Picture of stacked coins and the Scottish budget document

Budget 2022-23: Mind the (Block Grant Adjustment) Gap

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This is an initial blog analysis of the 2022-23 Budget. More detailed SPICe briefings and additional blogs will follow in due course.

Yesterday, the Cabinet Secretary for Finance and the Economy presented the Scottish Government’s tax and spending plans for 2022-23 to the Parliament, alongside a wide range of other policy documents.

This is an extended blogpost, so to help with navigation, please use the contents pop-out below.

Note for budget nerds: The publication of the Budget documentation and figures immediately highlighted a political disagreement about how the numbers are presented. In its October Budget and Spending Review, the UK Government presented the 2022-23 Scottish Budget as representing a 7.7% real terms (inflation adjusted) increase in Scotland. The UK Government reached that figure by taking out the COVID support funding provided for 2021-22 from the baseline. They argued this allowed for a like-for-like comparison as the UK Government hopefully winds-down direct pandemic related fiscal interventions.

The Scottish Government, however, has presented the numbers differently, including the 2021-22 COVID funding in the baseline. The Scottish Government argues that as the pandemic is still with us and requiring financial support, it is better to include COVID funding in the baseline.  The effect of presenting the numbers this way is to show the Scottish budget falling in real terms in 2022-23 relative to 2021-22.  

Detailed SPICe briefings and more infographics will follow, but the overall spending numbers presented in the budget document compared to this year (2021-22) are shown in the following infographic.

Infographic showing budget changes in cash and real terms from 2021-22 to 2022-23.  TME decreases by 0.7% in real terms, Resource decreases by 2.8% in real terms, Capital increases by 1.2% in real terms.  AME increases by 11.6% in real terms and Non-Cash decreases by 22.1% in real terms.

Yesterday, alongside the Budget, the Scottish Fiscal Commission (SFC) published its latest economic and fiscal forecasts, which are key to determining the overall size of the Scottish Budget.

Let’s look at the key SFC judgements…

SFC forecasts

For the economy

The SFC forecasts for the Scottish economy are far more buoyant than they were in January this year, when the previous Budget (for 2021-22) was being framed. This is due to the opening up of the economy and the successful roll out of the vaccine programme. As a result, the SFC is now expecting economic growth of over 10% this year, with Scottish economic activity returning to pre-pandemic levels by the second quarter of next year – far earlier than previously predicted.

However, there are economic risks on the horizon, chief amongst them the new COVID ‘omicron’ variant, which has dominated the news agenda in the last couple of weeks. The SFC had ‘closed’ its forecast prior to the detection of this new variant, meaning that the economic outlook does not contain SFC judgements as to any possible economic impact from the new variant taking hold in the UK.

Another risk to the future economic outlook stems from inflation, which has increased in recent months, driven by high energy prices. The SFC central view is in line with that of the Office for Budget Responsibility (OBR) and Bank of England, and sees annual CPI inflation peaking at 4.4% in the second quarter of 2022. The SFC points out that if inflation remains high for a prolonged period, this will erode real disposable income and household consumption. Low income households could be disproportionately affected as they spend a higher proportion of their income on essentials like energy.

For tax receipts

The SFC expects Scottish income tax revenues to grow more slowly than in rUK, with significant implications for the size of the Scottish spending envelope.  

Key to determining the size of the Scottish budget are the SFC forecasts on tax receipts. Where the SFC tax forecasts are higher than the offsetting Block Grant Adjustment (BGA) for taxes, the Scottish Budget is better off than it would be without fiscal devolution. Therefore, the converse is also true – if the SFC tax forecasts are lower than the offsetting tax BGA, the Scottish Budget is worse off than it would have been without fiscal devolution. 

For 2022-23, the SFC is predicting that the Scottish budget will be worse off than it would be without income tax powers to the tune of £190 million. This is despite people living in Scotland paying around £500 million more in income tax overall than income tax payers south of the border (more detail on income tax policy is set out below).  The different income tax policy in Scotland has not been enough to compensate for weaker employment and earnings growth and the differences in the taxpayer mix. For more detail on income tax in Scotland, please see our detailed briefing from earlier this year.

Sadly for Scotland’s public finances, the SFC expects this BGA income tax gap to grow over the forecast period, reaching £417 million by 2026-27.

As readers of these blogs will know, the final outturn numbers are reconciled down the line, and the Cabinet Secretary will be hoping that these large gaps are reduced.

The income tax policy for 2022-23 means that all taxpayers in Scotland will pay slightly less income tax than they did in 2021-22.  However, the changes are very small – only 65p over the year for those in the lowest half of the income distribution and £4.57 over the year for the rest.  On the other hand, around half of taxpayers are paying more tax than they would elsewhere in the UK and here the differences are much bigger – around £1,500 for those earning £50,000.

For social security spend

SFC forecasts on social security also point to an increasing gap between the BGA being provided to the Budget and the spending being required to fulfil policy. For social security powers BGAs are added to the Scottish budget to reflect spending foregone by the UK Government. In 2022-23, the BGA added to the Scottish budget in respect of social security is £3,587 million, but the forecast spend on social security is £4,065 million, a gap of nearly £500 million.  Much of this difference is explained by the introduction by the Scottish Government of new social security payments which would not be expected to be covered by the BGA, because they are unique to Scotland, such as the Scottish Child Payment.

The SFC forecasts that by 2024-25, spending on social security in Scotland will be £750 million more than the corresponding funding received from the UK Government.

The SFC states that the Scottish Government will need to carefully manage these funding gaps identified in income tax revenues and social security spend in the future. This will be something for Parliament to watch closely in the upcoming Spending Review, planned for May next year.

The spending outlook for 2022-23

The Cabinet Secretary has made some decisions which will increase the spending power of the budgetary envelope. These include using some of the flexibilities afforded by the Fiscal Framework with the UK Government, via the drawing down of £179 million from the Scotland Reserve, borrowing £15 million in Resource and £450 million in Capital.

Additionally, the plans include some assumptions around significant anticipated Budget income from UK government transfers (£92 million) and “other income” (£620 million). Commenting on these assumptions, the SFC states:

“In developing its Budget the Scottish Government has assumed that it will receive extra income of £620 million for the resource budget in 2022-23 from a number of sources, some of which are still a matter of negotiation between the Scottish and UK Governments. We have reservations about the likelihood and amount of income available from some of these sources, but, considering the possibility of resource underspends materialising in the current financial year, we consider that, on balance across all the sources together, the Scottish Government assumptions are reasonable.”

The net impact of this means that the Scottish Government discretionary spending power for next year will be £45,588 million (Resource and Capital).

Health and social care spending

The health and social care budget is just over £18 billion in 2022-23, reflecting the priority attached to this area of the budget.  Health and social care resource spending now represents 44% of the total resource budget.  Specific funding for the continued response to the pandemic is not separately identified in the plans for 2022-23, although the document states that “we await the outcome of further detail that was promised in the UK Spending Review to support our plans.”

The Scottish Government states that the proposed budget takes it towards meeting the numerous commitments around health and social care spending that were set out in the Programme for Government. These included passing on all Barnett consequentials received in relation to health resource spending to the health and social care budget and increasing frontline health spending by at least £2.5 billion by 2026-27.  Many of the commitments are hard to track in the budget document as the detail is lacking.  A significant transfer will take place from the health budget to local government in respect of social care (£846.6 million), which includes the £200 million cost of increasing pay for adult social care staff to a minimum of £10.50.  

Local government

The local government budget settlement for 2022-23 is £11,141 million. This is mostly comprised of General Revenue Grant (GRG) and Non-Domestic Rates Income (NDRI), with smaller amounts for General Capital Grant and Specific (or ring-fenced) Resource and Capital grants. Within that, the total revenue budget (for day to day spending) is essentially flat in cash terms (and so a 2.6% real terms (or £284m) reduction) and there is a small cash and real terms increase in the capital budget.

Overall, taking resource and capital together, this represents a £21 million increase over the year, translating as a cash increase of 0.2% or a real terms reduction of 2.5% (or £264m).

Once revenue funding transferred from other portfolios to local government is included, the total is £12,474 million. This represents an increase of £854 million over the year; a cash increase of 7.3% or a real terms increase of 4.5% (or £539m) – this is the figure highlighted in the strategic chapter of the Budget.

Much of this increase comes from funding for additional teachers and support staff, care at home, delivering a £10.50 minimum wage for adult social care staff, as well as other health and social care funding from the Health budget.

It is also worth noting that there is only a one year settlement for local government (and other portfolios of course), despite the UK Spending Review confirming overall Scottish Treasury figures through to 2024-25. 

On Council Tax, the Scottish Government states that local authorities will have full flexibility to set Council tax rates, “enhancing their fiscal autonomy”. The appetite of Councillors to raise significant revenues from council tax, however, may be tested by the local authority elections of May next year.

A few hours after the Budget was presented, COSLA published its initial response. Although acknowledging increases to both the revenue and capital settlements, they argue that much of these additions relate to Scottish Government national commitments which, they believe, will be considerably more expensive for local authorities to deliver than the Budget document assumes. COSLA calculates that these policy commitments and the resulting pressures will cost local government an extra £891 million, so £100 million more than the cash increase of £791 million set-out in the Budget document.

Tax policies

On Income Tax, the largest by value of the devolved taxes, the Scottish Government has decided to broadly keep things the same. It proposes that Income Tax rates will remain unchanged, with the bands at which they are applied increased for lower earners. The Starter and the Basic rate bands will increase in line with September’s CPI (Consumer Price Index) inflation of 3.1%. The higher rate thresholds will remain frozen, meaning earnings of between £43,662 and £150,000 be taxed at 41%. The higher rate threshold will also be frozen, meaning a 46% rate for those earning over £150,000.

Land and Buildings Transaction Tax rates and bands will be maintained at their current levels and Scottish Landfill Tax will increase in line with rUK to avoid any divergence and incentivising of “waste tourism” where one part of the UK has a lower rate of tax on landfill.

On Non-Domestic Rates, the Cabinet Secretary stated that maintaining 100% rates relief for retail, hospitality and leisure (RHL) properties to deal with pandemic effects was not sustainable beyond April next year – the 100% rate relief in England ended in July of this year.

For 2022-23, the Scottish Government proposes 50% rates relief for the first three months for RHL properties, capped at £27,500 per ratepayer. This compares with more generous proposals for the same type of properties in England, with 50% relief for the full year capped at £110,000. However, Scotland does have a slightly more generous basic system for smaller properties with a rates poundage of 49.8p compared with an equivalent of 49.9p in England.

What next?

We now move to the Parliamentary scrutiny phase of the Government’s budget proposals, where Committee and plenary discussions will focus on weighing up these plans. MSPs have a crucial job in raising questions around whether these are the right choices for delivering the outcomes we all want to see.

In light of the Scottish Government and Green Party agreement, this Budget will very likely pass without the need for any post-publication, cross-party horse-trading. However, parliamentary scrutiny and questioning of these proposals is no less important.

Ross Burnside, Nicola Hudson, Greig Liddell, SPICe Research