The Scottish Government’s Five Year Financial Strategy

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The Scottish Government published its Five Year Financial Strategy yesterday.

Publication of this document follows a recommendation of the Budget Process Review Group (BPRG) that the Scottish Government takes a more medium to longer-term approach to financial planning.

The document was also envisaged by the BPRG as giving a focal point for parliamentary scrutiny of some of the medium term opportunities and challenges for the Scottish public finances.

The document is informed by the latest Scottish Fiscal Commission (SFC) forecasts for tax revenues, Social Security spending and economic growth, which are produced twice per year. These forecasts, along with other assumptions, underpin the Scottish Government’s projections for available resources in the coming years.

Continued subdued economic growth

The SFC forecast for GDP growth is broadly the same as it was in December. The SFC envisages that Scottish growth will remain below 1% per annum for the forecast period through to 2023. This is significantly below the overall GDP growth forecast for the UK produced by the Office for Budget Responsibility (OBR).

Slow growth will feed through in to Income tax receipts

In its report on Draft Budget 2018-19, the Finance and Constitution Committee noted the following with regard to the impact of the SFC’s weak GDP growth outlook for tax revenues and the Scottish budget:

“While it is not clear what the impact will be on income tax revenues there is nevertheless some risk to the public finances which will require close monitoring by both the Scottish Government and the SFC.”

The latest SFC forecasts highlight this risk as they adjust down the forecast for income tax relative to their most recent forecasts of February 2018 (which took account of tax changes agreed as part of the Budget negotiations).

Latest income tax forecasts are presented in table 1. For the current financial year, the SFC is forecasting £208m less in revenues from income tax compared to its previous forecast. The SFC say that this relates to lower than expected real wage growth.

Table 1: SFC income tax forecasts (£m)

Budget Bill Financial Strategy Difference (£m) Difference (%)
2017/18 11,584 11,467 -117 -1.0%
2018/19 12,177 11,969 -208 -1.7%
2019/20 12,647 12,345 -302 -2.4%
2020/21 13,152 12,805 -347 -2.6%
2021/22 13,733 13,335 -398 -2.9%

Forecasts for Land and Buildings Transaction Tax (LBTT) and Landfill Tax are slightly higher than they were in December. The forecast for LBTT in the current year is up £26m (4.4%) and Landfill Tax is up £8m (7.5%).

It is important to note, however, that these forecasts will not directly impact the Scottish budget for the current financial year. Scottish spending for 2018-19 was “locked in” when the Budget Bill was passed in February this year.  Any actual impact will only be felt in future years, when actual revenues are known.  The extent to which these differ from what was forecast will determine the extent of any future reconciliation and adjustment to budgets in future years.  That is, if forecasts turn out to be unduly pessimistic or optimistic, future budgets will be adjusted upwards or downwards to reflect this.

The importance of the Block Grant Adjustment

Under the Fiscal Framework, equally important to the Scottish budget as the SFC revenue forecasts, is the block grant adjustment (BGA) made to the Scottish budget to reflect the revenues foregone by the UK government from the devolution of each tax (see also yesterday’s blog from the Fraser of Allander Institute).

 

Source: SPICe

The BGA is linked to the growth rate of revenues in the “equivalent” taxes in the rest of the UK. If the BGA is also falling, then this has the potential to offset the falling revenues being forecast by the SFC.

However, when the OBR updated its UK forecasts in March this year for the Spring Budget, it raised its income tax forecast for the rest of the UK compared to its previous forecast. This caused the BGA for income tax to increase by £181m.

This means that the latest set of forecasts for Scottish revenues point to the outlook for the Scottish budget worsening in two ways compared with the previous set of forecasts. The SFC has revised down its income tax forecasts by £208m and the BGA has been revised up by £181m. This means that according to the latest set of forecasts, the Budget could be £389m worse off than it was just a few months ago.

As mentioned above, these latest set of forecast will not impact immediately on the Scottish budget. The forecasts that matter for 2018-19 spending are the ones made at the end of 2017 in the UK and Scottish Budgets. We will need to wait until fully audited outturn data is available for tax revenues raised in the current financial year (in 2020) before we know the extent of any adjustments that will need to be made.

The latest set of forecasts, however, suggest that the Scottish Government may need to plug a revenue shortfall by reducing some areas of spend, increasing taxation, borrowing or accessing the Scotland Reserve.

Portfolio priorities

The document does not contain budget allocations “at this stage” or detailed scenarios by portfolio. The Cabinet Secretary in his statement to Parliament highlighted the challenge in doing so, but hinted that this may be possible following the UK Spending Review next year:

“we do not currently have any resource budget allocation from the UK Government beyond 2019-20. It is hoped that the UK spending review next year will offer sufficient future year budget information to allow the Scottish Government to develop multiyear budget allocations.”

The document lists a series of already announced policy Budget priorities around Health, the Police, Early Learning and Childcare, Attainment and Higher Education. The implications of these priorities for other parts of the Budget will be subject of future SPICe analysis.

The Financial Strategy

On tax, the document restates the Scottish Government’s approach to taxation founded on the four “Adam Smith principles of certainty, convenience, efficiency and proportionality to the ability to pay”. It restates the approach taken to the setting of tax rates in 2018-19.

The document is noticeable, however, for not including any new Scottish Government strategies for handling the potential economic and budget challenges highlighted by the SFC’s weak economic growth and reduced tax revenue forecasts.  The document’s conclusion includes the following statement:

“This forward look does not set out any new decisions or policy commitments, particularly in relation to the public sector, and only seeks to explore and explain the range of factors and variables which require consideration by the Scottish Government when making financial decisions and undertaking longer-term budget planning.”

Whether this sufficiently meets the expectations of the Budget Process Review Group recommendations for a medium term financial strategy will be debated by Parliament in the coming months.

This blog has also been discussed in a Scottish Parliament podcast.

Ross Burnside, Senior Researcher, Financial Scrutiny Unit