A busy week of news on the Scottish budget

Its been a busy week of news on the Scottish budget, with three significant announcements.

First, on Tuesday, income tax outturn data for 2018/19 was published. This showed that the Scottish budget will face a downwards ‘reconciliation’ of £309m in 2021/22 as a result of forecast error in 18/19. Whilst this is not great news, the £309m figure is not nearly as bad as the most recent forecasts had implied; these had suggested the reconciliation might be as high as £550m.

The £309m actually observed is fairly manageable, as the Scottish Government can mitigate the impact in budget 21/22 by borrowing almost the full value of the reconciliation (£300m) and spreading the cost over subsequent years.

The other implication of the outturn data is that, whilst it implies that the Scottish tax base (earnings) did grow slightly more slowly in 18/19 than in rUK, the difference in the end was fairly marginal. The government’s five-band income tax policy introduced in 2018/19 did boost its resources by £119m. Realistically this is a disappointment given the original forecasts implied a budget boost of £428m; but recent forecasts had prepared the government for worse news.

Second, the Scottish government published its Autumn Budget Revisions. This re-emphasised the colossal scale of the budgetary changes since March. Resource spending is set to be over £5bn (over 15%) higher this year than set out in the March budget, whilst NDR reliefs will cost around £1bn in lost revenues. These budget changes are possible as a result of £6.5bn of additional consequentials flowing from the UK Government through the Barnett formula.

Third, the UK Government announced that it was cancelling the UK autumn budget. This has significant implications for the Scottish budget.

The normal expectation is that the UK budget will be published in November, paving the way for the Scottish budget to follow in December. The UK budget sets out key parameters for the Scottish budget, including the Barnett consequentials (which determine the block grant), and the UK tax forecasts for taxes that are devolved in Scotland. These directly impact the Scottish budget via the block grant adjustments (BGAs) which are deducted from the block grant and reflect an estimate of the revenues forgone by the UK Government of transferring various revenue streams to the Scottish budget.

How much of a problem is it if the UK budget is not published until March and the Scottish budget has to come beforehand? After all, that is what happened in 2020, without apparently causing significant problems.

Assuming the UK Government does publish a one-year spending review in autumn, this in principle eliminates much of the uncertainty, as it would give a reasonably robust indication of the size of the Scottish block grant.

But the big problem is around the BGAs. If, at the time the Scottish budget is published (in say February next year), the OBR has not produced any UK tax forecasts since March 2020, then there is no remotely viable forecast for UK tax revenues in 2021/22, and hence for the BGAs.

In normal times this absence of a very up-to-date UK tax forecast is less of a problem, and there is a precedent/protocol for how it is dealt with: the Scottish Government can use the latest BGA estimates available at the time of its budget, and these are ‘locked in’ until outturn data is published. In this way, Scottish budget plans are not upended by the publication of a UK budget afterwards.

But the implicit assumption is that the difference between the BGA forecasts available when the Scottish budget is published, and any subsequent BGA forecasts, is not unusually out of kilter.

However, the OBR’s March 2020 forecasts for 2021/22 are likely to look significantly optimistic compared to its next round of forecasts. This means that if the Scottish Government publishes its 2021/22 budget (say in February 2021) using the SFC’s contemporaneous forecasts for Scottish tax revenues, but the OBR’s March 2020 estimates of the tax BGAs, the effect will be a relatively constrained budget settlement. Why? Because the budget will be underpinned by up-to-date, post-Covid forecasts for Scotland, but pre-Covid forecasts for the UK and hence BGAs.

Under the existing precedent, it is true that if the OBR’s updated tax forecasts for the UK, published alongside a UK budget in March 2021 resulted in additional revenues coming to Scotland (which they would assuming that the March 2021 forecasts will be lower than the March 2020 forecasts), then the Scottish Government can choose to take any budget windfall within the 2021/22 financial year.

But given that this windfall could be quite significant – and very uncertain in size – dealing with such large budgetary variations in-year does not feel very satisfactory, for government, parliament and the organisations which rely on government funding.

Are alternative arrangements possible? In theory the OBR could be asked to produce a set of UK tax forecasts towards the end of 2020 to inform the BGAs. But the UK Government is unlikely to want to ask them to do this, given that individual taxes cannot be forecast in isolation from the wider economy forecasts that frame them. Moreover, there is still the risk that UK tax forecasts would change significantly, potentially as a result of UK tax policy change at the March budget. Another alternative is for the fiscal framework rules to be suspended for one year, recognising the scale of uncertainties and the limitations of the Scottish Government’s tools to deal with it. But how that would work in practice, in a way that would nonetheless enable the Scottish Government to capture the revenue impacts of its own policies, is unclear.

So whilst uncertainty was clearly going to be an integral part of the Scottish budget process this year – even more so than in recent years – changes to the timing of the UK budget only serve to accentuate those uncertainties. Coming shortly after the Finance Ministers of the three devolved governments have written jointly to argue for greater engagement and collaboration from the UK Government on tax and budgetary matters, the changes to UK budget timing will create a further source of intergovernmental tension.

Authors

David leads the FAI's work on fiscal policy and the Scottish budget.

 

 

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