Day: May 27, 2023

THIS week the Deputy First Minister and Cabinet Secretary for Finance Shona Robison presented her first major fiscal statement to parliament (writes Fraser of Allander Institute’s MAIRI SPOWAGE).

For the uninitiated, the Scottish Government’s Medium Term Financial Strategy (MTFS) is a document that outlines its financial plans and priorities over the next five years. The strategy aims to provide a framework for fiscal decisions, resource allocation, and economic management in Scotland. It takes into account various factors such as economic forecasts, revenue projections, spending priorities, and the government’s policy objectives.

The MTFS was introduced following the Budget Process Review Group’s final report, which recommended a number of changes to the budgetary process at Holyrood so the parliament could move to year-round budgeting. The idea is that this sets out the context at this time of year, to allow Committees to plan their pre-budget scrutiny in the Autumn, feeding into the Budget which comes towards the end of the year.

It’s fair to say that this hasn’t always looked like a particularly strategic document: perhaps in the past setting out possible challenges, without engaging with what might need to be in response. It is clear from what the DFM said yesterday that she is trying to highlight and engage with the challenges to outlook presents, which is to be welcomed.

A chunky document at 117 pages – we’ve read it so you don’t have to!

Funding Commitments are outstripping the funds available

The big headline from the MTFS is that public spending in Scotland is currently projected to outstrip the funds available by significant amounts of money from the next fiscal year (2024-25). The document says:

Our modelling indicates that our resource spending requirements could exceed our central funding projections by 2% (£1 billion) in 2024- 25 rising to 4% (£1.9 billion) in 2027-28.

The funding gap has been presented in the media this morning using that dreaded phrase “black hole”. Of course, this gap cannot be allowed to manifest itself in reality. For context, this £1 billion gap is bigger than the whole of the Rural Affairs and Islands budget; or about the same as we spend on prisons and courts combined.

Given the Scottish Government has to present a balanced budget, and if the funding coming from both Westminster and devolved taxes is as expected, what this means in practice is that difficult decisions are going to have to be made about spending. Of course, there are also options to raise taxes  – but let’s come back to that.

Opposition politicians were quick to criticise the Government for saying that they were prepared to take tough decisions to deal with this challenge – but not setting out what these tough decisions were, i.e. where the axe might fall if it needs to.

To be fair, this is not the first one of these documents to highlight a potential funding gap if things continue as they have been. The difference was that DFM was very upfront about the fact that this was going to mean tough decisions were necessary. The financial statement yesterday was not a budget, and we should not have expected detailed allocation announcements.

So while we can see the uncertainty that this causes for service providers in terms of what is coming in December, to a certain extent the MTFS has done what it is supposed to do: to set the context for the start of the year-round budgeting process in Holyrood.

However, having said that, there are a number of commitments the Government has already made that are not included in this – such as the expansion of childcare provision, or further investment in the National Care Service. Therefore Ministers will have to be clear over the Summer and in the Programme for Government that they are acknowledging the tough decision environment when policy announcements are being made.

The DFM was fond of saying to opposition parties that they need to set out where cuts should happen if they are asking for more to be spent on particular areas – therefore the Government needs to hold themselves to the same standard.

A large income tax reconciliation still looks likely – but won’t be confirmed until the Summer

One of the issues that is contributing to the difficult outlook for the next financial year is a large income tax reconciliation.

To explain what this means, I’ll hand over to the Scottish Fiscal Commission (our boldening)…

When the Scottish Budget is set, funding from Scottish income tax for the financial year is based on forecasts and does not change during the year. Only when outturn information on income tax revenues becomes available is funding brought in line with outturn and a reconciliation applied to the following Scottish Budget. We can derive indicative estimates of future income tax reconciliations by comparing our latest forecasts and the latest forecast Block Grant Adjustments (BGAs) to those used in the Budget setting forecasts.

As we have highlighted in recent publications, we continue to expect a large and negative income tax reconciliation for the Budget year 2021-22. Comparing our and the OBR’s latest forecasts indicates a large negative reconciliation for 2021-22 of -£712 million. Final outturn data should be available in July 2023, with the resulting reconciliation being applied to the Scottish Budget for 2024-25.

So, we will know in July to what extent this reconciliation emerges in practice. This feature of the operation of the fiscal framework highlights the complexity of the arrangements that now determine the Scottish Budget.

Some of the coverage of this reconciliation have been characterised (by the IFS on socials for example) as a result of “over-optimism on tax receipts”. Let’s break down what is causing the reconciliation.

The forecasts for which the 21-22 budgets were set were still in the middle of the pandemic (Jan 2021), and the reconciliations are a function of both the view of the OBR of the rest of UK tax receipts and the SFC’s view on Scottish Income tax. Both of these figures were quite far out (the OBR’s more than the SFC’s) but it is absolutely to be expected given the uncertainty.

So, the current view of Scottish Income Tax is that it will be 9% higher than was forecast at the time of the 21-22 budget; but the current view of the Block Grant Adjustment is that it will be 15% higher than was forecast at the time of the 21-22 budget, hence the negative reconciliation.

To characterise this situation as “over-optimism” doesn’t seem very fair.

The outlook for the public sector workforce is assumed to be quite different in the document compared to the Resource Spending Review last year

When the Resource Spending Review was presented in May 2022, one of the main things that stood out was the analysis of the public sector workforce. The suggestion was in aggregate that the public sector workforce had increased significantly over the period of the pandemic, and that one of the ways that the tight fiscal environment could be dealt with was to manage down the public sector to its pre-pandemic size.

What wasn’t set out last year, or indeed anytime since, was how this would be achieved and in which areas the workforce would be managed down.

The MTFS does present different scenarios for the evolution of public sector pay settlements and the size of workforce. However, none of these assume that the public sector is to reduce overall. The scenarios the government examines in the document are:

• Low Scenario – 2% pay award in 2023-24, and 1% pay award from 2024-25 onwards, 0.3% workforce growth
• Central scenario – 3.5% pay award in 2023-24, and 2% pay award from 2024-25 onwards, 1.1% workforce growth
• High Scenario – 5% pay award in 2023-24, and 3% pay award from 2024-25 onwards, 2.2% workforce growth

The document still indicates that reductions may be required in some areas of the public service, but it seems clear that this will be driven by the budget allocations that will be dished out:

Where a reduction in workforce is required for a public body to remain sustainable, we would expect this to be through natural turnover wherever possible and we restated our commitment to no compulsory redundancies in this year’s Public Sector Pay Strategy.

Let’s talk about talking about tax

The Deputy First Minister has announced that an external tax stakeholder group will be established this Summer. The document says:

This group will build on the Government’s inclusive approach to tax policymaking and will consider how best to engage with the public and other stakeholders on the future direction of tax policy, including whether a “national conversation” on tax is required.

It is hard not to be cynical about this announcement: those of us in the tax policy field have been invited to many conversations and round tables about tax over the years, but engagement is only meaningful if feedback and suggestions are taken on board. This sounds a little like a group to talk about how to talk to the public about tax. Not bad in itself, but it’s not clear how this is going to feed not many of the announcements that have already been made about taxation by this refreshed administration.

The idea is that this engagement will shape a refreshed tax strategy from the Scottish Government. A couple of things that we would say (if we are asked of course!) –

• Discussions about wealth taxes look very difficult in a devolved context. However, completely within the gift of the Scottish Government is the reform Council Tax, something the SNP have said they wanted to do since coming to power in 2007. Given the number of commissions and groups that have discussed this over the years, another one is not required to set out the issues with CT, or indeed to set out options for replacement. Meaningful discussions about replacements and the political bravery to recognise there will be losers, as well as winners, will be required.
• Further additions to the higher and top rates of income tax are unlikely to be able to yield large amounts of revenue. For example, there is the suggestion from the new FM (which had been put forward by the STUC) to introduce a new band at 75,000 and up the rate by 2p. The new ready reckoners published by the Scottish Government yesterday show that even if the whole of the Higher Rate Tax band is upped by 2p, this will raise £176m – not an insignificant amount of money, but not enough to deal with the funding gap outlined in the MTFS.
• Tax rises are not cost-free. If engagement is to be meaningful, it is important that the SG engage with those who can see some of the costs as well as the benefits to either (i) more complexity in the tax system (ii) more divergence from the rest of the UK and (iii) higher tax burden overall.

Multi-year Funding envelopes will be set out with the 2024-25 budget (so probably in December)

The Government have committed to publish refreshed multi-year spending envelopes alongside the Budget for 2024-25. Given everything that has changed since the Resource Spending Review was published in May 2022, this is to be welcomed – although given the difficulties overall it is unlikely to be good news for many areas.

Hello? Is it MSPs you’re looking for?

Given the importance of the statement yesterday, we were quite surprised at both the time the was given in the chamber but mostly by the lack of MSPs who were in the chamber to hear the statement.

This is basically the equivalent of the Autumn Statement at Westminster – not the budget, no, but it gives clear signals of the context for the budget to come. This sets off the Budget process, and highlights that really difficult decisions are going to have to be made in the 2024-25 budget.

Engagement from across the chamber will no doubt increase as we get to the sharp end of the budget process – let’s hope it’s more meaningful than it was yesterday.