Over the next month there will be several publications which will inform pre-budget scrutiny in the Scottish Parliament. Yesterday, the Scottish Fiscal Commission (SFC) published the first of these – their updated economic and fiscal forecasts. This forecast sets out how the expected performance of the Scottish economy will feed through to the Scottish Budget, and cover the period to 2030-31.
These forecasts were originally planned to accompany the Scottish Government’s medium term financial strategy, but the MTFS has been delayed until 25 June to follow the UK Spending Review on 11 June, as explained in a recent SPICe blog. These forecasts are therefore based on current policy, and will be updated next month to account for any policy changes outlined in the MTFS.
This blog will give an overview of the key messages, looking in particular at the outlook for funding for the Scottish budget, the net tax position and social security spending.
What do the new economic forecasts tell us?
The SFC forecasts cover 4 main areas;
- Scotland’s economy and how average earnings are expected to change,
- the performance of devolved taxes (Non-savings, non-dividend Income Tax, Land and Buildings Transaction Tax, and Scottish Landfill Tax),
- how the performance of devolved taxes feeds through to public finances; and
- the outlook for social security spending (which assumes that current and announced Scottish Government policy is delivered).
Economic growth is expected to remain fairly muted in 2025, with only a small pick up in 2026-27. Over the forecast period, GDP growth remains low compared to historic levels.
Inflation has already increased during 2025-26, largely driven by the impact of increasing consumer bills in April, such as energy bills which rose for many due to Ofgem increasing the price cap, as well as annual increases to bills like council tax. The SFC expect it to remain above the Bank of England 2 per cent target for the remainder of the year, before reducing to 1.9 per cent in 2026-27 and thereafter remaining around the 2 per cent target.
The outlook for real earnings growth remains muted – while positive it hovers around or just below 1 per cent throughout the forecast.
The latest labour market trends publication from the Scottish Government shows that the estimated unemployment rate for January to March 2025 rose to 4.5%. The SFC forecast that it will remain above 4 per cent throughout 2025-26, and remain relatively static throughout the forecast period.
What about the fiscal outlook?
Funding available to the Scottish Government is determined by the policy decisions and performance of devolved taxes, as well as decisions made by the UK Government. This forecast is therefore sensitive to forthcoming changes that will be announced at the UK Spending Review, and in the MTFS, both of which will be published next month. On the funding allocations to be announced in the UK Spending Review, the SFC note that:
“We have had to make some assumptions to update the funding position in future years. The UK Spending Review on 11 June 2025 will confirm how the UK Government plans to allocate spending between departments. We have assumed that spending in devolved areas grows broadly in line with planned total growth in departmental budgets, with an adjustment to capital spending for announcements on defence spending. However, should the UK Government choose to allocate less to devolved areas, such as by further prioritising defence, it will result in funding being lower than we forecast.”
Resource funding grows in each year, although slows in 2027-28 due to a larger anticipated income tax reconciliation (this relates to the 2024-25 budget year). Reconciliations take place when actual tax receipts turn out to be different from the forecast receipts that were factored into the budget when it was set.
The SFC notes that the outlook for capital funding is more variable. Capital funding is more reliant on decisions made by the UK Government – around 85% of the 2025-26 capital budget is the core Barnett settlement. In total, the capital budget is projected to grow by just under 6% between 2025-26 and 2030-31 in cash terms. While the capital budget grew significantly between 2024-25 and 2025-26 (15.7% growth in real terms), it is then expected to decline in four of the next five years in real terms.
How do the economic forecasts compare to other forecasters?
There have been several recent forecasts of the UK economy; from the Office for Budget Responsibility (OBR) in March 2025 to accompany the UK Spring Statement, from the Bank of England in their May Monetary Policy Report, from the National Institute of Economic and Social Research (NIESR) in their UK economic outlook (May), and from the International Monetary Fund (May).
Looking across these forecasts, there is a broad consensus that growth in 2025 is likely to be relatively muted in Scotland and the UK, and recent forecasts expect this to pick up slightly in 2026. On inflation, the forecasters expect a slight reduction throughout 2025 following the increase in April, with most forecasters expecting inflation to fall to closer to the Bank of England’s 2 per cent target by the end of 2026.
The SFC forecasts for Scotland look broadly comparable to these UK forecasts; economic growth is expected to be marginally higher than the OBR and the Bank of England expect for the UK in 2025, and both the SFC and the OBR expect slightly higher growth in 2026 than the Bank, NIESR or the IMF, and the SFC’s inflation expectations (for the UK) are consistent with most of the other forecasts for the UK.
What are the key changes since the last forecast?
The economic outlook for Scotland has not changed significantly since the last forecast, which was published alongside the Scottish Budget in December 2024. There is a slight reduction in expected growth during 2025, reflecting slightly weaker data at the end of 2024 and early in 2025. There are a few more significant changes though:
- The OBR forecasts for average earnings in the UK have changed, and are now more in line with the SFC projections for Scotland. This reduction in the difference between Scottish and UK performance has implications for the tax forecast, and importantly the block grant adjustment (BGA), which is the amount by which the Scottish Government’s block grant is adjusted to reflect devolved tax and social security powers. The improved outlook for earnings growth in the UK means that the block grant adjustment will be larger than anticipated at the time the 2024-25 Budget was set.
- The SFC now expect greater social security spending compared to social security BGAs, particularly in the later years of the forecast. £0.2 billion is due to the cost of the Scottish Government’s policy to mitigate the two child cap, and £0.4 billion is due to reduction in the BGA following changes announced to UK welfare policy this year. If the UK Government changes any decisions that have been announced – for example to the two child cap or winter fuel allowance – this would affect the mitigation costs and the net position on social security.
- Total funding in 2025-26 is nearly £0.8 billion higher than assumed in December, because of additional UK Government funding and an increase in drawing down from the Scotland reserve (£200 million was added to Scotland reserve in the 2024-25 Spring Budget Revision which will be drawn down in 2025-26).
Budget net tax position
One of the important features in the operation of the fiscal framework is the economic performance of Scotland relative to the UK, in particular the growth in average earnings. We discussed this in more detail in a previous SPICe blog. The SFC forecast will set out how much is expected to be raised by devolved taxes in Scotland, while the OBR forecast will set the amount by which the Scottish budget will be reduced through the block grant adjustment for devolved taxes.
While the resources available in budgets are set using forecasts, when actual (outturn) data is available this is reconciled. The SFC forecasts the net tax positions in future years using the latest assumptions from the OBR.
Of course, it isn’t just relative economic performance that affects the revenues raised by devolved taxes – policy choices do as well. Since 2017-18, the Scottish Government has increased the number of bands and changed the rates in Scotland, with the net effect that while most taxpayers will pay less than they would in the UK, higher earners will pay more.
As noted above, one of the main differences between the latest SFC forecasts and its December 2024 forecast is the relative improvement in the OBR’s forecast for earnings growth in the UK. The impact of this is to reduce the difference that existed at the time of the previous SFC forecasts which informed the 2024-25 and 2025-26 Scottish Budgets. A smaller positive difference means that the Scottish Government should have had fewer resources available than was assumed, and so this difference will impact future budgets. The SFC explain that:
“There is a large negative reconciliation of £851 million currently projected for 2027-28 relating to the 2024-25 Income Tax net position. This is largely because the Block Grant Adjustment (BGA) has increased by substantially more than our Scottish Income Tax forecast since the 2024-25 Budget was set in December 2023. The reconciliation has become more negative since December 2024 when we projected it at minus £701 million. If a reconciliation of this scale materialises, it will exceed the borrowing limit, which is currently forecast to be £663 million. Therefore, resource funding in 2027-28 may be reduced even if the Scottish Government makes full use of its borrowing powers.”
Social security expected to account for an increasing proportion of resources
Following the Scotland Act 2016, aspects of social security have been devolved to the Scottish Parliament. From a fiscal point of view, this operates in a similar way to the tax reconciliation. The OBR calculates what expenditure on social security would be in Scotland if there was no policy divergence, and this determines the block grant adjustment. The Scottish Parliament then sets social security policy, and any differences in the cost of delivery compared to the BGA must be covered from elsewhere in the Scottish Budget.
The Scottish Government has adopted policy which has broadly increased access to existing social security payments, introduced new policies such as the child payment, and spent or committed to spend to offset the impact of certain UK policies such as the two-child cap and winter fuel payment. As a result, the costs of delivering social security policy in Scotland have consistently been higher than the BGA, and the SFC forecasts that this gap will continue to grow. However, as noted above, any changes to UK policy in these areas would have implications for the gap between BGAs and Scottish social security spend.
This chart shows that as a proportion of total spending, social security is expected to rise from 11.0% in 2024-25 to 13.3% in 2029-30. Meanwhile, the difference between the social security BGA and the costs of delivery in Scotland is expected to increase from £922 million in 2024-25 to over £2 billion by the end of the forecast period – accounting for over 3% of all spending.
How will the Scottish Government respond to this fiscal pressures?
The Scottish Parliament must balance its budget, which means fiscal pressures such as lower than expected revenues from devolved taxes, relatively stronger economic performance in the rest of the UK, or pressure to increase spending in areas such as social security will require trade-offs with other policy areas.
In recent fiscal sustainability reports, the SFC has highlighted two long term challenges which will increase the pressure on the Scottish Budget – the transition to net zero with the significant investment required (alongside the costs of adapting to an already changing climate), and the demographic challenge that Scotland and other developed countries face through aging populations.
The updated forecast from the SFC sets out the financial context for the remainder of this parliamentary session, and suggest that the final Scottish Budget before the election will face some difficult trade offs. Next month’s publication of the MTFS and the Fiscal Sustainability Delivery Plan should provide us with more information on where the Scottish Government intend to prioritise funding, and how they plan to address the medium term challenges.
Andrew Feeney-Seale, Senior Researcher, Financial Scrutiny Unit, and Andrew Aiton, Data Visualisation Manager
“Money” by Peter is licensed under CC BY-SA 2.0.