Scotland Act 2012 and 2016: annual implementation report 2021

Fiscal Framework Implementation

The Fiscal Framework agreement between Scottish and UK Governments determines how the Scottish Government is funded, and underpins the powers set out in the Scotland Act 2016.

This chapter covers further areas of Fiscal Framework implementation relevant to this report: progress on policy spillovers; and the review of the Fiscal Framework.

Key developments

143. In August 2020, the Scottish Government agreed with the recommendation of the Advisory Group on Economic Recovery^[32] to undertake the review of the Fiscal Framework as quickly as possible. The review should be robust and comprehensive, taking into account views from stakeholders. However, as the arrangements for the review depend on joint agreement with the UK Government, we rely on their commitment to achieve this ambition.

144. In October 2020, the Scottish Government and the Scottish Parliament's Finance and Constitution Committee and Social Security Committee published a joint report^[33] to inform the review of the Fiscal Framework, and the independent report that precedes the review.

145. The Scottish Government continues to engage with HM Treasury to seek to progress the spillover claim in relation to UK Government increases to the income tax Personal Allowance. Further engagement will take place to resolve this issue as soon as possible.

Progress on policy spillovers

146. The Fiscal Framework makes provision for policy spillovers – instances when one government makes a policy decision that affects the tax receipts or expenditure of the other. In these circumstances the decision-making government should reimburse the other in cases of additional costs, or receive a transfer if there is a saving. Any decision or transfer relating to a spillover effect must be jointly agreed by both Governments.

Personal Allowance spillover

147. The Scottish Government continues to pursue a spillover claim in relation to UK Government increase to the income tax Personal Allowance.

148. UK and Scottish Government Ministers agree that the impact of Personal Allowance increases on the Scottish Budget should be accounted for. However, UK Ministers believe that only above inflation increases should be accounted for. The Scottish Government believes that all increases in the Personal Allowance should be accounted for because there are relatively more basic rate taxpayers in Scotland than in the rest of the UK. Therefore, any decision to increase the UK-wide Personal Allowance will reduce Scottish tax receipts. This means that the Scottish Budget is made worse off by increases in the Personal Allowance. The Welsh Fiscal Framework provides an example of a more equitable framework, which deals with this issue by using a BGA that automatically accounts for the differences in the composition of the tax base.

149. The Scottish Government continues to engage with HM Treasury to seek to progress the spillover claim.

150. If no resolution can be reached, the matter becomes a formal dispute and would be referred to Ministers to be raised and discussed at a meeting of the Joint Exchequer Committee (JEC) as per section 99 of the Fiscal Framework.

Fiscal Framework Review

151. The Fiscal Framework agreement states that a review of the Fiscal Framework should be undertaken by the Scottish and UK Governments after the Scottish Parliament elections in 2021, and that this will be informed by an independent report, which will be presented to both governments by the end of 2021.

152. In April 2020, the Advisory Group on Economic Recovery (AGER) was established to provide the Scottish Government with expert advice on Scotland's path to economic recovery after COVID-19. The Scottish Government welcomed the findings of the report^[34] and its recommendations. In relation to the Fiscal Framework review, the Scottish Government agreed that the review, and independent report which informs it, should take place as quickly as possible and be robust and comprehensive, particularly given the significant political and constitutional changes since the agreement was made, and in light of the recent and ongoing experience of COVID-19.

153. However, the arrangements for the review depend on agreement with the UK Government, so progress on scope and timing for the review relies on their commitment to achieve this ambition. The Scottish Government will continue to engage with UK Government in good faith and set out a clear vision of what is wants the review to achieve.

Scope of the Review

154. The MTFS sets out the Scottish Government position on the scope of the review. It should include both an assessment of how the framework has operated to date, as well as a wider consideration of the levers that the Scottish Government has to manage the risks to which the Scottish Budget is exposed, particularly in light of the COVID-19 pandemic.

155. Ultimately, it should ensure that funding arrangements are fair; that budget volatility is minimised; and that the Scottish Government has the powers and flexibility to manage risks and to support economic recovery in the years ahead.

156. The Scottish and UK Governments have begun engagement to progress the arrangements for the review, with a view to reaching agreement at a future meeting of the Joint Exchequer Committee.

157. Beyond the input of the two governments, the Scottish Government recommends that stakeholders' views should also be an integral part of the process.

Finance and Constitution Committee, and Social Security Committee Joint Working Group Report

158. In October 2020, the Scottish Government, and the Scottish Parliament's Finance and Constitution, and Social Security Committees published a joint working group report^[35], which identifies a number of issues arising from the operation of the Fiscal Framework to date that should be considered by the body tasked with delivering the independent report, and that should ultimately inform the review itself. The report, which has been shared with the Chief Secretary to the Treasury, sets out a number of issues and recommendations for consideration including:

i. Structural risks - demographic risks and risks relating to the distribution of the tax base in Scotland relative to the rest of the UK

ii. Forecast risks - risks relating to forecast error, and the impact on the Scottish Budget, including the potential divergence in forecast performance of the SFC and OBR.

iii. Budget management tools and capital borrowing powers - whether the limits and caps on the borrowing and reserve powers are sufficient to manage the volatility created by the framework; how these limits should evolve over time; and the merits of a prudential capital borrowing regime.

iv. The no-detriment principle - the reasonableness of the arrangements in relation to administration and implementation costs and how the policy spillovers provisions in the framework are operating.

v. Policy autonomy and policy risks - how the devolved and reserved tax and social security regimes interact, and what changes might be considered to promote better policy co-ordination and to limit constraints on policy autonomy.

vi. Intergovernmental relations and dispute resolution – the effectiveness of the dispute resolution processes and governance arrangements.

vii. Transparency and accountability – scope to simplify the framework, and ensure the timely provision of information on the operation of the Fiscal Framework to support wider understanding and scrutiny.

viii. COVID-19 – to consider whether any longer term changes are required as a result of the experience of COVID-19.

Analytical programme

159. The Scottish Government has committed to develop a programme of analysis to identify further options for reform of the Fiscal Framework. The MTFS 2021 contains new analysis relevant to the operation and review of the Fiscal Framework, including:

• An assessment of the forecast error risk to the Scottish Budget; and
• Evidence in relation to the risks to Scottish Income Tax receipts, including sectoral impacts and impacts in relation to income distribution.

160. The analysis illustrates the existing limitations and operational risks of the Fiscal Framework, and demonstrates the importance of consideration of these issues as part of the Fiscal Framework review.

Scottish Government Budget 2021/22: Supporting the COVID-19 Recovery Consultation

161. In September 2020 the Scottish Government launched "Budget 2021-22: Supporting the COVID-19 recovery – Scotland's taxes and Fiscal Framework consultation^[36]" to seek stakeholder opinion on the role of its devolved taxes and the operation of the Fiscal Framework during COVID-19 and to support economic recovery.

162. Stakeholder responses noted fiscal challenges faced as a result of COVID-19 and the existing fiscal arrangements, as well as providing recommendations to mitigate some of these challenges. There was strong support from respondents for increased borrowing limits to allow the Scottish Government to support the economy in response to the COVID-19 pandemic. Some respondents supported greater fiscal autonomy on a more permanent basis, and some suggested more permanent changes to the Fiscal Framework that should be considered, while others noted that the current arrangements were adequate.

163. Further detail can be found in the Scottish Government's published analysis of the consultation.