First Spending Review in a decade provides welcome insight on Government priorities, and highlights scale of challenge facing public services

Context

Today’s Spending Review is the first multi-year spending settlement published by the Scottish Government since 2011. It covers the government’s spending plans for the remainder of this term of parliament – from 2023/24 to 2026/27.

The government should be given credit for setting out its plans for the remainder of the parliament, as this provides the context for a much more informed public debate about the outlook for the public finances and the implications of spending decisions.

The outlook

The government warned that the outlook was challenging. It is. The block grant from the UK government – the key factor determining the size of the Scottish budget – is projected to barely increase at all in real terms between 2022/23 and 2025/26, and then increase slightly in the final year of the forecast.

If you want a slightly more upbeat perspective, it is worth bearing in mind that the devolved budget in 2022/23 is at a relatively high level in a historic context.

The outlook for the contribution of income tax revenues to the budget has deteriorated in 2022/23 and 2023/24 compared to the position in December 2021 (Chart 1). But the outlook has improved considerably in later years, partly because of changes to assumptions about Scottish and UK government income tax policy.  In particular, the decision of the UK Government to cut the Basic Rate to 19% from 2024-25 is improving the net position (as it lowers tax receipts in the rest of the UK).

Chart 1: The implied income tax net position, 2019/20 – 2026/27

Source: Scottish Fiscal Commission

The plans

Spending plans are expressed at ‘level 2’ for the four years of the SR period. That’s less detail than desirable for the first two years, but understandable for the final two years, when uncertainty around the budget outlook is much higher. The focus on Level 2 means that there are no specific allocations for organisations whose funding is at ‘level 3’ or ‘level 4’ – these include for example SEPA, Health Boards, Zero Waste Scotland, and many others.

Nonetheless, even at this relatively aggregated level, the key direction of travel when it comes to resource spending is clear enough – and the effects are stark.

The government said it would prioritise spending on health, social care, and social security.

Whilst spending on these areas is projected to increase over the spending review period, many other significant areas of public spending see their allocations remain flat in cash terms throughout the SR period.

It does not need to be said that when inflation is high, a budget that is flat in cash terms is declining in real terms.

The Spending Review implies that the local government budget will decline by 7% in real terms between 2022/23 and 2026/27. The enterprise agencies see their allocations decline by 16%. Meanwhile, universities and colleges (including student grant support), the police authority, prisons, fire and rescue services and the legal aid budget, amongst other areas, see real terms declines in their allocations of 8% over the period.

However, this does not necessarily mean that the ‘protected’ areas are awash with cash. The health budget is projected to increase by only 3% over the parliament. Whether this is sufficient to meet the government’s aspirations – addressing pandemic pressures and dealing with other budgetary pressures – seems doubtful.

Whilst spending on health is set to increase by almost £2bn over the course of the parliament, spending on social security is set to increase by a similar amount in cash terms, reaching over £6bn by the final year of the parliament.

Importantly, spending on social security is now forecast to exceed the additions to the Scottish block grant by over £700m in the final year of the Spending Review period (see chart 2). This difference largely reflects policy decisions by the Scottish government around the newly devolved disability and carer benefits.

But it does not include the costs of ‘new’ Scottish social security payments notably including the Scottish Child Payment; these add a further £500m to social security spending each year.

Chart 2: Social security spend net position (BGA less spending), May 2022 forecasts

Source: Scottish Fiscal Commission

Uncertainties

There are of course uncertainties around all this. The UK government may increase its plans for public spending in light of the impacts of higher inflation and continued pressure on the public finances. The flipside – reductions in UK government spending plans – is also possible but seems relatively less likely.

One way in which the government plans to manage and mitigate spending pressures is to freeze the public sector pay bill at 2022/23 levels. Assuming some pay increases, this can only be achieved managing the size of the public sector workforce back to pre-pandemic levels. How realistic this is in the face over surging inflation – with many public sector workers calling for higher pay increases – remains to be seen.

A black hole?

There was much discussion in the lead-up to the Spending Review of a ‘black hole’. It was in fact the government’s own analysis in December 2021 which showed a £3.5bn gap between its total spending aspirations and its likely budget in 2026/27.

This analysis was undertaken by the government to provide context on the scale of the challenge and manage expectations. The gap itself was rather meaningless, as it wasn’t clear what spending assumptions had gone into it.

In reality, there can’t of course be a funding gap or black hole because the Scottish government has to run a balanced budget. What we don’t know explicitly is which elements of its spending aspirations the government has had to do without to bring its aspirations into line with budget reality.

Summary

In FAI’s 2021 Budget Report, we argued that the government’s ‘commitments on health, social care and social security imply that the resources available to the Scottish government to fund spending on remaining areas of public policy are likely to decline in real terms between 2022/23 and 2024/25’.

This is indeed exactly what today’s Spending Review sets out starkly. In fact the cuts pencilled in for many areas of public spending exceed the 1% annual real terms cuts that we said were likely.

The outcomes of today’s Spending Review is therefore not a surprise. The real terms erosion of the funding allocations of local authorities, police, universities and colleges represents the continuation of a longer trend.

Whether these decisions are the right ones is for others to debate. But it is useful to see the future direction of the government’s spending plans set out more transparently than we have been used to in recent years, not least as this can set the scene for more informed discussions about budget challenges and priorities in future.