Fiscal Sustainability Report offers Scotland some tough choices
By Justine Riccomini, Head of Tax (Employment and Devolved Taxes)
17 April 2023
Justine Riccomini explains what lies ahead for the Scottish economy, as set out in the Scottish Fiscal Commission’s latest report.
Why has the report been published?
The report comes after recommendations made not only by the Scottish Parliament’s earlier iteration of what is now the Finance and Public Administration Committee, but also due to the recommendations from the OECD’s review of the SFC back in 2019 – two years after its creation. Some of the SFC’s counterparts with independent status also publish such reports – so this is not an unusual move, and to produce one every five years, as the SFC have undertaken to do, seems like a sensible and balanced activity when considering current global economic volatility and its effect on local and national economies. No doubt these reports will be well-thumbed by the Scottish Government, Audit Scotland and the Scottish Parliament to name but a few over the course of each Parliament.
Why is it important to the Scottish people and Scottish business?
Whilst the report is openly characterised by the SFC as a broad-based set of projections, which long-term analysis can only really ever be, there is some important information contained in it. As more of these reports are produced over time, no doubt some trends will emerge and paint a picture of Scotland insofar as its population (and thus the proportion of taxpayers which make up the tax base), and tax and spend capabilities goes.
The SFC said: “We use the analysis to provide an insight to the scale of changes that may be required in terms of overall spending and tax decisions. Although there is uncertainty about the scale of the challenges, those shown by the fiscal sustainability analysis are real and these are what our report focusses on.”
How can such a report be realistic or even possible?
A crystal ball may seem necessary, but short of the complete unknowns it is generally possible to produce realistic projections based on historical factors and current trends.
The SFC are well-placed to produce this report because they already analyse and forecast the impact of fiscal decisions in the Scottish and UK Budgets on the Scottish economy every year, and liaise with their UK counterpart, the Office of Budget Responsibility (OBR), setting out the impact of the decisions being made.
In that context, they are already experts on the peculiarly Scottish aspects influencing the economy and public service provision. This of course includes the current and future tax powers of the Scottish Government, and the agreement between Scotland and the UK as to how much money will flow from the UK into the Scottish purse each year (The Fiscal Framework), the Scottish population, and how these are influenced by global and national events and trends. Of course there are a myriad of factors which can influence these projections, and the role of the SFC is to try to factor in as many of them as possible to maintain balance. Factors such as a changing working age population demographic, food chain safety, political shifts, climate change, and international crises such as wars or pandemics therefore come into it.
What does the report tell us?
The report is likely to cause concern in the Scottish Government as the SFC predicts “that the Scottish Government will face significant challenges in funding the future provision of devolved public services in Scotland.”
Declining birth rates = an ageing population
Why is this? First, the statistical information obtained by the SFC from National Records of Scotland shows a projected fall of around 400,000 over the next 50 years due to declining birth rates. This means that unless migration into Scotland by working age (16-64 year old) taxpayers over the same period increases by at least this amount, Scotland’s impending taxpaying population will decline.
Combine this with the fact that the population in Scotland is ageing over the same time frame (as a result of declining birth rates), and we can see that as per the below diagram produced by the SFC, the average age rises from 42 in 2023 to 49 in 2073. The over 65 cohort will represent 31% by 2073.
Health spend v education over 50 years
From the SFC projections, it looks likely that health spend will increase by 15% over 50 years to represent 50% of all Scottish public spending, whilst the spend on education will decrease by 7% over the same time frame.
Labour market
A natural consequence of this decline in the working age population is a decline in labour market supply, and this may become particularly prevalent in some sectors. For example, in recent years the UK Road Haulage Association has reported a decline in staffing availability as the majority of lorry drivers who are predominantly white males of around 60-65 years of age approach retirement age, needing urgent action to re-staff to maintain logistical viability.
A report by the Office for National Statistics in 2021 also showed that there had been an increase in 50 to 70 year olds becoming economically inactive, in other words, withdrawing their labour permanently and taking retirement. As readers will know from the 2023 Spring Budget on 15 March, the UK Government has aimed its fiscal policies at four “pillars” – one of these being employment – in a bid to try to attract more over 50s back into the workplace.
Scottish public services funding
Scotland is currently funded by a mixture of devolved and partially devolved taxes with a greater part also being funded by the block grant – an annual funding settlement based on UK revenues received and re-distributed based on a ‘needs’ formula per head of population and UK spend on devolved matters. This means the UK and Scottish economies are inextricably linked.
Putting it bluntly, the SFC state that the funding available from a combination of devolved taxes and block grant funding under the current fiscal framework arrangements will fall short of public services requirements by an average 1.7% per annum if the same levels of delivery are maintained. However, this is not the whole picture, because they go on to say that to make UK public finances sustainable, they have:
“…modelled a scenario where the fiscal tightening is applied evenly across all areas of UK Government spending and taxation. This would lead to a reduction in funding for the Scottish Government budget through a reduction in the Block Grant and higher BGAs for tax. The end result is a considerably higher fiscal gap in the Scottish Government budget, with an average over the next 50 years of 10.1 per cent of total spending each year.”
Difficult questions lie ahead
Scotland must therefore ask a number of questions concerning how it might wish to manage fiscal sustainability over the next 50 years. A primary question has to be what the spending cuts or tax increases might need to be – something which ICAS has called for transparency on, not just now but in the event of a vote in favour of independence, given the shrinking nature of the tax base and ageing population.
Clearly it is vital that the health of the Scottish population is boosted to optimum levels in future, and the working age population needs to be maintained or ideally increased, with more taxpayers and more people paying tax at the higher end of the scale – currently the vast majority of Scottish taxpayers are at the lower end of the scale. Attracting taxpayers into Scotland has probably never been more important.
Is Scotland alone in this position?
Whilst the outlook appears rather grim, it is clear Scotland is not alone in this regard and the UK is also at risk of suffering a similar fate if matters are not addressed – which is why these SFC and OBR reports are so important as they assist government policymakers in their decision processes. The OBR’s own projections in their most recent report clearly highlight that the UK public finances are also on an unsustainable path in the long-term if the same fiscal and economic policies remain in place.
If any ICAS member wishes to comment or make the ICAS Tax team aware of an issue relating to UK and devolved taxation, please contact a member of the Tax team.