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IFS response to Scottish Resource Spending Review

Observation

8% cuts to many service areas and hidden tax rises relative to the rest of the UK

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

“Today’s Scottish Resource Spending Review gives a clear indication of the areas prioritised by the Scottish Government - and the services that on current funding plans at least will be cut back as a result.

On the plans set out today, the axe is set to fall on a wide range of public service areas. Budgets for local government, the police, prisons, universities and rural affairs are due to fall by around 8% in real-terms over the next four years. Spending on enterprise, tourism and trade promotion is set to fall even further - by 16% in real terms over the same period.

The relative winners are health, some smaller service areas, and above all social security spending. Spending on health is set to increase by 2.6% in real-terms over the next 4 years, although this will almost certainly be slower than is needed to meet rising costs and demands. Indeed, on this basis, health services could really struggle over the next few years. Social security spending is forecast to increase by a much more substantial 48% as new, more generous, Scottish benefits replace UK-wide benefits. 

Underlying these difficult decisions are UK government funding plans that look less generous than when they were set last Autumn as a result of higher inflation. But big increases in social security spending and a relatively poor income tax performance also make the challenges more difficult, and that’s despite the Scottish Government implicitly assuming a further rise in income tax relative to the rest of the UK."

The overall funding envelope

The Scottish Government has based its spending plans on forecasts from the Scottish Fiscal Commission (SFC) which set out a very tough few years for overall funding. The Spending Review pencils in a real-terms spending increase of around 5% (or 1.2% a year) over the next four years. 

This is relatively slow growth by historic standards, with the exception of the early-to-mid 2010s when austerity measures saw cuts in funding. In part this reflects the fact that the UK government front-loaded funding increases in its own 2022-23 to 2024-25 spending review - ‘core’ non-COVID budgets across the UK grew substantially this year and are set to grow much more slowly over the next few years. It also partly reflects the recent rise in inflation since the UK government set out its spending totals in Autumn 2021 - higher prices mean that given cash budgets will stretch less far. 

However, there are several Scotland-specific factors that contribute to this tight funding environment. 

  • First, this year and to a lesser extent the next two years will see some temporary funding flows - such as from the licensing of offshore wind farms - that are not available in the later years of the Spending Review period. 
  • Second, relatively poor tax revenue performance. As discussed further below, past revenue forecasts have turned out to be overly optimistic, necessitating money to be repaid to the UK government in the next few years. And after stripping out some measures that will increase tax revenues in Scotland relative to the rest of the UK over the next few years, underlying tax base growth is forecast to be slow, acting as a drag on the budget.  

Public spending choices

Scottish policy decisions also contribute to the tight settlement for many services. Above all, the Scottish Government is prioritising spending on social security benefits. 

Spending on devolved Scottish social security benefits is forecast to increase from £3.9 billion this year to £6.4 billion in 2026-27 - an increase of 48% in real terms. Much of this increase is due to inflation and underlying increases in the number of people claiming the mainly disability-related benefits devolved to the Scottish Government. But the Scottish Fiscal Commission expects spending on these benefits to be around £700 million higher than the block grant adjustments added to the Scottish Government’s budget when these were devolved, largely due to reforms by the Scottish Government that are expected to lead to more people qualifying for payments, and increases in some payments. 

On top of this the Scottish Government has introduced a range of additional benefits such as the Scottish Child Payment. These payments amount to a further £600 million, meaning that the Scottish Government is forecast to be spending £1.3 billion more on social security benefits than the funding it receives from the UK government following social security devolution. 

A number of other smaller areas of spending are also set to see large real-terms increases in funding including:

  • Funding for employability and training services (up 67%). 
  • Active and low carbon travel (up 47%).
  • Concessionary fares and bus services (up 24%)

But this prioritisation of social security and a few other areas requires cuts and tough choices for many large areas of public service spending:

  • Budgets for local government, the police, prisons, justice, universities and rural affairs are set to fall by around 8% in real-terms over the next four years. This is equivalent to a real-terms cut of £1.1 billion from these areas of spending over four years. 
  • The budget for enterprise, tourism and trade promotion is set to fall by 16% in real terms over the next four years. 
  • Funding for the Health and Social Care portfolio is set to increase by 0.6% a year in real-terms over the next four years - or 2.6% in total. While better than most large areas of public service spending, this is much slower than we would expect to be required to meet rising costs and demands for services - which would likely be closer to 2.6% per year rather than over four years.

Overall, excluding social security, the Spending Review proposes funding for public services to be flat over the spending review period. 

Tax choices and forecasts

No tax changes were announced alongside today’s Spending Review. But that doesn’t mean that tax revenues and policy had no implications for the spending plans set out today.

  • The SFC now assumes that the higher rate income tax threshold in Scotland will be frozen over the next four years rather than increased in line with inflation. This would be one year longer than the freeze announced by the UK government and raises £500 million a year by 2026-27. If the Scottish Government instead chooses to increase the higher rate threshold, its funding will be lower than assumed in the Spending Review, potentially necessitating further spending cuts. 
  • In addition, no decision was taken on whether to follow the UK government and cut the basic rate of income tax to 19%. Not cutting it raises close to a further £500 million by 2026-27 relative to following the UK government, but would mean that all but the very lowest income taxpayers in Scotland would pay more income tax than their counterparts south of the border, and would further increase taxes on middle and higher income Scots relative to the rest of the UK. Again, if the Scottish Government instead decides to match the cut in income tax rates, less funding will be available for Scottish public services. 

Income tax policies have therefore generated around £1 billion to address the gap between spending pressures and funding identified by the Scottish Government in its December Spending Review framework report. 

However, movements in the underlying tax forecasts have acted to reduce the Scottish Government’s funding over the next few years. 

The SFC now forecasts that the Scottish Government may have to repay £817 million in 2024-25 as a result of forecast errors in relation to Scottish income tax revenues and block grant adjustments in the year just ended, 2021-22. This partly reflects data suggesting that income tax revenues have grown more strongly in the rest of the UK than Scotland. But it also partly reflects a decision by the Scottish Government at the start of last year to use initial low forecasts of the block grant adjustment when confirming its spending plans, rather than higher more up-to-date forecasts. This boosted the funding available to the Scottish Government last year (because the block grant adjustment subtracted from its budget was smaller) but will reduce the budget in 2024-25 (as this forecast error is reconciled).

While tax revenue forecasts have been revised up for future years, the upwards revision is smaller than for the rest of the UK once one strips out the policy effects discussed above. This means that the SFC’s forecasts imply a further deterioration in expected growth in the Scottish tax base relative to the rest of the UK. Some of this appears to relate to slower forecast growth in employment from 2023-24 onwards - which may partly reflect the ability of the SFC to build in negative impacts of the cost-of-living crisis on economic growth. But it’s unlikely this can explain the full difference and the SFC’s plan to investigate this further later this year is highly welcome. Given that underlying tax revenue performance is forecast to be an increasing drag on Scottish Government funding, it’s important to understand why that is, and what could be done to address it.

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