Next week’s Scottish Fiscal Update will show more money this year – but cuts looming next year

Next Tuesday (25 August), the Scottish Fiscal Commission will publish a ‘Fiscal Update’. As in previous iterations (such as the 2025 and 2024 editions), this will set out the major economic and fiscal development since the Scottish Budget in January, and discuss the implications of this for the Scottish Government’s finances in both the current financial year (2026–27) and future years. In this comment, we use the latest fiscal data to both estimate how Scottish Government funding this year has changed compared with January’s Budget figures, and analyse the funding outlook for future years. We also highlight some of the key challenges and opportunities facing the new Finance Secretary, Jenny Gilruth, as she develops her 2027–28 Scottish Budget. The comment draws on submissions we have made to pre-Budget inquiries by the Scottish Parliament’s Finance and Public Administration Committee and Public Service Reform Committee.

How has Scottish Government funding for 2026–27 changed since January’s Scottish Budget?

The latest official estimates of the amount of funding available to the Scottish Government this year were published by the Scottish Fiscal Commission in January at the time of the last Scottish Budget. These show total funding for day-to-day (resource) spending of £54.1 billion. Devolved social security benefit spending was forecast to amount to £7.4 billion, meaning £46.7 billion for day-to-day spending on public services. Funding for capital investment is set to amount to £7.6 billion, including £0.5 billion of capital borrowing.

There have been two key changes over the last seven months, both of which mean the Scottish Government’s funding this year will now be higher:

• First, funding from the UK government has been increased. By far the largest component of this is extra funding via the Barnett formula as a result of a decision by the UK government to cover 90% of the accumulated deficits that English local authorities have run up as a result of their spending on special educational needs services outpacing the funding made available to them. This amounts to a one-off £571 million extra for the Scottish Government in 2026–27. A further £54 million in funding for day-to-day spending has been provided as a result of a range of other changes to spending plans for England, including additional spending on childcare, and funding for business rates reliefs for pubs and live music venues in England. And a further £7 million in funding has been provided for capital investment.
• Second, provisional out-turns data suggest that the Scottish Government underspent its final budget for day-to-day spending last year (2025–26) by £312 million, and its final budget for capital investment by £46 million. The Budget plans for the current year (2026–27) already assume using £150 million of underspends last year carried forward via the Scotland Reserve. But this still means an additional £162 million of funding for day-to-day spending will be available for drawdown from the Scotland Reserve if necessary.

Taken together, these two changes mean an additional £787 million of funding for day-to-day spending and £53 million in funding for capital investment are now available compared with January. This is equivalent to an extra 1.4% in overall funding for day-to-day spending, or an extra 1.7% in funding for day-to-day spending on public services (assuming no changes to devolved social security spending). On the capital side, it is equivalent to a 0.7% boost.

Other parts of the budget – including devolved tax revenues, devolved social security spending and associated block grant adjustments – will also change, but it is too early to say precisely what the net effect of this will be. 

Even so, it is clear that there is a not an insubstantial amount of money that the Scottish Government could deploy in its upcoming Autumn Budget Revision to top up the initial budgets set for this year.

What are the implications of this funding change?

It may therefore be tempting to think that the Scottish Government has the funding to start progressing the SNP’s manifesto pledges – such as a £2 cap on bus fares and expanded childcare provision – without having to make tough choices elsewhere in the Scottish Budget. This would be mistaken, for two key reasons.

First, the Scottish Government will likely need to top up budgets for some existing services if it wants to avoid cuts to staffing and other inputs, and a resulting decline in performance. This is most obvious in the health and social care portfolio. Previous IFS analysis from February found that once funding for councils to increase social care workers’ pay in line with the ‘Real Living Wage’ is stripped out, the remaining funding for day-to-day spending on the health and social care portfolio is set to fall in real terms this year. Updating this analysis for the provisional spending out-turns for last year and the latest inflation forecasts implies a fall of 0.4% in real terms this year compared with last.

As it has in each of the last few years, the Scottish Government will therefore likely feel the need to top up the initial health and social care spending plans this year. An increase of £540 million would be needed to match the increase in health and social care spending planned for England this year (2.2% in real terms). An increase of £765 million would be needed to match the projected medium-term real-terms increase in health and social care spending needs assumed in the Scottish Government’s Medium-Term Financial Strategy (3.3% in real terms).

The as-yet unallocated increases in funding this year could enable the Scottish Government to find these top-ups without having to cut back other areas of spending in-year (as it had to do in 2023–24). But doing so would leave little left to spend more elsewhere even if the Scottish Government chose to utilise all of the as-yet unallocated funding this year.

Second, using the as-yet unallocated funding in full this year is probably not the wisest choice – particularly for recurrent spending pressures, such as the core health and social care budgets (or the cost of capping bus fares or paying for more of families’ childcare costs). This is in part because the bulk of additional funding – most notably that coming Scotland’s way as a result of writing off historical special educational needs spending deficits built up by English councils – is currently set to be one-off. As we and others have highlighted previously, using one-off funding to pay for recurrent spending pressures is risky – because in future years, funding needs to be found from recurrent sources instead, if further one-off sources do not become available. But, in addition, as we discuss below, the financial picture for next year, 2027–28, looks particularly challenging.

It may therefore make sense to carry some of the as-yet unallocated funding forward via the Scotland Reserve, to ease future financial pressures a little. Depending on how much the Scottish Government decides to carry forward and the extent of any top-ups to health and social care spending (and spending on any other priorities), it is possible that it will feel the need to make at least some in-year cuts to some services to top up budgets for others.

What is the outlook for 2027–28 and beyond?

As it stands, 2027–28 looks like a particularly difficult year financially for the Scottish Government, reflecting several factors.

First is a planned slowdown in spending growth by the UK government – and hence in the amount of funding the Scottish Government receives via the Barnett Formula. Official figures from HM Treasury suggest overall real-terms growth in funding for day-to-day spending by UK government departments and the devolved governments is set to slow from 2.8% this year to 0.7% next year. This slower spending growth is part of the UK government’s strategy to reduce borrowing and stabilise government debt as a share of GDP.

Second, as IFS research has previously highlighted, the Barnett formula means a smaller percentage increase in funding for the Scottish Government than for the UK as a whole. This is because the Barnett formula provides the same pounds-per-person increase in spending for Scotland as for England. With funding per person currently higher in Scotland, the same pounds-per-person increase is a smaller percentage increase.

Third, as discussed above, most of the top-up to funding this year is currently one-off funding – most notably the funding as a result of writing off 90% of English councils’ accumulated special educational needs deficits. The UK government has also announced an increase in spending from 2028–29 onwards, when it takes responsibility for funding special educational needs services in full, but as it stands there is a dip in funding in 2027–28.

Fourth, after several years during which the Scottish Government’s budget has been boosted by positive reconciliation payments as a result of devolved income tax revenues turning out to be stronger than forecast, that is set to change in 2027–28. For example, whereas stronger-than-expected income tax revenue performance in 2023–24 led to the Scottish Government receiving a positive reconciliation payment this year of £406 million, weaker-than-expected performance in 2024–25 means there will be a negative reconciliation payment of around £728 million instead in 2027–28. While the Scottish Government will be able to borrow up to £668 million to help spread the cost of this payment back to the UK government, this change in tax fortunes will be a drag on its overall funding.

Taking account of these various factors, we estimate that the Scottish Government’s funding for day-to-day spending is currently set to fall by around 1.0% in real terms next year. After stripping out current forecasts for rising spending on devolved social security benefits, the amount available for day-to-day spending on public services would fall by 1.9% in real terms.

The Scottish Spending Review published in January has already pencilled in cuts of around 2% in real terms next year for many portfolios, including both the finance and local government portfolio and the justice portfolio. However, in order to protect the NHS from cuts in funding, the Scottish Government would likely feel the need to cut back other spending by significantly more than that 2% if overall funding for public services does indeed fall in line with our projections. Even bigger cuts to council funding could presage another year of large council tax rises – and still leave councils potentially needing to cut back services. And the fact that Scotland’s police and fire services do not raise any of their own funding via council tax (unlike in England) means Police Scotland and the Scottish Fire and Rescue Service would face particularly tough choices over spending if their funding was cut back substantially.

Our analysis suggests the Scottish Government’s funding for day-to-day spending on public services is then set to rise in 2028–29 – by a projected 1.4% in real terms – partly but not fully undoing the cuts expected next year. Carrying forward some of the as-yet unallocated funding from this year into next via the Scotland Reserve could therefore help smooth the amount the Scottish Government has available to spend.

It is important to note, though, that just how the Scottish Government’s funding will change next year and beyond is subject to significant uncertainty. Different factors could increase or reduce the financial challenges new Finance Secretary Jenny Gilruth will face as she sets her first Scottish Budget and begins updating medium-term spending plans:

• It seems more likely than not that forecasts of the future net contribution of devolved income tax revenues to the Scottish Government’s budget will be downgraded, which would increase the financial difficulties she will face. For example, if the factors underlying the weaker-than-expected revenue performance in 2024–25 are expected to persist, we would expect downwards revisions to forecast revenues from 2025–26 onwards too. And, as discussed in previous IFS research, even if these factors are expected to be temporary, existing forecasts for the net contribution of Scottish income tax revenues to the Scottish budget are likely to be biased upwards. This is because while revenues are forecast by the Scottish Fiscal Commission, the associated deductions to block grant funding are forecast by the Office for Budget Responsibility. The two bodies’ different views of average earnings growth mean that average earnings are implicitly assumed to grow at a faster rate in Scotland than in the rest of the UK. If in fact earnings grow in line with the rest of the UK – which is a more reasonable central assumption – the net contribution of devolved income tax revenues to the Scottish budget would be around £500 million lower in 2028–29 than currently forecast, and around £1 billion lower in 2030–31.
• On the other hand, it is possible that the UK government will increase the funding it provides to the Scottish Government via the Barnett formula. For example, a further write-off of the ongoing deficits English councils are still accumulating in relation to special educational needs services is likely to be needed, which would result in another one-off top-up to the Scottish Government’s budget. And while the new Burnham administration has informed departments that they must find the money to pay for new measures this year and next from within their existing budgets, the 2027 Spending Review may see top-ups to spending plans for 2028–29 onwards to avoid cuts in the run-up to the next UK general election, and to pay for mooted expansions of service provision in England, such as adult social care. Each £5 billion increase in spending in England on services that in Scotland are devolved would generate approximately £500 million in funding for the Scottish Government.

This uncertainty will make it harder for the Scottish Government to plan its spending, particularly after next year. But unless the UK government were to very substantially loosen the purse strings, it is clear that tough tax and spending choices are looming. And prudent financial management means preparing for the worst, not just hoping that more money will become available down the line.

What are the key fiscal challenges, opportunities and decisions facing the Scottish Government?

In our responses to the Scottish Parliament’s pre-Budget inquiries, we have highlighted several issues that Finance Secretary Jenny Gilruth will need to be particularly mindful of as she develops her plans for 2027–28 and beyond:

• Public sector employment and pay. Public sector pay makes up over half of the Scottish Government’s day-to-day spending. The Scottish Government’s Fiscal Sustainability Delivery Plan published last summer set a target of reducing devolved public sector employment by 0.5% a year in each of the five years from 2025–26 to 2029–30, while its pay policy envisages pay rises averaging 9% in total over the three years from 2025–26 to 2027–28. Neither plan appears to be on track. The most recent employment statistics suggest devolved public sector employment actually increased by 0.6% on a full-time-equivalent basis between 2025 Q1 and 2026 Q1. And as highlighted by the Scottish Fiscal Commission, pay deals agreed for 2025–26 and 2026–27 average around 8% over two years, meaning increases in pay of more than 1% in 2027–28 would bust the three-year cumulative increase envisaged in the current pay policy. The Finance Secretary will therefore need to decide whether to double down on existing plans or revise them. For pay, recent years have seen increases outpace those seen in the rest of the UK, so in a tough financial environment, a period of smaller pay increases is worth considering. But holding increases to 1% or less next year when inflation is likely to be over 2% would likely be challenging, especially for a government that has long championed higher pay for public sector workers – and which has in some cases already negotiated pay deals with explicit inflation protection. A new pay policy for 2027–28 is therefore needed. For employment, cuts of 3% between now and 2029–30 would be needed to meet the original 0.5% a year target given the step backwards seen in 2025–26. This is certainly feasible: employment was reduced by nearly 7% between 2009 and 2013, for example. But given changes in demand for different services, changes in technology and a drive for broader public service reform, some types of jobs will need to be cut back by much more than this so that new roles can be created elsewhere – for example, in medical diagnostics and in digital and AI-based services. The Scottish Government and public sector bodies need to decide how actively they will reshape as well as reduce their workforces, including through the use of compulsory redundancies.
• Public sector reform and efficiency. The Scottish Government has big ambitions for changing how public services are organised and delivered, both to improve outcomes for service users and to reduce costs. On the cost front, it is targeting a 20% reduction in administration and other ‘corporate’ costs, such as property and procurement costs, while ensuring the protection of ‘front-line services’. While it makes sense to ensure back-office functions are efficiently structured and delivered, such functions can also play an important role in improving the efficiency and quality of front-line services – a binary ‘front-line good, back-office bad’ approach is unlikely to be helpful. The Scottish Government should also be open to changes in how front-line services are delivered: changes to working practices and new technology may enable cuts to some front-line costs and staffing, while maintaining or even improving services. And as its wider public service reform strategy envisions, some costly activity may be avoidable through preventative services and earlier intervention. Getting the pace of change right will be a tricky task with overall funding constrained though. For example, indicative figures in the Scottish Spending Review suggest such a big increase in the share of health and social care spending going to community and social care in 2027–28 and 2028–29 that funding for hospitals would be virtually flat.
• Social security spending and reform. This year, spending on Scottish social security benefits is forecast to be around £925 million more than is provided by the social security block grant adjustments (BGAs). This is the result of active decisions by the Scottish Government to provide more generous benefits, particularly for low-income families with children, and to reform how eligibility for disability benefits is assessed and reassessed. Falling application success rates and higher shares of existing recipients having their payments reduced or ended at reassessment mean Scotland’s disability benefit system is now expected to cost less than previously estimated, easing pressures on the Scottish budget somewhat. However, with the UK government’s Timms Review of its disability benefits reporting this autumn, and Reform UK proposing big cuts to these benefits if it wins the next election, the Scottish Government will need to consider how it would respond if the amount it receives via the social security BGAs is reduced as a result of reforms elsewhere in the UK.
• Tax policy and revenue. The first Scottish Budget of a new parliamentary term will provide the Scottish Government with an opportunity to set out a tax strategy for the next five years. The SNP’s manifesto said that an SNP government would not increase existing income tax rates or add any additional tax bands. It also implies that the basic and intermediate tax thresholds will be increased by above inflation to ensure the Scottish Government can say a majority of Scottish income tax payers pay (a little) less than those in the rest of the UK – although these savings, currently up to £40 a year, are dwarfed by the extra paid by higher-income taxpayers in Scotland. These pledges do not preclude other changes to income tax. An aim of making income tax simpler could see the number of tax bands reduced, although doing so would require some people to pay more unless the Scottish Government were willing to forgo revenues. And pledges to increase the basic- and intermediate-rate thresholds do not preclude freezes or even reductions in the higher-, advanced- or top-rate thresholds, which would raise revenues by dragging more people into higher tax bands but further increase the income tax penalty faced by higher-income Scots compared with residents of the rest of the UK. Decisions on the top rate of tax in particular should be guided by forthcoming HMRC analysis of the behavioural effects of increases made in 2023–24 and 2024–25. If this more detailed analysis finds evidence that the increase in the top rate led to such large behavioural responses that it reduced rather than increased revenues – as some initial analysis of aggregate data suggests it might have – the Scottish Government should be open to reviewing the top rate of tax. The Finance Secretary should also develop a plan for property tax reform, building on a recent consultation on council tax reform. As we have previously highlighted, comprehensive reform of devolved property taxes (council tax, business rates, and land and buildings transaction tax) could lead to a tax system that is both fairer and more conducive to economic growth.
• A strategy for growth. Beyond tax reform, Jenny Gilruth will have to consider how the wider Budget can support growth, and navigate any trade-offs between such measures and the Scottish Government’s other objectives. For example, as spending on constructing new prisons winds down, the Scottish Government has chosen to increase investment in social housing and improved transport for the Highlands and Islands. Both are worthy uses of the funding, but a focus on growth might have suggested a different mix, including on transport within the more densely populated Central Belt. A policy of free university tuition, while substantially reducing the amount of debt students incur during their studies, is also unlikely to be a particularly cost-effective way of boosting the skills of the Scottish population. And there may be trade-offs between concerns about the environment, and leveraging Scotland’s comparative advantages in energy production and energy-intensive industries – such as data centres.

Tackling each of these challenges would help improve both public and private sector productivity – helping public money stretch further, and helping boost growth and in turn tax receipts. A lack of progress would increase the pressure on the finances of the Scottish Government, households and businesses. These and other issues beyond just setting the budgets for the Scottish Government’s different spending portfolios mean big challenges – but also opportunities – for Ms Gilruth and her colleagues in both the 2027–28 Scottish Budget and beyond.