The numbers behind Scotland's devolved powers
Scottish Finance Secretary Derek Mackay delivered his first budget on 15 December 2016. It was the first time the Scottish Parliament had powers to set its own rates and bands for income tax on earnings.
In fact, Mackay chose to exercise the new powers cautiously, with the only significant divergence being the decision to raise the higher-rate threshold for Scotland to £43,430, in line with inflation, rather than following the Chancellor’s approach for the rest of the UK of a significant above-inflation increase to £45,000.
That careful approach should not, however, distract from the fact that the changes underway in devolution are far reaching, and will have implications for the way the Scottish budget-setting process is carried out and scrutinised.
First, the proportion of devolved spending funded by taxes raised in Scotland is set to go up significantly from 10% prior to the Scotland Act 2012, to around 52% once all the devolved powers set out in the Scotland Act 2016 are in place.
From the 2017/18 fiscal year onwards, the Scottish Parliament will be able to set rates and bands for income tax, apart from on dividends and savings income. Revenues from income tax on earned income are estimated at around £12bn.
Air passenger duty (APD) and the aggregates levy are also due to be fully devolved, with APD coming under Holyrood as 'air departure tax' from 2018, and the aggregates levy once a state aid investigation by the European Commission is complete.
A further £5bn will be devolved through the assignment of the first 10p in VAT receipts at the standard rate and the first 2.5p at the reduced rate. This is expected to take effect from 2019/20. Work is currently underway to agree a methodology for estimating VAT receipts attributable to economic activity in Scotland.
Furthermore, a number of welfare powers are also due to be devolved involving public spending of around £2.3bn in Scotland, which will transfer to Holyrood.
Planning for risk
A significant impact of the next phase of devolution, and one that has probably yet to be appreciated by the public, is the increased volatility affecting the Scottish Government’s revenue and expenditure.
The Smith Commission, which arrived at an all-party deal for devolution following the 2014 referendum, established the concept of “no detriment” arising for either Scotland or the rest of the UK as a result of powers being transferred to Holyrood.
Scotland will, however, gain if its economy outpaces the rest of the UK or lose out if the reverse happens.
The process is complex and untried. Nobody has done it before. Everyone is learning, including the two respective governments.
The Scottish Government has powers to borrow more to support revenue spending on a temporary basis in the event of a Scotland-specific economic shock. Fundamentally, though, its spending plans will be affected not only by how tax receipts rise or fall compared with the rest of the UK, but also by demand-led services, especially in the area of welfare. All this will have to be done within the constraints of ensuring a balanced budget.
Graeme Roy, Director of the Fraser of Allander Institute, said: “It will be slightly more challenging for the Scottish Government. For example, the UK Government has much greater freedom to borrow to meet its needs, subject to the market, while the Scottish Government is restricted to borrowing in specific circumstances.
“The process is complex and untried. Nobody has done it before. Everyone is learning, including the two respective governments.”
He added that Scottish institutions both inside and outside of government are having to gear up the resources devoted to scrutiny and forecasting to an extent that has not been required previously.
The Scottish Commission
The Scottish Fiscal Commission will play a key role in helping to plan strategically, equivalent but not identical to the Office for Budget Responsibility (OBR) at UK level.
Significantly, legislation passed in March 2016 by the Scottish Parliament gives the Commission direct responsibility for producing key economic and fiscal forecasts for Scotland, and also requires it to produce an assessment of the reasonableness of the Scottish Government’s borrowing projections.
The Commission also has scope to produce forecasts, assumptions and projections about fiscal factors that it thinks are appropriate – for example, one possible role might be to produce a biennial 'fiscal sustainability report' as the OBR does.
Auditor General Caroline Gardner said: “Understanding the way that the Scottish economy affects the revenue forecast is bound to take time. It’s a ‘work in progress’, but the building blocks are there.”
Another tool to help make sense of the big picture could be 'whole of government accounts' (WGA), which would show the assets and liabilities of the public sector in Scotland as a whole, including central and local government, in one consolidated set of accounts.
This approach has already been applied to the UK Government – including Scotland – but so far it has not been done at the Scottish level. This could be helpful in strengthening transparency and accountability, and the Scottish Government may be in a position to publish WGA (for the 2016/17 fiscal year) in the spring of 2018.
What happens next?
The Scottish Government and Parliament have set up a budget process review, which is carrying out a fundamental review of the Scottish Parliament’s budget process following the devolution of further powers in the Scotland Act 2012 and Scotland Act 2016, and is expected to report in May 2017. Meanwhile, Audit Scotland is also looking at what processes and resources it will need.
Non-government bodies such as ICAS, the Law Society of Scotland and the Fraser of Allander Institute have also been helping to inform the process. For ICAS, this has involved the Public Sector Committee and the tax team.
Alice Telfer, Head of Business and Public Sector with ICAS, stated: “Scotland’s public finances are undergoing momentous change – significant increases in tax raising and spending powers need to be supported by a robust framework for public scrutiny and accountability.
"We are supportive of efforts to ensure that forecasting information, fiscal and financial reporting evolves to meet these growing needs. Easy access to succinct yet complete and understandable financial information is an essential tool to enhance public accountability, as well as supporting effective decision making and scrutiny of public finances.”
Transparency is paramount and enables taxpayers to hold both the UK and Scottish governments to account.
Justine Riccomini, Head of Scottish Taxes at ICAS, agreed: “It is important to ensure that sound financial processes and clear, meaningful information is available to the public to encourage a wider education and understanding of tax and financial matters.
"Transparency is paramount and enables taxpayers to hold both the UK and Scottish governments to account. Access to clear analyses of devolved revenues against budget, so that we can critically analyse government policy outcomes against expectations, is another important function of our day-to-day role.”
Some political decisions have yet to be made. VAT, for example, and the ongoing Brexit saga will have implications for devolution, with a question over which powers residing with the EU will be repatriated to Holyrood and Westminster.
Whatever happens, the Scottish Parliament’s fiscal responsibilities look set to become more complex and wide-ranging, and the need for effective information and accountability has never been greater.
This article was first featured in the full version of this article in the February 2017 edition of CA magazine.