Scots face escalating Budget risks
In the latest forecasts published by the Scottish Fiscal Commission, Donald Drysdale finds much instructive detail about the budgetary risks facing the Scots.
Role of the SFC
The Scottish Fiscal Commission (SFC) is the independent fiscal institution for Scotland. Its statutory duty is to provide independent and official forecasts of Scottish GDP, devolved tax revenues and devolved social security expenditure, to inform the Scottish Budget.
The four Commissioners of the SFC are Dame Susan Rice, Professor Alasdair Smith, Professor David Ulph and Professor Francis Breedon.
On 30 May the SFC published its fourth set of forecasts, now covering the years up to and including 2024/25. This 136-page document sets out official economic and fiscal forecasts to inform the Scottish Government’s Medium Term Financial Strategy.
The publication includes a new fiscal overview chapter containing an analysis of the key issues facing the Scottish Budget. This explains the role of the forecasts, the block grant, and the block grant adjustments (BGAs) in determining the size of the Scottish Budget.
It explains how future Budgets will be adjusted once the final out-turn is known and sets out the potential size of such reconciliations, which are a central theme of the report.
The Scottish Government’s Budget is becoming more complicated. Firstly, more tax and spending powers are being devolved to the Scottish Parliament. Secondly, adjustments need to be made to account for the differences between the forecasts and the amounts actually raised from tax or spent on social security.
Together these factors create greater fiscal risks which will need to be managed using the existing limited borrowing and budget transfer powers.
The Scottish economy
The SFC observes that economic growth in Scotland, at around 1.3% over the last year, exceeds the average 1% growth since 2010. Unemployment is at historic lows, and earnings growth has started to rise. A fall in sterling has supported a strong net trade performance.
In 2019 and 2020 the SFC expects Brexit uncertainty to limit growth. Business investment, which fell in 2018, is expected to decline for the next two years. Overall, the report projects growth of 0.8% in 2019 and 0.9% in 2020 – thereafter returning to a longer-term trend of around 1.2%.
The SFC assumes that the UK will leave the EU this October, followed by a transition period lasting until December 2020; that new trading arrangements with the EU and others will slow import and export growth; and that the UK will tighten its migration regime. It discounts a no-deal Brexit, acknowledging that this remains a significant downside risk to its forecasts.
Although the latest forecasts from the UK’s Office for Budget Responsibility (OBR) expected that Brexit would have occurred on 29 March, the SFC considers its own new assumptions to be broadly in line with the OBR’s, with no significant or fundamental differences in outlook for the UK and Scotland.
Social security spending is harder to control than other areas of spending. It is determined by the number of eligible applicants, all of whom must be paid.
Scotland Act 2016 reserves certain social security benefits to Westminster. These include Universal Credit, Contributory Job Seeker's and Employment Support allowances, Child Benefit, Maternity Allowance, State Pension, Pension Credit and Bereavement benefits.
By contrast, Ill Health and Disability Benefits are devolved to Holyrood, together with Carers Allowance, Sure Start Maternity Grant (now Best Start Grant), Funeral Expenses, Cold Weather Payments and Winter Fuel Payments, Discretionary Housing Payments and some powers over Universal Credit (e.g. the ability to split payments among household members).
In 2019/20 the Scottish Government will spend an estimated £447m on social security. From April 2020 the Scottish Government will be responsible for payment of all devolved benefits, projected as £3.5bn in 2020/21 before any policy changes are taken into account.
The Scottish Government plans to reform some benefits and how they are delivered, without knowing yet exactly how such changes will be implemented or how people eligible will respond. Forecasting spending on new benefits or those that are changing adds extra uncertainties.
The Scottish Government will have to meet its expenditure on devolved social security benefits as it arises, even if this differs from the initial Budget forecast.
In 2020/21, £15.9bn of the Scottish Budget will come from tax revenues. These will consist of £12.3bn from Scottish income tax, £2.9bn from non-domestic rates, £691m from land and buildings transaction tax (LBTT) and £87m from Scottish Landfill Tax (SLfT).
The SFC forecasts a series of large negative adjustments for income tax. Compared with previous estimates, the Scottish Government will receive £229m less in 2020/21, £608m less in 2021/22 and £188m less in 2022/23.
As a result of these negative adjustments, less money will be available for future Scottish Budgets. The Scottish Government will be able to manage some but not all of this shortfall through borrowing or by using the Scotland Reserve. However, it will also have to adjust its spending plans or increase taxes.
Subject to political manoeuvring, assignment of a proportion of VAT revenues to Holyrood may be delayed. Had it already been implemented, it would have replaced some £5.9bn of the Scottish Budget in 2020/21. Currently the SFC sees a risk to the Scottish Budget from implementation of VAT assignment because of the limited history of estimates and forecasts.
Devolution of air passenger duty (APD) and its replacement in Scotland by air departure tax (ADT) have been delayed. Scotland’s share of APD is estimated at £307m.
The SFC highlights two particular longer-term risks for the Scottish Budget, and therefore for Scots in general.
One is the Scottish Government’s obligation to manage the huge increase in social security expenditure for which it will become responsible from April 2020.
The other is the new environment in which the UK Treasury will begin to make adjustments to reflect actual income tax collected. In coming years there will be a greater number of such reconciliations applied to each Scottish Budget.
These factors represent risks that significantly threaten the size of the Scottish Budget and increase the potential volatility of future expenditure to which the Budget is exposed. The important thing is how the uncertainty and volatility are managed.
The fiscal framework gives the Scottish Government key management tools. First, resource borrowing powers allow it to borrow to manage forecast errors. Second, the Scotland Reserve enables it to set aside any savings or surplus fully-devolved tax revenues from any particular year, to be drawn down in future years.
Beyond those specific powers, the Scottish Government may need to manage the Budget risks by exercising prudent housekeeping and adjusting its spending plans. However, ‘austerity’ is a controversial word north of the border.
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