Scotland Act 2012 and 2016: annual implementation report 2021

Block Grant Adjustments, Reconciliation and Indexation

The Fiscal Framework agreed that the Scottish Government’s Block Grant would be adjusted to reflect the impact of the transfer of greater fiscal powers to the Scottish Government. Deductions are made to reflect the retention of devolved tax revenues and additions are made to provide funding for devolved social security benefits.

Key developments

55. As a UK Budget had not been published at the time of the Scottish Budget in February 2020, provisional Block Grant Adjustments (BGAs) were used to inform the Scottish Budget 2020-21 as directed under the Fiscal Framework.

56. Updated BGAs were produced at the UK Budget in March 2020. The Cabinet Secretary for Finance decided to use the provisional BGAs to inform the Scottish Budget 2020-21.

57. Executive competence for five of the Social Security powers was transferred to the Scottish Government at the 2020-21 Scottish Budget and the Block Grant Adjustments for these benefits were calculated for the first time and are now in operation.

58. The third Fiscal Framework Outturn Report^[18] (FFOR) was published on 1 October 2020 to report, amongst other things, on the operation of the Block Grant Adjustments. However, the latest published Fiscal Framework data update, which supersedes data set out in the FFOR, is included in Annex C of the Scottish Government's Medium Term Financial Strategy (MTFS) 2021^[19].

59. Outturn data for 2018-19 Income Tax was published on 23 September 2020, determining the income tax reconciliation, which in turn impacted the 2021-2022 Scottish Budget.

60. Scottish and UK Government Ministers have agreed that the issue of the BGAs for the Proceeds of Crime (POC) should be considered as part of the Fiscal Framework Review.

Provisional BGAs

61. The Fiscal Framework sets out that, where the Scottish Budget takes place before the UK Budget, the Scottish Budget will be based on provisional BGAs. Since the UK Budget 2020 took place after the Scottish Budget, provisional BGAs were used to inform the 2020-21 Scottish Budget.

62. For taxes, the provisional BGAs were based on forecasts published by the Office for Budget Responsibility (OBR) at the UK Spring Statement 2019, which were then restated on 16 December 2019, alongside the Welsh Budget. The restated forecasts took account of the 2017-18 outturn data as well as in-year information from the Pay as You Earn (PAYE) system, but did not take into account any changes in the underlying economic outlook.

63. For Social Security, as the UK Spring Statement 2019 did not include Scottish forecasts for all of the benefits being transferred in 2020-21, the Scottish and UK Governments agreed a bespoke methodology for calculating these provisional BGAs and their corresponding baseline year figures^[20].

64. The Framework also sets out that, where the UK Budget takes place less than three months before the start of the financial year, provisional BGAs will be applied to the Scottish Block Grant for that year. However, the UK and Scottish Governments agreed that the Scottish Government could choose to use the BGAs provided alongside the later UK Budget if it preferred to do so. The Cabinet Secretary for Finance decided to use the provisional BGAs to inform the Scottish Budget.

65. A similar order of events has occurred this year, with provisional BGAs underpinning the Scottish Budget 2021-22, announced in January 2021, as the UK Budget was not published until 3 March 2021. While an updated set of BGA figures for 2021-22 is now available, the Scottish Government has confirmed that it will also continue to use the provisional BGAs to inform the Scottish Budget 2021-22.

66. In-year reconciliations to the 2020-21 Scottish Budget have been made in the normal way, on the basis of the comparison between the provisional BGAs which underpinned the 2020-21 Scottish Budget and the provisional BGAs which underpinned the Scottish Budget 2021-22.

Data update: Fiscal Framework Outturn Report 2020 and Scottish Government's Medium Term Financial Strategy

67. As set out in the Written Agreement between the Scottish Government and the Finance and Constitution Committee^[21], the Scottish Government published a Fiscal Framework Outturn Report on 1 October 2020 to report on the operation of the Fiscal Framework.

68. Due to COVID-19, the Scottish Government's MTFS was not published in May 2020 as per the normal timings, but was instead published alongside the Scottish Budget in January 2021. That meant that the Scottish Fiscal Commission did not publish forecasts of tax revenues and social security expenditure in May 2020, and the forecasts contained in FFOR 2020 were from the Scottish Budget in February 2020.

69. Similarly, the forecasts of the Block Grant Adjustments were based on the OBR's forecasts of UK tax revenues and social security expenditure at the UK Budget in March 2020. Therefore, the forecasts included in the FFOR 2020 did not account for the impact of COVID-19. Given delays to the publication of outturn data as a result of COVID-19, the report also largely draws on provisional 2019-20 outturn revenue and expenditure and BGA data.

70. The Scottish Government's MTFS, published in January 2021 alongside the 2021-22 Scottish Budget, sets out updated forecasts that accounted for the impact of COVID-19 and final outturn data for tax revenue and social security expenditure.

71. Annex C of the MTFS sets out the final reconciliation to the 2021-22 Budget as follows:

A reconciliation of -£319 million would be made to the 2021-22 Budget which is the net impact of the reconciliations for Income Tax from 2018-19, and for the fully devolved taxes, Fines, Forfeitures and Fixed Penalties, Proceeds of Crime Act revenues, and Carer's Allowance for 2019-20.

Income Tax reconciliation

72. Outturn data for Income Tax for 2018-19 was published by HMRC on 23 September 2020 and a reconciliation of -£309 million was applied to the 2021-22 Budget. This was the second income tax reconciliation since the implementation of the Fiscal Framework. Further information on the reconciliation can be found in the Fiscal Framework Outturn Report.

Proceeds of Crime

73. The Scottish Government believes that the application of a BGA for POC Act revenues of £4 million per annum breaches the Smith Commission's "no detriment" principle . This is because the Scottish Government previously retained these proceeds (subject to a cap of £30 million, which was never breached). Further to discussion through the official-level Joint Exchequer Committee (JEC(O)), in January 2021 the Cabinet Secretary for Finance and the Chief Secretary to the Treasury agreed that the issue should be considered as part of the Fiscal Framework Review. The BGA remains at £4 million pending the outcome of the review.

Borrowing and Scotland Reserve

Key Developments

74. The Scottish Government's MTFS 2021 set out the principles and policies that guide the use of the Scottish Government's borrowing and reserve powers.

75. The SFC's January 2021 forecasts indicate that the criteria for a Scotland-specific economic shock occurring in 2021-22 have been met. This has resulted from the fact that the respective SFC and OBR forecasts have been produced at different points in time. The OBR forecasts produced alongside the UK Budget in March 2021 indicate that the criteria for a shock continue to be met, however, this continues to result from timing differences in the forecasts.

76. There is no evidence that Scotland's economic or tax performance has been materially different from that of the rest of the UK. The triggering of the shock provides the Scottish Government with some limited additional flexibilities in relation to the use of borrowing for forecast error, and the Scotland Reserve.

77. In an attempt to manage volatility risk, in 2021-22 Scottish Ministers plan to borrow £319 million to smooth the negative budget impact of forecast errors arising from tax and social security reconciliations. A decision has been taken to borrow £450 million to support infrastructure investment. Final borrowing drawdown will be confirmed over the course of the year.

Scotland-specific economic shock

78. The Fiscal Framework has provisions for a 'Scotland-specific economic shock' to be triggered. When this happens, the Scottish Government has access to increased borrowing and reserve flexibility. This provision is triggered when onshore Scottish GDP growth is below one per cent in absolute terms on a rolling four-quarter basis, and one percentage point or more below UK GDP growth over the same period. This can be either on the basis of outturn data, or on the basis of forecasts.

79. The SFC's forecasts, published on 28 January 2021, show that the technical requirements for this provision are triggered in 2021-22. The OBR's March 2021 forecasts also show that these criteria continue to be met. However both forecasters have been clear that rapid developments in relation to the pandemic can result in material differences between their respective forecasts, even if only a couple of months apart. It is as a result of these differences that the Scotland-specific economic shock provisions are met.

80. The SFC has made clear that the outlooks for Scottish and UK GDP are broadly similar. There is also no evidence to date that Scotland's economic or tax performance has been materially different from that of the rest of the UK. Further information is set out in the SFC's Economic and Fiscal Forecasts^[22], the Scottish Government's MTFS, and the SFC's March 2021 Fiscal Update.^[23]

81. The triggering of this provision of the Fiscal Framework allows the Scottish Government to borrow £600 million rather than £300 million per year for forecast error on tax receipts and social security expenditure, and removes the limits on drawdown from the Scotland Reserve. This applies in the financial years 2021-22 until 2023-24.

82. These flexibilities will not be withdrawn retrospectively should revised forecasts or outturn data indicate that the criteria for a Scotland-specific economic shock are no longer met.

Capital Borrowing

Since 1 April 2017, the Scottish Government has had the power to borrow up to £450 million each year, up to a maximum total of £3 billion, to support investment in capital infrastructure.

2020-21 draw down

83. The 2020-21 Scottish Budget outlined plans to borrow £450 million, noting that final borrowing decisions are subject to the in-year budget management position.

84. At the time of publication of the 2021 MTFS and 2021-22 Scottish Budget no funds had yet been drawn down but for the purposes of budgeting and forecasting plans were revised downward to £300 million for 2020-21.

85. £150 million of Capital Borrowing was drawn down from the National Loans Fund in February. This borrowing has a term of twenty five years and interest rate (on an annuity basis) of 1.14 per cent.

86. Final decisions on additional borrowing drawdowns have not yet been confirmed with funds expected to be received on 30 March, with the amount and interest rate subject to change until this date.

2021-22 borrowing plans

87. As part of the Scottish Budget 2021-22, a decision has been taken to borrow £450 million to support infrastructure investment.

88. As is the case with 2020-21, final decisions on the specific borrowing arrangements for 2021-22 are taken over the course of the year, reflecting an on-going assessment of programme requirements and value for money assessment of the options available. Final borrowing levels may therefore be below initial estimates.

Capital debt stock

89. On the basis of existing and planned borrowing, the Scottish Government will have accumulated £2.2 billion in capital debt by the end of 2021-22, 74 per cent of its overall limit. Details of the capital borrowing and repayment schedule can be found in the Scottish Government's MTFS, published January 2021.

Resource Borrowing

Since 1 April 2017, the Scottish Government has had the power to borrow up to £600 million each year within a statutory overall limit for resource borrowing of £1.75 billion.

The Fiscal Framework sets out the conditions and limits for elements of resource borrowing:

• for in-year cash management, an annual limit of £500 million;
• for forecast errors and annual limit of £300 million; and
• for any observed or forecast shortfall where there is or is forecast to be a Scotlandspecific economic shock, an annual limit of £600 million.

2020-21 draw down

90. The 2020-21 Scottish Budget set out plans to borrow £207 million, noting that final borrowing decisions are subject to the in-year budget management position

91. At the time of publication of the 2021 MTFS and 2021-22 Scottish Budget no funds had yet been drawn down but plans remained unchanged.

92. Final decisions on resource borrowing drawdowns have yet to be taken and funds are expected to be received on 30 March with the amount and interest rate subject to change until this date.

2021-22 borrowing plans

93. In an attempt to manage volatility risk, in 2021-22 Scottish Ministers plan to borrow £319 million to smooth the negative budget impact of forecast errors arising from tax and social security reconciliations.

94. As the MTFS states, the Scottish Government will assess all planned resource borrowing decisions to smooth the funding trajectory over five years.

95. In order to promote budget stability and maintain flexibility in the Reserve, Scottish Government budgets will assume full borrowing against known and/or forecast Income Tax reconciliations. Any in-year volatility will be managed within the resulting overall budget envelope.

Scotland Reserve

The Scotland Reserve has applied since 1 April 2017. It replaces the Budget Exchange mechanism and enables the Scottish Government to manage volatility associated with its fiscal powers. The Scotland Reserve is capped in aggregate at £700 million, with annual drawdown limited to £250 million for resource and £100 million for capital. There are no annual limits for payments into the Scotland Reserve.

96. The triggering of a Scotland-specific economic shock has removed the annual drawdown limits on the Reserve. This applies in in the financial years 2021-22 until 2023-24. However the annual cap of £700 million remains.

2019-2020 Reserve position

97. The 2020-21 Reserve position, as reported to Parliament as part of the Spring Budget Revision process, is reproduced below. The Cabinet Secretary will provide an updated report on the Reserve position to the Scottish Parliament as part of the provisional outturn statement in June 2021.

Table 7: 2020-21 Reserve position

	Resource	Capital	FT	Fiscal
	£million	£million	£million	£million
2019-20 opening balance	381	65	159	605
2019-20 withdrawals	-249	-60	-120	-429
2019-20 Additions	85	74	97	256
2020-21 opening balance	217	80	136	433
2020-21 Scottish Budget commitments	-131	-5	-32	-168
2020-21 Summer Budget Revision	-18	-7		-25
2020-21 Autumn Budget Revision		-58	28	-30
2020-21 Spring Budget Revision	-22	5	22	5
Estimated 2020-21 Drawdown	-171	-65	18	-218
Provisional Reserve balance at Spring Budget Revision	47	15	153	214
Budget Monitoring forecast	164	18	99	281
Forecast Reserve Position	211	33	252	495

98. Table 7 sets out analysis of the forecast Reserve position at the time of this report being published. Final figures show current forecasts for the year-end Reserve balances for Resource, Capital and Financial Transactions

99. Notwithstanding the flexibilities provided through the triggering of a Scotland-specific economic shock, a reserve capped at £700 million with a maximum limit of £350 million for annual drawdowns severely limits the capacity for Scottish Ministers to plan for the impact of future fluctuations in tax receipts while also prudently managing any underspend across financial year.

Request for additional fiscal flexibilities in response to COVID-19

100. The Cabinet Secretary has repeatedly called on the UK Government to provide additional fiscal flexibilities to allow the Scottish Government to mobilise and deploy funding in the most effective way to support Scottish citizens in response to the COVID-19 pandemic, given the significant and ongoing economic and fiscal challenges that it has presented. The flexibilities requested include:

• greater borrowing powers;
• flexibility to utilise capital underspend for resource expenditure;
• increased reserve limits; and
• greater end-year flexibility.

101. The UK Government has confirmed that the further funding allocated as part of the UK Supplementary Estimates process in the 2020-21 financial year would be accompanied by additional flexibility to carry forward into 2021-22, without having to use the Scotland Reserve. However, this flexibility is limited and temporary. It does not change the fact that Scottish Government cannot borrow at its own hand to fund spending in response to COVID-19 or support the economy in the way that countries around the world have done.

102. The Scottish Parliament's Finance and Constitution Committee has also recommended that HM Treasury should give further consideration to providing the devolved governments with greater access to borrowing in emergency situations such as the current crisis, as set out in its Pre-budget Scrutiny 2021-22 report.^[24] This position was endorsed by the Scottish Parliament in a motion on 9 December.