Fiscal Policy and Tax, Scottish Economy

Scotland’s Budget 2016

Graeme Roy, David Eiser and Anna Murray

On Tuesday we’ll be publishing our new annual report – Scotland’s Budget 2016 – at a conference in Edinburgh.

The report will set out the key opportunities and risks facing Derek Mackay as he prepares to deliver his first Draft Budget later in the year.

This year’s budget is especially important for a number of reasons.

First, it follows a period of unprecedented cuts to Scotland’s budget. Funding for day-to-day public services such as the NHS, teachers etc is down around 5% since 2010/11.

Second, it is highly likely that Mr Mackay will have to plan for a fiscal and economic outlook that is now much more uncertain and challenging – with important knock-on effects to the resources available for public services.

Third, and arguably most importantly, it marks the first budget in which a Scottish Finance Minister will be able to use Scotland’s new income tax powers (as well as factoring in the welfare powers to follow in later years). From next year, around 40% of the Scottish budget will be funded by tax revenues collected in Scotland – a figure that will rise to 50% once VAT revenues are assigned later in the parliament.

Our report will pull all of these elements together and set out the outlook for Scotland’s Budget over the course of the new parliament.

What are the key factors to watch for?

First, the new Chancellor has set that he will ‘reset’ UK fiscal policy following the UK’s vote to leave the EU.  We don’t yet know what he exactly means by reset. But if it changes public spending across the UK this could, via the Barnett Formula, have knock-on effects for the chunk of the Scottish budget that is still determined by the block grant from Westminster.

Second, what is crucial in determining the size of the Scottish budget in future years is not just the revenues raised from the devolved taxes in absolute terms. Instead, what matters is the growth rate of the devolved revenues relative to the growth of the equivalent taxes in rUK. This subtle point is not yet widely understood. Scotland’s budget will be neither better nor worse off relative to the previous arrangements, provided Scotland’s devolved and assigned revenues grow at the same per capita rate as the equivalent taxes in the rest of the UK. If Scotland outperforms the UK then the Scottish budget will be higher relative to this baseline; but the Scottish budget will be worse off if devolved and assigned revenues grow relatively slowly. So Scotland’s growth outlook will be crucial.

Third, the size of the Scottish budget will also be influenced by choices made on tax policies, whether these are tax cuts (e.g. the planned lowering in Air Passenger Duty) or tax increases (e.g. the Scottish Government’s plan to freeze the higher rate threshold on income tax).

Finally, the spending commitments that the Scottish Government makes will have potentially significant implications for the way in which resources are distributed across public services in Scotland.

Without revealing our conclusions (just yet!), what is clear is that taking all these factors into consideration, the outlook for the Scottish budget is likely to remain highly constrained over the course of the new parliament.

Coming on the back of six years of cuts, tough choices will have to be made. This won’t be easy. But then again, this is what greater fiscal responsibility is all about.


The Fraser of Allander Institute (FAI) is a leading economy research institute based in the Department of Economics at the University of Strathclyde, Glasgow.