Budget 2020/21 – key issues to watch for

On Thursday, Mr Mackay will present his fourth budget – the penultimate budget before next year’s elections.

The budget will be delivered against the backdrop of the UK’s recent departure from the EU, significant frictions between both governments on issues ranging from constitutional change to budget timing, devolution of major new social security powers, and a weak outlook for the economy.

So what are the key points to look out for?

  1. Timing issues: stick or twist?

Mr Mackay is likely to express his disquiet at having to present his budget before the UK budget on 11 March. He will argue that the potential for UKG spending announcements in March, changes to tax forecasts, or UK tax policy choices for taxes devolved to Scotland, creates additional uncertainty, and limits his room for manoeuvre.

Arguably, these timing issues are more political than financial – at least as far as 2020/21 is concerned.

The UK Government may announce further departmental spending increases (it seems unlikely that they will announce cuts relative to the September Spending Round) – spending increases announced in March will  feed through to the Scottish budget 2020/21 in autumn.

Changes to the OBR’s forecasts of rUK tax revenues (for taxes that are devolved to Scotland) will impact the ‘block grant adjustments’ – the deductions to the Scottish block grant to account for the devolution of those taxes. If the forecasts for 2020/21 published on 11 March are higher than those currently available, this would imply a bigger deduction to the block grant. A higher forecast for the BGAs could reflect a more upbeat assessment by the OBR of revenue growth in rUK, or tax policy changes by UKG which increase revenues.

However, such changes to the BGAs – if they arise – would not actually impact the Scottish budget in 2020/21. Instead, the BGAs that underpin the Scottish budget when it is published are ‘locked-in’ until outturn data is available. As such, upward revisions to BGAs in March will not impact the government’s spending power in 2020/21 – but they could potentially mean a larger reconciliation in future years if the BGAs that inform the budget are a less good indicator of eventual outturn BGA.

Conversely, if the March BGAs turn out to be lower than those currently available, Mr Mackay can choose to ‘bank’ the resulting budgetary boost in the 2020/21 financial year.

So on March 11, Mr Mackay will decide whether to stick or twist. If the March BGAs are higher than those that underpin this week’s budget, he’s likely to stick with what he has, and worry about the difference when reconciliation happens (which, for income tax, will be in 2023/24). If the March BGAs are lower than those underpinning the budget, he is likely to take up Treasury’s offer that the lower BGAs can inform this year’s budget, effectively delivering a windfall cash increase to the budget in autumn 2020.

  1. Taxing choices – last minute changes?

Might the budget contain changes to Scottish income tax policy? Its possible that there will be some changes to thresholds (previous budgets have tended to increase the thresholds for the Scottish basic and intermediate rates in line with inflation, but to freeze the higher and additional rates in cash terms), but fundamental changes to the five-band structure seem unlikely. This is partly because of Mr. Mackay’s previous comments about a ‘settled’ structure, and partly because of the constraints imposed by the uncertainty of not knowing how the UK Government might make changes to UK income tax.

For the reasons described above, UK Government income tax changes may or may not influence the Scottish Government’s spending power in 2020/21, depending in part on whether the changes represent tax cuts or tax increases.

But even though the Scottish budget in 2020/21 will be in some sense protected from the revenue implications of UK tax policy changes on 11 March, major changes to UK income tax at the UK budget could have political implications. A major UK income tax policy change (such as a big rise in the higher rate threshold) could widen the gap in tax schedule between Scotland and UK, potentially to a point that had political costs for the Scottish Government.

This risk seems small (the UKG has ruled out tax increases in relation to major taxes, whilst it has little room for tax cuts on the basis of its own fiscal rules). But if it does materialise, the Scottish Government can in principle respond if it wants to.

How so? Although the Scottish income tax policy for 2020/21 has to be confirmed in a ‘Scottish Rate Resolution’ before the Budget Bill can pass – and although Scottish tax rates and bands cannot be changed once the financial year has started – the prevailing view in parliament is that it would be possible for the government to cancel or annul a Scottish Rate Resolution that had been passed before the 11 March and pass a different rate resolution before the end of the month.

So its possible that the income tax policy that is agreed as part of the budget process is not the tax policy that prevails at the start of April – potentially raising big questions for scrutiny and transparency.

  1. Economic and tax forecasts – an improving outlook?

With income tax revenues accounting for over one third of the resource budget, the Scottish Fiscal Commission’s forecasts for the economy, earnings and employment plays a crucial role in influencing Mr Mackay’s spending power.

The story of the past two budgets has been of a faltering outlook for growth, feeding through to relatively weak income tax revenues.

Might this year’s budget contain better news?

On economic growth, that seems unlikely. In its most recent forecasts of May last year, the SFC was forecasting growth in GDP per capita of 0.5% in 2019. Outturn data reveals that GDP per capita has grown less than 0.3% during the first three quarters of the year. On that basis there seems little grounds for the SFC to move materially from its forecast for growth in GDP per capita of 0.6% in 2020.

However, there may be some marginally better news on earnings growth, with some data published in the second half of last year pointing to slightly faster earnings growth in 2019 than the 2.6% that had been forecast.

So recent data seems to present a mixed picture, and it will be for the SFC to interpret this in the context of longer term trends before coming to a view about income tax revenues in 2020/21.

But what complicates the picture further is that the Scottish budget depends not simply on the growth rate of Scottish revenues, but how this growth compares to the equivalent growth in rUK revenues per capita.

On Thursday, we will get one side of the story – the outlook for Scottish revenues. It’s not until 11 March that we’ll get the OBR’s take on the prospects for equivalent rUK revenues. An improvement in the outlook for Scottish revenues announced on Thursday could be offset by an equivalent improvement in rUK revenues in March – although, as described above, the impacts of this on the Scottish budget may not be felt until ‘reconciliation’ in 2023/24.

Conversely, if the outlook for rUK revenue growth has worsened compared to what the OBR had forecast last year, this could yield a cash boost for the Scottish budget – which Mr Mackay can choose to cash-in later in the 2020/21 financial year.

 

  1. The resource budget – increasing, but by how much?

The spending outlook is much healthier now than it was 15 months ago.

The UK Government’s Spending Round last September resulted in an extra £1.1bn of resource ‘consequentials’ for the Scottish budget in 2020/21. That comes on top of increases to the 2019/20 block grant of around £600m that have been announced since the 19/20 budget was set (not all of this reflects new spending power – about half reflects new responsibilities).

So, it seems likely that the block grant for resource spending in 2020/21 will be about 2% higher than it was in 2019/20.

We know that this increase will be offset somewhat by the £200m reconciliation for income tax revenues in 2017/18. This ‘reconciliation’ reflects the fact that the 2017/18 budget was based on a set of forecasts for income tax that turned out to be overly optimistic to the tune of £200m. Taking the reconciliation into account means the resource grant will increase by around 1.4% in real terms.

Beyond this, the total resources available to the Scottish Government will depend on the SFC’s tax forecasts. The outlook for the resource budget could improve or worsen a bit once the SFC’s forecasts are taken into account.

The basic message is that the government’s budget (excluding new social security powers – which we’ll touch on below) is likely to increase by somewhere approaching 2% in real terms compared to last year; a reasonably healthy increase in the context of the post 2010 austerity period.

 

  1. Spending magic – baselines, borrowing and reserves

Whilst the resource budget limits might increase by a bit less than 2%, the government is likely to announce spending increases that imply slightly faster growth than this.

How does this work?

In presenting the resources available to it, the budget will set out in Chapter 1 the evolution of the government’s ‘budget limits’ between 19/20 and 20/21. As discussed above, this will show an uplift in the block grant of around 2% in real terms, somewhat offset by a reconciliation for income tax.

But the spending lines will compare the budget allocations made in budget 20/21 with those in budget 19/20, ignoring the impact of some of ‘in-year’ increases in funding during 2019/20 that were not known about when the 19/20 budget was set.

Additionally, the government will draw-down up to £250m in accumulated underspends from its ‘Reserve’.

It might also choose to exercise its right to borrow the £200m resulting from the income tax reconciliation rather than funding the reconciliation from this year’s budget. But it would need a well argued case for doing so.

 

  1. Social security – new funding, new risks

Last year’s budget contained a new chapter on social security, which was associated with spending of just under £600m.

This year’s budget will see the social security budget line increase to around £3.5bn, reflecting the transfer of financial responsibility for new social security payments. This does not mean that Scottish claimants will begin receiving payments of replacement benefits from Social Security Scotland in 2020 – that transfer will take several years.

But from 2020/21 the Scottish budget will bear the risk that spending on the new social security payments is higher than the corresponding uplift in the block grant. This could happen over time if replacement Scottish payments are more generous in some way than the UK legacy payments, or simply if claimant rates in Scotland grow more quickly than in rUK.

 

  1. Spending choices

How will Mr.Mackay allocate the additional resources he will have available to him compared to last year?

As normal, the health portfolio will anticipate a real terms increase in its funding. A strict interpretation of the government’s manifesto commitment to ‘pass on’ health related consequentials would see the health budget increase by £600m, or 2.5% in real terms.

How the remaining budget uplift is allocated might give us a preliminary view on where the government feels the main election battles next year will be fought. Will it:

  • Protect the local government core settlement in real terms, or going some way to offsetting last year’s real terms cut? (the latter would cost around £400m)
  • Bring forward planned increases in social security spending? (the Government has announced a flagship policy to create a new ‘income supplement’, a payment to low income families with children. This will no doubt be re-announced at the budget, although the barriers to a more rapid than planned roll-out are likely to be more administrative than financial).
  • Launch a spending programme aimed at addressing potential economic weaknesses as a result of Brexit? (which could include efforts aimed at promoting Scotland and Scottish businesses overseas and/or support for exporters)
  • Give further prioritisation to health, over and above the commitment to pass on consequentials?
  • Investments in support of the government’s climate change agenda, and the ambition to secure a ‘low carbon’ economy?
  • Sprinkle additional funding around evenly, in order to ensure that no individual budget line experiences real terms cuts in 2020/21?

 

  1. A step-change in investment spending

In its 2018 Programme for Government, the government announced what at the time appeared to be very ambitious commitments on future infrastructure investment. These included a ‘Mission’ to ‘increase annual infrastructure investment so it is £1.5 billion per year higher at the end of the next Parliament [2025-26] than in 2019-20’.

The pledges made by the UK Chancellor in the run-up to the General Election suggest that it may be possible for the Scottish Government to attain its ‘Mission’ simply as a result of increases in the size of its capital block grant from Westminster.

Indeed, the UK Government’s Spending Round pencilled in a £400m (6% real terms) increase in the Scottish Government’s block grant for investment spending in 2020/21.

It will be interesting to see whether the Scottish Government responds by reducing its planned use of capital borrowing powers, or if it in turn increases the scale of its capital investment plans.

 

  1. A well-being budget?

Nicola Sturgeon has said she wants to put wellbeing at the heart of everything her government does, and the government has indicated that it may produce a ‘well-being’ budget this year.

What this might mean in practice remains unclear.

Of course all Scottish Government budgets up until now have implicitly been about improving well-being, whether that be through investments in health, education, the economy or the environment.

The pursuit of a well-being budget signals a desire to articulate more explicitly how a set of funding choices contribute to improving well-being. That’s inherently a difficult thing to do given the multiplicity of factors that can influence wellbeing – not to mention the fact that the factors that influence the well-being of one person or group will not always correlate with the factors that the influence the wellbeing of another person or group.

A key question in evaluating a wellbeing budget is the extent to which it leads to different decisions or allocations – or whether it is simply a presentational exercise to excite analysts, politicians and media, but that makes no difference to budget allocations in practice.

Authors

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

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