Immediate response to today's Scottish Fiscal Commission economic and fiscal forecasts

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

“The latest Scottish Fiscal Commission forecasts for devolved tax revenues and social security benefit spending were only revised slightly from December. But while small, when combined with the most recent Office for Budget Responsibility forecasts for equivalent taxes and benefits elsewhere in the UK, the updates point in the same direction: slower funding growth for Scottish public services over the next few years. Funding for day-to-day spending on public services is now forecast to grow by an average of just 0.8% a year in real-terms between this year and 2028–29, down from 1.5% in December’s forecast. Such a scenario would, given the priority expected to be afforded to the NHS, likely imply cuts to spending on many other public services. And, at least given current UK government spending plans, risks are skewed to the downside.”

“Of course, the outlook is highly uncertain, and actual tax revenue, social security spending and funding from the UK government could differ from these forecasts by billions of pounds over the next five years. Still, these forecasts – and the UK government’s Spending Review on 11 June – frame the tough choices facing the Scottish Government. The forthcoming Medium-Term Financial Strategy is a chance for the Scottish Government to set out how it will address the difficult financial outlook and make trade-offs between tax and spending in different areas. With devolved elections next May, there may be a temptation to delay difficult decisions. But doing so would shorten the time to address the challenges facing any future Scottish Government.”

Economy forecast:

• The Scottish Fiscal Commission (SFC) has aligned its economic forecasts with the latest forecasts from the Office for Budget Responsibility (OBR, the UK’s official forecaster). This means that differences in the timing of SFC and OBR forecasts (in late May and early March, respectively) do not lead to a potentially misleading picture of the outlook for the Scottish Budget (which depends on both sets of forecasts). This is a sensible approach. But it does mean that today’s forecasts do not account for the tariff and other measures (and further uncertainty associated with them) announced by President Trump since early April.
• The SFC highlights this means that risks to its forecasts for growth (which over the next 4 years or so are similar to its most recent forecasts from December) are weighted to the downside: actual growth is more likely to fall short of forecasts than exceed them. It expects Scotland to be similarly exposed to US tariffs as the rest of the UK, though its exports to the US are more concentrated in the beverages sector (25% versus 3% for the UK as a whole).

Tax forecasts:

• The SFC has made little change to its devolved tax revenue forecasts since December. On income tax, its forecasts were revised down for 2024–25 by £107 million (-0.6%), while its forecasts for 2029–30 were revised up by £358 million (+1.5%). Revisions for earlier years were generally downward, reflecting the latest data, while forecasts for future years were upgraded slightly, due to higher expected nominal wage growth.
• What matters for the Scottish Budget is how revenues raised compare to the ‘block grant adjustments’ (BGAs) subtracted from Scottish block grant funding to reflect the fact that the Scottish Government now retains these tax revenues instead. These BGAs depend on how revenues perform in England and Northern Ireland. Here the picture is somewhat weaker than expected back in December. For example, because Scottish income tax revenue forecasts have been revised up by slightly less by the SFC than England and Northern Ireland forecasts have been revised up by the OBR, the net contribution of income tax to the Scottish Budget is expected to be £200 million to £300 million a year lower over the next few years than expected last December. Again, this is a relatively modest revision compared to what has previously been seen, but still adds pressure to already challenging public finances.  

Social security forecasts:

• Updates to social security spending forecasts mirror those for tax revenue. Figures for last year and this have been slightly revised down in line with the latest data on actual spending. Forecasts for future years have been revised up due to the inclusion of estimates of the cost of the Scottish Government’s two-child limit mitigation policy. This is expected to cost £156 million in 2026–27 when it first takes effect, rising to £199 million in 2029–30 as the number of families affected by the two-child limit (and so eligible for mitigation payments) rises. Changes to forecast spending on other devolved benefits since last December are modest overall.
• As with tax, the impact on the Scottish Budget depends on how social security spending compares to the associated BGAs, which in turn evolve according to how social security spending changes in England and Wales. Here, changes are more pronounced. First, there is the cost of two-child limit mitigation which is unique to Scotland. Second, the UK government has recently announced reforms to health-related benefits, including Personal Independence Payment, designed to slow the growth in the number of claimants and expenditure. With – at least to date – no announcement of any similar changes to Scottish disability benefits, this increases the net cost of the Scottish system. Net Scottish benefit expenditure is now forecast to increase from £1.3 billion this year to £2.1 billion in 2029–30, with the latter figure £600 million higher than December’s forecast. A more generous benefit system than in the rest of the UK is a legitimate political choice, but it does squeeze the funding available for public services.  

Overall fiscal outlook:

• Together with assumptions about funding from the UK government, these tax and social security forecasts allow the SFC to project forward the Scottish Government’s total funding for day-to-day spending over the next few years. Overall the increases average 1.4% a year in real terms between this year and 2028–29.  
• Excluding social security spending, this implies that available funding for public services would increase by an average of 0.8% a year in real terms over the same period – substantially down from the 1.5% a year increase implied by the SFC’s December forecast.  
• This revision is in part because the SFC now accounts for UK government funding to compensate public sector employers partially for increased employer National Insurance contributions. But more important are the aforementioned downgrade in the net devolved tax revenue position, and higher forecast net spending on devolved social security benefits. The UK government also slightly reduced planned day-to-day spending growth in its March budget (from an average of 1.3% a year in real-terms to 1.2%), reducing the amount of block grant funding the Scottish Government is assumed to receive in future years.
• As in December, the SFC assumes that the block grant will track UK-wide spending: now 1.2% a year, on average. Final allocations will depend on how funding is distributed between services in the UK government’s Spending Review on 11 June (in particular, how much is allocated to services that in Scotland’s case are devolved). As with devolved tax and social security forecasts, there is uncertainty about this figure.  
• However, the operation of the Barnett formula means that it’s likely that the block grant will increase less quickly than overall UK government spending. This is because the Barnett formula allocates the Scottish Government a population share of any increase in relevant spending by the UK government. And because spending per person is higher to begin with in Scotland (around 25% per person more than in England), a population share (i.e. the same cash amount per person) is a smaller percentage increase than in the UK as a whole. Modelling based on plausible (albeit uncertain) scenarios for UK government spending decisions suggests that the block grant might grow by closer to an average of 1.0% a year in real terms (not 1.2%).
• If realised, this would reduce the overall rate of growth in Scottish Government funding for day-to-day spending on public services to 0.6% a year. This suggests the upcoming Scottish Medium-Term Financial Strategy and any Scottish Spending Review will be highly challenging.