Manufacturing, Tax and Brexit: A Scottish Economist’s Letter to the First Minister

Ben Wray

Professor Monojit Chatterji, Director of Economics at Trinity Hall, Cambridge, publishes his letter to the First Minister Nicola Sturgeon. Written in a personal capacity, it looks at recent economic data on the Scottish economy in the context of Brexit, and poses a number of questions. 

DEAR First Minister,

I write to you both as a Scottish citizen and as an economist who is concerned about the future of Scotland particularly in the wake of the sad outcome of the 23 June referendum. Some of my earlier writing is on the Common Weal website.

The latest bulletins of the Scottish Government (Quarterly National Accounts Scotland Quarter 4 2015 Release Date: 4 May 2016) clearly show two important features of the Scottish economy which have not received much attention in public debate.  Both these facts concern the structure rather than the size of our economy. First, the bulletin shows clearly (Table D) that we are not a manufacturing nation- some 75% of our GDP being in the service sector and around 10% in manufacturing.  Second, the bulletin also shows (Table F) that a considerable part of our GDP (40%) is profits (as opposed to labour compensation which is 60%). 

Taking our small manufacturing sector first, it is well known that productivity growth in services is generally lower than in manufacturing. Also manufacturing more than services is the fundamental export good. Hence a healthy manufacturing sector is necessary for economic growth.  To achieve this we need more new investment in manufacturing. Both Scottish and foreign businesses are more likely to commit to new factories in Scotland if we are able to remain within the single European market. Within the EU, businesses have a far greater choice of whom to hire. Furthermore, for businesses outside the EU (Chinese/Indian), Scotland (within the EU) would be much more attractive as a potential foothold and launch pad to exploit the large European market.  Can the Prime Minister  be persuaded to support and negotiate our continuing membership even if the rest of the UK pulls out? Are there not precedents (inexact ones to be sure) in the Greenland/Denmark scenario and in the Cyprus/North Cyprus scenario?  Scottish Brexit bodes ill for our manufacturing industry in terms of productivity, output, jobs , and exports.

The large share of profit in our GDP also raises some important issues as we acquire greater fiscal autonomy.  In 2015, pre-tax profits in Scotland were estimated (in the May 2016 bulletin) to be £50 billion while the wage bill was £73 billion.  What does this imply for the size of our tax base? Will we have the right to levy the Scottish rate of income tax (SRIT) on all those resident in Scotland (regardless of where their income is earned)? Or will we have the right to levy income tax on all those whose labour activity is in Scotland – what we might call Scottish workers (regardless of where they live). How large is the gap between these two tax bases?  And what about taxing profit income? What proportion of the £50 billion of profits remains in Scottish hands in Scotland? If most shareholders in Scottish based companies are not resident in Scotland, then presumably they are outside the reach of SRIT? The answers to these questions are not clear from the published statistics.  We must get the data to inform and guide policy on such pressing questions as the tax structure and public spending priorities for the future. If most of the profits generated within Scotland flow out to England or elsewhere, we must find an imaginative way of taxing profit income at the “factory gate” so to speak BEFORE it reaches shareholders.

I appreciate that these observations are not a fully formed plan. I offer them in the hope of stimulating a focussed national debate on some of the important issues of our times.  As there is no public forum for such discussions that I am aware of, I have taken the liberty of sending them to you.

Yours sincerely

Monojit Chatterji