Spending review

Scots face higher taxes or cuts to plug £3.5bn gap

Tom Arthur addressing the CIOT/ATT lunch (pic: Terry Murden)

Scottish government ministers may have to raise taxes or cut services in order to plug a projected multi-billion pound deficit in Scotland’s finances.

The Institute for Fiscal Studies (IFS) has warned that a spending spree on a range of projects, together with underwhelming tax revenues and the effects of inflation has created a £3.5 billion black hole in the public finances equal to £640 per person.

The Scottish government’s spending review, to be announced on Tuesday, will be “no easy task” for Finance Secretary Kate Forbes who will announce plans to the end of the parliament in 2026-27.

She said this will  “give our public bodies and delivery partners greater financial certainty to help them rebuild from the pandemic and refocus their resources on our long-term priorities.”

But economists have warned the government may have to consider axing some policy commitments or increasing taxes.

“Difficult choices on Scottish tax and spending will eventually have to be faced,” the IFS said.

Kate Forbes
Kate Forbes: difficult choices

It is likely to prompt Ms Forbes to repeat her call for more powers from Westminster to enable the Scottish government to better manage its affairs.

Scottish Labour finance spokesperson Daniel Johnson said:  “The IFS paper lays bare the price of SNP economic failure. 

“Fifteen years ago, Scottish salaries were growing more quickly than the UK average – now they lag behind. 

“It is clear that the spending review, due next week, will spell out the heavy cost all Scots will have to pay for nationalists prioritising constitution over the economy.

“This will be counted in lost jobs, cuts to public services and few will be able to forgive the SNP them for it.”

Call for more borrowing powers

Yesterday, the public finance minister Tom Arthur told the Chartered Institute of Taxation and Association of Taxation Technicians joint lunch in Edinburgh that the Scottish government was looking for clarification on the fiscal framework on the devolution of tax and that more borrowing powers remains a key demand.

He said the government wanted to work with tax professionals on refining the tax system and also appealed to them for help in improving public understanding of how it works.

Some of those present said public understanding was low because the overlay of Scottish taxes on to the Treasury system had made it too complex.

Fiscal Commission forecasts ‘in a different world’

The Fraser of Allander Institute said: “A spending review is not a multi-year budget, and we shouldn’t expect it to look like one. But we have no idea whether the government is going to set out spending plans at portfolio level, or in more detail than this.

“There is a possibility, too, that the government does not in fact set-out portfolio level spending plans, but instead provides information about its spending plans for only a selective list of its policy ‘priorities’. This sort of approach would certainly represent a missed opportunity.”

The institute notes that the Scottish Fiscal Commission, which issues its forecasts this week, last did so in December but “a huge amount has changed in the five months since then.”

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The December 2021 forecasts described an economy that had recovered from the pandemic more strongly and smoothly than had been anticipated earlier that year. The economy was forecast to grow 2.2% this financial year and 1.2% next. Unemployment was forecast to peak at 4.9% in 2022, down from an expected peak of over 7% in its previous forecast. Inflation was expected to increase in 2022 to around 4.4% – enough at the time to cause the SFC to forecast a fall in real earnings.

“We live in a different world now. By March 2022, inflation was 7%, and by May the Bank of England was expecting inflation to peak at 10% this year. The rise in inflation, together with tax increases, leads the Bank to forecast that 2022 will see the second largest annual fall in disposable household incomes since the 1960s.

“The SFC’s forecasts will inevitably paint a similarly gloomy picture for real household incomes in Scotland, which in turn will result in a contraction of its forecasts for economic growth, and probably a deterioration in its medium term outlook for the labour market. Exactly how the SFC sees the cost of living crisis play out will be interesting to see.”

It says the SFC’s economic forecasts will have implications for the Scottish budget, via the income tax forecasts in particular.

Tuesday’s forecasts will give an indication of whether the outlook for the contribution of income tax to the budget has improved or deteriorated since the budget forecasts in December.

“It’s very difficult to predict the outcome,” says the institute. “Its quite conceivable that the forecasts for Scottish income tax revenue will be revised up, if the SFC believes that higher inflation and recent further falls in unemployment will drive up earnings growth.

“But what ultimately matters is how the SFC’s judgements play out alongside the OBR’s equivalent judgements for the UK (since these are what determine value of the income tax block grant adjustment).

“The December forecasts painted a gloomy picture. Scottish income tax in 2022/23 was forecast to raise £190m less than what was taken out of the block grant to account for tax devolution, and £257m less in 2023/24.

Kate Forbes will be hoping for any signs of an improvement in the outlook. But whatever the implication of Tuesday’s income tax forecasts, they will in reality need to be taken with a pinch of salt, given the differences in timing between the OBR and SFC forecasts.

“The other really important element of the fiscal forecasts will be what they say about the outlook for devolved Scottish social security spending, relative to the related uplift in the block grant.

“Spending will inevitably be substantially higher than the level of additional resources flowing through the block grant, as a result of policy divergence in Scotland (in relation to disability benefits, carer’s allowance, and the new Scottish Child Payment).

“But the extent of the gap will have implications for the resources available to the Scottish government in other areas of devolved spending.”

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