An introductory guide to this week’s Scottish Budget

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On Thursday, Mr Mackay will publish the Scottish Government’s Draft Budget for 2018/19. This blog – the first of a series in advance of Thursday’s statement – summarises what it will contain and how the various components link together.

The interaction between the block grant, the block grant adjustments and devolved taxes

In the past, making sense of the Scottish Budget was relatively straightforward.

The amount of money that the Scottish Finance Secretary had at their disposable was largely determined by the block grant from Westminster. Each year, changes to this block grant were driven by changes to spending allocations made to comparable departments in Westminster. These so-called ‘Barnett consequentials’ would determine whether or not the overall Scottish Budget increased or decreased from year-to-year and by how much.

Following the Smith Commission, new tax powers were devolved to the Scottish Parliament.

Devolved taxes picture

Some social security powers are coming soon as well. For a discussion of these powers see our Scotland’s Budget Report 2017.

As a result of these changes, a new arrangement was put in place – the so-called ‘fiscal framework’.

Under this framework, the Scottish Government’s resource block grant from Westminster continues to be determined by the Barnett Formula.

The latest (real-terms) figures we have for this block grant are shown in the figure below.

Scottish resource block grant (2017/18 prices)

Fiscal DEL Diagram

But this block grant is now adjusted (i.e. reduced) to take account of the fact that some taxes are now devolved to the Scottish Parliament – these adjustments are known as ‘Block Grant Adjustments’ or the BGAs.

How does this happen?

Each BGA is effectively a measure of the tax revenues that the UK Government has foregone as a result of each new tax power being transferred to the Scottish Parliament.

The BGAs consist of two elements: an initial deduction and an indexation mechanism.

  • The initial deduction is equal to the tax revenues collected in Scotland in the year prior to devolution of the new power. This ensures that the Scottish Budget is no better or worse off simply from the devolution of the new taxes. For income tax, this was 2016-17.
  • What happens after this is governed by the indexation mechanism comes in. Its purpose is to provide a measure of the rate at which comparable revenues have grown (or declined) in the rest of the UK (rUK). The basic idea being that the BGA should grow at the same rate as the growth in comparable revenues in rUK.

So for 2018-19, alongside the block grant figure on Thursday the Scottish Government will publish the equivalent BGAs.

What will be added back in will be the devolved tax revenues forecast to be collected in 2018-19.

The budget we will see on Thursday will be comprised of the key elements as below.

BGA diagram

What is the role of the Scottish Fiscal Commission?

As part of the deal to transfer new tax and welfare powers to the Scottish Parliament, a new institution was established – the Scottish Fiscal Commission (SFC).

The role of the SFC is to provide independent forecasts for the Scottish economy and Scottish devolved taxes (and social security) for five years ahead. They will publish their first ever forecasts on Thursday alongside the Budget.

It is these tax forecasts that the Scottish Government will use to plan their spending for next year.

The SFC do not forecast the BGAs. They are provided to the Scottish Government by HM Treasury based upon forecasts made by the OBR.

Will Scotland’s budget be better or worse off?

The answer to this question depends upon the specific definition of ‘better or worse off’.

If we are looking to see whether or not the budget has gone up or down compared to last year then it remains relatively straightforward to check. All we have to do is compare this year’s budget with that from last year.

But of more interest is perhaps the question “are we better or worse off under these new powers than we would have been had we stayed with the old Barnett system?”

Figure 1 shows how this can be determined. In short, if the sum of the revenues raised from the devolved taxes is greater than the sum of the BGAs, then the Scottish budget will be better off than it would have been without tax devolution.

Scotland’s Budget could be better off under the new system if –

  • the tax base grows relatively more quickly in Scotland than in rUK; or
  • tax policies in Scotland seek to raise revenues relative to those in rUK.

Of course the reverse could happen – Scottish revenues may grow relatively more slowly than those in rUK, in which case the Scottish budget will be worse off than it would have been without tax devolution.

Whilst we will be able to see whether or not the Scottish Budget is higher or lower than what would have been the case with Barnett, separating out these different effects – growth in the tax base versus tax policy – will not be entirely straightforward.

What other issues are worth watching for?

The new fiscal framework is full of a complex mix of new arrangements for managing cash flow, borrowing and forecasting.

The Scottish Government are also likely to provide an update on how much they intend to invest in the new Scotland Reserve – a sort of rainy day fund that they can draw in the future.

The government will also have to set out their plans for local taxation, including council tax and non-domestic rates. The outlook for non-domestic rates looks particularly interesting following the recent report by the Auditor General showing that the NDRI pool was in negative balance of nearly £300 million in 2016/17.

What about spending ?

Alongside the outlook for the overall budget and taxation, what will matter most for public services is the individual allocations by portfolio.

The budget document will set out detailed spending plans at both the portfolio level – e.g. health, education etc. – and what is known as Level 2 and 3 budget lines which provide a little more detail.

Comparisons will be made between spending plans for 2018-19, with the plans agreed for 2017-18 and passed in that year’s Budget (including the changes made following the deal with the Scottish Greens to secure their support for the 2017-18 Budget).

For each portfolio, there will be two important spending lines.

  • Firstly, there is resource spending – this is spending for day-to-day public services. For example, the pay of public sector workers like nurses and teachers, funding for modern apprenticeship programmes or college places, refuse collection and so on.
  • Secondly, there is capital spending. This largely covers government investment in infrastructure – new roads, schools and hospital buildings. It is possible for the government to switch revenue spending into capital spending but not the other way around.

Unlike resource spending, the capital budget is still largely determined in the same way as before – by a block grant from Westminster.

Again in contrast to resource spending, this is on track to increase over the next few years.

Scottish capital block grant (2017/18 prices)

Capital DEL

On top of this, the Scottish Government can now borrow up to £450 million extra in 2018-19 should they wish to add to their capital spending plans.

And they have £1bn of financial transactions to allocate – effectively loans to the private sector.

One-year or multi-year spending plans?

It is highly likely that we will – once again – only receive detailed spending allocations for 2018-19. This follows on from single year budgets set for 2016-17 and 2017-18.

Multi-year planning is a challenge given current levels of uncertainty and the fact that the Scottish Government is a minority administration.

But deep-seated societal challenges inherently need to be addressed over the long term through a coherent and sustained approach. The insecurity and uncertainty that short term funding brings can only diminish this.

It will be essential to return to multi-year budgeting as early as possible in order that public services can be planned for on a sustainable basis.

 

 

 

December 11, 2017