On Wednesday, Chancellor Rishi Sunak will set out his Autumn 2021 Budget, encompassing a three-year Spending Review. The Spending Review will provide day-to-day and capital spending settlements for individual departments for the following three years (2022/23 to 2024/25) – the first multi-year spending settlement since 2015. The Spending Review will pencil-in real terms increases in the Scottish block grant over the next three years. But a large share of this increase will be generated by increased health spending in England. This will in turn influence the shape of the subsequent Scottish budget in December.
The economic outlook underpinning the Budget and Spending Review has improved in some ways since the March budget. Economic activity recovered faster than expected in spring and early summer, and indications that the longer term impacts of the pandemic on the size of the economy may be less severe than feared. At the same time however, inflation is rising, reducing disposable incomes and raising the spectre of interest rate rises that will increase the costs of government borrowing. There were clear signs that the strong economic recovery in the early part of the year faltered in late summer, whilst Covid-19 cases and hospitalisations are on the rise again.
This presents a challenging backdrop for the chancellor. He may be tempted to increase the size of the departmental spending envelope he set himself in early September – indeed with the recovery faltering and many spending departments still struggling with the legacy of Covid, there would be a good case for doing so. But he is also keen to present himself as a prudent chancellor. He is expected to use the budget to set a new fiscal commitment to run a current budget balance (i.e. to borrow only for investment spending, but not day-to-day public services spending) three years ahead, and this will limit his room for manoeuvre.
Scottish implications: block grant for day-to-day public services spending – the current picture
From the perspective of the devolved Scottish budget, the main significance of Wednesday’s budget and spending review is that it will establish the outlook for the Scottish Government’s resource and capital block grants over the subsequent three years.
Having said that, we already have a reasonable idea of what the implications for the Scottish budget are likely to be. This is because the UK Government has already set out, on 7 September, the spending review ‘envelope’ (its planned total departmental expenditure). Within that envelope, it has set some key departmental allocations (notably for health, schools and defence). This gives us a pretty good idea of the likely level of resources to flow to the Scottish budget via the Barnett formula.
Prior to the September announcement, the outlook was for the Scottish Government’s core resource block grant (to cover day-to-day public services spending) to increase by around 2 per cent per year in real terms from 2021/22 until 2024/25. The UK Government’s 7th September announcement of additional health and social care spending, funded through a new health and social care levy, will generate further consequentials for the Scottish budget. These are likely to result in around a 2.5 – 3.0 per cent real terms average annual increase in the resource block grant from 2021/22 to 2024/25[i].
This continues recent trends of real terms growth in the core block grant, (see chart). But it is worth noting that the outlook for the resource block grant in 2022/23 – 2024/25 is just about the same on current plans as it was pre-pandemic. The UK government’s March budget this year saw Rishi Sunak scale-back departmental spending plans for 2022/23 – 2024/25 by around £15bn per year compared to the pre-pandemic plans. The announcement on 7th September brings total UK departmental spending (almost) back to the pre-pandemic trajectory, albeit with a greater emphasis on health.
So the outlook for the core Scottish resource block grant looks healthy enough in terms of the year-on-year increase over the spending review period. However, assuming the Scottish government ‘passes on’ the health related consequentials to the NHS in Scotland, other areas of public spending may well face challenging settlements when the Scottish Government presents its budget in December. UK health spending is likely to account for a large share of the consequentials coming from Wednesday’s announcements – and this will in turn shape the subsequent Scottish budget.
Chart 1: Outlook for the Scottish resource block grant
Sources: FAI analysis of: HM Treasury – block grant transparency; UK Government – building back better, our plan for health and social care; HM Treasury – spending review launch; HM Treasury – Public Expenditure Statistical Analyses
A bigger envelope?
What could make a more significant difference is if the Chancellor decides on Wednesday to increase the size of the envelope he set himself in September. There are at least two good reasons why he may do this.
First, there is likely to be some improvement in the economic forecasts compared to the previous forecasts in March, giving the Chancellor some space to loosen fiscal policy in the short-term.
Second, and more significantly, the current settlement looks extremely challenging for non-protected departments, as both the IFS and Resolution Foundation have pointed out. The UK government has made no provision as yet for any Covid related spending after this year, and unprotected UK departments (outside of health, schools and defence) face very challenging settlements over the next few years.
Make no mistake, the Chancellor is unlikely to extend the existing departmental spending envelope substantially. A substantial increase in the size of the spending envelope will likely not be consistent with the new fiscal commitment he seems likely to make. But some further increases are possible.
Outlook for the capital block grant
The UK government’s spending envelope envisages real terms spending increases for capital (investment) spending of around 2.3- 2.8% per annum over the spending review period (depending on choice of deflator). This comes on the back of more sizeable increases in the last two years. The block grant for capital spending is likely to look generous in a historic perspective.
The spending review will reveal how the UK government’s capital spending envelope will be allocated across UK departments, which will in turn determine the consequentials for the Scottish budget. Announcements made already include increased spending on NHS equipment. There is also expected to be an emphasis on addressing net zero (through decarbonising domestic heating, public buildings and transportation), and on public transport in English cities as part of the levelling up agenda. Much of this activity should generate consequentials for the Scottish budget, although the UK government’s recent approach to the territorial allocation of funding for its ‘levelling up’ agenda has tended to court controversy, with some of this funding being allocated to specific projects by UK ministers, rather than through the Barnett formula.
Finally, the budget will also contain updated forecasts for tax revenues and social security spending. These will impact the calculation of the ‘block grant adjustments’ for devolved tax and social security payments in Scotland. There are unlikely to be changes to income tax policy by the UK Government, given the commitments made in the March budget. But it is thought the Chancellor may announce changes to Air Passenger Duty – this is not yet devolved to Scotland but is due to be.
In short, the UK budget and Spending Review on Wednesday is critical in establishing the financial parameters of the Scottish budget, due to be published on 9th December.
[i] Note for boffins: pandemic related economic shutdowns have resulted in significant volatility in the GDP deflator between 2019/20 and 2022/23. This volatility in deflator can exaggerate real terms spending changes between individual years. To avoid this issue, several commentators (including the Resolution Foundation and Institute for Government) smooth the change in the GDP deflator between 2019/20 and 2022/23. However, in its recent Green Budget, the IFS chooses not to smooth the GDP deflators on the basis that such smoothing is arbitrary. The decision on whether or not to smooth the deflator does influence the assessment of real terms funding changes during the spending review period. Compared to an unadjusted deflator, the smooth deflator implies lower increases in real spending over the period 2021/22 – 2024/25, as plans are deflated by a larger amount at the start of the period. Comparisons over a longer time period (e.g. 2019/20 – 2024/25) are not affected by the choice of deflator. We estimate that the Scottish resource block grant will increase by around 2.5% per annum over the period using a smoothed deflator, and 3% per annum using an unsmoothed deflator.