Windfalls, dilemmas and deals: looking ahead to the Scottish budget

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Wednesday’s Scottish Budget announcement will almost certainly play second fiddle to Brexit as a news story, and justifiably so given the significance of the UK’s future relationship with the EU.

But the Scottish budget is important too, and not just because it tell us how much income tax and council tax we can expect to pay next year. It also sets the direction of devolved public spending in Scotland, which, when set alongside budgets of previous years, is beginning to tell a story of substantial change in the way in which devolved public spending is distributed across public services.

A windfall, a dilemma and a re-evaluation

This time last year, the outlook for the Scottish budget in 2019/20 was weak, with a projected real terms fall in the government’s resource budget of almost 1%.

But the outlook for the Scottish budget has changed in three ways since this time last year. These can be summarised as: a windfall, a dilemma, and a re-evaluation.

The windfall comes in the form of an additional £720million in Barnett ‘consequentials’ for the 2019/20 block grant. The majority of these consequentials result from additional spending on the NHS in England relative to previous plans.

The dilemma is what to do about the income tax Higher Rate Threshold. The UK Government announced a significant increase in the threshold for rUK taxpayers in 2019/20, to take it to £50,000. Assuming that Derek Mackay chooses not to follow, then this policy decision by the UK Government provides a further boost to the Scottish budget.

(Under the rules of the fiscal framework, a deduction is made to the Scottish block grant equivalent to an estimate of the income tax revenue that the UK Government would have raised from income tax in Scotland, had it not been devolved. This counterfactual estimate is calculated on the basis of UK Government policy. So a UK Government policy that raises relatively less income tax revenues implies a smaller deduction from the Scottish block grant.)

In effect therefore, the UK Government’s increase in the Higher Rate threshold represents a conditional windfall for the Scottish budget – it delivers a further windfall (of around £200m), conditional on the Scottish Government not raising the Higher Rate threshold in Scotland. The dilemma that this creates for the Scottish Government is a political one, in that not increasing the Higher Rate threshold in Scotland will mean having to defend a higher income tax burden in Scotland (for some taxpayers) compared to what exists in rUK.

The re-evaluation refers to the likelihood that the Scottish Fiscal Commission will take a slightly less positive view about the outlook for the Scottish economy than they did this time last year, with an implication for tax revenue forecasts. This might be accentuated by the publication of income tax outturn data during the summer, which may result in the SFC revising down its forecasts of the revenue effects of previously announced income tax policies.

We won’t know exactly the size of this effect until the SFC forecasts are published on budget day. But it seems likely that expectations of slightly slower earnings growth in Scotland compared to this time last year will offset some (but by no means all) of the windfall.

Taking these three factors into consideration, we can say that the overall Scottish budget is likely to increase this year compared to last year, although the scale of the increase is likely to be small (around one per cent) once adjusted for inflation.

Piecing together the story from multiple single-year budgets

How will the government choose to allocate its budget? It has committed to ‘pass on’ health related Barnett consequentials to health spending in Scotland. This means that the health budget will increase by at least £550m in 19/20 (2.4% in real terms).

But the government may go further than this. Indeed, given the financial strain that the NHS is under, and the electorate’s enthusiasm to protect and enhance healthcare provision, the government is likely to allocate as much to health as it feels able to do so within the constraints of the overall budget. Health spending, currently around 47% of the government’s resource spending, could reach 50% by the end of this parliament.

As ever, much interest will be on what these spending decisions mean for other portfolios. Will the local government core settlement escape real terms cuts? How many other organisations and portfolios will experience a real terms squeeze in 19/20?

How might the draft budget change?

It is important to remember that Wednesday’s draft budget will almost certainly undergo some change during the subsequent weeks of parliamentary scrutiny and debate. In order to get the Budget Bill passed, the minority SNP government will have to do a deal with another party.

In each of the past two years, this budget deal has been done with the Scottish Greens. It has involved setting a lower than initially proposed threshold for the higher rate, and using the revenue proceeds to support local government spending.

Of course we won’t know on Wednesday what this year’s deal might eventually hinge on. But it will be interesting to see whether the higher rate threshold again forms the cornerstone of the budget deal – or whether the deal hinges on some broader commitment to local tax reform in the remaining years of the parliament.

December 10, 2018