Fiscal framework: agreement between the Scottish and UK Governments

Annex A: Smith Commission Principles for Scottish Government's Fiscal Framework

95 (1) Barnett Formula: the block grant from the UK government to Scotland will continue to be determined via the operation of the Barnett formula.

95 (2) Economic Responsibility: the revised funding framework should result in the devolved Scottish budget benefiting in full from policy decisions by the Scottish Government that increase revenues or reduce expenditure, and the devolved Scottish budget bearing the full costs of policy decisions that reduce revenues or increase expenditure.

95 (3) No detriment as a result of the decision to devolve further power: the Scottish and UK governments' budgets should be no larger or smaller simply as a result of the initial transfer of tax and/or spending powers, before considering how these are used.

(a) This means that the initial devolution and assignment of tax receipts should be accompanied by a reduction in the block grant equivalent to the revenue forgone by the UK government, and that future growth in the reduction to the block grant should be indexed appropriately.

(b) Likewise, the initial devolution of further spending powers should be accompanied by an increase in the block grant equivalent to the existing level of Scottish expenditure by the UK government, including any identified administrative savings arising to the UK government from no longer delivering the devolved activity, and a share of the associated implementation and running costs in the policy area being devolved, sufficient to support the functions being transferred, at the point of transfer.

95 (4) No detriment as a result of UK government or Scottish Government policy decisions post-devolution:

(a) Where either the UK or the Scottish Governments makes policy decisions that affect the tax receipts or expenditure of the other, the decision-making government will either reimburse the other if there is an additional cost, or receive a transfer from the other if there is a saving. There should be a shared understanding of the evidence to support any adjustments.

(b) Changes to taxes in the rest of the UK, for which responsibility in Scotland has been devolved, should only affect public spending in the rest of the UK. Changes to devolved taxes in Scotland should only affect public spending in Scotland.

95 (5) Borrowing powers: to reflect the additional economic risks, including volatility of tax revenues, that the Scottish Government will have to manage when further financial responsibilities are devolved, Scotland's fiscal framework should provide sufficient, additional borrowing powers to ensure budgetary stability and provide safeguards to smooth Scottish public spending in the event of economic shocks, consistent with a sustainable overall UK fiscal framework. The Scottish Government should also have sufficient borrowing powers to support capital investment, consistent with a sustainable overall UK fiscal framework. The Scottish and UK governments should consider the merits of undertaking such capital borrowing via a prudential borrowing regime consistent with a sustainable overall UK fiscal framework.

(a) The Scottish Government's borrowing powers should be agreed by the Scottish and UK governments, and their operation should be kept under review in conjunction with agreement on the mechanism to adjust the block grant to accommodate the transfer of taxation and spending powers.

(b) Borrowing powers should be set within an overall Scottish fiscal framework and subject to fiscal rules agreed by the Scottish and UK governments based on clear economic principles, supporting evidence and thorough assessment of the relevant economic situation.

95 (6) Implementable and Sustainable: once a revised funding framework has been agreed, its effective operation should not require frequent ongoing negotiation. However, the arrangements should be reviewed periodically to ensure that they continue to be seen as fair, transparent and effective.

95 (7) Independent Fiscal Scrutiny: the Scottish Parliament should seek to expand and strengthen the independent scrutiny of Scotland's public finances in recognition of the additional variability and uncertainty that further tax and spending devolution will introduce into the budgeting process.

95 (8) UK Economic Shocks: the UK government should continue to manage risks and economic shocks that affect the whole of the UK. The fiscal framework should therefore ensure that the UK government retains the levers to do that, and that the automatic stabilisers continue to work across the UK. The UK Parliament would continue to have reserved power to levy an additional UK-wide tax if it was in the UK national interest.

95 (9) Implementation: the Scottish and UK governments should jointly work via the Joint Exchequer Committee to agree a revised fiscal framework for Scotland based on the above principles. The two governments should provide updates to the Scottish and UK Parliaments, including through the laying of annual update reports, setting out the changes agreed to Scotland's fiscal framework.