not to implement the plan cut to corporation tax which would save around £5 billion given that the pressures that there are to increase public sector pay and at £5 billion there's a huge amount of money to be cutting in corporation tax how likely do you think it would be that we would see corporation tax being cut and public sector pay cap not being lifted? I wouldn't want to put probabilities on it but I think if in if I was the chancellor looking at the difficulties I've got at the moment knowing that the parliamentary arithmetic frankly makes most tax rises quite difficult and I was looking for some additional money then not implementing something which is in currently the plans looks a lot easier than raising something I mean the problem is that that I mean that corporation tax cut is legislated so we'd have to legislate not to bring it in I don't know whether it'll do it but it seems to me he's bound to be considering it and as you say part of the trade-off there is if you get that extra five billion in then that helps with things like public pay or whatever else the other priorities might be the reason he might not do the you know reverse the corporation tax cut is precisely to do with issues around brexit which is you know we know already that the uncertainty around brexit is reducing the long-term investment that some big companies are doing and whilst small cuts in corporation tax don't have big impacts on these things they might be seen as a signal supporting that so again it's you know it's a it's not a straightforward choice but but sorry to repeat if I were if I were the chancellor I did want an extra five billion of revenue that would be pretty close to the top of my list. Just on the public sector pay I'm a minute Patrick you've said some very strong things around the public sector pay poll in the past I think last November you said I'm sorry on pay levels generally one cannot see how extraordinary dreadful this is and I think yesterday if I've got this right and people are giving me the right briefing here and I hope I've got this right that we've now got the lowest wage growth since the 1750s. Mark Carney that yes it was Mark Carney that said that because that's because then then what concerns me is the cumulative impact between the stuff you're talking about with Ash and the single market and the impact on living standards together with that low wage growth the cumulative impact on people's standard of living I don't want to say a bit more about that well I mean I mean yes I mean it has been I mean it has been an extraordinary decade in all sorts of ways so um average earnings today are still below where they were in 2008 which is just astonishing as you know people people dispute whether it's the 1750s the 1800s or the 1850s the last time we had a decade this bad but but certainly certainly for a very very long time in terms of in terms of earnings now in terms of living standards in terms of earnings it's particularly been younger people who have been hit worse so people in their 20s so earnings of people in their 20s are still significantly below the earnings of people in their 20s in 2008 whereas earnings for older workers have generally recovered the when we had a period in 2014-2015 in which real earnings were beginning to rise again but the spike in inflation we've had this year means that over the last year real earnings have started falling again and that's you know as we've discussed directly down to the fall in sterling now going forward we hope that earnings will start to rise again but given the discussion about the economic uncertainties around brexit they're presumably going to rise less quickly than they would have done in a in a different world in which we weren't leaving the european union but that you know that does mean a long view the OBR's projection is that average earnings in 2020 will still be below where they were in in 2008 and that's something that was in their judgment that was something that tipped i mean in a sense it doesn't really matter it's just a statistical artifact but that was something that tipped after the referendum so they thought in 2015 in before the referendum in march 2016 the earnings by 2020 would have got above their 2008 level and then after the referendum they thought they wouldn't by 2020 get to above their 2008 level just wanted to explore some of the figures that you've given us on public sector pay and i'm glad that your comments just in those last few moments recognised that there's a difference between people's real experience and what the average is you know the the level of inequality is something that we're i hope all very concerned about rather than just the average you've suggested that increasing average public sector pay in line with prices or private sector earnings would increase the cost of employing the 5.1 million public sector workers by around six billion per year by 1920 i'm assuming that those figures are based on UK wide full public sector not just those directly employed by the UK government and subject to pay negotiations on that direct basis you're talking about all of the other public sector bodies yeah yeah has that figure taken account of the additional income tax that would be paid or other indirect effects in other words is that a measure of the affordability yeah or is it just about the pay bill itself that's a really good question um the uh the the answer is yes we've tried to take account of the effect of income tax and national insurance and pension contributions so the gross number is about nine billion and you know that's a number we'd be quite confident of the net number is actually quite a lot more difficult to calculate which is why i think use words like around um but it's around that six billion and that's the affordability across the public sector number and that's really important from the point of view of any individual um any individual department so the uh so the health service for example will feel the gross cost whereas the treasury will feel the net cost and it relates to Neil's point i think as well about the uh the size of the public sector in scotland relative uh to the UK as a whole if more of that uh income tax revenue is being uh generated in Scotland then that has a potential effect on the uh the block grant adjustment mechanism uh yes because yes i mean that that will i mean you'll yeah it'll ensure that income tax revenue in scotland rises possibly a little bit faster than that and the rest of the UK massively but it could be a little bit on the other hand it will be the UK treasury which gets your the higher national insurance contributions for example there'll be other indirect effects like potentially reduced demand for social security payments of one kind or another potentially reduced demand on the health service for example if we're talking about public sector work as many of whom are low earners reducing the direct amount of poverty that many of those are in will have a a positive effect in in other areas of public services has that been taken account of those more indirect you know one step removed again from the from the direct pay bell no we can't take account of that though i think it's um it is important i mean whilst clearly there are low paid public sector workers and there are those who are on benefits about two-thirds of public sector workers are graduates i mean much much i mean public sector workers the average pay of public sector workers is actually much higher than private sector workers because they are so so much a graduate high skilled workforce and actually among the lowest paid public sector workers so the least skilled public sector workers are the ones who command the biggest premium over the private sector so actually the the the real problem about poverty pay is a private sector problem much more than it's a public sector problem sure just finally in in the Scottish government's response to whatever the UK government does in its in its budget is the Scottish government in a position to easily calculate the total cumulative affordability of increasing public sector pay at or above inflation taking into account yes the direct effect on the pay bill to the to itself and other public sector bodies that it funds but also the the knock-on effects on taxation on devolved elements of social security or other public services is that a an achievable calculation it ought to be yes and is anybody other than the government in a position to do it can it be done based on what is in the public domain already uh you probably best ask the people behind me it may well be that Fraser Rallander or David Bell or somebody can do that I don't know thank you Alexander thank you committee good morning yes i'm changing direction if you're a chancellor for a day type question um you've written a lot written at length about how you'd improve the UK system to be more efficient and effective given you're up here could ask you to maybe put yourself in the finance secretary shoes and are there any obvious suggestions for how the system up here could be similarly improved but bearing in mind you'd have to get around and get cross party support for any observations we I mean you're I mean you've obviously got also a lot more constraints on what you're able to do so a lot of the big problems with the UK system sit with capital taxation which I don't think you can change with national insurance contributions which again I don't think you can change with the VAT system which again I don't think you can change so actually in terms of structural issues many of them are not within your purview and certainly the biggest many of the biggest ones are not within your within your purview I mean within those that are the taxation of housing remains a huge issue across across the UK and I mean our view is that there's a strong case of rebalancing away from what in England is stamped you in here is the land of rebalancing away from that towards council tax and I know that you've had council tax frozen for a long time here there's a strong economic argument actually for having council tax which is a closer reflection of the actual value of properties or the relative value rather than being regressive in the size of the in the value of the property and based on very out of date valuation so one thing I might do is reduce the transaction tax and reform and increase the council tax now that will help both with the functioning of the market it would help actually with one of the inequalities that we haven't talked about which is that between generations where the current system benefits those who are currently owning expensive properties and it's a problem for those wanting to get on to the housing markets so the tax system actually makes that worse so I mean I think there are definitely things within the taxation of housing which are which you can do now you've obviously also got some choice over the income tax system actually that there's not much structural that you can change there because a lot of the problems are about the way that the income tax system treats earnings relative to capital income and that as I understand it's not something that you can shift I mean so the one thing that you could do which you may not decide to do I guess is you move away from this rather silly whatever it is 60 odd percent rate on earnings between 100 and 120,000 that we have under the current income tax system thank you when you say move away could you expand what you mean by that well so at the moment as you know the personal allowances so-called tapered away for people earning between 100 and 120 something thousand a year and that creates a 60 including national insurance a 62 percent marginal tax rate on people in that region so I mean you could at some expense and obviously in a way which would help high earners you could just stop doing that or you could do you instead of having a 60 rate over 20,000 range you could have a lower rate over a 50,000 pound range for example now I don't I don't I don't present that as a big priority I don't think this does any great harm except that you know if you happen to be earning 120,000 pounds you probably feel that's a little unfair okay well given what you've said about the who the the the significant levers are but around the economy still remaining with Westminster and the UK government and given that the new fiscal framework now means we've either got to match or or outgrow the UK economy if we're going to have a net benefit to our settlement and what is that available to us within the basket where we do have who we can start to make a difference I mean there's an issue between the short run and the long run I mean my view is that governments have quite a lot that they can do in the long run in terms of investing in appropriate infrastructure having a good education system an effective planning system and things like that I think focusing on long run economic development will pay dividends in the end and certainly you certainly if you look at England the slowness over making choices over big infrastructure developments whether it be Heathrow or anything else clearly holds the UK back for you know because of the trade offs that are or that are involved having a Scottish system which is better at choosing infrastructure projects and doing them quickly would help clearly the education system I mean again looking at England we have a dreadful system for anyone who wants to move on from school at 16 or 18 and do anything other than the university and that holds the economy back so if Scotland were to get that working better in particularly the FE sector that that could have a significantly positive impact relative to relative to the rest of the UK I think the other thing is is actually immigration as I think we someone said earlier actually Scotland has a much much less net immigration than the rest of the UK in a way which I find quite surprising in some ways given that you've got some of the world's best universities and so on here actually anything which attracts more people not just high-skilled people but certainly including high-skilled people into Scotland over time would clearly particularly given the overall policy would clearly be would clearly help you growing given the way that the formula works would would be a big positive benefit okay it's very helpful Marie I think you're a supplementary just something that dawned on me has been listening to all the discussion this morning I'm aware that there's been a downgrading in the credit rating of the UK and I just wonder what impact that's likely to have on the public purse given the cost of of debt and also where that is likely to head are there any predictions about where that's likely to head in the future with the shrinking of the economy that we've been chatting about this morning I mean I don't think the downgrading in itself will have any impact I'm not sure that the people the buying gilts take much notice of these things I'm begin to wonder what the point of some of this is if I'm honest but but it could be taken as a symptom of increased uncertainty about where the UK economy is going so we've clearly got without making any judgments quite a lot of political uncertainty we have a government which barely has a working majority which makes for example increasing tax very difficult if that becomes necessary and I think you know one of the as I've said one of the big constraints on the chancellor will be the difficulty he would have getting any tax increases through parliament so political uncertainty clearly creates risk the uncertainty around whatever the brexit deal might look like creates risk you've got an opposition party with again without making judgments with a set of economic policies which are very different from anything we've seen in in a couple of generations so again people will see that as creating some kind of risk as well as potential opportunities so I think when you put all of that together then concerns both about political capacity and about uncertainty over growth will weigh your might way eventually on people's willingness to purchase UK government debt but let's be absolutely clear at the moment it remains the case that people are desperate for this stuff and the interest rate being paid is extremely low by historical standards now partly that's a good thing it's also partly a reflection of concerns about the world economy because you know the fact that people are still willing to buy this stuff when it's got negative real returns is an indication of how worried people are I think about where the world economy is going I think what starts to get really worrying for the UK in a sense and this may be where we're going is a world in which investors get more confident about the rest of the world and we know that the euro zone growth has been you know really quite strong recently if investors start to get more confident about the rest of the world and less confident about UK government at that point the cost of this stuff may start to rise okay I'm not saying that I was looking for supplementary and paul that was very useful our of your time I'm very grateful for you coming along this morning and giving us your thoughts and setting the context for us as we begin to drive forward to the setting of our own budget here in Scotland at the end of the year the beginning of next year and the context is important in that whole process so we're very grateful to you and I now suspend the meeting to allow a change over witnesses okay colleagues the second item on our agenda today is to discuss the impact of brexit on the Scottish economy which is part of our focus on the budget scrutiny this year and we're joined for this item by Professor David Bell who's a fellow at the Royal Society of Edinburgh and Professor David Heald who's Professor of Public Sector Accounting at the University of Glasgow thank you both for providing us with your written responses and I think we'll just get straight to questions and Adam you're going to begin this around some of the issues around growth I think thank you Camino I suppose for the record I should say I'm also a fellow at the Royal Society of Edinburgh although I had nothing to do with the preparation of these of these papers so whether that's a relevant interest to declare or not I don't know um professors you heard um Paul Johnson our earlier witness say earlier this morning that there is an unprecedented level of uncertainty in the economy do you both agree with that yes I think the really very striking thing is we've got a coincidence of three major issues at the same time the first one is that the basis on which the Scottish Parliament is funded has actually fundamentally changed we're moving from moving from a position from 1999 when it was essentially funded by block grant but with some some tax powers in the form of a tax and local government taxation to a position where to position where the funding of the Parliament depends upon depends upon the performance of the UK economy and the performance of the Scottish economy relative to the UK economy we're also the second point is that we're going through the kind of longest period of fiscal austerity for 100 years not the deepest but generally speaking when you have periods of public expenditure cuts tax increases they usually last for a relatively short number of years it looks as the whole of the 2010s are going to be affected and the third point is obviously Brexit the you've heard from the previous witness that the bounds of economic opinion would be that the effect on the UK economy will be negative that will lead to lower the lower affordability of public spending at the UK level and hence less money coming down coming down the Barnett pipeline what deeply concerns me about this is that the whole of the public debate seems to be concentrating upon what I regard as a pretty irrelevant issue and that is the divorce bill the net UK contributions are about 1% of total total managed expenditure so it's a relatively small item that is actually dominating public debate and creating a pretty toxic atmosphere between the European Union and the United Kingdom when it is important things like trade and the future relationships that actually matter. Professor Bell. I agree with the premise that we are in a period of very considerable uncertainty. I just add a couple of points to what David has just said. One in relation to austerity well actually what also lies behind that is something that Paul Johnson was talking about which hasn't perhaps anything it doesn't have its roots within Scotland certainly and that is whether a secular change is taking place in the UK's economic performance and indeed maybe beyond the UK in terms of the lack of productivity growth the slowness of recovery from this recession which as we've heard is almost historically unprecedented I've looked through the duration of the great crash and various other recessions that we've experienced what we maybe me more than most of you experienced during the 20th century and the duration was much much shorter than what we're experiencing now and secondly in relation to Brexit and the way that Scotland's finances are now going to be determined what will matter a lot is the relative performance effect caused by Brexit of the Scottish economy on the one hand relative to the rest of the UK economy on the other because that will ultimately have a bearing on the block grant adjustment and therefore the ability to fund public services. Given that you both agree that there is an unprecedented level of uncertainty can I take you to some of the figures in particularly your paper Professor Bell and you've given some very disturbing alarming concerning figures about forecast of growth particularly as regards to GVA and various of Scotland's economic powerhouses and cities given the level of uncertainty how are we to take these figures how serious are they how robust are they? Yeah I mean I do think I think that's a fair point so this is work done by Overman and Steve Machen at the LSE which is based on an overall model of trade effects on on the UK so it's looking at the long-term impacts of changing trade patterns in the first instance and then bringing those down to a spatial level and looking at the effect on areas and cities now I would treat them with you know I would say they're indicative I would not go further than that. Is there any evidence at all to support to support these figures is there any is there any sense that these that mean their forecasts we all know that forecasts can be can be wrong they can sometimes be wildly wrong is there is there any evidence at all that these forecasts are are correct or just guesswork? Well they are forecasts so we don't we can't really know that until you know the the the time point by which they are they are predicted to occur and one of the big difficulties around this that hasn't yet been mentioned is that the dynamics of this is really really uncertain so if you remember there were some who who forecast the almost complete demise of the British economy the day after the referendum as a result of the of the of the Brexit vote that it seems to me was wrong obviously wrong but it also failed to or these forecasts failed to make clear that one of the the particular uncertainties is around when things will happen you know if trading patterns change how long does it take businesses to decide to change their investment plans how long does it take to new contracts being made and so on so I would see these as being indicative and the message that that actually is quite important that does underlie a lot of them is that areas that are particularly exposed are our cities that are particularly exposed are those which have high concentrations of private sector service workers and this is on the basis that as we've heard earlier trade agreements that have much by way of agreements around trading services are pretty thin on the ground and therefore those services are the things that may find post-Brexit life most difficult. I saw you being interviewed Professor Bell about this by Gordon Brewer on the television on Sunday and he put to you a question which I think it would be useful to get on the record here as well which is that you know if these indications as you call them are the sorts of numbers upon which we should place any weight at all wouldn't you expect to see already business confidence beginning to diminish business investment plans beginning to change because these are plans that are made in anticipation of the way in which the economy is developing and there is no evidence to support the idea that Glasgow's growth for example is going to be cut by the kinds of numbers that you've put in your paper. Well so there's a you know it's difficult to disentang—these are the effects of Brexit and of course we're living in an economy where other things are going on as well. We've already heard a discussion about the effects of or the potential effects of the depreciation of the pound which may in some cities have had a beneficial effect. So in trying to isolate those effects which is what Overman and Machen have done these are being placed in terms of a counterfactual which where nothing else is going on but always there's other stuff going on. Right. So we shouldn't place too much weight on these figures. I think well I think they're useful indications and I think the basic point about trade that we are in currently in a single market where we have extremely advantageous trading relationships and moving to one where there's great uncertainty and all kinds of issues that trade economists would say would make life more difficult. I think these are the general lessons that are worth placing some weight on. Can I just comment on the question of the relative performance of the Scottish economy? That seems because of the way the fiscal framework works that seems to be a very important issue for this committee. One of the things that concerns me is obviously the ramifications of the decline of the old sector. I spent much of my working life working in the north-east of Scotland and very clearly you're seeing effects across the north-east economy of what's actually happening in oil and I suspect also the linkages are affecting the rest of the Scottish economy as well. In terms of looking for why you might think that this has appeared with the coincidence of the fact, as I mentioned, when the Scottish economy might perform worse than the UK economy, the ramifications of oil are important. The question about what kind of deals will be done to protect important parts of the UK sector, the UK economy. For example, if the UK Government makes trade-offs that protect the financial sector, there may well be benefits to the non-Scoedish parts of the UK, particularly the south-east of London. The relative performance has become very important because how much the Scottish Parliament will be able to spend will depend, in part, on that relative performance and the effect on the block grant adjustment. Neil Hamilton, I think that you wanted to build on some of the questions that— Yes, just on the impact on cities in Scotland and the impact of Brexit. Obviously, there's not going to be a uniform impact to Brexit. It is going to be felt differently in different areas. I understand that it is a forecast, but it would be wrong of us to ignore such warnings in terms of the impact that the figures that have been quoted in gross value added that Aberdeen likely to have a fall more than any other city in the UK, Edinburgh, to fall by 3 per cent, and obviously not just the Aberdeen and Edinburgh but also an impact in Dundee and Glasgow. I thought that it was interesting what you were saying about the areas that will be the worst effect to have the highest level of private sector service workers and the evidence that we have just heard suggests that they are the lowest-paid workers. As a result, that will be the impact on the poorest members of society as a result of the hit in terms of Brexit. I note that, Mr Bell, you said that the Scottish Government and its city partnerships should consider how best to mitigate the impact that is going to be in the cities and just ask what would be your suggestions for how the Scottish Government and councils in city partnerships can best mitigate the impacts that are going to be on the cities. First of all, it is true that at the lower end of the pay distribution you find more private sector workers than you do public sector workers. That is true, but it is also true that what we are talking about here are effects that are largely to do with trade and which parts of the economy are going to be most affected by a different trading environment. There, it is going to be the higher-paid private sector workers that are most likely to be affected. For example, in Edinburgh, if it becomes more difficult for life sciences to penetrate markets or for high-tech computing firms to break into new markets, those are the effects that are most likely to impact on the overall GVA in any particular city. Remember that, as far as the relative performance of Scotland is concerned, it is the higher earners in a sense that matter more because they are the bigger contributors to income tax revenues. It is relative performance in relation to income tax per head that will really determine how the block grant adjustment is going to evolve. That is not to say that there will not be trickled-down effects that will affect poorer workers, but the lesson that I took from the Overman and Mates and stuff was not necessarily that this is something that will particularly affect poorer people. It will affect those cities as a whole because it will have a negative effect on their trading relationships with other people, with whom they currently trade or potentially could trade in the future. In terms of calling for the Scottish Government and the city partnerships to look at ways in which they can medicate the potential impact on cities? I could launch into an explanation that the committee might find interesting and might not on that, but it is. What happens to the structural funds is quite important, what post-Brexit is. One possibility is that that kind of money moves into the city partnerships. What that does is that it changes the UK regional policy in this sense, that we have some policies that are placed neutral. What that means is that, to get them, you have to qualify in terms of income per head or some measure of relative poverty or whatever, but the standard one that has been applied by the European Union in the latest budget is regions that fall below 70 per cent of EU average per capita income are eligible for direct support. That applies only now to Cornwall and West Wales. If that money is taken and put into city partnerships, then the money will be allocated to places where deals are being done in terms of engagement with other stakeholders, like the university in Edinburgh is a big stakeholder in the city deal. Obviously, the local authority is as well. Those deals are done with places where there are actors that are willing to engage with them. What may happen as a result of that is that places would currently qualify for some sort of EU-type support. If there is not a similar place and neutral regional policy put in its place, all the money ends up concentrated on the cities and you get left behind towns, rural areas and so on. That has to be thought through very carefully. It is not clear what the UK Government is thinking of setting up some kind of fund, but it is not very clear. It is quite important in terms of both the social fund and the structural funds that currently come from Europe where they are going to end up. Obviously, there is a decision that has to be made about that. Are they going to come to the Scottish Government anyway, or are they going to be retained at the UK and distributed at the UK level? God forbid that the structural funds cash ends up in cities in Scotland only, but North Ayrshire East Ayrshire would throw their hands up in horror at the prospect of this, but he touched on just in the last comment that you made there, Professor Bell, that there needs to be a strategic approach to this. North Ayrshire's submission to his suggests that about up to 25 per cent of Scottish councils spend in economic development comes from the European Union. It supports a wide range of things such as infrastructure, business investment and youth unemployment and supporting youth employment in areas such as North Ayrshire and East Ayrshire. The impact that will not just be felt in the cities that I suggest to my colleague on the table, but there is a case to be made to have a regional policy in Scotland to continue to support those. Is there any work being done on that aspect that is out with the cities of Scotland to see what the Brexit impacts may be in the councils around the country? Some of the parts of Scotland's large swathes of England qualify for transitional funding because their income per head is between 70 per cent and 90 per cent of the EU average. In European social fund money, which I think is what you are referring to, there is no work as far as I know about that being done because of the uncertainty associated with what is going to happen to those funds. Are they even going to be allocated towards regional development? Are they going to be allocated at Westminster level, or are they going to be allocated to the devolved assemblies? A lot of that goes back. Cain said that a lot of what practical men do is ultimately have been thought through by some economists long ago. Ultimately, that is based on a difference between where you should allocate your money. That is not going to be good news for MSPs from rural areas. The argument that has been put is that you get more returns by concentrating your resources in cities. That is what lies behind the initiatives that have been taken in relation to cities at UK level over the past 10 years or so. That clearly goes against equity, but the argument is that efficiency suggests that you should concentrate your resources in cities. All I say is that those are the kinds of thinking that lie behind decisions about allocation of resources to different parts of the country. We currently have a mixed economic development set-up where the EU is not caring about where the money goes as long as the money goes to a place that qualifies. On the other hand, the UK Government and the Scottish Government with city proposals where they try to get people together to agree on policies to promote the growth of those cities. We have now gone on to the question about what happens about functions that are going to be repatriated. There is much talk in the media of a power grab by the UK Government that has upset the devolved administrations. However, there is a crucial question about whether there will be UK common frameworks for example in the context of agricultural subsidies and the question of how they will be financed. Obviously, the UK Government could keep everything and run everything from the Treasury. Alternatively, the money could be the existing Scottish spend on the present EU finance functions and could be transferred into the Scottish bloc with future changes going through the Barnett formula. One of the points that I make in my memorandum will introduce a new set of controversies into the budget process because there will be a direct conflict between spending money on nurses and spending money on sheep. Because it was done within a European framework, the budget was actually segmented. Those two budgets were not fungible. As soon as you put it into the bloc, there is a question of whether the future changes that come through Barnett are sufficient to pay for the agricultural subsidies and the question about what relative priority should be given. In terms of turning the focus to the specifics of the budget process, that seems to be a very important issue for the committee to think about. I can almost see my colleagues in East Ayrshire and North Ayrshire South Ayrshire reaching for the emails at the moment in horror at the prospect of a city-only regional policy. We will get the spin-off benefit from that, of course, as we always have done. I do not think that they will really follow that. Do you think that there is a need for a more regional policy to develop in Scotland about those types of frameworks so that we do not get left out and it is not just the cities that get the attention through regional policies? I think that one thing that you could argue is that that kind of policy that I have been describing and that I do not necessarily subscribe to does not take account of the externalities associated with them. One of the externalities that we have seen for a long time in Scotland is the effects of young people being attracted to cities and other parts of the country being left with much more challenging age structures than the average over Scotland as a whole. The consequences of that, a lot of it has to be borne by public service costs, higher costs for hospitals and care and so on. I think that there is a good case for looking at economic development in the round, one that I do not really believe that the UK Government has done, taking into account those kinds of externalities and taking into account the equity considerations. It is not just about efficiency in terms of driving up GDP, it is partly about maintaining a balance between different parts of the country. David Bell said something about the impact on higher rate taxpayers and the potential for greater attrition in that area in terms of jobs, etc. When you compare that with some of the stuff in your paper, David Heald, where you talked about the numbers being striking from the HMRC work that was done in 2017, at bullet point 1 on page 4, you say, of the 2,601,000 Scottish income taxpayers in 1415 paying 1.68 billion, 4.38 per cent with those greater income than 50 per cent accounted for 38.39 per cent of that total. I think that that is worthy of a bit more discussion just now about the impact on that sector as a result of leaving the single market in Brexit, because that could have quite potential serious consequences for income tax taking in Scotland, from what I am hearing, if I have got that right. David Heald, do you want to pick that up first? I mean, when I originally about seven or eight years ago saw those figures in the HMRC survey of personal incomes, I was actually sufficiently shocked that I thought I had actually calculated them wrong, but they are broadly consistent from year to year, roughly speaking, five per cent of income tax pay has produced 40 per cent of Scottish income tax revenues, so what it does is it shows the importance of thinking carefully when the Scottish Parliament sets tax bans and rates upon that group. There are two issues. One is the one that you directly raised, and people in the private services and the old sector have had very high incomes, so there are issues about what is actually happening not just because of Brexit but because of other things as well. One of the things that one has to be very careful about is to think about what the relationship is between the Scottish tax regime and the UK tax regime. I was one of the people who was behind the Tartan tax 30 years ago. One of the things that happened with the Tartan tax was the atrophid, because there was so much money coming down the Barnett pipeline. It is very important that the Scottish Parliament and the Scottish Government do not allow the Smith commission tax powers to atrophy, but the point that they are making is that they have to be used carefully. To make a broader political point, the idea that you can fund public services, increase in public services or protect public services solely by taxing the well-off, for example, additional rate taxpayers, is wrong. If Scotland, in the context of austerity, of continuing austerity and pressure on public services, wishes to spend more relative to what the bloc would fund, Scotland has to face the fact that it will have to be broad-based. The income tax powers will have to be used across the spectrum. One thing that the Scottish Parliament has got is that it has not got control over the personal allowance. Trying to use a zero-percent band would create complications with certain social security benefits, but it does have control over those bands. For a long time, I have taken the view that the higher rate threshold was too low. What the UK did from the 1980s was to move to a two-rate system, a basic rate and a higher rate, and to think carefully about what those bands would be. People on the income of £43,000 do not go from 20 per cent to 40 per cent. The practical difficulty that we have is that the Scottish Parliament does not control national insurance, so when one is talking about the effect on individuals' households, one has to think carefully about the relationship between marginal rates of combined income tax and national insurance. I assume that all things are equal in terms of where Scottish taxation is. It may or may not shift, but I heard from David Bell that if all things are equal, nothing changes in the Scottish tax system. There will still be a potential negative effect on the higher tax payers as a result of Brexit. If we do nothing, there will be an impact in the Scottish budget on how much income we will get from income tax. Do you like to say a bit more about that, David? Taking into context what David Hill said as well as the impact of the choices that we decide to make, but the broader point? I think that there is a level effect and a relative effect as far as the Scottish budget is concerned. The level effect is that Brexit, other things being equal, is more likely to induce falls and income among the higher earners, or the emigration of higher earners, particularly EU nationals who are currently living in Scotland, whether that be from the public service or the private sector. That is because those people are closer to or have easier access to markets or countries or policies outside the UK where they may prosper relative to the UK. More than the low-paid workers are considering those options a lot of the time. The relative effect comes through the block grant adjustment, and the question is who is doing worse, the rest of the UK in terms of higher earners or Scotland. That might off partly, notwithstanding the forecast for difficulties that particular cities may face. Overall, the expectation is that Scotland would be less affected than the rest of the UK. How that comes through in terms of those at different levels of earnings is difficult to predict at the moment. That can affect the block grant adjustment clearly. The only thing that really is in that is what happens to the city of London. That is the question incredibly for the Scottish block grant. What happens to the city of London will have a huge impact on what happens in Scotland? Although we have no direct evidence yet from investment intentions, I was yesterday at my daughter's primary school in Wimbledon. Her class has been depleted by six in the last year of six kids whose parents are European. There is evidence of already some changes that are taking place. Before those enter the official statistics, this is just hearsay. It is probably getting in the trouble, but it probably means that, in Scotland, to make sure that we further Scottish interests, we are going to stand up for the city of London. If I could come back in. I did say that it would get me in trouble. Because it is such an important technical point, we have been tending to stress the question of the relative performance of the Scottish economy to the rest of the UK economy. However, I think that the biggest effect on Brexit on the Scottish economy and the Scottish budget will be if the UK economy does badly. Because if the UK economy does badly, we are likely to get an even longer period of austerity. Everybody must understand the significance of the block grant adjustment and the fact that relative performance matters. However, my major concern would be about the overall effect of the UK economy at a time when there are other reasons, such as the decline of oil, where one is worried about the Scottish economy. Okay. It is all complicated and stuff. Ash. What is going to ask about that? Sorry, I just realised, by apologies, that there were two people who had supplementaries in this area. Forgive me, apologies. Murdo and Patrick. Just a very brief point, Professor Hill. I wanted to come back on your use of the term atrophy in relation to the Scotland tax powers. I do not really understand that language because the Scottish Parliament has to set tax rates now on an annual basis. We have to have a positive vote in Parliament to set the tax rate. It may well be the choices, as some of us would argue, to keep tax rates in line with the rest of the UK. Others will argue for a different choice. However, how is the atrophy of the Scottish Parliament actually making a positive vote to set tax rates? I take your point. I was thinking very much about the £19.99 tonne tax power. I was around when those powers had been discussed. What people did not appreciate at the time—certainly I did not—was the significance of the Parliament not having to have a positive vote. One of the consequences of the Parliament not having to have a positive vote is that over time it became much more difficult to use the powers because they had been unused and then the administrative machinery collapsed without the Parliament being told that the administrative machinery had been collapsed. My concern about the present powers in the 2016 act is that I take your point that a positive decision has to be made, and that is welcome. The longer one goes with no or minor use of those powers, I think that there is a danger that, for example, the preparedness of HMRC to actually be able to execute those powers will decline. By atrophying, I mean that if you do not use powers over time, the administrative machinery disintegrates and, of course, it is costly to maintain it, and, secondly, the political difficulty of making a decision that becomes more severe. I would like to hope that the discussion paper that the Scottish Government has committed to producing on income tax is an opportunity to avoid the atrophy that you are talking about. Professor Heald, your written submission uses a phrase that I found interesting. For each tax within the Scottish Parliament portfolio of taxes, there will be those who advance plausible or specius arguments about the economic benefits of tax reduction. You mentioned a number of examples in relation to that, such as aviation tax. Is there a danger that income tax becomes seen in the same way and that that leads to the kind of tax competition that leaves all parts of the UK's revenue washed off, rather than anything that creates a benefit? Yes. One of the things that filled me with a certain amount of disquire during the discussions about the Smith commission is that lots of people in Scotland seem to think that having more tax powers would mean that you would be able to spend more. The reason why Scotland seemed to want more tax powers was so that it could spend more to have a more generous welfare state and better public services. However, there has always been a different strand of argument—a different strand of argument—that, if a subnational Government has to raise its own tax powers, it will spend less. That is possibly one of the reasons why one went from a position whereby there was very substantial opposition to the Titan tax in the time of the 97 referendum, to a position whereby almost everybody was competing to give Scotland more tax powers at the time of the Smith commission. One of the difficulties, of course, is that Scotland, although it has very substantial tax powers now, interacts with other taxes. The whole question is that the UK has got two income taxes. In my view and the view of most economists, national insurance is essentially a second income tax, which is in the UK. The interaction of them is very important. You will probably remember that, under the Labour Government, Tony Blair and Gordon Brown promised not to increase income tax, so the increased national insurance contributions. The political relationship between those two is important. What is called income tax is probably far better understood than the operation of the national insurance system. The other issue is that the Scottish Parliament does not set the tax base for income tax, and the income tax powers only relate to non-savings and dividend income. So there are going to be issues about the relationship between the personal income tax and possible avoidance strategies such as incorporation into companies, and the question about the move to self-employment and the question of relative enforcement. Not for the first time, I think. Adam and I have apologies to make to the country on behalf of the Smith commission for the complexity of the process, if nothing else. I want to sort of park some of what we talked about, because it is not directly relevant to the discussions about the Brexit context at the moment, although it is obviously of huge importance generally. I think that the political will to take a different tax policy is far more important than just the debate on powers. Scotland has had very broad powers on taxation for local services, and there can be no greater example of atrophy than the failure to do anything serious with them over the years. The kind of potential changes that you have talked about that relate to Brexit, which you have both touched on around whether people move, whether people leave, whether people organise their affairs in a different way in response to what is happening with Brexit and with the economy, brings me to the question about the potential impacts of tax changes at the additional and higher rates. The argument has been made repeatedly that increasing tax at the additional rate might not generate additional revenue because there will be behavioural changes. That might be exacerbated in the context of Brexit where people might already be thinking about relocating or arranging their affairs differently, but I have asked repeatedly a number of people, including the Government, whether there is any evidence that the same thing applies at the higher rate as the argument is being advanced at the additional rate. Is either of you able to answer the question, is the higher rate of tax or potential increases at the higher rate equally vulnerable to those kind of behavioural effects as the additional rate? Is there any reason for being able to estimate the size of that effect? I could not help them with estimating the size. The point that I would make is that there are very few additional rate taxpayers in Scotland. The number that you see widely quoted is 17,000, so it is very, very small. Obviously, there are a lot more higher rate taxpayers. My more general point about the higher rate threshold is that when the higher rates were operating in the past, it was not expected that they would catch people with moderate incomes in the way that they do now. My argument about the higher rate threshold being too low and insufficient in the system is more of an equity argument. I basically think that the higher rate threshold is low. There is a very important question about how much attention HMRC pays to the enforcement of residence rails. Going back to the question of additional rate taxpayers, I suspect that a lot of additional rate taxpayers in Scotland might have other residences. The question about the extent to which HMRC actually polices residence and makes sure that the system operates as legislative as it is, is important. It applies generally about enforcement, but because so much money comes from the additional rate, the potential gains from avoidance behaviour become greater. On the point about the higher rate, the greater concerns are about incorporation. You might well remember that Gordon Brown as chancellor provoked an enormous increase in incorporation by having a zero-rate band of corporation tax. There is evidence from the past that taxpayer behaviour can actually be quite sensitive. The UK is in a very unusually fiscally centralised state. If you go to Canada or the United States, the idea that a different province or state might have a different income tax or no income tax at all would create no surprise whatsoever. A geographically compact country like the United Kingdom with no tradition of income tax has been differentiated geographically. One has to make sure that the administrative system works properly. In my view, it requires to be caution in the way that those powers are operated. On a more political level, I would repeat the point that if the Parliament wishes to protect public services from future austerity, the use of the income tax powers should be across the board and should certainly not be solely concentrating on the additional right or the higher right. Caution but not atrophy. Professor Bell wants to tell me, but presumably you would agree that changing the higher rate threshold is not the only or perhaps not the most effective way of achieving better graduation. We do not need to assume that one basic rate for the entire swath of income range needs to stay forever. I agree pretty much with what David has just said, just to point out. As far as I am aware, Paul May has different views, but I do not know of any evidence on the higher rate per se, and I know that it is quite difficult to work out the effects. Just to add to what you were saying earlier, another option that people might be taking in relation to Brexit is not to come. For the higher education sector at the moment, it is something that we are pretty much aware of. In terms of income tax in general, Brexit might, perhaps, for certain classes of workers, make the move option one thing that has been considered more than it has been in the past. David has talked about the redefined option, which is about incorporation for higher rate pairs. There are other two kinds of classic reactions that people might have to higher tax rates. One is to cut hours, so you work fewer hours. That is important probably for married women and for older workers in general. The other is to drop out completely to decide whether life holds other challenges than working. That does not really happen very much among working-age people, but one of the big changes, and in a sense it references to what Paul Johnson was saying about intergenerational equity that has happened in the past 10 years, is that the fastest-growing group of workers are those aged 50+. Indeed, the HMRC has very much surprised the increase in income tax revenues from those aged 65+. People are staying on longer, and that is helping to boost income tax revenues. There is a huge opportunity to do some work on that to try to understand that better. However, when you are trying to think about bands and rates, you have to think about all the different options that people might have when confronted by either a fall or a rise. I was just going to ask you about the Brexit divorce bill. I know that Professor Heald said that you think that that is pretty irrelevant in the wider scheme of things, but it seems to have caught people's imagination somewhat. The RSE paper mentions that the bill, or it suspects the bill, might be around the £36 billion mark. However, if additional payments form part of the final divorce bill, there are likely to be consequences for the Scottish budget. Can you explain that for us? I am trying to remember why that was the case in the paper. If the UK is paying more than it expected to the EU, then there will obviously not be consequentials, because the other things that it might have spent its money on, like more health and more education, will not be available as options to it. The higher the bill to exit the EU, the less money is available for UK domestic services and to the extent to which they have Barnett consequentials, that would affect the Scottish budget. We have heard that some parts of the public services budget are under huge pressure at the moment of health being a kind of obvious one, and that would immediately have Barnett consequentials. I think that that was the way that we were thinking about in relation to the wording of the paper. One of the aspects of the devolved funding system, even after the fiscal framework, is how much discretion is in the hands of the Treasury. If the UK paid £50 billion divorce bill, it would depend on whether the Treasury said that had to be fitted within one year or several years against the existing envelope of total marriage expenditure. If the Treasury said that this is a one-off, it would not have any Barnett consequentials, whatever it would not displace expenditure would generate Barnett consequentials. That is a very good example of how, even after the fiscal framework, so much depends upon the discretion of the Treasury. At this point, is there any way to put any numbers on what the impact of the Scottish budget might be, or is it too early to say? The big choice is whether the UK—there are two big choices, one is it a lump sum payment in one year, or is it spread over a number of years? The second choice is whether it would score against existing expenditure totals, or do we just say that this is a one-off? If it scored against existing expenditure totals, it would depend on what got displaced, whether what was displaced was Barnett relevant or not Barnett relevant. As a representative of the Highlands and Islands, you can imagine that I am hearing a great deal of concern about the potential uncertainty around cap funding. I wondered if either of you would be able to give me an idea of just how significant a contributor that is to the economy compared to maybe other forms of EU funding. Well, I have forgotten what the current Scottish spend on cap is. I was going to say that £470 million was my guess, so clearly in terms of the overall Scottish budget, it is still relatively small. However, I think that in terms of the role that it will play in relation to the general Brexit debate, its role will be much larger than its size in the economy, because there will be a conflict around which powers are retained at Westminster and which are handed on to the Scottish Government. The agenda here is in relation to free trade, it seems to me. Currently, there are certainly groups within the Government that are keen on free trade. Free trade means no tariff barriers on goods traded. Those goods that are traded, the highest tariffs currently are on agricultural goods. By some distance, they are the highest tariffs. I think that, like beef, we are talking about 80 per cent of that kind of rate. If a UK Government wanted to enter into a deal with another country—a free trade deal—then the ability of the UK Government to continue to subsidise agriculture would be under question. Interestingly, the EU, in the deal with Canada, has not resulted in changes to the cap in Europe. We know that, and the cap has not changed. Relative strength matters here. If you are doing a deal with someone, then who has more at stake is a key question. If the UK wants to be in a position where it is willing to put everything on the table, because it wants concessions for some other sector, then its ability to continue to protect agriculture may come under threat. That comes back to the point that I raised before about whether there are going to be common frameworks in the areas where previously you did not need a UK common framework because there was a EU common framework. The subsidiary question is who makes the decisions about it. Is it something that is negotiated with the devolved administrations, whose agricultural sectors are more dependent on subsidies than is England? Is it something that the UK Government is going to impose, either because the UK Government wishes to assert itself or to keep its hands free in the context of the free trade agreements that David Bell was speaking about? Interestingly, the part of the UK that is most dependent and much more so than Scotland on agricultural subsidies in Northern Ireland? When we were talking about the efficiency versus equity, I would hear the argument regularly in the Highlands that cap funding is one of the most efficient ways to inject money into the local economy, because farmers, certainly in the Highlands and Islands, the money goes straight direct from the farmer's pocket into paying vet bills or for purchasing feed, things like that. Have you any thoughts around that? Would there be a more efficient way to subsidise a rural economy if that option is not available to the UK? I presume that the power is through there. The EU, over the years, has gradually moved away from the idea of subsidising output, so subsidising the production of wine or subsidising the production of sheep or whatever it is, and has moved more into trying to encourage farmers to produce the kinds of goods that it wants. That might be things like a better environment rather than the production of sheep. It also wants to protect rural communities. It also has that. There are different streams of funding that go through the cap. Some of them may end up in vet bills, but there are different streams of funding. There is a question about what you actually want to produce from the agriculture sector. Is it vibrant rural communities? Is it an outstanding environment? Or is it more output? The way that you design the agricultural payment system will cause the incentives that farmers face to do one thing rather than another thing. It is all up for grabs. If we are about to redesign our agricultural support system, if we are not to have one at all, those kinds of issues have to be thought through. It is an issue for the Scottish Parliament and the Scottish Government. I am imagining that there might be significant policy differences in those areas that you have just mentioned between the Scottish Government and the UK Government. They are bound to be because the structure of agriculture is quite different. What happens in Scotland is not the same in terms of the structure of agricultural production in England, and indeed Wales is also different. Have you got a supplementary on that? No, there are a couple of other points. Let me go to Murdo first on structural fund issues. I have a couple of points that I want to raise. One is on structural funds. I think that we all understand that Scotland does relatively better out of structural funds than many other parts of the UK. Therefore, the answer—well, you can tell me if you agree or disagree on that, but what I am trying to get to is that if we are replacing the structural funds with some other sort of funding, that needs to come not through the Barnett formula process that might disadvantage Scotland but through some new system of regional policy funding. Is that really what you are saying? Well, in the past, when the Scottish Parliament has got new functions, the real franchising being the obvious important example, what actually happens is that the spend in the year before it happens gets transferred into the block and then subsequently used the formula. It is not a question of getting a population share of UK spend. I agree with David on that. Another point that lies behind that and I did not really bring out. Another thing that will be up for grabs is the ability of different parts of the UK to provide direct support to industry. Scotland has, with EU agreement for many years, been able to spend money on regional selective assistance for particular companies coming in or under certain conditions. The EU agreed with Scotland that that did not jeopardise the internal market significantly. The original selective assistance died a long, long time ago in England. It is not one of the options that is allowed to be applied in England. Not only is there the size of the structural funds but there are also all of the rules around where support can be given and where support cannot be given that need to be thought through. It appears that the EU was content for Scotland to have a somewhat slightly different set of rules than was applied in England. Therefore, when those come up for discussion, it will be interesting to see whether the UK Government is willing to negotiate a continuation of that kind of difference between different parts of the UK. If you look at the Treasury's annual public expenditure statistical analyses, you will see that the index of public expenditure on economic development in Scotland is vastly higher than the UK average. Within the umbrella of EU funding, Scotland has maintained a system of industrial support that, as David Bell said, has tended to wither in England. In terms of the internal UK market framework, there will obviously be one of the issues up to discussion. One of the things that concerns me about the expenditure side and the tax side is that, freed from EU constraints—which everybody is blamed for lots of things—there is a danger of competitive subsidy bidding within the UK and also a danger of competitive bidding on the tax side, as with proposals to reduce air passenger jitter. My view would be that Scotland, Wales and Northern Ireland should avoid that kind of competitive bidding with England. Although that does happen to an extent already. I have one other question on a slightly different topic. It follows up from Ash Denham's questions about the impact on the budget. The thing that seems to mean that it is missing from both your papers is any recognition that there will be a net benefit to the UK finances from leaving the EU. It might not be £350 million a week, but, as Paul Johnson said earlier, it would be £8 billion a year net. Even factoring in the prospect of a divorce bill in the longer term does not mean that there is more money to spend than less. I sat at the back listening to Paul Johnson's evidence and what he said, the overall fiscal effect would be negative because of the effect on the forecast growth of the UK economy. I have seen various figures of the UK contribution in different years, but the net contribution is about £8 billion. However, one must not just look at the budget numbers but to think about what the affordability of future plans are in relation to the growth of the economy. I do not think that it is valid at all. On one level, it is right to say that £8 billion will be freed up, but the overall economic context will be more difficult. As we know, the forecast may or may not come out to be true. I am just surprised that none of that was recognised in either of your submissions that you made to the committee. A couple of things are two or three things that I want to touch on very briefly. The first one was to go back to something that Neil Bibby had raised earlier on and asked the question about what is the best thing that the Government could do to mitigate the impact on the cities of the impact of Brexit. Do you agree that surely the best thing that can be done to mitigate that effect is to find a way to stay in the single market? My personal view is that the UK should not leave the single market or should not leave the customs union. I accept that the direction of travel is that both will happen. It is likely to happen irrespective of whether it is a good idea or not. I mentioned scenario planning in our paper. There is an argument now for thinking through what are the implications of different types of Brexit. Indeed, a hard Brexit would pose particular challenges to industry. I guess that the Scottish Government might have a role in trying to mitigate the effects of those challenges that industry might be facing, such as our financial sector. What are the issues that it might face in accessing markets that it currently faces if there is no agreement and we fall back on WTO rules? What would be the challenges that it faces? We know that RBS is thinking of setting up an office in Amsterdam. I think that there are possibly some real issues for possibly even some quite small businesses in Scotland—food exporters. What are the kinds of things that they need to be thinking about if they want to get through a situation where there is a hard Brexit? To my definition, soft Brexit would mean staying in the single market, either in a UK context or potentially in a Scottish context through a differentiated solution. The second point is that people are surprised that only 4 per cent of the tax base raises 40 per cent of the revenue. That is just classic Pareto, so nobody should really be surprised at that. My main substantive point was about immigration, and it is something that you have raised in your paper, David. I suppose that I want to explore a bit further, and you heard my question to Paul Johnstone earlier. What is the impact of the significant reduction in net immigration into Scotland, or potentially net migration, on growth rates and on public sector finances, given the age profile and on the tax-taking pension rates that that would cause in the medium to long term? As a follow-up to that, if Scotland was able to achieve a differentiated immigration solution, similar to what it has in Canada and Australia, what opportunities would that present to the Scottish Government and the Scottish economy? My argument is that, given that Scotland attracts a relatively small proportion of UK migrants, which is surprising given its income per head, Scotland is an outlier. Given its income per head, you would expect Scotland to attract quite a lot more, it does not. We do not exactly know why that is the case. However, if the UK reduced net immigration to the tens of thousands, it would be difficult to see net immigration to Scotland being anything more than 10,000, and even that might be pushing it. That has, over the long-term demographic implications, because, effectively, what you are saying is that the population is bounded by a lack of net inflow, deaths and births more or less equalise each other. Therefore, the population more or less stabilises at whatever it is at the moment, at 5.4 million or something like that. What effect that has on the economy, again, Paul Johnston, is important to differentiate between GDP overall and GDP per head. If the population is not increasing, GDP could be stable, but both rates are always based on GDP. In terms of living standards, it is GDP per head that matters. Certainly, a slowdown in migration would result in slower GDP growth. It is more difficult to say what would affect GDP per head, but you have got the other effect that you mentioned, the ageing of the population on-going, which already is affecting Scotland more than the rest of the UK. Therefore, more people are outside the labour market than is the case in the rest of the UK, unless there is a continuation of people working on more into their 60s and 70s. What that looks like is certainly a less optimistic view of the Scottish economy going into the medium and long term than would be the case if net immigration was roughly at the kind of levels that we have experienced in the past 10 years. In terms of the differentiated solution, that could offer opportunities. The differentiated solution is almost like taxation. There are countries where immigration is set centrally, and immigration is set by sub-national governments and national governments in consultation, and some where the sub-national government plays the leading role. There is a very good paper by Christina Boswell, which explores the possibilities for a differentiated migration policy in Scotland. It does not seem to me to be necessarily a huge... One could conceive of policies, and I can go into detail if you like, which do not necessarily threaten the overall target for the UK, but nevertheless allow for some differentiation in Scotland? Alexander has been very patient. There are two people who said that they want supplementaries on what Ivan has asked, so can we make those tight, please? Patrick, and then Willie. It was just two points that I wanted to clarify that I have understood what is being said properly. The first relates to Murdo's questions about potential longer-term opportunities and the fact that both of your papers and in fact all of the other written submissions so far as I can see talk about the economic harm of the process and not about potential benefits. Is it fair to say in your view that even a hard right fully signed up Brexiteer, with a vision of the sunlit uplands of empire 2.0, can only really have a rational argument about the scale of the damage that the process of leaving will do, even if they think that there may be further opportunities in the longer-term ahead? Is there any plausible scenario in which the leaving, the taking of this country out of the European Union, will not cause economic harm? There has been some discussion in the newspapers about Singapore on tents, so that the logic of leaving, if the UK was going to go into a low tax, low regulation, low public spend environment, I would not support that policy, but I understand the logic of that policy. One of the things that I find very striking is that, effectively, we seem to be delaying the date of exit from the European Union by two years because of the transition period. I think that that is going to create its own difficulties in the context that decisions will be taken in the UK by making contributions to a body that it has no representation on, so that I can imagine a new wave of difficulty. However, I do not understand an argument that we leave the European Union, we leave the European Union and then bind ourselves to the same regulations and similar financial contributions that we already make. If I wanted to construct an argument in favour of Brexit, it would be a question of making a complete break with the European social model and the heavily regulated European economies. I do not see the point of having to mirror those regulatory regimes in order to secure access to markets. I mean, that kind of transformation seems to me difficult to predict what effect it would have. It would require huge structural change in the UK economy, people doing things quite differently, doing different things from what they have done before. I do not think that the benefits of that can come through in the short to medium term. It would certainly be the long term. All of the research recently on trade patterns shows that it is still the case that value chains are really centred in the world around China on the one hand, Germany on the other hand and the United States on the other hand. The countries around about them trade with them very extensively. We are moving out of the ambit of one of the three key trading partnerships in the world. Just very quickly, just that you said to Ash Denham about the divorce bill, have I understood you correctly that the UK Government, if it wants to avoid adding another dose of something toxic to the relationship between itself and the Scottish Government, has complete freedom to decide whether it will pay for that divorce bill in a way that avoids a knock-on consequence to the devolved administration's budgets. Thank you very much. How realistic is it to suggest to people that are leaving the single market, paying the divorce bill means the end of everything and we do not pay a further penny when you consider that we are inextricably linked to the digital single market in Europe and there's a huge range of services that we currently share and will continue to share beyond Brexit. It's ridiculous to suggest that we'll get that for nothing. You've got Roman charges have been flattened out. Online content will be available right across Europe from next summer. There's general data protection regulations coming in that the UK's signing up to. There's huge amounts of digital infrastructure already in place. Isn't it ridiculous to say we'll pay a one-off bill to say cheerio but continue to use all that? Isn't it a bit like saying we'll be off the bus and on at the same time when it comes to the digital market? To the extent that you're picking up what I said, my personal view is that it will be sensible if the UK completes the discharge of its financial obligations to the European Union. You have a clean break. At that point, you then discuss what future collaborations you're going to have and almost certainly you'll be in union and expect the UK to pay for them, but to make it really quite clear what the divorce bill is on the day that divorce takes place, there's a clean break. If you want future relationships, for example, contributing into Erasmus or Horizon 2020, that's very important for Scottish universities, you are going to pay for that. It's quite transparent in terms of presenting to the public that the divorce is over. Our future relationship is something that we do on a transactional basis. You think that we can be out of the single market but in the digital single market at the same time, but out of the single market in the digital single market? I confess that I don't know much about the digital single market. I'm sure that David Bell is going in late. No, not really. I just think that all of these things will be determined by negotiation whether we're in Horizon 2020 or the digital market. A lot will depend on European politics and whether they particularly want to engage with us or not. It's unlikely that it will be a free lunch for us. Alexander, you've been very patient what you said earlier. Thank you very much, convener. Given the noise of Brexit, one of the most incisive points that I've seen put on paper to date is Professor Heal, one of your conclusions, where you say, conflicting forecasts of prosperity or doom align with the individual's view of the desirability of Brexit. I wonder where you put yourselves in that statement. As I said at the beginning of my contribution, we live at an age of remarkable uncertainty. Economic models tend to be calibrated on the basis of past experience. There's much rhetoric, but people are talking about this being the biggest change in Britain's relationship to the outside world since 1945. To some extent, existing data isn't necessarily going to tell you what's going to happen. One point that I forgot to make earlier is that I'm surprised that we haven't talked more about the cost pressures on the Scottish budget, because that seems to me partly Brexit-related in terms of exchange rate depreciation, but it also relates to the issue that I raised at the beginning about the long period of austerity. I think that one of the reasons why the public sector pay cap may be coming to an end is that, apart from the political difficulties that the Government experienced at the last election, there's also the fact that recruitment difficulties are beginning to appear, that might be accentuated by Brexit, by losing access to the European Union workers or becoming less attractive to European Union workers. One has to think through that, if there was a sudden release of the public sector pay cap, Barnett will not, because the Scottish public sector employees are a higher proportion of the total workforce than the UK average, Barnett isn't necessarily going to pay for that. A 3 per cent increase across the board on a UK national agreement will cost Scotland more. There's definitely going to be budget pressures on public spending in the UK, but Scotland, Wales and Northern Ireland are also going to affect to the extent that they have larger public sector workforces. I think that a very significant issue is going to be in the context of public sector pay. Professor Bell? I would hope to think that I'm driven by the evidence. I don't claim to be a trade economist, but all the examinations of patterns of trade show that geography matters, being close to something matters in terms of who you trade with. If you cut yourself off, that will be an issue. In relation to migration, it's important to realise that for the foreseeable future, the Migration Advisory Committee will play a key role in determining whether we get more anaesthetists, for example, if they are from outside the UK in the future. If Scotland has differentiated needs in particular occupations, it is incumbent on the Scottish Government to make the case to the Migration Advisory Committee that those occupations will be placed on that list so that it is more easy to get people from outside the UK to fill whatever vacancy. Currently, it works for non-EU migrants, but there is a big debate to be had about its role changing to cover EU migrants post Brexit. I had a significant session this morning with our two professors. I thank you for helping us to delve deeper into the issues that we are going to face in detail. It was extremely useful. The public part of the meeting is concluded. I now move the meeting into private session.