Scottish Budget - implications of the UK Government fiscal statements: expert panel final commentary

Executive Summary

Introduction

On 27^th September, the Scottish Government appointed us as a panel to provide economic advice on the implications for Scotland of the UK Government’s UK Growth Plan (or mini budget) of 23^rd September.

Subsequently, the UK Government has made several further fiscal statements, reversing many of the previously announced measures. In our interim commentary ^[1] of 2 November 2022, we provided independent economic advice to the Scottish Government on the implications of the statements for Scottish economic and fiscal policy.

Our advice was that the Scottish Government must provide clear and consistent fiscal policy – providing certainty to households and businesses so that they can make informed spending and investment decisions – and adopt a cautious response. Alongside focusing on key investment areas reflecting political priorities, we suggested a continued focus on economic resilience and the opportunities to improve productivity and growth.

Following the UK Government Autumn Statement on 17^th November, our final commentary builds on our previous advice and sets out our thinking on how the Scottish Government could respond to the challenges posed by the Autumn Statement.

UK Government Autumn Statement

The UK Government Autumn Statement set out a fiscal consolidation of approximately £55 billion split between spending reductions (£30 billion) and tax rises (£25 billion), with the former largely delayed until after 2024-25. It also announced a looser set of fiscal rules, focusing on overall borrowing and retaining a target to reduce debt relative to GDP. The aim was to rectify the mistakes of the UK Government mini-budget, which had a short but material impact on economic conditions.

The package provided a degree of certainty to financial markets on the direction of UK fiscal policy which, combined with the accompanying OBR forecasts, helped stabilize borrowing costs and reduced the short term level of uncertainty for UK businesses and households regarding the economy.

The OBR forecasts, however, point to continued economic disruption and suggest the UK economy is currently in recession which they forecast to continue until 2024, with household incomes falling in real terms by 7 per cent over the next two years.

The Scottish Government is now facing a fundamentally different scenario to that following the UK Government’s mini-budget in September. The changes, driven by the market and political response to that budget, nonetheless highlight the impact of UK Government decisions on spending and tax choices in Scotland.

Implications for Scotland

The Scottish budget will receive an additional £1.5 billion in funding over the next two years as a result of policy decisions that do not apply UK wide. The Scottish Government is required to balance the budget each year and it cannot borrow to any significant degree.

There are changes to the revenue and capital split which also have implications for investment and productivity in Scotland. Changes to the profile of revenue and capital by the UK Government mean the latter is being cut in real terms from 2025‑26, which, given the restrictions on Scottish Government capital borrowing, will mean reductions in capital investment in Scotland.

The UK changes to the additional rate of income tax threshold mean the Scottish Government will have to decide whether to match this change (increase tax) or forego the equivalent revenue raised in Scotland from the UK change via the income tax Block Grant Adjustment (BGA).

Advice with Regard to Scottish Budget

Economic uncertainty remains elevated. The UK growth outlook remains weak and investment in productivity enhancing activity remains key for the economy. We again highlight the importance of innovation and investment in driving productivity in Scotland and the UK and the need for Scotland’s budget to target these objectives.

Real terms UK spending cuts are likely to be forthcoming from 2025-26 onwards and will need to be planned for. This means adjusting the budgetary path for many areas of Scottish Government spend over the next two years to align with that outlook. Adding future fiscal commitments or pressures given the spending outlook would simply require a larger subsequent negative adjustment to spending in the future, although there remains an open question as to whether the next UK government will implement the plans set out by the Chancellor.

To mitigate or potentially reverse the impact of decisions made at the UK Government Autumn Statement on public finances and public services in Scotland, the Scottish Government may have to consider whether to raise taxes, or consider introducing new taxes or other ways of raising revenue, both in the current context and particularly from 2025-26 onwards.

There are, however, implications (and constraints) for devolved taxation. The interaction between the withdrawal of the reserved personal allowance for taxpayers earning more than £100,000 and Top Rate Threshold is worth further consideration. In our earlier commentary we highlighted the risks to revenue from tax differentials between Scotland and the rest of the UK. The UK Government has lowered its Additional Rate Threshold to £125,140, but matching the new lower threshold may not be sufficient to prevent a deterioration in the Scottish Government’s funding position, given the income tax distribution in Scotland. However, lowering the threshold further would significantly increase marginal tax rates.

Public services and government spending provide an important stabiliser during economic downturns and can help maintain the productive capacity of the economy and the wellbeing of citizens. It is important to prioritise improving wellbeing and productivity across all areas of government spend. The public sector reform programme remains key to ensure that public services become more productive and take advantages of the opportunities that, for example, digital technology offers in the delivery of services.

Finally, we note that there is an inconsistency with the UK Government cutting capital spending in real terms when productivity growth is a priority and we recommend the Scottish Government seek to maintain as much capital spend as possible and look to spend and leverage that in areas of maximum impact such as the transition to net zero. There has never been a more important time to consider prioritisation in public services and productivity-enhancing reforms in the public sector.

Professor Sir Anton Muscatelli

Professor Frances Ruane

Dr. Mike Brewer