Report looks ahead to Scots Budget

Donald-Drysdale By Donald Drysdale for ICAS

22 November 2019

As the Fraser of Allander Institute publishes its searching look ahead to Derek Mackay’s forthcoming Scottish Budget, Donald Drysdale finds uncertainties around every corner.

Scotland's Budget Report

At an event in Edinburgh on 15 November, the Fraser of Allander Institute (FAI), a leading independent economic research institute within the University of Strathclyde’s department of economics, published Scotland’s Budget Report 2019.

Scotland's Budget Report is FAI’s annual analysis of the Scottish Budget. It discusses the state of the economy, the outlook for Scotland's block grant and tax revenues, and the policy options open to the Scottish Government as it prepares to set its Budget each year.

This year’s event, supported by Deloitte and the Scottish Policy Foundation, was chaired by Graeme Roy, Director of FAI, and his colleagues David Eiser and Mairi Spowage presented findings of their research.

Paul Johnson, Director of the Institute for Fiscal Studies, Andy King from the Office for Budget Responsibility, Caroline Gardner, Scotland's Auditor General, and Charlotte Barbour, Director of Tax at ICAS, also spoke at the event.

In an introduction to the report, John Macintosh of Deloitte wrote that scrutinising Scotland’s tax and spending plans is becoming increasingly challenging with the postponement of the UK Budget and an upcoming general election.

As the Scottish Government takes on more tax and spending responsibilities, it becomes increasingly important to understand the strengths and weaknesses of the Scottish economy, the impact these will have on the Scottish Government’s ability to meet its objectives, and the challenging trade-offs that will be required.

The report highlights some key tax questions.

Scottish income tax

Only a few years in from the Scotland Act 2016, there is growing divergence between Scottish and UK income tax policies, but will this continue?

Scottish income tax has a more progressive charging structure than in the rest of the UK. As this imposes increasing tax costs on higher earners, their possible behavioural reactions relative to those in the rest of the UK will need to be factored into decision-making.

There are some 2.5 million income tax payers in Scotland, and they have average annual earnings of around £25,000. On the latest figures, 7.7% of Scottish adults (351,000 in absolute numbers) pay higher rate income tax at 41%, while only 0.3% (16,000) pay the top rate of 46%.

These figures show that there are relatively few higher rate and top rate Scottish earners. It is important for Scotland to attract more. Further divergence might encourage some to move away from Scotland, and dissuade others from settling there. Thus, the size, shape and potential mobility of the Scottish income tax base create particular challenges.

Holyrood has no influence over decisions taken at Westminster regarding the UK-wide personal allowance or the income tax rates which apply in the rest of the UK. Such UK decisions, and Holyrood’s reactions to them, may increase tensions between the income tax regimes north and south of the border.

Planning for the unknown

Scottish Finance Secretary Derek Mackay had planned to deliver his Budget for 2020/21 to the Scottish Parliament on 12 December, which is now the date on which the general election is to be held.

In a letter dated 14 November to the Scottish Fiscal Commission, Mackay has now announced his intention to postpone publication of the Scottish Budget until after Christmas – and ideally until after the UK Budget has been published.

UK tax measures, and the potential for radical Brexit-related fiscal measures or election-related sweeteners, may cast a long shadow over the forthcoming Scottish Budget. Many must now be asking whether a Scottish Budget can be fully and adequately considered if the UK Budget proposals are not yet known, or if they become known unexpectedly late.

Other unpredicted factors are at work. For example, the FAI report highlights ‘reconciliations’ required to the next two Scottish Budgets – reducing funds available to meet Scottish pubic spending, to adjust for weaker growth in the Scottish tax base which had not been forecast when the first Budgets were set.

Sustainability

At the event launching Scotland’s Budget Report, Caroline Gardner, Scotland's Auditor General, spoke of key risks affecting the sustainability of the Scottish budget; she labelled these economic performance risk, policy risk, forecasting risk, and budget management risk.

She warned of more complexity, uncertainty and volatility in the budget as the effects of the fiscal framework start to be felt, and she noted that budget risks would affect the level of resources available.

Financial sustainability relies on understanding budget risks and responding effectively. This would require effective budget management, and appropriate budget scrutiny and transparency would become more important than ever.

Fiscal risks

A report on Pre-budget scrutiny 2020-21 published on 12 November by the Scottish Parliament’s Finance and Constitution Committee provides some interesting insight into work undertaken in reviewing the operation of the fiscal framework.

This report looks at final outturn figures for Scottish income tax for 2017/18, the first fiscal year since the power to set income tax rates and bands for non-saving, non-dividend income was devolved and therefore the first year of operation of the reconciliation process for income tax.

Lessons have been learned from the reconciliation process, which needs to be more transparent. Risks arising from differences in the distribution of the tax base in Scotland and the rest of the UK need to be considered more fully in the Scottish Government’s medium-term financial strategy.

According to the Scottish Fiscal Commission, Scottish earnings growth exceeded UK earnings growth throughout the 2000s and early 2010s, but this then went into reverse. Average Scottish earnings growth – the key determinant of growth in income tax revenues – has been slightly slower than average UK earnings growth for several years now.

Under the fiscal framework, there should be no detriment as a result of UK Government or Scottish Government policy decisions. ‘Policy spillovers’ are where either government makes a policy decision that affects the tax receipts or expenditure of the other. There is uncertainty whether increases in the UK-wide personal allowance fall within this definition.

The report discusses the current delay in plans to assign part of the VAT receipts attributable to Scotland to the Scottish Budget. As FAI suggests, it seems that VAT assignment does not bring scope for any distinctiveness or divergence to Scottish tax policy, nor can it be clearly linked to the Scottish Government’s economic policy, so it may be an unwanted power.

Finally, of interest to those paying land and buildings transaction tax (LBTT) on acquiring buy-to-let dwellings or second homes, the Finance and Constitution Committee acknowledges that challenging circumstances can arise from the additional dwelling supplement in individual cases, and that the Scottish Government needs to undertake further work on this matter.

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