Budget 2021/2022: supporting the COVID-19 recovery - Scotland's taxes and fiscal framework - consultation

Scotland’s Fiscal Powers

Funding the Scottish Budget

The Scottish Budget is funded through a number of component parts and is principally comprised of a Block Grant^[1], local tax revenues, net devolved tax revenues, and additional funding for devolved social security powers. The overall funding position depends in large part on the operation of the Fiscal Framework, as follows:

• Component One - Barnett formula-determined Block Grant – Barnett continues to determine the initial size of the Block Grant and block grant funding remains the largest component of the Scottish Budget.
• Component Two – Block Grant Adjustments (BGA) – the Block Grant is adjusted to reflect the devolution of tax and social security powers. The size of the adjustment is based upon the performance of the corresponding UK Government tax revenues and social security expenditure.
• Component Three – Devolved Tax Revenues – the revenues from devolved local and national taxes, which contribute to Scotland’s funding.

Until recently, Scottish Government revenue came almost exclusively via a Block Grant from the UK Government.  The devolution of further tax powers in the Scotland Acts 2012 and 2016 means that decisions made in Scotland now have greater influence over the size of the Scottish Budget, with around 40% of the Scottish Budget in 2020-21 being funded from revenue-raising powers devolved to the Scottish Parliament. 

Borrowing and reserve powers

The Fiscal Framework agreement extended the fiscal tools available to the Scottish Government to manage the increased budget risk and volatility associated with the devolution of new powers.  The Scottish Government has the power to borrow up to £600m of resource borrowing each year, within a statutory overall limit of £1.75bn.

Resource borrowing can only be undertaken for the following reasons: 

• For in-year cash management, with an annual limit of £500m.
• For forecast errors in relation to devolved and assigned taxes and social security expenditure, with an annual limit of £300m (increasing to £600m in the event of Scotland-specific economic shock).

The Scottish Government also has the ability to smooth expenditure, manage tax volatility and determine the timing of expenditure through building up funds in, and drawing down funds from, the Scotland Reserve.  The Reserve is capped in aggregate at £700m and is split between resource and capital.  Annual drawdowns are limited to £250m for resource, and £100m for capital.  There are no annual limits for payments into the Scotland Reserve.

The Scotland Reserve also replaced the Budget Exchange Mechanism which allowed the Scottish Government to manage underspend between financial years.  The Reserve is therefore also used to manage expenditure between years.

The Scottish Approach to Tax

Taxes fund public services and allow the Scottish Government to encourage growth and support business through economic development, skills investment and major infrastructure projects.  Taxes can support three important functions: 

• To raise money to fund public services, investment and public goods (e.g. schools, health care and infrastructure).
• To promote a more equal society through objectives such as redistribution of income and wealth.
• To encourage people to change their behaviours, in order to promote societal benefits, in areas such as health or the environment.

Since the devolution of tax powers to Scotland, the Scottish Government’s approach to tax policy has reflected Adam Smith’s four principles of taxation:

Illustration Description

A graphic of six hexagons showing the Scottish approach to tax – including the key tests when implementing tax policy and the Scottish Government’s approach to engagement and tax avoidance

• Certainty
• Proportionality to the ability to pay
• Convenience
• Efficiency

Our approach to tax is also based on a firm approach to tackling avoidance, where we have the power to do so, and a collaborative approach to tax policy development.  We have a strong track record of taking an open and consultative approach to tax policy and using the powers we have to make taxation fairer and more progressive^[2].

Devolved Tax Powers 

The Scottish Parliament has limited powers when it comes to taxation.  Under the current devolution settlement, the vast majority of tax powers remain reserved to the UK Government and Parliament (see figure 1).  Decisions made on reserved taxes can sometimes generate unanticipated consequences as a result of interactions with devolved tax policy and other devolved policies. 

Illustration Description

This image shows an illustration of the Scottish tax landscape. This includes taxes reserved to the UK Government, devolved taxes which the Scottish Government controls and lastly Council Tax, which is paid to your local government.

The Scottish Parliament currently has devolved responsibilities in relation to five taxes:

• Scottish Income Tax is partially devolved – the Scottish Parliament is able to vary rates and bands for Scottish income taxpayers on non-savings and non-dividend income, e.g. earnings from employment, pension or property. The tax is administered by HMRC. The personal allowance, reliefs and the rates and bands for savings and dividend income all remain reserved to the UK Parliament.
• Land and Buildings Transaction Tax, the tax paid in relation to land and property transactions in Scotland, and Scottish Landfill Tax, a tax on the disposal of waste to landfill, are fully devolved national taxes and are collected by Revenue Scotland. 
• The Scottish Parliament also has powers over local taxes for local expenditure, which were devolved in 1998. Currently, the two main local taxes are Council Tax and Non-Domestic Rates (also known as business rates), which are collected by local authorities.

In addition:

• The power to introduce two further taxes has been devolved to Scotland, but these have not yet been implemented and the relevant reserved taxes therefore continue to apply. These taxes are Air Departure Tax, a tax on all eligible passengers flying from Scottish airports, which will replace Air Passenger Duty when introduced, and the Aggregates Levy, a tax on the commercial exploitation of rock, gravel, or sand.
• A portion of VAT revenues generated in Scotland is due to be assigned to the Scottish Budget, referred to as VAT Assignment. This is not a power, as VAT policy remains reserved to the UK Government, and its implementation is dependent upon agreement between UK and Scottish ministers regarding the methodology for assigning VAT receipts. 
• The Scottish Parliament has the power to create new local taxes. There is also a mechanism allowing the UK Parliament, with the consent of the Scottish Parliament, to devolve powers for new national devolved taxes to be created in Scotland.