Scotland’s fiscal outlook: possible large reconciliations ahead

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The Scottish Government published its Medium-Term Financial Strategy (MTFS) yesterday.

The document is informed by the latest Scottish Fiscal Commission (SFC) forecasts for tax revenue, social security spending and economic growth, which are published twice per year. These forecasts, along with other assumptions, underpin the Government’s projections for their available resources over the period covered by the MTFS.

Economic growth forecasts are down in the short term due to Brexit uncertainty

 The SFC has revised down its short-term GDP growth forecast from December citing “ongoing uncertainty created by the Brexit negotiation process”. They are projecting that growth will fall from the 2018 outturn figure of 1.3% to 0.8% in 2019 before rising slightly to 0.9% in 2020.

SPICe_FSU_2019_MTFS May__Scottish GDP Forecasts

This is below the overall GDP growth forecast for the UK produced by the Office for Budget Responsibility (OBR) at the Spring Statement in March – 1.4% in 2018 and 1.2% in 2019 and 1.4% in 2020.

However, as the figure below shows, Scottish GDP per head over the forecast period is much more closely aligned with the UK as a whole. It is slower population growth in Scotland that is driving the overall slower GDP growth. On a per person GDP basis, the SFC economic forecasts show that Scotland is expected to converge with the UK, but “remain lower overall because of slower productivity growth in Scotland.”

SPICe_FSU_2019_MTFS May__AV economic growth

Income tax forecasts point to a large shortfall in future budgets

The big story from these forecasts for the Scottish budget relates to the anticipated reconciliations that may need to be made at future budgets.

The forecasts that matter for the setting of the budget are the ones made by the SFC (for revenues) and the OBR (for the block grant adjustment) at the time of the Budget. These are then locked in and that is what is available for public spending.

Under the Fiscal Framework, as the chart below shows, 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.

SPICe_FSU_2017_DraftBudget_How is the budget determined

However, the Budgets are then subsequently reconciled with outturn income tax receipts some 16 months after the end of the financial year. The first reconciliation for income tax in 2017-18 will be made in July 2019, and applied to the Scottish budget set for 2020-21, which will be published in late 2019.

The latest income tax forecasts suggest that the Scottish Government may need to plug a significant revenue shortfall in each of the next three years because forecasts have changed since the budgets were set. However, it is important to note that these are just forecast reconciliations at this stage. The actual reconciliations could be better or worse.

Over the three years these reconciliations total over £1 billion. This means on latest forecasts the Scottish budget has allocated over £1 billion that it may not actually have had.

Table 1: Income tax reconciliations

Budget year
Outturn data published
Budget affected
Forecast econciliation(£ million)
Summer 2019
Summer 2020
Summer 2021

Source: Scottish Fiscal Commission

Options available to the Scottish Government for addressing the reconciliations if and when they arrive might include reducing some areas of spend, increasing taxation, borrowing or accessing the Scotland Reserve.

The forecast reconciliation is highest in 2021-22 when the Cabinet Secretary is potentially faced with a shortfall of over £600 million. This is an amount that exceeds the resource borrowing limit of £300 million for forecast error set by the Fiscal Framework; and is also significantly higher than the Scotland Reserve access limit of £250 million Resource and £100 million Capital set out in the Fiscal Framework.

If reconciliations exceed the flexibilities provided by the Fiscal Framework for dealing with them, that may be an issue for consideration when the Fiscal Framework is reviewed in 2020 and 2021.

A more detailed SPICe briefing covering the outlook for other devolved taxes will follow in due course.

Portfolio priorities

The document contains high level projections for the total spending envelope over the coming years, but no new information on how the Scottish Government plans to distribute budgets.

It is the Government’s intention to publish a Scottish Spending Review following on from the UK Spending Review. The Government also notes its intention to publish a three-year settlement for local government when it delivers its budget later this year. Chapter 4 of the MTFS sets out the Spending Review framework criteria that will govern the assessment of budgets, but no new decisions or spending commitments are presented in the document.

This document is an important element of the information produced by the Government to support the new parliamentary budget process.  The extent to which subject committees find the document of use in adding value to their pre-budget scrutiny work will be debated in the coming months.

Ross Burnside, Senior Researcher, Financial Scrutiny Unit