For some time now, a niche group of Scottish budget aficionados have been discussing the issue of “Income Tax reconciliations”. For non-budget aficionados reading this blog, Income Tax reconciliations are budget adjustments that need to be made to account for the difference between what forecasters thought would be raised in Income Tax in their original forecasts and what was actually raised in reality.
We have some experience of this now. The current year’s budget (2020-21) incorporated a £204 million negative Income Tax reconciliation. This related to the amounts raised (outturn) for 2017-18 compared with the forecasts made when the budget for 2017-18 was set, and was applied to the 2020-21 budget.
The 2018-19 reconciliation (to be applied to next year’s 2021-22 budget) was expected to be large, with the most recent forecasts indicating that a downward reconciliation of £555 million was in the offing.
Today’s publication by HMRC of Income Tax outturn figures, however, confirms a negative reconciliation figure of £309 million, which is much less than the most recent forecasts suggested.
What this means is that the Budget the Scottish Government plans to bring to the Parliament in December will be reduced to the tune of £309 million to accommodate these Income Tax outturn figures. While still a sizeable negative reduction, it is much less than feared and probably had been planned for by Scottish Government Ministers.
So, what is driving these numbers?
Calculating the reconciliation requires comparing the forecast and outturn figures for the Scottish Government’s Income Tax revenues and for the Block Grant Adjustment (BGA) – the BGA is an estimate of the revenue foregone by the UK Government for transferring Income Tax powers to the Scottish Parliament.
A joint document published by the Scottish Government and HM Treasury points out that the two reconciliation components have the following effect:
- Block Grant Adjustment: The block grant adjustment is lower than was forecast at the time of the 2018-19 Scottish Budget so this has the effect of increasing the Scottish Government’s block grant by £312m in 2021-22.
- Scottish Income Tax revenues: The Scottish Income Tax outturn is lower than was forecast at the time of the 2018-19 Scottish Budget so this will reduce Scottish Government self funding by £621m in 2021-22.
The net reconciliation effect is a £309m reduction in the Scottish Budget for 2021-22.
The SFC make the fair point that a large part of the £621 million over-estimation of Scottish Income Tax receipts made when the 2018-19 Budget was set related to them having only sample data and not access to accurate historical outturn data when they made their forecast. They say that this accounts for £538 million of the £621 million ‘forecast error’.
On the other side of the equation, the forecast for the BGA, which is a figure derived from the forecasts of the Office for Budget Responsibility (OBR), was overestimated to the tune of £312 million.
The HMRC document does show some encouraging signs in the Scottish Income Tax data
The good news in the HMRC data was that the Scottish Income Tax data surprised forecasters on the upside.
The data shows that in 2018-19 Scottish Income Tax revenues grew by 5.9% (compared with 4.4% for the UK as whole).
It also shows that the number of higher rate taxpayers outgrew the UK (there is a lower threshold at which Scottish taxpayers pay the Higher rate); and that the Additional Rate Taxpayers in Scotland grew (+7.9%) at a similar rate to the UK as whole (+8.0%). This is important given the Income Tax revenues generated by higher earners.
Do the Scottish Government have any fiscal tools to offset this reconciliation?
The Fiscal Framework allows the Scottish Government to borrow up to £300 million for forecast errors, which is obviously just less than the forecast error arising in this instance. It is important to note that there will be adjustments made to the Scottish budget for other powers devolved to the Scottish Parliament in recent years (although Income Tax is by far the most significant in terms of value). This means that the net final “reconciliation” figure may be more or less than £309 million. We will have more information on the net impact when the Fiscal Framework Outturn Report is published next month.
Additional flexibilities in the Fiscal Framework agreement allow the Scottish Government to draw down from the Scotland Reserve up to £250 million for day-to-day spending (Resource) and £100 million for Capital.
The COVID-19 pandemic has seen debates grow around the adequacy of the Fiscal Framework flexibilities in a time of national crisis. These debates will surely continue. However, there will some relief that the 2018-19 Income Tax reconciliation was lower than anticipated and not significantly higher than the £300 million borrowing flexibility the Fiscal Framework agreement allows for.
Ross Burnside, Senior Researcher, Financial Scrutiny Unit