‘Too simplistic’ to expect that economic growth will increase the Scottish budget, Holyrood committee concludes

Holyrood’s Finance and Constitution Committee has warned of “structural risk” within the fiscal framework that governs most of Scotland’s budget and said that it is “too simplistic” to expect that economic growth will lead to a growth in the Scottish budget.

The fiscal framework sets out the way that Scotland’s share of UK spending – passed on from the UK Government through the block grant – is calculated.

The block grant is worked out through the Barnett formula, where a percentage of UK spending on areas such as health or education that are devolved is passed to the devolved administrations to run those services as they choose.

But since income tax was devolved to Scotland in 2017-18, the block grant has been adjusted to deduct an estimate of what the UK Government would have taken in that tax year if it was collecting tax in Scotland at the same rates, bands and levels of growth as across the rest of the UK.

The intention was to make the Scottish Government responsible for economic growth, meaning that it could potentially increase the Scottish budget if it brought in more income tax than would have been collected by the UK Government.

However, after scrutiny of the economic data for the first year of devolution of income tax, the Finance and Constitution Committee has warned of problems in the way the fiscal framework works.

In 2018-19 Scotland matched the UK for percentage GDP growth and outstripped it for GDP growth per capita.

However, this did not translate into similar growth in the Scottish budget, because while the economy grew, wages – and therefore the amount raised through income tax – rose less in Scotland than in the rest of the UK.

Evidence to the committee suggested that was due to Scotland having less income inequality, with the rest of the UK having a higher concentration of higher rate taxpayers and a rise in their income had driven UK tax growth.

This was exacerbated by a significant overestimate of the amount of income tax that would fall under the Scottish rate of income tax due the lack of previous data on how much income tax would be collected in Scotland, since it was being devolved for the first time.

The difference between the estimate and reality will have to be corrected by deducting it from the 2020-21 budget.

Finance and Constitution Committee convener Bruce Crawford MSP said: “A key element of the fiscal framework is that it is intended to incentivise the Scottish Government to increase economic growth relative to the UK economy.

“After one year’s outturn data for Scottish income tax, our committee is warning that it is too simplistic to assume that faster relative economic growth will indeed result in an increase to the size of the Scottish Government’s budget.

“Our pre-budget report notes that there may be potential structural issues affecting how the fiscal framework operates arising from the extent to which the make-up of the tax base is more unequal in the rest of the UK compared with Scotland.

“As such, we recommend that the review of Scotland’s fiscal framework – due to happen in 2020-21 – should consider the impact of differences in the Scottish income tax base relative to the rest of the UK.”

However, elsewhere in the committee’s pre-budget report, it said it was “disappointed” by the lack of information from the Scottish Government in its medium-term financial strategy on how it intends to manage the potential £1bn shortfall in Scotland’s public finances over the next three financial years caused by corrections to the forecasting errors from the first three years of devolved income tax.

The committee called on the Finance Secretary, Derek Mackay, to confirm whether enough money to cover the shortfall would be available through borrowing, drawing on the Scotland Reserve or through increases to the Scottish block grant.

It also asked him to provide an assessment of the future risk due to the distribution of higher rate taxpayers in Scotland and the rest of the UK.