Tag: Fraser of Allander Institute

The Economy: Don’t Panic But Do Worry

This year has not seen the return to normality that many businesses hoped for. Supply chain disruption, rising prices, hiring difficulties, interest rate increases, and lack of confidence are taking their toll (writes Fraser of Allander Fellow JAMES BLACK).

Many economic organisations are now forecasting potential slowdowns in the UK and globally, but significant uncertainty remains around forecast business conditions.

One of the challenges in predicting slowdowns is the timing. Robust data often takes months to collect, so we often do not know if the economy has started slowing until months after it begins.

It’s helpful to step back and look at the significant economic drivers in times of such uncertainty. Survey snapshots, such as our recently published Scottish Business Monitor sponsored by Addleshaw Goddard, can provide some hints. So, what are businesses saying about their current performance and expectations for the coming year?

Starting with the positives, more businesses reported an increase in sales volume in the year’s second quarter than a fall, resulting in a net balance of +15%. This net figure is reasonably high, and this level hasn’t been seen in our survey since 2014. Employment, new business, and capital investment indicators also remained positive for the second quarter.

On the face of it, businesses have been remarkably resilient. Few people predicted emerging from one of the greatest human health crises in over a century with unemployment rates near record lows. Scottish onshore GDP grew by 0.6% in May, now 1.1% above February 2020 levels of output.

But concerns are now starting to emerge in the data. The net balance of the sales volume is still positive but has weakened since the start of the year. Looking ahead to expectations over the next six months, the positive but weakening finding is consistent across many indicators such as business volume, new business, and employment.

This weakening is mirrored across several other surveys. The June RBS Purchasing Managers’ Index showed the weakest expansion in Scotland’s business activity since January. Only 13% of UK businesses in the ONS’ Business Insights and Conditions Survey reported an increase in turnover in June compared to 24% reporting a decrease, and expectations for August are negative.

The most commonly reported challenge impacting these turnover figures is the cost of materials. Our survey has been asking Scottish businesses to report on their business costs since 1998 and provides a useful reference for the scale of this challenge.

The past four quarters have shown cost increases across the board. Costs for energy, employees, inputs, imported goods and services, distribution, and credit are all increasing or already very high. Compared to the 23 years of surveyed total business costs between 1998 and 2020, each of the past four quarters is a record breaker.

The knock-on impact of these price rises continues to filter through to the economy. An ONS survey states that 44% of UK firms have reported absorbing costs, while 26% passed on price increases to consumers. Two in five Scottish firms we surveyed said they expect to reduce their operations due to energy prices.

Concerns exist around how these supply-side issues could lead to significant demand-side impacts and contribute to a slowdown. So, what does the evidence show on how the major drivers of demand – consumer spending, export demand, government spending, and investment – have been affected?

Household spending accounts for almost two-thirds of Scotland’s GDP, but many people have seen their costs increase while their wages have failed to keep up. The likely impact is people dipping into savings, borrowing, buying fewer goods and services, or substituting for cheaper goods and services.

On savings, aggregate data up to May on net household deposits to UK banks has so far remained relatively stable over the year. If consumers, as an aggregate, start dipping into savings, this would be worrying not just for living standards but also for a potential reckoning down the road as these savings eventually run out. Credit card borrowing does appear to have increased, but total borrowing is still moderate compared to the past decade.

However, UK Retail Sales data up to June shows rising sales values and falling sales volumes. Inflation has driven what is now a significant wedge between these trends. Sales volumes have fallen close to levels seen in June 2019. Perhaps not yet concerningly low, but the trend is worrying both in terms of living standards and the consequential impact on businesses and their supply chains.

For now, the data primarily points to reductions in delayable purchases such as furniture. Mostly anecdotal evidence suggests that consumers are opting for cheaper options in supermarkets and switching to budget retailers.

If domestic demand appears to be showing initial signs of slowing, will exporting come to the rescue? Most Scottish businesses in our survey say no. Pessimism exists about export performance over the next six months, and a global slowdown in 2023 appears increasingly likely.

Government spending in Scotland was projected to barely increase in real terms between 2022/23 and 2025/26, and inflation expectations have since worsened. The cost-of-living payment and £400 energy rebate will likely partially offset but not reverse expected negative consumer trends. However, it remains to be seen how UK policy may change under new leadership.

According to the Bank of England, investment intentions are still positive, and firms are increasingly looking toward energy-saving investments. But some firms are reassessing investment plans as the economic outlook worsens.

The challenges this year result from a perfect storm of supply chain issues. This included several surprises on the downside. An optimist may hope for the possibility of surprises on the upside too. Any signs of improved energy supply and production levels in China deserve attention over the coming months.

For now, the message for businesses is don’t panic but do worry. But for many people, there is increasing evidence that we are leaving a health crisis only to enter a crisis of living standards.

Six things to look out for in Tuesday’s spending review and fiscal forecasts

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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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

An exploration of how financial inequality prevents the success of Scotland’s climate change aims

This essay, written by Ellen Keefe, was the overall winner in the Fraser of Allander 2021/22 Economic Futures Essay Competition.

Students were invited to write an essay on an Economics topic related to the climate crisis and climate change policy in Scotland.

Each of the four winning essays were featured as a perspective in the March 2022 edition of the Fraser of Allander Economic Commentary.

In the wake of COP26, targets to slow climate change have been set across the world. As the host of the climate conference, Scotland has set the ambitious target of reaching net zero emissions by 2045 (Sturgeon, 2021).

Scotland aims to reduce emissions in areas such as transport and housing with numerous initiatives set for the coming years. However, are these targets inclusive for everyone in Scotland? How financial inequality excludes lower income households from reducing their emissions and accessing government support to do so will be explored.

The transport sector creates significant carbon emissions causing climate change (Apostolicas, 2019). This has driven the innovation of electric vehicles. In order to reach net zero, the target for Scotland (and the rest of Britain) is to stop the sale of new petrol/diesel cars after 2035 (Burch, Gilchrist, 2018).

A higher uptake of electric cars within society will be beneficial for reaching climate change targets, however, considering all members of society, this is not realistic. Electric cars have a significantly higher upfront costs and therefore an individual could buy a larger petrol/diesel car for the price of a smaller electric vehicle (Mehta, 2021).

Due to these drawbacks, financial incentives are needed to convince a lot of the public to opt for an electric car (Rotaris, Giansoldati, Scorrano, 2021).

In Scotland there is financial support to aid individuals buying an electric car. Interest free loans up to £28,000 paid back in up to 6 years for new electric cars and up to £20,000 paid back in up to 5 years for used electric cars are available (Net Zero Nation, 2021).

The cheapest used electric car that can currently be purchased costs from £9,675 however, numerous used petrol/diesel cars can be purchased for below £5000 (Buyacar, 2021). Therefore, interest-free loans are not enough to make electric cars accessible/desirable to low-income households.

Grants could be provided to low-income households to facilitate the purchase of an electric car and even the playing field of choice between electric and petrol/diesel vehicles.

Alternatively, government intervention into reducing the costs of electric cars would make them more accessible. The Scottish government should look to partner with electric car manufacturers such as Nissan to fund innovation and reduce tax on production of electric vehicles. With a significant reduction in the price of electric cars to match the price of petrol/diesel cars the financial barrier of purchasing would be removed and uptake across Scotland would increase, hence reducing transport emissions.

One of the benefits of owning an electric vehicle is their low running cost.

Charging points have been installed across Scotland which initiatives to increase accessibility set. However, electric cars are mainly charged by a charging point which is installed at the owner’s home.

The installation of a home charging point costs around £800 (DriveElectric, 2020). Grants of up to 75% of the cost of installing home charge points are available (Gov, 2021).

As of April 2022, this will only be available to homeowners living in flats and people in rented accommodation. This change demonstrates governments aim to aid lower income households more in purchasing an electric vehicle.

Nevertheless, even with a grant of the maximum, 75% of an £800 would still leave a £200 installation cost, which is significant in particular to individuals in rented accommodation. Can people be expected to invest this much into installing a charge point into a home that is not theirs?

In 2018 there were 2.48 million households in Scotland, 14% were in the private rented sector, 22 – 25% in the social rented sector and 61-62% in the owner-occupied sector (Gov, 2019). A large proportion of people in Scotland do not live in a property they own.

Arguably, households in rented accommodation are excluded from accessing means to reduce emissions. In particular low-income households.

Some individuals in Scotland have enough disposable income to invest in an electric vehicle and charging point with/without government loans and grants dependent on their eligibility.

However, for those without sufficient disposable income available, loans and grants are not enough, excluding a large portion of society from reducing their emissions. But transport is not the only area where financial inequality is prevalent and hinders Scotland’s climate change aims.

The Scottish government has been working to “promote home upgrades” to meet the net zero target (Sturgeon, 2021). Across the UK people’s homes contribute 22% of emissions (Sustainable Energy Association, 2019). However, as seen in the transport sector, sufficient support is not provided to lower income households.

As mentioned, over a 3rd of households in Scotland in 2018 were private or social rented (Gov, 2019).

The Future Homes Standard will be introduced in 2025 which will increase efficiency requirements of new homes being built (Gov, 2025). People who buy, rent or build their own new home are rarely low income.

Targets for existing property have also been set to increase efficiency and reduce emissions. T

he Scottish governments Housing to 2040 plan sets out objectives for increasing home efficiency. It states “To lead by example, we will aim for all new homes delivered by Registered Social Landlords and local authorities to be zero emissions homes by 2026” (Gov, 2021). 

The objective is there but the execution is not.

In 2018 it was found that 1 in 3 homes in Scotland did not meet the living home standard (Shelter Scotland, 2018).

The government is failing to improve energy efficiency in social houses. In Scotland, 38,046 social housing properties failed to meet minimum standards and 25,564 were exempt from meeting the standard (Campbell, 2021).

This is detrimental to the reduction of emissions within the housing sector but also highlights the issue of fuel poverty within Scotland. Moodie argues “the hardest to fix homes are being left until last” and as lots of social housing is old and inefficient, this is widening the gap between those in energy efficient housing and those in fuel poverty (from Campbell, 2021).

Moodie further argues, support that is available to homeowners and private tenants is not available to those in social housing (from Campbell, 2021). Therefore, financial inequality is evident in the housing sector in hindering the provision of energy efficient housing.

As with purchasing an electric car, government financial support is available to make homes more energy efficient. Interest free loans are available to cover costs of installing various renewables systems (Gov, 2021). 

Furthermore, households can receive a maximum of 40% cashback (with a maximum of £6000) for certain energy efficient improvements (Gov, 2021). This is an incentive for homeowners with sufficient disposable income to invest in making their home more efficient, especially due to increasing energy prices which are predicted to soar for years to come, yet a large proportion of society cannot afford to make these changes despite loans available (Jack, 2022).

The possibility of receiving cashback for efficiency improvements is not a sure enough return for many individuals who cannot afford to invest in upgrading their home.

For those living in private rented accommodation, this issue is amplified as individuals will not invest thousands of their own income in improving the efficiency of a home that is not theirs.

If they have to move, they have lost this investment therefore government support available is not appealing enough. Hence, those who cannot afford to improve their homes energy efficiency will suffer more as costs rise as well as their emissions remaining high.

To tackle issues of incentivising home energy efficiency and installation of charge points in rental property, landlords must be encouraged as oppose to tenants. A reduction of tax on landlord’s rental income for properties based on energy efficiency level and presence of an electric vehicle charge point would encourage improvements. Furthermore, moving into a rental property with a charge point makes purchasing an electric vehicle more accessible.

To conclude, the negative impact of financial inequality on Scotland’s aim to reach net zero by 2045 is evident in the transport and housing sector.

First Minister Nicola Sturgeon states “that focus on justice and fairness will be central to Scotland’s whole approach to COP26” (Sturgeon, 2021). However, is there justice and fairness in the support available for the Scottish public to reduce their emissions?

With only zero interest loans available to aid the purchase electric vehicles, high upfront costs still prevent lower income households from accessing them.

Similarly, with interest free loans and cashback available to increase home energy efficiency, households with enough disposable income have incentive to upgrade homes however, support is not sufficient in aiding those with lower incomes.

The large proportion of the public who rent property are not incentivised to make improvements and as energy prices soar, the issue of fuel poverty increases with the government’s claims to upgrade the energy efficiency of social housing failing.

Scotland’s target of reaching net zero emissions is not attainable by 2045 with current inequality. It is clear that the if changes are not made, financial inequality within Scotland will prevent Scotland from meeting its net zero goal and tackling the climate crisis.

Ellen Keefe

Fraser of Allander Institute: Looking ahead to local government elections

Local elections will be held across all 32 Scottish local authorities on 5th May. Just over 1,200 council seats will be determined.

Local government is a hugely significant part of the public service landscape in Scotland. Local government’s revenue settlement from the Scottish government in 2022/23 is almost £12bn, accounting for just shy of one third of the Scottish government’s total revenue spending.

Drawing on this settlement – plus resources from council tax, fees and charges – local authorities will manage and deliver social care services, pre-school and school education, and a raft of environmental, planning and cultural services.

In this context, it is perhaps surprising that turnout at local government elections is typically less than 50% (turnout in 2017 was 47%). Low turnout partly reflects a sense among the electorate that their vote makes relatively little difference to the delivery of public services, for two reasons.

  • First is a pervasive view that local authorities have relatively little power to influence service delivery in meaningful ways, regardless of the political control of the council, as local authorities are often perceived largely as delivery agents of the Scottish government.
  • Second is a set of issues around political accountability. The results of local government elections are often ambiguous – after the 2017 elections, no mainland council authority was controlled by a single party (moreover, it is not always the case that the largest party forms part of the governing coalition). On top of this, the profile of local politicians is often low. Recent research indicates that three quarters of people are not confident that they could name the leader of their council.

Data from the Scottish Household Survey – an annual survey of around 10,000 households – indicates that in 2019, fewer than a fifth of adults thought they could influence decisions affecting their local area.

At the same time, only just over one quarter actually wanted to be more involved in the decisions of their local council (Chart 1). The last decade has seen a persistent decline in the proportion of adults who want to be more involved in local democracy.

Chart 1: Percentage of respondents agreeing or strongly agreeing with various statements about local services.

Source: FAI analysis of Scottish Household Survey

The Covid pandemic may have raised the public’s awareness of local government and the breadth of activities it is responsible for. Local authorities were instrumental in delivering financial and other support during the pandemic – both to households and to businesses – supporting testing and tracing infrastructure, and ensuring the safe reopening of schools. It will be interesting to see whether this manifests in any increase in turnout in this year’s elections.

People have different views about how much we should care about the public’s relatively low interest in local government, and what we should do about it. For some, the answer is greater policy autonomy, both in general terms and in relation to local taxation in particular. For others, elected mayors (or provosts) would raise profile and accountability.

On the first of these issues, policy autonomy, there has been little progress during the past five years. In fact if anything, things are moving towards less not more local autonomy. Throughout the past five years the Scottish government has made increasing use of specific (ring-fenced grants). Meanwhile, the government’s plans to establish a new national social care agency – which have a number of well meaning justifications – have been referred to by Cosla as ‘a direct attack on localism and on the rights of people to make, and benefit from, decisions taken locally.

Local government funding, 2017/18 – 2022-23

One of the dominant issues going into the 2017 local government elections was the very constrained nature of the local government financial settlement over the past five years. Between 2013/14 and 2017/18, the core local government revenue settlement declined by £750 million in real terms according to SPICe which is equivalent to a 7% real terms reduction in its budget.

What’s happened to local government budgets during the past five years?

Unsurprisingly, local government budgets increased substantially during the pandemic. Local government General Revenue Grant increased by £2.4bn in 2020/21 to reach £9.3bn. The increase offsets the loss of around £1bn of non-domestic rates revenue as a result of pandemic-related tax reliefs, and  also reflects increased grant to enable local authorities to play a critical role in delivering pandemic-related support to households, businesses, and the wider pandemic infrastructure (e.g. testing facilities).

The local government settlement in 2021/22 was not as high as in 2020/21, as the recovery began to take effect.

By 2022/23, core local government funding – including general revenue grant, NDR income and specific grants – is slightly lower in real terms than it was in 2017/18 (Chart 2). If we also include additional funding from the Scottish Government that is transferred into the local government settlement from other portfolios, then the story is that local government funding from the Scottish government is around 3.5% higher in 2022/23 than in 2017/18.

These additional revenues include £380m for health and social care integration and mental health, £234m to pay the living wage to social care staff, and £150m for additional teaching and support staff in schools. It does make sense to include these elements in the calculation. But even so, the 3.5% real terms funding increase has to be seen within the context of a significant increase in local government’s delivery responsibilities over the same period.

In other words, whilst the story of the past five years has not been one of funding cuts – at least as clearly as at the last election – local government’s funding settlement has nonetheless been very constrained.

Chart 2: Local government core funding from Scottish Government, real terms.

Source: For 2017/18 to 2021/22, Provisional Outturn and Budget Estimates (POBE); for 2022/23, Local Government Finance Circular 1/2022.

One result of this funding constraint is a further concentration of local government spending on education and social care. Between 2017/18 and 2021/22 (the latest year for which data is available), spending on education increased 6% in real terms, whilst for social work the increase was 5%. The flipside of this was a 9% real terms decline in local government spending on cultural services and an 8% decline in environmental services spending.

Despite these funding pressures, overall satisfaction with council services had held up reasonably well, at least until 2019 – the latest year for which we have comparable data (Chart 3). However, there was also some evidence of a decline in satisfaction with particular aspects of local government service delivery in 2017 and 2018. This coincides with a period when local government funding was cut particularly rapidly. It will be interesting to see how this trend is affected by the pandemic once data is available.

Chart 3: Percentage of respondents agreeing or strongly agreeing with various statements about local services.

 Source: FAI analysis of Scottish Household Survey

Looking ahead

Local government will retain a critical role over the next five years in delivering key Scottish government priorities and commitments, particularly around childcare, educational attainment, and climate objectives (e.g. in relation to improvements to the housing stock and active travel plans). And clearly, major existing agendas such as health and social care integration and digitalisation of public services will remain high priorities.

Yet at the same time, it is hard to see an immediate reversal in the broad trend of funding constraint. The forthcoming Scottish government Spending Review, to be published in May, should shed further light on the funding outlook for 2023/24 and 2024/25.

In addition to consideration of the local government funding envelope in totality, local government will be interested to know more about the outlook for its core budget, relative to elements of the budget that are ringfenced in some way.

The government has committed to work with local authorities to produce a fiscal framework for local government this parliament. The expectation is that this might set out clearer criteria about when it is or isn’t appropriate for local government funding resources to be ringfenced. But the timescales for production of the review are not yet known.

A major area of uncertainty is what the future of social care will mean for local government.

The Scottish government has set out its intentions to establish a new National Care Service by 2026. There are a number of well-founded justifications for the proposed National Care Service, including parity with the NHS, stronger opportunities for staff retention, and consistency of service across the country.

But there is little clarity yet about what the reforms will mean for the role of local government in shaping local priorities. COSLA has accused the proposals as representing an attack on localism.

Another uncertainty is the prospects for local tax reform. The past five years have seen relatively little movement on this front. The government has introduced legislation to allow local authorities to introduce Workplace Parking Levies, although the practical advantage of this as a policy has been temporarily stymied by the pandemic.

Debates around the introduction of local powers over tourism levies is progressing slowly. On council tax, the SNP-Green Collaboration Agreement makes the case for a ‘fairer, more inclusive and fiscally sustainable form of local taxation’. It proposes a process of deliberative engagement and a citizens jury to consider reforms in further detail. Whether this process culminates in a more concrete political willingness to reform council tax than previous processes remains to be seen.

The past five years have seen no major revolutions of local government financing arrangements or public services delivery. But evolution continues at pace. Local government played a critical role in supporting the pandemic response, and continues to play an increasingly important role in delivering core Scottish government commitments in areas from child poverty and the cost of living crisis to climate change.

The next five years may see more substantive evolution in the role and responsibility of local government in Scotland. Whether this happens in a way that enhances, or further erodes, public engagement with local democracy remains to be seen.

You can read the Economic Commentary here.

The 2022 Spring Statement: reaction and implications for Scotland

Analysis by the Fraser of Allander Institute

Many had anticipated that the Chancellor would use today’s Spring Statement to announce a more targeted package of support for lower-income households than he had in February. Instead, the Chancellor used it to reiterate his emphasis on fiscal prudence whilst promising an income tax cut in 2024.

The surprise (1): no targeted support

There was a broad expectation that Sunak would use today’s announcement to announce financial support for lower income households, probably via additional spending on social security. There was certainly a very strong case for him doing so.

Part of the reason why the current spike in inflation is creating a cost of living crisis is that the inflationary rise has happened so suddenly that normal benefit uprating policy is out of touch with reality. Benefits are normally uprated in April each year in line with inflation. But the measure of inflation used is from September the previous year.

In September, inflation was running at 3.1%. By February it was 6.2%. It is forecast to average 7.4% in 2022 (peaking at 8.7%). This means big real terms cuts for benefits in 2022, potentially followed by a big upswing in 2023, as uprating catches up with reality.

Households, particularly low income households, are not well placed to deal with such volatility. But governments are. Addressing this disconnect would have been relatively easy, and fiscally neutral in the medium term.

Surprisingly, the Chancellor offered nothing on social security. The cost of living crisis will affect lower income households much more acutely than those on middle or higher incomes.

Spending on energy and food makes up a higher share of their incomes; they less ability to absorb cost increases via savings; and they have fewer options to make savings by switching to lower priced product lines. There does not appear to be much consideration of the distributional dimension to this crisis.

The only attempt at targeting towards the most financially constrained was an additional £500m for local authorities to distribute to households most in need. The Scottish Government will receive a Barnett consequential as a result (likely to be around £50m). But this is a small amount of support in the context of the scale of the problem.

… but more broad-based support

Instead, Sunak’s support for households was again broad-based. The main element was a 5p cut in fuel duty. This is very weakly progressive as a policy – low income households spend proportionately more of their income on petrol than higher income households – but it provides a larger cash boost to high income households. And, by spreading support so thinly, the £5bn cost of this policy will provide limited relief to households most financially exposed to the rise in the cost of living. (If it provides much relief at all – how much of the 5p cut might be passed on to consumers is unknown).

The Chancellor chose not to postpone the increase in employee and employer NICs that was announced in September. This in itself was sensible – postponing the rise would mainly have benefitted higher earners. Furthermore, there would be a real risk that a one-year postponement could evolve into a permanent postponement as the election gets closer and the memory of the pandemic – used in part as justification for the NICs rise – fades

But what he did do was increase the threshold at which NICs is due, from £9,900 that was pencilled in for 2022 to £12,570 (bringing forward a sensible commitment to align the threshold with the income tax personal allowance). This increase in the threshold is worth just over £300 per year for employees. The effect is to offset the impact of the increase in NICs rate for the majority of earners in 2022. The cost of the measure in 2022 is £6bn.

The surprise (2): Income tax cut in 2024

Chancellors traditionally leave their flagship policy announcement until the end of their speech. Sunak’s flagship today was a promise to cut the basic rate of income tax from 20p to 19p in 2024.

The economic rationale for this is far from clear. The rise in employee and employer NICs (and subsequent health and social care levy) was justified by the need to address long-term fiscal challenges resulting from an ageing population and a smaller economy (thanks to Brexit and Covid).

But the proposed income tax cut will offset most of the impact of the Health and Social Care Levy on revenues. The outcome of the two policies together – the income tax cut and NICs rise – is to transfer the burden of tax from pensioners, landlords and others with unearned income to earners.

The proposed income tax cut will not apply in Scotland (a small caveat to this is that the income tax rate on savings will be cut to 19p UK-wide, since it is not devolved). Instead, the Scottish Government will, in 2024, receive an increase in its block grant which is broadly equivalent to the costs of a 1p reduction in the UK basic rate in Scotland.

The Scottish Government will be free to decide how to allocate this additional resource – whether that be through tax cuts of its own, or higher spending on public services. The politics of this will be interesting.

Summary

This was not the set of measures that many people had expected or hoped for. 2022 is set to see the biggest single-year fall in real household disposable income since records began in the late 1950s, according to the OBR.

The main policy measures announced today for 2022 were the 5p fuel duty cut, which will make little difference to the households most exposed to the crisis; and the rise in the NICs thresholds, which ensures that the government’s tax rise will not add to the cost of living burden this year for most earners.

These policies of course have to be seen alongside February’s £9bn package – which included the £150 grants to households in council tax bands A-D, and a £200 reduction in energy bills in 2022 (repayable in future years).

In combination, the announcements in February and March equate to some £17.6bn of support for household incomes in 2022/23. This includes £3bn on grants via council tax, £2.4bn through fuel duty cuts, £6.3bn through raising the primary NICs threshold, and £6bn of direct support for energy bills which is recouped in the subsequent five years.

On one level this is a generous package of support. But it has to be seen within the context of an substantial and sudden shock to living standards. The government is in a better position to smooth the impacts of this shock that individual households, particularly those on the lowest incomes.

But across the two announcements, there has been no targeted support to the lowest income households. As a result, benefits are set to rise 3.1% in April, against a forecast inflation rate in 2022 of 7.4% – a real terms cut in benefits of 4% (or more, when we factor in low income households higher proportionate spending on energy and food).

This outcome could have been avoided relatively costlessly by adapting standard benefit uprating rules. There is certainly no sense in which such a measure could not have been ‘afforded’, even within the Chancellor’s own fiscal rules.

There was also no extra spending on public services. This means that the cash allocations set out in last year’s Spending Review are now worth less in real terms. Public departments face rising costs of energy too, and meeting these costs within existing budgets will mean less for other things.

Rishi Sunak is rapidly repainting the image he carved for himself during the pandemic. Gone is the priority to ‘do whatever it takes’. It is replaced by a reiteration of his desire to meet his own fiscal rules, whilst pencilling in a flagship cut to income tax.

The political calculation is that the promise of tax cuts and fiscal prudence will appeal to the core elements of the electoral base.

But this may yet prove a risky strategy. In the meantime, 2022 is set to be an extremely tough year for many households.

Scottish businesses report first shoots of economic recovery

For the first time in over a year, businesses in Scotland can see the first shoots of recovery as COVID-19 restrictions begin to lift, according to a leading quarterly survey led by the Scottish Chambers of Commerce (SCC).

The SCC’s Quarterly Economic Indicator (QEI) for the second quarter of 2021 indicates more positive growth across all sectors surveyed, albeit, caution is still the watchword for many businesses.

Key Findings:

• Pent up demand unleashed: All sectors have reported substantial rises in confidence and domestic sales, owing to the easing of general and domestic travel lockdown restrictions. Most results are positive for the first time in over a year, albeit from historically low bases.
• Caution looking ahead: All sectors have projected positive expectations for Q3, on balance, likely boosted by the expected further easing of lockdown restrictions. While firms are optimistic about sales revenue, they are more cautious around investment and staff levels with most firms envisaging no change to these in Q2.
• Faltering export sales: Covid-19 disruption and Brexit fallout has resulted in trading difficulties for businesses in services, manufacturing and retail as evidenced by falls in export sales and orders across these sectors.
• Inflation pressures: All sectors have recorded increases in concern over inflation, which may escalate as more consumers spend savings accumulated over the last 16 months and create uncertainty for business in terms of their costs and prices.
• Flat labour market: Most sectors saw a slight increase in employment, apart from retail, which saw no change over the quarter. Most firms, across all sectors, expect little change in Q3 which could result in sluggish jobs growth, with further challenges expected as the furlough scheme is withdrawn.

Tim Allan, President of the Scottish Chambers of Commerce said: “The success of the vaccine rollout has enabled the easing of restrictions and the gradual reopening of the economy, unleashing pent-up demand in the economy. This has allowed some sectors to rebound more quickly than others, however, the route to economic recovery will be a marathon, not a sprint.

“It’s clear that concerns remain around the ongoing impact of Covid-19 as businesses grapple with huge uncertainties over what the economy will look like post-pandemic. Towns and city centres face new challenges as more people work from home and more flexibly, impacting on footfall and changes to consumer behaviour.

“The needs of employers and employees alike need to be finely balanced as we shape the recovery of our city centres which will impact on a wide range of sectors and supply chains.

“Equally, sectors such as tourism and international travel, which continue to operate with severe restrictions, are having to adjust to increased domestic demand, a simultaneous fall in international travel and a tightening supply of skilled labour. The sector needs continued financial support and greater clarity on when confusing and burdensome travel regulations will end, allowing greater numbers of international visitors to return.

“As we approach the end of restrictions businesses are increasingly turning their attention towards how to achieve long term growth and renew Scotland’s economy.

“We have recorded the first shoots of growth returning to our economy, and it is essential now that both the Scottish and UK Government’s do all that they can to stimulate demand and boost confidence in the coming months.

“Priority must be given to continuing the provision of targeted financial support where it is needed most and looking ahead, both Governments must create the right environment for businesses to get back on their feet, create jobs and trade successfully again.”

Commenting on the results, Mairi Spowage, Director at the University of Strathclyde’s Fraser of Allander Institute, said: “In April, we saw growth in the Scottish economy of 2.0%.

“This takes us above the previous post-pandemic peak in October. However, the economy still remains 3.7% below the pre-pandemic peak.

“Despite the optimism in the economy, there are risks to recovery which could provide headwinds to growth. The dislocation in global trade was significant due to the pandemic.

“However, we also know that the end of the EU Transition Period has caused significant issues for manufacturers and others trying to rebuild these supply chains since the start of this year. This chimes with today’s survey results, which show significant negative impacts on exports.

“Recent announcements of the delay to the restrictions roadmap will lead to calls from some sectors that there should much more extensive business support to get them through to a position where they can properly operate. As well-meaning as initiatives like a new Council for Economic Transformation may be, practical policy measures to help these businesses survive through the winter are likely to be needed.”