Fiscal Policy and Tax, Scottish Budget

The choices facing Mr Mackay

As he has been developing his budget over the past few weeks and months, Mr. MacKay will have confronted a number of difficult choices. How should he prioritise his £27bn resource budget across portfolios ranging from health to education and local government? Should he use his tax powers to raise additional revenues, and if so by how much? What can he do to support the conditions for inclusive economic growth?

In previous blogs and in our latest commentary, we’ve discussed some of the key aspects of Thursday’s budget from the perspective of the economy and public finances.

But what are the big things to look out for from a policy perspective?

2018/19 will undoubtedly be a tough year for the Scottish Budget. The government’s block grant from Westminster for day-to-day spending on public services will be around 0.8% lower than it was in 17/18. This is equivalent to a fall of just over £200 million, bringing the 18/19 block grant back to its 2016/17 level in real terms.

The Scottish Government’s revenue choices

The Scottish Government has indicated that it is likely to seek to increase income tax rates to counter – at least some of – this fall in its block grant. A tax rate increase will pose two questions.

  • First, how much is the proposed policy like to raise? This will be a judgement for the Scottish Fiscal Commission, which will issue its forecasts on the same day as the Budget. The options outlined in the Scottish Government’s consultation paper on income tax raised between £80m and £250m. In other words, the amount raised might just be enough to offset the reduction in the block grant – but we shouldn’t expect a spending bonanza.
  • Second, how will any increase in the tax burden be distributed across those with different levels of income? The government has expressed a preference for increasing the tax burden on higher incomes. But will it simultaneously seek to reduce the tax burden for those with less than median incomes?

We should remember too that the government’s tax revenues don’t just depend on tax policy. The growth of the underlying tax base (taxable income) is critical too. The key question is whether the Scottish Government’s tax revenues (including the effects of any tax policy change) are bigger or smaller than the ‘block grant adjustment’ – the bit taken out of the block grant to account for the revenues foregone by the UK Government.

The Scottish Fiscal Commission’s view of the outlook for the Scottish economy – and in particular the rate of employment and wage growth – is critical (the SFC will publish its forecasts on the same day as the budget). If the SFC considers that Scotland’s income tax base will grow more slowly than rUK’s, it is possible that a tax rate increase is merely enough to mitigate this weaker growth, but is not sufficient to offset the overall fall in the resource budget.

In contrast to income tax where the political momentum seems to be moving towards tax rate increases, the government has been under pressure for some time to reduce rates of residential LBTT. Taxes on residential property transactions are higher in Scotland than in England on properties over £333,000, and a narrative (but little in the way of causative evidence) has emerged that equates higher rates with a perceived slowdown in the upper end of the Scottish housing market. In addition, Mr. MacKay may face pressure to match cuts to Stamp Duty for first time buyers in England announced in the UK Budget.

Changes to LBTT rates may be welcome if they are part of a more strategic and longer term vision about how property should be taxed in Scotland. But Mr. MacKay will face criticism if he is seen to be replicating an English policy that is forecast to have only a limited impact on improving housing affordability for young people and which effectively imposes an English system on a Scottish housing market which is quite different.

The Scottish Government’s resource spending choices

What about spending choices? The government has committed to increase spending on health by £500m more than inflation during this parliament. Remaining on track to meet this commitment will imply health spending of over £13bn next year.

This might sound generous but it is equivalent to a real terms spending increase of barely one per cent. This is only just enough to keep up with demographic pressures. It will be interesting to see whether there is any acceleration of health spending beyond this, for example to support a relaxation of the pay cap.

The spending commitments made in relation to health, together with those for police spending (protect the police budget in real terms) and some elements of education (in particular the commitment to allocate £750m over the course of this parliament in the Attainment Fund, and protecting the number of college places), necessarily mean that some unprotected areas of the budget will face particularly acute pressure.

The local government allocation will come under close scrutiny, and we will consider the local government settlement in a companion blog.

The Scottish Government’s capital spending choices

The outlook for the Scottish Government’s capital block grant is more positive. The capital block grant will increase by 6% in 2018/19. And the Scottish Government can now also borrow to support further capital investment. Use of these borrowing powers in full in 2018/19 could take capital spending back to levels not seen since the historic high of 2010/11, when capital investment was £3.7bn. Given ongoing economic fragility and low borrowing costs, a convincing case to use these powers could be made. The question is whether there are enough projects in the immediate pipeline for delivery next year.

In the context of business and enterprise support and housing, it will be particularly interesting to see whether the government comes forward with new proposals about how to use the additional ‘Financial Transactions’ spending it was allocated following the UK Budget.

There has been much debate about the role and value of Financial Transactions. Financial Transactions are a specific form of capital spending that can be used to support lending to the private sector. In that way they are different from traditional forms of government resource or capital spending but can still help support new investment in the economy.

In recent years the majority of Scottish Government Financial Transactions expenditure has supported the Help to Buy programme (where the Scottish Government takes an equity stake in a new build property, repayable by the house buyer at any point with no interest). But Financial Transactions are also used to provide loans to businesses in relation to energy efficiency schemes and some loan support to SMEs, rural businesses and farmers. It seems unlikely that demand for Help to Buy in Scotland is sufficient in its current form to absorb the almost £500m of Financial Transactions allocation in 2018/19, so new proposals for use of these funds is required.

Presentational issues

A technical point to look out for on Budget day is how spending lines for individual spending areas are presented. The Scottish Budget tends to present spending for resource and capital combined into one line. With a rising capital budget, it is possible that relatively less positive resource budget settlements are disguised somewhat by higher capital spend and announcement of new capital projects. Capital spending is of course welcome, but it doesn’t in itself ease pressures facing organisations in meeting their day-to-day commitments.

Bear in mind too that year-to-year changes in allocations to individual portfolios will often be presented in cash terms; but what is arguable more important is how budgets are evolving in real (i.e. inflation-adjusted) terms.

So its possible that Mr. Mackay will present a budget that is rising by £700m in cash terms (the resource block grant is increasing just under £200m in cash which could be augmented by £2-300m as a result of tax policy changes, and the capital budget is increasing just over £200m). But an important question to ask will be how these total cash terms increases translate into real terms resource allocations – once capital is taken out and account is made of inflation.

Final thoughts

So Budget 2018/19 poses many challenges and difficult questions. Remember that the politics of minority government means that the Budget published on the 14th is likely to undergo various tweaks and amendments as the government navigates the budget bill through the various legislative stages.

What remains unclear is the extent to which the budget document will give a sense of the government’s budgetary priorities in 2019/20 and even beyond. Uncertainties about the ‘parliamentary arithmetic’ will no doubt be rolled out to explain why little if any detail can be attached to plans beyond 2018/19 itself. But after single year budgets in 2016/17 and 2017/18, there is a danger that annual budget decisions are taken in a vacuum from the longer term context that should be informing the budget planning process.


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