Independent Report preceding the Fiscal Framework review: terms of reference

The remit of this report is to provide an independent assessment of how different methods for calculating Block Grant Adjustments deliver on the Smith Commission’s principles. These include the principles of no detriment, taxpayer fairness and economic responsibility (as shown in Annex A), as well as broader principles identified by the Smith Commission including sustainability and transparency.

These Block Grant Adjustment arrangements operate alongside the Barnett-determined Block Grant as part of the Scottish Government’s overall funding arrangements. This report will include an assessment of the risks that different Block Grant Adjustment mechanisms allocate to each government and the extent to which these align with the risks held under the Barnett formula, in line with the Smith Commission principles.

This report should consider the arrangements for the baseline adjustments and subsequent application of the following indexation methods for calculating Block Grant Adjustments:

• indexed per capita
• comparable
• indexed
• levels

The report can further consider any alternatives, including income tax ‘by band’ models, methods that incorporate demographic change, and various iterations of these.

The aim of the report is to outline clearly and transparently the implication of these different methods in the context of the principles mentioned above.

The report will consider the tax and welfare powers devolved and assigned under the Scotland Acts 2012 and 2016, namely:

• tax: Income Tax; Stamp Duty Land Tax; Landfill Tax; Air Passenger Duty; VAT; Aggregates Levy
• welfare: Carer’s Allowance; Personal Independence Payments; Disability Living Allowance; Attendance Allowance; Industrial Injuries Disablement Allowance; Severe Disablement Allowance; Cold Weather Payments; Winter Fuel Payment

It is not expected that the report will calculate what the Block Grant Adjustments would have been for each power under each method. Instead, the report will set out the implications of the different options with reference to the Smith Commission principles, drawing on specific examples and scenarios for illustrative purposes. The report will draw out where the implications of a particular Block Grant Adjustment method might vary depending on the specific tax or benefit in question.

The report should also seek input from stakeholders. The process for obtaining this input will be established with consideration as to how to best bring together a strong evidence base to inform the wider review of the Fiscal Framework. Engagement will be sought specifically on issues related to the operation of the Block Grant Adjustments, including how the Block Grant Adjustments could best deliver on the Smith Commission principles. Whilst the report authors will design the consultation

questions and analyse the responses, the process of administering the call for evidence and collating of responses will be led jointly by the UK Government and Scottish Government.

It is anticipated that the report will take around three months from launch to completion. As set out in the Fiscal Framework agreement, the report will be presented to both governments on completion. It is expected that the report will be published, though this will be agreed by both governments as part of the wider review process.

The purpose of the independent report is to provide a robust analytical evidence base on Block Grant Adjustments that can be used to inform the subsequent review, rather than make recommendations on future arrangements, which will be a matter for the review.

The UK Government and Scottish Government will provide secretariat support to the independent commission to deliver on its remit. The secretariat will manage the consultation process and support the report authors in collating relevant data – this is largely anticipated to relate to historic data on tax and spending in Scotland and the rest of the UK in relation to the taxes and benefits in scope.

Annex A

The Fiscal Framework agreement between the UK Government and Scottish Government was published in 2016. The provisions outlined in the Fiscal Framework were agreed to deliver on the principles set out in paragraphs 94 and 95 of the cross-party Smith Commission. Both Governments remain committed to implementing the conclusions of the Smith Commission.

The relevant principles from the Smith Commission are as follows:

• • 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
    • • 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
      • 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:
    • • 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
      • 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 “Taxpayer fairness”
  • 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