The IFS Scottish Budget Report – 2025–26

The Scottish Government’s Budget for 2025–26 takes place after Chancellor Rachel Reeves’s first UK Budget transformed the short-term funding outlook for public services nationwide, but the medium-term outlook still looks challenging. General purpose funding from the UK government for day-to-day public service spending is set to be £2.2 billion or 5.8% higher this financial year than when the 2024–25 Budget was initially set back in December 2023. Funding for 2025–26 is set to be £2.6 billion higher than expected at that point. The Scottish health service has been the biggest beneficiary of the funding increase so far, but current plans imply no further real-terms increase in day-to-day health spending in 2025–26. Health spending in the coming year will almost certainly have to be topped up as it was this year. But with a tricky fiscal situation meaning it highly unlikely that Ms Reeves will be able to top up overall funding significantly, boosting health spending in the coming year will require funding to be carried forward from this year via the Scotland Reserve and/or cuts to other areas of spending. 

Capital spending is set for an even bigger boost in 2025–26 and then a fall in 2026–27. This lumpy path is unlikely to be optimal, and could increase the cost of key inputs, including labour costs. Indeed, history suggests projects may slip, leading to a slower-than-planned ramp up in investment spending. And, to the extent that investment is front loaded, it may make sense to invest in equipment and software that can boost the productivity and performance of the health service and other public services – such investments are less prone to demand-driven inflation (at least due to demand from a single small country) and could help make tight public service budgets in future years go further.  

Alongside the Budget, the Scottish Government published its first Tax Strategy. This is best thought of as a framework for how a strategy for tax policy could be developed, rather than a strategy itself. But it is welcome nonetheless and sets many laudable aims for tax policymaking, and commits the Scottish Government to evaluating key policies, such as recent changes in income tax rates. Also welcome is a long overdue process to develop and consult upon reform of council tax – with council tax bands based on values over a third of a century old, at a bare minimum, plans for a revaluation should be made. Less welcome were the changes to land and buildings transactions (LBTT) tax on second and rental homes, which make arguably Scotland’s most economically damaging tax even more damaging. 

As well as income tax, policy in Scotland on school teacher numbers and public sector pay has increasingly diverged from that in the rest of the UK in recent years. Commitments to maintain teacher numbers in the face of falling pupil rolls and higher public sector pay are legitimate policy positions, but as with income tax it will be important to evaluate their effects given their implications for other areas of spending.  

The rest of this report proceeds as follows.

Chapter 2 assesses the Scottish Government’s tax strategy and recent tax policy decisions. It first sets out the key elements of the tax strategy, before evaluating the strategy: is what it says sensible? And does it represent a coherent strategy for the tax system? It then describes and analyses recent reforms to income tax, business rates and LBTT.  

Chapter 3 looks at council tax specifically. It sets out why revaluation and reform are needed, before considering how the effects of two example reforms – a simple revaluation and a system where tax rates for each band were proportional to the up-to-date average value of properties in those bands – on different types of households. In both cases, reforms are modelled to be revenue-neutral across Scotland as a whole, and we assume funding for individual councils is updated to account for changes in their tax bases. The chapter also discusses issues such as transitional arrangements and mitigation measures to ease the passage of reform, and legislation to keep council tax up to date in future.

Chapter 4 focuses on Scottish school spending, as well as teacher and pupil numbers. It first sets out the large increases in per-pupil spending in recent years, which now exceeds English levels by around 20%. It then looks at trends in teacher and pupil numbers. With pupil numbers set to fall, a commitment to maintain teacher numbers would see a significant reduction in class sizes, which may not be the best way to improve school attainment, or ensure the sustainability of Scottish councils’ finances.

Chapter 5 looks at Scottish public sector employment and pay. It begins by looking at the level and trends in public sector employment compared to the rest of the UK, before turning to look at public sector pay. Median public sector pay is now 5% higher than in the UK as a whole, whereas it was roughly in line with it during the 2010s. The chapter then looks at how retention of workers in the public sector in Scotland compares with England, finding little evidence that higher pay has improved retention, although it may have other benefits. 

Finally, Chapter 6 looks at the overall Scottish Government funding and spending outlook. It shows how Rachel Reeves’s top-ups to public spending UK-wide have boosted Scottish Government funding, but that a downgrade in forecasts for devolved tax revenues in the short term will partially offset this next year. It then looks at how planned changes in both day-to-day and investment spending vary across services, finding that health and local government are currently set to see increases broadly in line with the average over the period 2023–24 to 2025–26, with smaller service areas seeing a mix of larger increases and smaller increases (and even cuts). The chapter concludes by looking to the period 2026–27 to 2028–29, when a planned slowdown in UK government funding will mean tough trade-offs as the Scottish Government allocates its funding between services. The chapter also highlights scope for the Scottish Government to be much more transparent about what its plans really mean for year-on-year changes in spending by consistently comparing plans for the coming year with the latest plans for the current year. Continued comparisons with superseded budgets for the current year risk giving a misleading impression of how resources are really changing – and hence what the public can expect from different services.