 Good morning, and welcome to the ninth meeting in 2016 of the Finance and Constitution Committee. Can I give apologies on behalf of Alec Johnson? The first item—I'm sorry, I should say also, your mobile phones, can you at least either switch them off or put them into a mode that don't interfere? The first item is in our agenda today to decide whether to take item 3 in private. Members agreed to do that. Great. Thank you very much. We will go and take that in private. The second item in our agenda is to take evidence as part of our pre-budget scrutiny by taking evidence on the public finances and economic performance. We have two witnesses with us today on the subject, Professor David Heald from Glasgow University and Professor David Bell from Stirling University. I just wonder if any of you would like to make a quick opening statement. Are you happy just to go straight to the questions? I had a short one. Do you want a very short statement, please? Okay. Thanks for the opportunity to speak to the Finance Committee once again. I do so at a time of greater than unusual uncertainty around the public finances. Brexit plays a part in that uncertainty, but there is also considerable uncertainty around the UK Government's economic and industrial strategy. The key short-run consideration for Scotland is how this may affect the UK fiscal stance and Scotland's budget. My argument that I put in my paper is that the full economic effects of Brexit will take some time to emerge and the recent statistics on UK economic growth confirm that conclusion. One key exception is the depreciation of Stirling, which has been sudden and dramatic. Financial markets are always quicker to react than the markets for goods and services and Stirling's depreciation reflects the long-run view of UK's economic prospects. The depreciation is likely to lead to a rapid rise in inflation, which I mentioned in my paper in which the National Institute forecast today will rise to 4 per cent. This will almost certainly lead to a decline in real incomes since wages are unlikely to keep up with that rate of increase of prices, and that is likely to lead to a slowdown in the economy tomorrow. However, although the UK economy is performing quite well, the tax revenues that it is generating are not performing as well as might be expected given the rate of growth of the economy. That means that the reduction in the UK's fiscal deficit is less than the OBR's forecast, which leaves the Chancellor in a difficult position when he comes to make his autumn statement. He has suggested that he will not be so zealous as Mr Osborne to cut the deficit, but he is in a position that he is already overshooting his target. Meanwhile, huge pressures are building on the public finances, health and benefits, as we have seen today, and on the criminal justice system in England, as we have seen today. Therefore, he may react to that by doing a reset on the public finances and giving himself longer to achieve a balanced budget, or he may go for a balanced budget only as far as current spending is concerned. If he goes for that, he may be able to increase infrastructure, which would be more capital spending for the Scottish Parliament, but not necessarily additional current spending. The last section of the paper is really off the point, but the point is that the autumn statement has a very strong case for reducing it to maybe a stock take of the economy rather than a time at which to introduce new fiscal measures. There is no need to have two fiscal events per year, and that situation has already been made clear by the Chartered Institute of Taxation, the Institute for Fiscal Studies and the Institute of Government. It is my view that the Scottish Parliament should swing behind that move to have the autumn statement downgraded, because it would get over a huge problem of the timetabling of the Scotland's budget. In your paper, you comment on page 4 about the impact of the decline of the value of sterling upon the UK economy since the Brexit vote, and you touched on that in your opening statement. Are there any impacts that either of you would like to highlight for the Scottish economy as a result of that decline, that are more significant or perhaps more exteniated for the Scottish economy than they would be compared with the impacts in the UK economy? Much of your paper is concentrated for obvious reasons on the UK, but it is understanding the impact in Scotland that I think would be helpful, and either of Professor Davids has a view on that. The way that you would approach that question is to think, where is the Scottish economy significantly different in its structure from the rest of the UK, and to what extent are those differences susceptible to changes in the exchange rate? Clearly, the food sector is probably more important to Scotland, and while we can continue to trade freely, that sector is likely to benefit. The tourism sector is more important for Scotland, and it will benefit. On the other hand, the oil industry, because our costs are largely, not completely, are mainly in sterling, and the revenues are in dollars. That may help the oil industry somewhat. In terms of imports, import dependence is not entirely clear to me how Scotland differs markedly from the rest of the UK. What parts of the Scottish industry suddenly have a big increase or a hike in their costs because of the depreciation? It may be the case that Scotland is less involved in very complex supply chains than is the case in the rest of the UK. For example, you think of the car industry, where they are importing components from all over the world, adding some value, then exporting all over the world. Scotland does not have sectors that are quite so complex as that, where it is difficult to figure out what is happening. When it comes to negotiating Brexit, that particular issue, which is very important for many sectors of the UK economy, may not seem quite so important for Scotland. The point that I would add is that, though the effects in the referendum do not seem particularly pronounced in terms of GDP, the exchange rate is really quite significant because it reduces the prosperity of the UK in terms of what it can buy abroad. In the medium term, perhaps not in the short term, because households are going to be worse off and what would expect public spending to be lower. Even if, in the short term, there is a fiscal loosening, the medium longer-term prospects would become worse. In any particular way, would Scotland hit any more than the UK in terms of the potential impacts? I do not think that we are in a very incredibly uncertain position about knowing what the effects are going to be and what the future trade and relationships are going to be. One of the significant points is that this has actually happened. It has coincided with a fundamental change in the way that the Scottish Parliament is funded. There is obviously so much more uncertainty attached to the future of revenues, particularly the linkages through the fiscal framework to what happens to the rest of the UK. One has gone into a period of much greater uncertainty from moving from a largely block grant funding system to a system where interconnections with the UK budget have become much more complicated. The fact that we have not got the draft budget for 2017-18 shows the way in which this change of linkages can be disruptive. In the past, it was very easy for the Scottish Government to have a rough idea of what the effect of any particular budget event other than a spending review was going to be. That is no longer the case. David Bell has already made the point about the abuse of the autumn statement as a second budget event. When George Osborne was Chancellor of the Exchequer, he imagined that he would have four budgets within 12 months. The parliamentary scrutiny side of the UK Parliament is dreadfully bad. No one really cares very much about that, because it suits whichever party is in office or thinks that it might be in office at some point in the future. I have given evidence to two Westminster committees recently, one about the supply procedure and one about the use of Government accounts. There are very obvious technical things that could be done to improve Westminster scrutiny, but not much sign that anything will ever happen. You touched on the block grant adjustment, David, in your opening statements as well. Given that the baseline adjustment for the block grant adjustment for income tax is going to be the financial year 16-17 in terms of the receipts, do you think that there are any concerns about that particular baseline, given the Brexit implications, so that I can unpick that a wee bit more? It is difficult to separate out the Brexit implications from other things that are going on, such as the decline in the oil industry, which is a separate shock that clearly is hitting Scotland in a way that is quite differentially from the rest of the UK. It is more difficult to get a differential Brexit effect that differentiates Scotland from the rest of the UK. One area that would be of concern to the UK Government would be a significant collapse in the financial sector, because the numbers of the reduction in employment would be dwarfed by the reduction in tax revenues in terms of their importance to the UK economy, because the financial sector is the one, notably, that produces the highest earners. The top 1 per cent of earners in the UK contribute 26 per cent of the income tax revenues, so a significant fall in the number of high earners that are mainly associated with the financial sector. If it happened differentially more in London than it did in Edinburgh, it would potentially benefit Scotland, because what matters as far as the block grant adjustment concern is per capita income tax revenues. The movement in that relative is what really determines how the block grant is going to be adjusted. Now, taking that next step further, what the per capita tax revenues are dependent particularly on is not the average but the people at the top, because they contribute so disproportionately to the overall income tax revenue. I have noted to keep an eye on how the financial sector affairs in terms of those negotiations and, of course, the passporting issue is very important for services and how that may be resolved. It seems to me that 16-17 might go badly for Scotland if there are still effects coming through for high earners associated with the oil industry. David Eiser pointed out to me last night that the top earnings in Scotland—or the people, three quarters of the way up the income schedule—did not increase so rapidly in Scotland as they did in the rest of the UK in April 2016. There was a noticeable difference in the Aberdeenshire area because of that. There are different things going on, but in terms of the relative movement in per head income tax revenues, you have to keep a very close watch on the top end of the income distribution. I have made a very good living out of the last 35 years of trying to persuade people of the Barnett formula that was not that complicated. I think that the Parliament is going to have a great deal of trouble explaining to the people of Scotland how the system now works. What about that, will you? The level of public understanding of how the public finances of the UK and the public finances of Scotland work is not high. That is a fairly general problem in industrial democracies, but we have a particular problem. The UK has a particular problem. The scale of the UK problem is that the Hezio government does not vote the supply estimates into the financial year, and they are not presented until the year has already started. There is a sense of not taking parliamentary scrutiny seriously. The UK, in technical terms, on public spending is very good, and the UK manages to combine good technical procedures with a lack of attention to scrutiny and to justifying itself from the process of the public finances to the wider public. For the past 40 years, I have been in favour of the Scottish Parliament having devolved tax powers, but one of the things that all worried me, and I kept saying to this committee and its predecessors, before the Scotland Act 2016, I was deeply worried by the way in which lots of people seem to think that more tax powers actually meant more spend. We have got the more tax powers at a particularly difficult time for the reasons that David Bell has been talking about. One of the things that is going to communicate very clearly is that the tax powers that Parliament has got are a substitute for part of the block grant that it previously received. Having the tax powers and using them in a neutral position does not mean that there is any more or any less expenditure. I think that the old thing that is actually happening is that there was a comment by Graham Roy when he gave evidence to the committee that we were now going back to the level of public spending in 2005-2006. When people have been used to very rapid increases in public spending, the fact that we are talking about being back to a position of 11 or 12 years ago is really a serious point. You notice mounting discontent about various public service sectors, be it health or transport or transport or what, but one of the points is that people got used to very rapid increases year on year in public expenditure. That period inevitably had to come to an end, but it has actually come to an end very abruptly. What has gone from four or four, five or six per cent real growth a year to no growth or negative growth? We are in a very difficult context in which to explain to the people of the United Kingdom and the people of Scotland what is actually happening. Obviously, the uncertainty attached to Brexit complicates that even more. David, can I add to David's point that in the interim between 2005-2006 and the present, there has been quite considerable shift in public spending towards certain groups who have done reasonably well, notably older people, and against some groups that have done relatively badly, namely working-age people who are dependent on benefits. Of course, the fact that there is a very significant demographic shift taking place concurrent with the difficulties that we are facing in expanding the real value of public spending means that those issues around rationing in some parts of the public services in not being able to meet the expected levels of service and so on are, as David says, breaking out. Thank you, convener. I mean, just picking up directly on that, I just wanted to ask you a couple of questions about what said in the Fraser Allander Scotland budget report that came out about six weeks ago about exactly the issues that you've just been talking about. Fraser Allander, for example, say that the fiscal powers that are coming to this parliament under the Scotland Act 2016 provide a set of tools to vary revenue, but also to achieve wider objectives around redistribution, growth efficiency and the overall balance of tax and spend in Scotland. So, it suggests that there is real meat to these powers and also that the advantage of the Scottish Parliament raising so much of its money from taxation rather than directly from a block grant gives the Scottish Parliament more flexibility about how it manages the economy, but, of course, the Fraser Allander also say that looking at the costly spending commitments that have already been made for this parliament by the Scottish Government that, and I quote, bold and radical solutions will be needed. Business, as usual, is not an option. I just wondered if you had any reflections, positive or negative, critical or otherwise, on these remarks from the Fraser Allander report. The Scottish Government now effectively controls around 40 per cent of the total tax revenue generated in Scotland. Income tax has not really been changed very much for many, many, many years. The thresholds changed by the rates don't change. It would certainly be open to the Scottish Government to introduce new bans. There's no question that it could do that and could generate additional revenues from so doing. Of course, as I implied in my previous answer, it has, and this is true for the UK as a whole too, it has become dependent from on a very, very small number of people to generate a huge proportion of total income tax revenues. What we don't know is the behavioural impact of changing, say, the very top rate of income tax, what effect that might have on revenues. I am going to a meeting this afternoon at Glasgow University with a man who wrote a paper about the change from 45 to 50p in the pound. His analysis of that on manning from the London School of Economics was that basically it had no effect on revenues. One has to be very careful about the use of those powers. One could introduce new bans and spread the costs of income tax somewhat more down the income distribution. That's really what the Scandinavian solution to the issue of having a high provision of public services is. It's not that you have very high top rates, it's more that you have more progressive rates because you introduce intermediate bans to income tax. There is potential, but there are obviously political issues that have to be got round to move in a radically different direction, because it would be seen as radically different. One doesn't know how businesses and taxpayers would react. As a precursor to what I'm going to say, my long-term support for fiscal devolution has been on an accountability basis. I've always been very uncomfortable when people argued that the Scottish Parliament could make an enormous amount of difference to the economic performance of the Scottish economy, given that most of the levers actually remain with the UK Treasury and with the Bank of England and monetary policy. There are constructive things that you can do. This Parliament got rid of the slab structure that was inherited from stamp duty loan tax. That was the constructive tax reform that the UK was incapable of making. Picking up what David Bell has just said, I've long thought that the jump from 20 per cent income tax rate to 40 per cent income tax rate was actually too abrupt. There's obviously been an argument about simplification. At one point, the UK went to only two rates of income tax. In my view, that went too far. There's also going to be for the UK the question of a relationship between income tax and national insurance contributions. Whatever the parapherophilia about it, national insurance contributions are essentially a second income tax. The Fraser Allander clearly is calling for bold and radical solutions. Would you join their call? Would one such bold and radical solution be to finally address something that we've talked about for a long time in Scotland but done very little about, which is to think much harder about outcomes in relation to tax and spend and less about targets? I'm stronger. I've always been in favour of looking at outcomes, but I think that outcomes are actually more significant and more difficult to measure and actually to attribute to particular policies than people often claim. There's two issues running here. One of them is a somewhat coded reference to commitments that the present Scottish Government has actually got in terms of things like bridge tolls and free prescriptions. There's a coded agenda about that, but I think that the most significant point is about having to come to terms with what is going to be a ffiscally difficult period where growth is actually going to be growth in spending, is going to be low even if it's positive. When people start talking about radical change, I want to know what the body of that radical change is before I'm willing to express a view about it. There are incremental things that the Parliament can do with its tax powers, but it's very important not to oversell those tax powers in terms of improving the growth of the economy when it's much more going to be affected by UK monetary policy and Brexit, but trying to think about how you get more coherent policy in ways in which the UK has not been able to get it. I agree with David about it. I don't think outcomes and radical change in the fiscal structure are necessarily related. I think that there is a strong case for focusing more on outcomes than we already do, but, as David says, they are incredibly difficult to measure. I am not convinced that we make enough effort to do that. The committee and the Christie commission spent some time arguing that preventative spending would be an appropriate way to approach the distribution of scarce public finances, but I have never really been convinced that the Scottish Government has got itself in a position where it really has enough evidence to prove that the efficacy of so-called preventative spending in helping to reduce firefighting spending, to which a lot of our public spending is addressed. You mentioned in your opening statement the impact of inflation and the potential exposure that that would give, and you also covered that in your note. In terms of the impact on the Scottish economy and the forthcoming Scottish budget, what are the particular pressure points around inflation? Again, I am not sure that I can really point to massive differences between Scotland and the rest of the UK. One possible one is energy costs, particularly those associated with transportation. My main concern about inflation is that it will hit poorer segments of society harder, partly because of energy costs, transport and heating costs, which are inevitably going to rise because gas and oil are determined by world dollar prices and food, much of which is imported into the UK. Intense competition between retailers can only hold back price increases eventually, and they will feed through. In terms of public spending, it seems to me that you have to think about the import content of public spending. A lot of current spending has limited import content in it. Maybe it is much more important to think about the capital spending on equipment that is coming from overseas that is necessary for our hospitals or for our education system and so on. Those are potential areas where the Scottish budget will be hit. I do not see it being significantly different from the UK as a whole, but it will add to Government costs, which in turn make the problem of balancing the budget a bit more difficult. I think that one of the significant influences will be in terms of potential wage settlements. We have all psychologically got used to a period of very low inflation, and if the number that David mentioned of 4 per cent is well outside our recent experience, one would expect industrial relations difficulties, recruitment difficulties and so on. The UK has been pretty successful in holding down public sector wages as a way of controlling public expenditure, but there is a limit to how far that can go. You will see a shift of labour towards exporting industries, because industries that are exporting will be able to afford the higher wages, whereas the ones that are trading mainly in the UK will not be able to. I think that those are at present points, and I know my colleague Patrick Harvie's got some specific questions around that, so I will not overlap on to that. Is there a potential for a lag effect in the sense that the Scottish draft budget is going to be published in December, and we potentially, from what you have said, see inflation pressures over the course of the next financial year? It may well be that the budget that is drafted and set in December faces a potential exposure with inflation increasing and putting pressure on the figures that were estimated at the time, but all of them have been underestimated. Within the year, public expenditure management is going to be very difficult in 1719. I can just add that for all of these price increases coming through, there is not only the difficulty of there being some kind of momentum within a market, say the retail market, to increase food prices, because none of the supermarket chains want to be the first to increase the price. There is also the issue of hedging, and on energy prices at the moment, that is actually very important. The big six hedge quite substantially their energy prices, so they have bought forward gas, electricity well in advance, whereas some of the smaller newer companies have not done that. Some of them have almost traded at spot prices. The consequence of that is that one or two of those have introduced pretty huge price increases in the last few weeks. The effect will indeed be lagged. Those price increases will take time to feed through to the public purse, and it depends on the reactions, the nature of hedging within the different industries. I was interested to read what you said in what was in this report about the future of the autumn statement. You will know that this group has discussed many times the timing issues for the Scottish budget, which is caused by the late autumn statement from the UK Government. I was particularly struck by the sentence that has been simmering concerns over the process of forming tax policy in the UK for some time. It has numerous flaws, including its complexity, lack of consultation and administrative burden. The formation of tax policy in the UK compares very badly with—oh, I have added in a very—badly with that and other jurisdictions. You have both addressed the issue already, and I am sure that we would all agree with your call to downgrade the autumn statement into something more resembling a stock-take to use your terms. I was very interested in what you said, Professor Heald, in the link between the sense of not taking parliamentary scrutiny seriously and the link between public understanding of how the country works and how public spending expenditure works. In this Parliament, we take scrutiny very seriously, and we are very keen to engage with the people of Scotland and help them to understand how that all works. I just wondered if you could give me some reflections on that. The point about the autumn statement is that having budget events at Westminster enhances the profile of the Chancellor of the Exchequer in post. One of the attractions of four budget events in a year is that the Chancellor gets more attention. There may be, with the present Chancellor, a change of style. I would slightly qualify what has been said before. Basically, we should go to a regime whereby there is one budget a year. There may well be, because of economic development, Brexit brings so much uncertainty. You may need another event, but it should be regarded as unusual and reflecting the fact that there are some specific circumstances. It should not just be opportunistic. There are two reasons why this Parliament did this much better. It had a clean start. One of the pieces of public service that I am most proud of was my membership of FIAC in 1998. FIAC did a good job, and the Parliament took that forward effectively. Westminster finds it very difficult to cast off these past procedures, but, as I said at the beginning, I think that there is a really big communication issue to the Scottish people that what the actual enhanced fiscal accountability of the Parliament actually means. It does bring additional risks. It brings certain opportunities, but it does not bring more spend. I think that my fundamental worry about the way that the tax powers debate has been published is that it is often understood to mean more spend, whereas it actually represents the substitution of revenue sources. I agree with David's point about the chancellor. The autumn statement has served to enhance the chancellor relative to other parts of government, it seems to me, in recent years, and I do not necessarily take that as a good thing. Although, one, there is a concern about parliamentary scrutiny, there should also be a concern about the involvement of other arms of government in the setting of fiscal targets. One argument is that the chancellor should only set the envelope for public spending and then the individual departments to set their own priorities within that overall envelope. It seems to me that recent chancellors have very much stepped into the space occupied by different departments, which, of course, has a very negative effect on morale within those departments, apart from anything else. Then there is the question of, should you be going wider than Parliament? If you believe that the tax system is there to encourage economic efficiency and equity over the long run, then everyone has a right to have their say in how that should be designed. If you think that the tax system is there very much to respond to current events, it has to, in some circumstances, but that is not the way that we should really try to envisage the tax system working. It seems to me that recent years have seen very much spur-of-the-moment decisions about patches here and there or new incentives to do this or that. What that does is to add hugely to the complexity of the system. It makes for bad decisions that sometimes have to be reversed within months. It places burdens on other departments' HMRC in particular and creates mountains of work for accountants and lawyers, which is not necessarily—I hesitate to say it—a good thing. When we are on budget review issues at this stage, you will both be aware that we have a budget review group, which is a tripartite organisation set up between the Government, Parliament and outside experts. Given some of your reflections here on the process and scrutiny, what do you think the key priorities should be for that budget review group in terms of the way it addresses the scrutiny of the budget in the future? I know that we are going slightly away from the subject matter today, but I might as well ask it whether I have a chance again to ask you that question. I think that the most important issue is to try to knock some sense into Westminster. This was going to be a difficult year anyway because of the new powers and because of Brexit, but we have seen the fact that well-established procedures of the Scottish Parliament have been disrupted by what happened at Westminster. There are huge benefits for the House of Commons and for scrutiny at Westminster if the budget process in the House of Commons was changed. If there is going to be an autumn statement, it ought to be in September at at least two months ahead of what we are going to have now. What I do not think the UK Government has come to appreciate is that, with the very complex asymmetric devolution that we have in the United Kingdom, the only way that can be made to work is by a degree of collaboration between Governments about processes. Governments do not have to agree about policies, but unless they are willing to agree about certain standard operating processes, the system is not going to work. If the UK Government does things at the last minute, for example does things about the forthcoming tax in the March budget, which then has a knock-on effect on the finances of the Scottish Parliament, that is going to cause serious intergovernmental friction. One of the things that we must not do is to lose what we have already achieved in the fact that the budget process has been taken seriously. That sounds like a modest claim, but in the context of what happens at Westminster, that is really quite a big achievement. I agree with David. The Scottish Parliament can justifiably be proud of itself and in the extent to which it has differentiated itself from Westminster as far as scrutiny is concerned. I guess that, thinking back to my time as adviser, one of the issues is at what point in the process should the committee, the Parliament, whatever, be trying to influence the design of the Scottish Government budget. I think that significant intervention, once the budget has been laid out, is probably not going to improve relations between the Government and the Parliament, certainly, and it may be better if the Parliament is trying to introduce its influence at an earlier stage. It is only on one occasion that such an intervention, actually, when there was a minority Government that we did have a small change in the budget prior to the process between September and the passing of the budget bill. It is finding those points of leverage where the committee, the Parliament, could be most effective in terms of, if we are starting to think about a more coherent system for designing tax policy in Scotland, then there are many different places at which the Parliament might have a willingness to be involved. I think that my colleague Neil Warren came and spoke to the committee about differences in the approach taken in New Zealand and Australia. None of those is perfect, but they are just so radically different from what happens in the UK that I was quite surprised when he described them to me and the extent to which Parliament is involved and the wider community is involved with these design issues seems to me to be such a contrast from what we have currently got that it is certainly worth looking at. Just one final question in that area. How important do you think it is that UK Treasury ministers are prepared to come in front of this committee to give evidence, given we now have a shared power area in financial terms? I think that if you are going to get the co-operation that David talked about, this may be a good time and may be not too antagonistic, an interchange that perhaps the UK Government might be open to consideration of alternative ways of doing things. I wanted to ask about the comment in your paper about the weakness and growth of tax revenues, which Professor Bell mentioned briefly in your introduction. I was wondering if you could explain or speculate as to why that should be at a time when the UK economy is growing reasonably strongly. We are not seeing a consequent growth in tax revenues. Given the importance of that issue in relation to the question of the block grant adjustment, is there any difference in the impact in Scotland compared to the UK as a whole? I have thought about this question. I have no and I haven't had time to do any analysis as such. One thing that I have done a little bit on is the growth in self-employment, because part of the success story in the UK reducing its unemployment rate to 5.1 per cent since the recession has been a very substantial increase in self-employment. In fact, self-employment, although it now accounts for about 13 per cent of total employment, has increased more in absolute terms since the recession than has employment. It has taken a huge part of the growth in overall employment since the recession. One thing about self-employed is that their income is even more unequally distributed than that of the employed. There are some very rich self-employed people who are employing people themselves, who have their own employees, their own companies and so on. However, there are also lots and lots of self-employed people who are not employing anyone who are relatively poor, even poor compared with poor employees. That addition to the workforce is probably not paying any income tax at all. If they are paying any, they are probably paying it late, because it will depend on when they complete their self-assessment. That is one possible explanation. It may also be the case, and this does differentially affect Scotland, is that there has been some weakening of the growth in top salaries. We know that, certainly true in Aberdeen and Aberdeenshire. That has a disproportionate effect on overall income tax revenues, but it is not just income tax revenues, rather, puzzlingly, it is also VAT, which has not grown as fast as expected and national insurance. Income tax, I think, is the main culprit for the shortfall, but there is also some fallen or less than expected growth in VAT revenues. I am a bit at a loss to explain that when the savings ratio has never been lower. People are spending their money. Either they are spending it in areas where VAT does not apply like food or maybe they are spending it on internet purchases, where VAT is not always added in the same way, but I suspect that that is probably only a very small effect. Nevertheless, this is an area that is worth exploring. It is very important for Scotland if there is a difference in the lack of growth of income tax revenues. My speaking from recollection, my understanding is that in many industrialised countries, the recovery from the recession has not been particularly tax-rich. I do not think that this is solely a UK issue. I do not have any insight into the difference between Scotland and England. Can I maybe ask a follow-up then to that? This also follows on from Adam Tomkins' line of questioning, based on the Fraser Vallander report. In a scenario where tax revenues are not growing as healthily as we might expect, the Scottish Government, by and large, has set its face against substantial tax increases in terms of the powers that it has. We have a shrinking amount of money coming from Westminster. We have large areas of the public sector that are protected, and we have a whole range of new spending commitments around, for example, childcare. How does that always add up? Silence. Or does it? I am not going to get tempted into giving political answers to political questions. You are very clearly making the point that I emphasised earlier that we are now seeing a build-up of tensions. We have a long period of remarkably high public expenditure growth during the period of the Labour Government until 2007. From 2000 to 2007, it was a remarkable period of public expenditure growth. That period was bound to come to an end. It came to an end quite abruptly. After a period of public expenditure growth, you can probably accommodate somewhat a reduction, but when that reduction goes on for a very long time, when growth stops or there is decline for a very substantial period of time, the tensions are building up. The tensions are building up with pressures within sectors such as health and with new spending commitments. Against the backlog of stalling resources. That is a political choice for the Parliament and the Government. I think that a really interesting question around the autumn statement will be how the chancellor decides to go. Clearly, borrowing at the moment is about as cheap as it has historically been. Nevertheless, the UK budget deficit is about twice the European average at the moment. On the one hand, the chancellor is talking about being less or no longer sticking to the 2019-20 budget surplus by that point in time, but we are not really clear at what time he does want to balance the budget or is he content, for example, to balance the budget in relation to current spending and be prepared to borrow for capital spending, which would be infrastructure. However, the problem is that the pressures that are building up are really around current spending. They are about the health system, criminal justice, benefits system and so on. He is in an interesting position. One of the things that concerns me in a tight fiscal climate is that Governments find ways of doing things that do not get reported. One only has to open the newspapers to read about letters of comfort and guarantees being offered and wondering what the financial cost of those guarantees and letters of comfort will be at some future date. I think that one of the things that Parliament should be watching carefully are for non-conventional ways of getting things done, particularly if there is going to be a financial sting later on. Ivan, you have got a supplementary question. You look at what you wrote about the UK Government missing its deficit targets, and largely it is a function of misforecasting about income tax and other tax receipts. That is not something new if you look back over, certainly back to the recession. It has been the same, the percentage projection in terms of income tax and national insurance receipts is way below where they are expected to be, and that has been the main driver of them missing on those numbers. You have seen it with George Osborne repeatedly missing the deficit targets over a number of years. Given the inability of the UK Government to—this is in the context of the fiscal framework and the block grant adjustment going forward—given the inability to get anywhere near those numbers correct and they have been at it for hundreds of years, given that we have now picked up the forecasting element that we have to do in the Scottish Government and the Scottish Parliament to review that, and given that the way that this calculation works, whereby it is not just a question of us getting the forecasting right, it very much depends on them getting their forecasting right as well because you get that double impact on the turn on the block grant adjustment. Clearly, there is potential for a lot of issues there, right? Not only that, but you then get a time lag because a lot of the stuff might not unravel for two or three or four years, given the way that the calculations are done. Do you want to comment on that? Are the borrowing powers clearly the buffer to deal with that? Are they big enough to cope with what could be quite substantial swings between forecast and outturn? One thing that I would take from what you just said is that the committee should be asking Robert Chote here and asking him what work they are doing in relation to the shortfall in tax revenues because it is the OBR that is responsible for those forecasts. It is not the Treasury. I do not know if they have the resources to do that work, but presumably there is a piece of work that ought to be done between the HMRC and the OBR to make those forecasts of tax revenues more accurate. As far as the block grant adjustment is concerned, it is a relative movement in per capita income tax revenues. It is very difficult unless you see a clear shock that affects Scotland or the UK and does not have significant knock-on effects in the other geography that you can say that the relative will change. Both might be going down at the same rate, in which case the block grant adjustment is not really affected. Clearly, the oil shock effect does affect Scotland in particular. I did a quick calculation for some other work that I am currently looking at, the welfare powers, which are to be devolved over the next two or three years. What I looked at was, I think, disability living allowance, which is the biggest of the powers that is being transferred. I think that the budget is around £1.4 billion. From 1415 to 1516, if you apply the Barnett formula, as opposed to looking at the actual claims for disability living allowance, the difference between them is £3 million. That is not having a huge impact in terms—in fact, it went in Scotland's favour, that particular calculation. Clearly, the borrowing powers are absolutely sufficient to deal with that kind of relative movement. It is fairly minor. It will be interesting to see that 1617 compared with 1718 will be the first real test of this. I do not think that I can say at the minute that the borrowing powers would be insufficient. I suspect that they will be of the correct kind of order. However, if there is a very specific hit on, say, high earners in one part of the country relative to the other, you could be testing their limits. I would just like to pick up on one particular issue, which I think that the Parliament should take very seriously. That is the question of partial fat assignment. The one ought to be able to get pretty good income tax numbers because of the way in which the HMRC runs the income tax system, but the administrative system for VAT will not support a geographical breakdown, so it has got to be done on survey data. The question is how good is that survey data? My understanding is that the existing surveys are actually really quite small that would have to be used. There is a serious issue to think about because one of the things that I think will cause great political problems for the Government and Parliament is that if in three or four years' time one gets big corrections to the block grant adjustment because of data changes, it is going to be incredibly difficult to explain to people why there is going to be less health spending in a particular year because of something that happened three or four years previously. The question about the quality of the data for the VAT assignment is something that the Parliament should take seriously. That is the time to start asking that question. I do know a little bit about this. The Scottish Government pays to oversample some surveys so that you get a bigger sample in Scotland relative to its population size. That happens with the family resources survey, which is important for calculations around poverty, benefits and so on. Where it does not happen is in the expenditure and food survey, which is where you are most likely to get good data on VAT and VAT payments. They are the sample size for Scotland, I think, around 500. You do not want to be making a decision of well over £1 billion based on that size of sample. I suppose that my question is more on the idea of the reality versus the perception in the short-term impacts that we have seen following the announcement of Brexit. I am sure that everybody has seen the headlines recently, where they have been crowing that the predictions of economic meltdown have not come to pass and that it is not marvellous that it has not happened. However, I visited a small food manufacturer this week and we were talking to them about how things were going for them and they do do a bit of exporting. They were saying that they were seeing already that their input prices were going up. However, there was severe pressure against them raising prices from the retailers and that they felt that, as a small Scottish manufacturer, they were between a rock and a hard place. It seems that this could be a really challenging time for Scottish business. It will be quite difficult. Clearly, when prices are volatile, the circumstances for businesses are more difficult than when prices are stable. It is particularly true that we have a relatively small number of major retailers in this country and they have considerable power over their suppliers. None want to be seen to be increasing prices because they attract a lot of negative publicity as a result of that. The result is pressure on the small suppliers. That is unwelcome. It is one of the ways that, as I said earlier, financial markets move more quickly than goods and services markets, but the financial market eventually puts the pressure through, in this case, because of a depreciation leading to higher prices. It puts pressure on the production of real goods and services markets and that is how the effects will emerge through time. On the other side, the consumers will then find that if the prices go up, they will find that goods on the shops are more expensive so that their budget will not go as far as it used to go. The economy shrinks as a result of that and, because of that instability, both consumers and producers are going to be negatively affected. I will say that that sharp drop in sterling does not seem to have captured the imagination as such so much with the commentators and yet it could be leading to quite significant impacts. Someone suggested this week that, if there are any more announcements from the UK Government about a hard Brexit, that that could lead sterling to drop even further. Presumably, that would also lead on to more impacts coming over the short and medium term. The correct interpretation and Paul Johnson of the IFS said that, soon after the depreciation, we are all poorer. It is not a good news story. It changes the distribution of the work that we do in the country so that more of us are working for foreigners and supplying them with goods that actually does not improve our standard of living at all. Nevertheless, a lot of commentators seem to treat it as a wholly good news story and I find that puzzling. I think that one of the things there is a lot of the commentary assumes that there is no import content to what the UK exports. I think that you are a question in the same area. I must convene her. It is also to follow on that point that I asked. I know of a local Ayrshire electronics company where the import component is mainly from China. It is part of their production and their reports and costs have gone up by about 13 per cent this year. Is there anything realistically that the UK Government can do or the chancellor can do when he is resetting the economy in a few weeks to help companies like that throughout the UK? There is not that much that the chancellor can do. There is possibly more power in the hands of Mark Carney. We saw yesterday that the pound recovered a bit after he gave some assurance that he was going to stay in post, which seems an odd thing for the financial markets to respond in that way. Clearly, if the UK increased interest rates that would make Sterling a more attractive currency than it has been recently, that would potentially push Sterling back up again. However, there would be costs associated with that, and businesses that have loans and homeowners that have mortgages would be exposed to higher interest rate charges. That would be the most effective way of increasing the value of Sterling again, but, as you can see, you are almost between a rock and a hard place because there are benefits and costs associated with the action that he might take. We are probably going to continue with low interest rates for some considerable period of time. I think that the commenter would make is that we are now coming to a period of testing this division between fiscal and monetary policy. My personal view for a long time is that monetary policy has been too lax and fiscal policy too tight, but that is not something that is easy to manage when you have established independent bank of England and independent monetary policy. There have been times over the past week that it seemed a bit like the chairman of a football club giving the manager a vote of confidence. We are in a strange period about the independence of the central bank, but there is, unquestionably, an issue about the balance between monetary and fiscal policy. Just on the issue of interest rates, you do not think that it is very likely that they will be increased, but what would be the budgetary impact of an increase in interest rates and would there be any Scottish-specific impact of interest rates changes? It would make pensions more affordable. It would increase the cost of incremental government borrowing potentially, but we do not know that for certain. At the moment, government borrowing costs are extremely low. It might increase what it is difficult to say, but I do not think that there would be massive effects. I cannot remember a time when I had so little sense of the direction in which UK fiscal policy was going. Depending on when you read the newspapers or which newspapers you read, the 23rd of November is either going to see fiscal tightening or fiscal loosening. My hunch is that there will probably not be that very much of anything, because though the UK can borrow very cheaply, the fall in sterling is giving a very bad signal. The problem about a falling in your exchange rate, even if you think that that might help to deal with your balance of trade problems, is that once your currency starts to fall, it is not necessarily very easy to put a floor under it where you want the floor to be. I think that there are significant constraints on what the chancellor can do on the 23rd of November, and my hunch would be that, net wise, there would be not very much. I will ask a supplementary question about the decline in sterling. You have been pretty clear that the most negative effect will be on the living standards of poor people. I wonder whether there were any particular thoughts about strategies that could be employed to mitigate that, either in the UK budget or in the Scottish plans going forward? I do think that the national living wage will possibly have a positive effect, and there is some evidence of that already coming through the earnings data. That helps those in a job, and we have pretty high employment rates at the moment. It does not help the self-employed because they do not have to pay themselves the national living wage. The effects of the national living wage are spread across the income distribution, not just the poorest members of society, although you might think that that is the case. Many of them earn households where there is a much better, someone who earns a lot more. That benefit might go to somebody in the middle of the income, or a household in the middle of the income distribution, or even towards the top of the income distribution. That has helped a bit. I guess the other thing, and clearly there is some momentum behind that, is that further cutting of benefits to working-age families is going to make the situation worse, it seems to me, and that one form of mitigation might not be to go ahead with further benefit cuts. Thank you very much, convener. Good morning. I think that since I joined this committee, I have been reminded of the saying, the more I see, the more I see there is to see, and this session has been very much putting me in mind of that. I wanted to ask about public sector pay, but can I first pick up on some of the tax discussions that happened earlier? There was this discussion a wee bit earlier about the danger, perhaps, of over expectations of what devolved tax powers can do, but also the tension between the argument for a bolder, more radical approach and the pragmatic desire to be slow and incremental and gradual about it. I am obviously not going to ask you to endorse a political direction. I have always argued that somebody on my income, for example, can afford to pay more tax. Just to explore what is possible in the Scottish budget, it seems to me that one way of making an incremental change in the direction of a more radical end point is to take the basic rate and split it into two and to either freeze or, perhaps relatively affordably, reduce it for people on a below-average income. That would allow people on an average income to be paying a little more, only people on a significantly average income to be paying significantly more without harming those who are on a lower than average income. That is surely an affordable option within the powers that the Scottish Parliament and the Scottish Government now have, because it would cost relatively little to reduce tax for those who pay very little tax and it would generate more from those who earn more. Obviously, it is possible. I think that the question would be to what extent would it result in the outcomes that you desire. You changed the tax band for 1,000 people and that would cause them to pay £100 a year more if you just do the street accounting, but do you generate £100,000 extra revenue? That is the real question. You need to do a bit of work around that, it seems to me. The issue is how might people respond. We know bits and pieces. We do not really know enough about Scotland to do that. There are various ways of people who can react. They could try to maintain their real income by working more hours. They pay more tax, but they work more and, as a result, they generate the same after-tax income that they had before. That is one possible reaction. Another is that they might reduce their hours. Another is that they might retire earlier. Another is that they might leave. For some people, those alternative opportunities are not there. The young do not tend to retire early. Some people do not have an opportunity to change their hours without changing their contract completely. My answer is that it is certainly not impossible, but it would be important to try to identify what the real reaction is going to be. If you think you are going to raise £100,000 but you only raise £80,000, it may still be worth doing, but you need to get some feel for that. We would only get some feel for that by at least putting a toe in the water. I think that you first of all ought to get the Institute for Fiscal Studies to do some fiscal modelling for you at the first point. Obviously, because Scotland has got this policy choice, there is going to be much more discussion of these kind of issues. I have already made the point that I am sympathetic to the argument that the 20 per cent to 40 per cent jump is actually too steep, and I thought that for a long time. When, during the Labour Government, the Liberal Democrats wanted to put the 40 per cent rate up to 50 per cent, I was against that and I still broadly hold that position, because I think that the problem at the top end is one much more of enforcement. One of the worrying things about income tax and taxes of high incomes is that we run the danger of the perception that taxes are not paid by such people, even though the data shows that a lot of the income tax revenue comes from a high earners. If we create a sense on the part of the public that income tax is something that the rich do not pay, we could get into the same kind of problems that we have got in with inheritance tax, whereas a lot of people whose inheritance tax liabilities are negligible or zero actually worry about it, and that is aggravated by the sense that, if people are rich enough, they can avoid inheritance tax. My view would be that one would think very carefully about enforcement issues at the top end, rather than thinking about the rates. To David's point and the point that he made earlier, remember that national insurance is effectively another income tax, and it would not necessarily change, so you have to think about the income tax rate and the national insurance rate in combination. You cannot just think of them on their own. In addition to the points about the income tax at the top end, we would also need a discussion about wealth taxes, which are a greater source of inequality, but that is perhaps for another day. I move on to the question about public sector pay. Let us assume that we see an autumn statement from the UK Government and that it either leads to some degree of fiscal listening or tax changes that benefit the Scottish budget in the short term, or that we have a Scottish Government that wants to, as I suggested, put a toe in the water and see what it can do with devolved tax powers. Let us assume that there is some capacity there from one source or the other. The erosion of the value, the real-terms value of public sector pay, has been really substantial since the late 2000s. Would it be reasonable to suggest that if we want any opportunity to recoup some of that value, to restore some of that lost value in public sector pay, it should be done before we anticipate inflation returning to significant levels, that now is the time to do it rather than waiting until after inflation has risen again? I understand where your argument is coming from, but the point that I would make is that one reason why the economy did much better in terms of employment during the fiscal consolidation period is that public sector pay got held down. There is a trade-off in the public sector between the number of jobs and pay rises, so the fact that public sector pay went down significantly in aggregate actually protected a substantial number of jobs. The point that was being made earlier in the Brexit discussion is that we are now, as a country, worse off economically than we were before. The idea that we were in a position to have an abrupt increase back to where we were at a previous period is extremely doubtful. There is always going to be a degree of trade-off between the amount of employment and the pay rates. Obviously, public sector pay cannot get too far out of line with private sector pay without damaging issues in terms of recruitment, morale and retention, but I do not think that this is the period for big increases in public sector pay. I did not necessarily suggest a single big bang restoration back to 2007 or 2008 or what have you, but to begin to try and recoup some of that value. Am I right in suggesting that there might be two reasons why that trade-off between retaining employment in the public sector and public sector pay were stronger back at the start of the process than they are now. One is that not just that we have the taxation powers to make a different choice, but that under the new settlement public sector pay increases would also increase income tax payments from those public sector employees in Scotland. As a separate consequence of that, it would reduce the block grant adjustment in future. Secondly, Labour-intensive public spending does not suffer from the problem that you identified earlier about imports being more expensive. Do those two factors make public sector employment better value for money now than it was before? I agree with your point about import content. There are public services that will not be seeing a rise in costs because they effectively have no import content involved in their activities. I do not know the answer in relation to the overall increase in income tax revenues. About 23 per cent of employment in Scotland is in the public sector. It all depends on how on average they have higher pay than private sector workers. I am not sure where the margin is at the moment. That does not mean that they make bigger contributions to income tax, because a few highly paid private sector workers can dwarf a large number of public sector workers that are close to the personal allowance. At the back of what you are saying, there is an issue at the moment, particularly in England, around public sector pay getting so low that there are problems of recruitment, morale and retention. If you get these wrong for a short period of time, the negative effects can be long-lasting. I noticed a story earlier this week that the university's admissions system has seen a 10 per cent reduction in the number of students wishing to become medical students. That is a signal that people are not thinking that going into medicine is as good a prospect as it used to be. I do not necessarily agree with everything that you are saying, but I think that that is something that might be an issue for the committee to look into. A huge proportion of the budget is being spent on wages and salaries, and is it effective in getting people into our public services that are motivated, that are willing to provide the kinds of service that the public wants? Can I come back to the point about the fact that people pay and get their money back in income tax revenues? You might get some of it back in income tax revenues, but if you take people's gross pay plus their national insurance contributions plus their occupational pension contributions, and given the fact that probably the people might not be that high earning, the actual feedback from tax is going to be much less than the actual gross expenditure. One thing that I should add is that the issue about pensions is one that is extremely important and has not been visited since Audit Scotland, public sector pensions, has not been visited since Audit Scotland did a review about five or so years ago. Some of them sit on the Scottish budget and are subject to pretty severe pressures, which may impinge on other parts of the Scottish budget. I have written something about this recently and would be happy to share it, but there is the potential for the component of the Scottish budget that goes on to public sector pensions expanding over time that perhaps the finance committee should be looking at. One last question on a separate issue, and this may be just flagging it up for something that we might look at in the future. The UK Government has obviously placed a lot of political emphasis on public sector debt at UK Government level. Have either of you looked at the level of debt held by local authorities, whether that is sustainable and affordable? Local authority debt will come within UK debt. It will be within the numbers of the Office of Financial Services 6, but I have not done any work on local government debt. I am thinking about the finances of our local authorities who are delivering services, and those services will be squeezed. Is the cost of the debts that they hold going to be a growing and a significant factor in their finances? I would expect so, but I have no information. One thing that I would add is that the UK produces each year a whole of Government accounts that goes beyond the national debt, which are the payments that the UK Government might make to meet its current liabilities. There are other contingent and future liabilities that are included in the whole of Government accounts. To some extent, Scotland is also exposed to public sector pensions, which are not strictly part of the accounting but will, over time, evolve. There is also national rail debt. There are a few things that are not there on the balance sheet that really there is a very strong case, not for panicking about them but for monitoring them. That was in Dad's Army for a moment now. Given us a very good understanding of some of the key economic and fiscal challenges that we face, can you tell us briefly what you think the prospects are for the medium term for the Scottish economy? I think that we are entering a somewhat difficult and uncertain period where the sources of growth are not obvious. The Brexit debate has yet to play out, so we do not know how far our trading relationships are going to change. We are perhaps a little less exposed than the rest of the UK in relation to that, because our exports to the rest of the UK have been growing much faster than our exports to the rest of the EU over time. It seems to me that we are not going to enter a phase where the economy will be growing very rapidly and alongside that, tax revenues growing very rapidly. Even though at the moment the economy is growing okay, we have already discussed the issue that tax revenues are not growing as fast as might have been expected had the past been replicated. I suspect that we are in for the difficult period where hard choices are going to have to be made. It is not obvious how we get out of that situation. I agree with that. James Whispidham, the ear of the scene from Jaws, where the sheriff looks and sees Jaws coming towards it and saying, we need a bigger boat. That is this discussion this morning. Thank you very much for coming along this morning. It has been a fascinating process. We have unearthed quite a lot of issues that we are going to have to consider. How we are going to put all this together in terms of all the aspects that you have drawn to our attention is going to be an interesting challenge for us. Thank you very much for coming along today. I now move this meeting of the committee into private session.