An immediate response to Scottish fiscal announcements

David Phillips, an Associate Director at the Institute for Fiscal Studies, said:

“In recent weeks the Scottish Government has announced that the universal credit two-child limit will be mitigated from next March, rather than April, as initially planned. And it has mirrored the UK government in re-extending eligibility for winter fuel payments to all pensioners with an annual income of less than £35,000 – and on top of this will increase payments by 1.7% this winter, in line with last September’s inflation. 

The two documents published by the Scottish Government today – its Medium-Term Financial Strategy (MTFS) and Fiscal Sustainability Delivery Plan (FSDP) – show that tougher financial choices lie ahead, including public sector job cuts. 

Based on plans set out in the UK Chancellor’s Spending Review two weeks ago and the latest forecasts for devolved tax revenues and benefit spending from the Scottish Fiscal Commission (SFC), the MTFS’s central scenario for growth in funding significantly lags projected growth in Scotland’s assessed spending needs. Indeed by 2029–30, a ‘funding gap’ of £2.6 billion a year for day-to-day (non-investment) spending is projected. That is roughly equivalent to spending on Scottish police and fire services, or the revenue from increasing all rates of income tax in Scotland by around 4 percentage points. The MTFS also projects a gap of £2.1 billion a year for the Scottish Government’s ambitious capital investment plans, including on energy and decarbonisation. 

As the MTFS and SFC make clear, current forecasts for the contribution of devolved tax revenues to the Scottish Budget are likely optimistic, as they assume earnings grow significantly faster in Scotland than in the rest of the UK from 2026–27 onwards. All else equal, if earnings instead grew at the same rate as in the rest of the UK, the ‘funding gap’ for day-to-day spending would be closer to £3.5 billion.

The Scottish Government cannot borrow to plug these gaps: some combination of measures to curb spending and boost revenues is required. The FSDP is a welcome move by the current government to begin setting out its approach to tackling this – information that’s previously been lacking. 

The most concrete part of the plan is a restatement of last week’s announcement of an aim of cutting £1 billion per year, or roughly one-fifth, from administration costs by 2029–30. The FSDP also sets a target of reducing the size of the devolved public sector workforce by 0.5% a year – which, given increases in front-line NHS staffing to tackle backlogs and to cope with an ageing population, will require substantially larger workforce reductions across the rest of the public sector.   

Further details on these plans, and where employment will fall, will be set out in a multi-year Spending Review to be published alongside the 2026–27 Budget. This will also have to say which services will be cut back in order to protect spending on the Scottish Government’s key priorities – poverty, climate change, economic growth and effective public services – and to shift resources to prevention and early intervention. This will likely require steep cuts to some other ‘non-priority’ areas, and a laser-like focus on how effective spending actually is – not all spending on the government’s priorities can and should survive the chop. Indeed, the scale of the fiscal challenge could necessitate the Scottish Government making trade-offs between its four priorities.

Together with some projected revenues from efforts to grow tax bases and improve tax compliance, the Scottish Government says its plans would allow it to close its funding gap. But most of the detail remains to be worked out. And the proof of the plans will be in their delivery – largely after the next Scottish elections in May 2026. 

The fiscal challenge facing Scotland is large and real. So as the current government and opposition parties begin to set out their election pitch to voters, it will be vital to scrutinise what their plans would mean for Scotland’s finances.” 

More information on the MTFS’s funding and spending projections

• The MTFS sets out projections for the Scottish Government’s funding and spending requirements, providing central, higher and lower scenarios to illustrate the uncertainty around these.
• Its central scenario for funding is based on the plans set out by the UK Chancellor Rachel Reeves in her Spending Review on 11 June, as well as forecasts for devolved tax revenues and benefit spending as set out in the SFC’s latest report. This scenario shows funding for overall day-to-day (non-investment) spending, including devolved benefits, increasing by an average of 1.0% a year in real terms between 2025–26 and 2029–30. Higher and lower scenarios show increases averaging 1.6% and 0.4%, respectively.
• Though presented as a downside, the lower funding scenario may still understate the true risk. It is based on the assumption that rather than growing faster than in the rest of the UK, earnings in Scotland grow at the same rate as in the rest of the UK. However, it is possible that earnings growth lags the rest of the UK (as it did between 2015 and 2022): each 1 percentage point of lower cumulative earnings growth would reduce revenues by around £0.3 billion a year.  
• For spending, the MTFS projects requirements for different areas forward using different approaches. In its central scenario: benefit spending is assumed to grow in line with SFC forecasts; health and social care spending by 3.3% a year in real terms in line with both recent trends and long-run SFC projections; public sector pay in line with agreed pay deals and public sector pay policy for the period to 2027–28, and inflation thereafter; with most other areas of day-to-day (non-investment) spending growing in line with inflation. Taken together, this results in requirements for day-to-day spending increasing by 2.1% a year in real terms over the next few years. Higher and lower scenarios for specific areas of spending (such as health and social care and the public sector wage bill) are provided, although these are not brought together into higher and lower scenarios for overall spending requirements.
• ‘Funding gaps’ are calculated by comparing these funding and spending scenarios. The central gap (based on the central funding and spending scenarios) reaches £2.6 billion a year by 2029–30. This illustrates how, in the absence of substantial additional funding from the UK government, some combination of reductions in spending growth or increases in revenues would be needed so that the Scottish Government can comply with borrowing constraints under the fiscal framework.
• Analysis of the projections for the various components of spending helps illustrate how tough these trade-offs could be. Accounting for forecast increases in the net cost of Scotland’s devolved benefit system – to over £2 billion on top of the funding provided by the UK government – the funding for day-to-day public service spending is set to increase by an average of just 0.2% a year in real terms between this year and 2028–29. And in both 2026–27 and 2027–28, funding is actually set to fall, unless the Scottish Government carries forward some additional money it now has this year via its reserves to help smooth the trends in funding. Either way, many areas outside the Scottish NHS would face potentially substantial spending cuts in the years following the next devolved elections, if such a scenario for overall public service funding came to pass.
• The FSDP implicitly recognises this by setting out some plans for administrative savings, re-prioritisation of spending, and a focus on boosting tax revenues. However, fuller detail on where cuts will fall is expected later this year in a multi-year Scottish Spending Review.
• The MTFS’s higher and lower scenarios underline just how uncertain Scotland’s fiscal outlook remains. Any multi-year Scottish Spending Review published later this year will almost certainly need revisiting as UK funding plans evolve, tax and benefit forecasts are updated, and the lessons from implementing the FSDP become clear.