Day: May 30, 2022

Tomorrow (Tuesday 31 May) the Scottish government will publish a Spending Review and a Medium Term Financial Strategy. At the same time, the Scottish Fiscal Commission will publish updated economic and fiscal forecasts for the period to 2027. 

This article by DAVID EISER at the FRASER of ALLANDER iNSTITUTE considers six key things to look out for:

1. How much detail will the government provide about its spending plans?

The government has said that its resource spending review will ‘outline resource spending plans to the end of this Parliament in 2026-27’. This will, it says, ‘give our public bodies and delivery partners greater financial certainty to help them rebuild from the pandemic and refocus their resources on our long-term priorities’.

What has remained unclear is the level of granularity at which the government intends to set its spending plans.

A spending review is not a multi-year budget, and we shouldn’t expect it to look like one. But we have no idea whether the government is going to set out spending plans at portfolio level, or in more detail than this. Portfolio-level plans would be useful, but some organisations would, justifiably, point out that Portfolio level plans provide them with little if any certainty about their own allocations.

There is a possibility too that the government does not in fact set-out portfolio level spending plans, but instead provides information about its spending plans for only a selective list of its policy ‘priorities’. This sort of approach would certainly represent a missed opportunity.

2. How will the government address uncertainty?

The UK government’s Spending Review in October set out spending allocations for the Scottish government for each year until 2024/25. These allocations aren’t necessarily set in stone, but whilst they might well increase a bit, they almost certainly won’t be reduced.

The Scottish government does not have confirmed allocations for 2025/26 and 2026/27 and there is significant uncertainty around what the government’s allocations will be in these years.

It will be interesting to see how the Scottish government addresses this uncertainty in the spending review. Will it set out plans for a single scenario only? Will it set out a central scenario, together with spending plans under alternative scenarios? Or will it provide broad ranges over which it expects spending on different public services to fall?

There is a reasonable case for the government to adopt a different approach for 2023/24 and 2024/25 than it does for 2025/26 and 2026/27. But it shouldn’t use the uncertainty in the last two years of the parliament as justification for providing less detailed information in the next two years.

3. What insights will we get into the government’s policy commitments… and the implications for non-prioritised areas of spending?

The Spending Review should give us some further clues about the government’s emerging plans in various areas. For example, the timescales for, and financial implications of, plans to establish a national care service may emerge more clearly.

What is less clear is how much the spending review will tell us – explicitly – about levels of spending for non priority areas.

The Scottish government’s MTFS in December pointed out that the difference between its spending aspirations and its likely budget was over £2bn in 2024/25 (see Figure 6). This is a substantial funding gap (although it is not clear what assumptions lie behind it).

The spending review framework notes that ‘With limited resources, increased investment in the Scottish Government’s priorities will require efficiencies and reductions in spending elsewhere: we need to review long-standing decisions and encourage reform to ensure that our available funding is delivering effectively for the people of Scotland.’

It will be interesting to see whether the spending review document itself is as candid about where spending reductions are taking place as the framework document implied it might be.

4. How significantly will the economic outlook deteriorate?

The last set of SFC forecasts were published in December 2021. A huge amount has changed in the five months since then.

The December 2021 forecasts described an economy that had recovered from the pandemic more strongly and smoothly than had been anticipated earlier that year. The economy was forecast to grow 2.2% this financial year and 1.2% next.

Unemployment was forecast to peak at 4.9% in 2022, down from an expected peak of over 7% in its previous forecast. Inflation was expected to increase in 2022 to around 4.4% – enough at the time to cause the SFC to forecast a fall in real earnings.

We live in a different world now. By March 2022, inflation was 7%, and by May the Bank of England was expecting inflation to peak at 10% this year. The rise in inflation, together with tax increases, leads the Bank to forecast that 2022 will see the second largest annual fall in disposable household incomes since the 1960s.

The SFC’s forecasts will inevitably paint a similarly gloomy picture for real household incomes in Scotland, which in turn will result in a contraction of its forecasts for economic growth, and probably a deterioration in its medium term outlook for the labour market. Exactly how the SFC sees the cost of living crisis play out will be interesting to see.

In May the Bank of England’s forecast implied prolonged stagnation in UK economic activity, although it did not (quite) forecast a recession in a technical sense. If the SFC does forecast a recession in Scotland, this will no doubt dominate headlines, but it will be important to look closely at how different the UK and Scottish economic forecasts are in a tangible sense.

5. What will be the implications of the fiscal forecasts for income tax and the Scottish budget?

The SFC’s economic forecasts will have implications for the Scottish budget, via the income tax forecasts in particular. These implications are not as immediate as you might think – Tuesday’s forecasts do not themselves have major significance for Scottish government spending this year, since the forecasts made at the time of the budget are what really matters until tax outturn data is available.

But Tuesday’s forecasts will give an indication of whether the outlook for the contribution of income tax to the budget has improved or deteriorated since the budget forecasts in December.

Its very difficult to predict the outcome. Its quite conceivable that the forecasts for Scottish income tax revenue will be revised up, if the SFC believes that higher inflation and recent further falls in unemployment will drive up earnings growth. But what ultimately matters is how the SFC’s judgements play out alongside the OBR’s equivalent judgements for the UK (since these are what determine value of the income tax block grant adjustment).

The December forecasts painted a gloomy picture. Scottish income tax in 2022/23 was forecast to raise £190m less than what was taken out of the block grant to account for tax devolution, and £257m less in 2023/24.

Kate Forbes will be hoping for any signs of an improvement in the outlook. But whatever the implication of Tuesday’s income tax forecasts, they will in reality need to be taken with a pinch of salt, given the differences in timing between the OBR and SFC forecasts.

The other really important element of the fiscal forecasts will be what they say about the outlook for devolved Scottish social security spending, relative to the related uplift in the block grant.

Spending will inevitably be substantially higher than the level of additional resources flowing through the block grant, as a result of policy divergence in Scotland (in relation to disability benefits, carer’s allowance, and the new Scottish Child Payment). But the extent of the gap will have implications for the resources available to the Scottish government in other areas of devolved spending.

6. What will the MTFS tell us about the government’s wider strategic ambitions?

The Medium Term Financial Strategy sets out risks to the devolved budget over a five year period. We can expect the MTFS to analyse issues including uncertainties relating to inflation and the implications for public sector pay.

But past MTFS documents have also given a steer about some of the government’s wider strategic fiscal objectives and asks. It will be worth looking at what this year’s MTFS says about these issues – which potentially include positioning statements in relation to further tax devolution, or extension of borrowing and budget management tools – particularly in the context of the upcoming review of the fiscal framework.

David Eiser is Senior Knowledge Exchange Fellow at the Fraser of Allander Institute