Scotland's Fiscal Outlook: The Scottish Government's Medium-Term Financial Strategy

1. Introduction

1.1 A turning point for Scotland

1.1.1 The impact of COVID-19

The Scottish Government’s core purpose is to create a more successful country with opportunities for all of Scotland’s people to flourish, through increased wellbeing, and sustainable and inclusive economic growth.

The COVID-19 pandemic continues to have a profound impact on our health, economy and society, with damaging effects on the way of life and the wellbeing of people in Scotland. Considerable uncertainty remains over the long-term impacts of this pandemic as the response from Scotland, and countries around the world, continues to evolve.

Scotland’s Wellbeing: The Impact of COVID-19, published in December 2020,^[2] shows that the pandemic is likely to have significant and wide-ranging effects, right across the National Outcomes. The weight of evidence suggests that the pandemic may widen inequalities in income and wealth over the medium term, as well as making unequal outcomes more severe in a range of other areas. Health, Economy, Fair Work, and Business and Culture outcomes have been deeply negatively affected.

Our Budget, published today, sets out the steps that we have taken, and will continue to take, to support households and businesses through this difficult time. Our response requires an unwavering focus on tackling the continued public health crisis. But we recognise that, in turn, this brings significant economic and social harms, as well as a need to protect people’s jobs and livelihoods in the immediate term alongside longer-term action to build back fairer and stronger. That is why we have made additional funding available to support businesses affected by the necessary restrictions to protect public health. We have also set out a comprehensive package of support for those facing financial insecurity or hardship.

Recognising the imperative to deal with the economic, as well as health and social crises that COVID-19 has brought, the Infrastructure Investment Plan will set out a multi-billion pipeline of investment over the coming five years, to boost market confidence and help public bodies with the certainty needed for sound financial planning.

However, alongside our ambitious plans for resilience, recovery and renewal in the face of the pandemic, this document sets out the precariousness and volatility of the ultimate funding position, and our continued reliance on the UK Government. Since the start of the crisis, we have provided £8.6 billion of additional funding to support our society and economy, including over £3 billion additional investment for health and wider initiatives, alongside almost £3 billion supporting employees and businesses, much of it delivered through a four nations approach.

While additional funding received to date has been welcome, it falls short of what is properly required to tackle the scale of the challenge. This will make recovery from this crisis all the harder. If we are to meet the ongoing challenges of COVID-19 and the UK’s exit from the EU, as well as support economic recovery, further funding and additional fiscal flexibilities are required.

1.1.2 Scotland cannot afford a return to austerity

Many key policy levers still remain out of our control, and our budget is still defined, in the main, by the spending decisions made by the UK Government. Following a decade of austerity, day-to-day spending on UK public services in 2019-20 was 6.6% lower in real terms than in 2009-10. Outside of health, real terms public service spending was 20% lower.^[3]

In the UK Spending Review on 25 November 2020, the Chancellor began the process of reducing non-COVID related spend by up to £13 billion a year, compared to his plans as announced in the March 2020 UK Budget. These cuts to core spending mean that austerity will not be over for many public services.

This return to austerity must be avoided and has been repeatedly rejected by the Scottish electorate. We know that the spending cuts and tax rises implemented over the past decade, at a total value of 8.3% of GDP or £185 billion in 2019-20 GDP terms, have resulted in chronic underfunding of our public services, disproportionately affecting the most vulnerable and poorest in society. In turn, the Scottish Government has attempted to mitigate these impacts as far as possible.

There is also growing evidence that austerity has undermined economic growth, as periods of fiscal consolidation have reduced both output and productivity in the economy.^[4] Both the International Monetary Fund (IMF) and the OECD have highlighted that rising inequality is bad for growth.^[5] The Scottish Government believes that growing the economy is vital to reducing the deficit and will prioritise economic growth and reducing inequality until the economy has fully recovered.

The economic rationale for infrastructure investment reinforces the important role that such funding plays in improving the productive capacity of the economy and delivering long-term economic benefits.^[6] We know the austerity approach adopted by the UK after the 2008 financial crash is counter-productive for growth, and such an approach cannot be afforded again. In 2018, The First Minister introduced the National Infrastructure Mission, to help Scotland take a different path: one that returns our infrastructure investment to internationally competitive levels, supports communities and creates good jobs.

Research undertaken by The National Society for the Prevention of Cruelty to Children Scotland (NSPCC) Scotland and Barnardo’s Scotland has highlighted the devastating impact of austerity measures on children and their families.^[7] Some families are now struggling to obtain adequate food, secure housing and basic necessities. This has been exacerbated by UK Government welfare reforms over the last decade. The Scottish Government’s commitment to tackling poverty must not be further impaired through the implementation of added austerity measures.

Cuts to public spending have also disproportionately affected women. This is due to a number of interrelated factors. Women are more likely to use public services, for example, they are the majority of welfare recipients. Women are also more likely to have a relatively lower income, as a consequence of a looser attachment to the labour market due to women disproportionately shouldering the burden of unpaid care.^[8]

Minority Ethnic (ME) households also face persistent structural inequalities in education, employment, health and housing, meaning that they have also been disproportionately affected by cuts to public spending.^[9] For ME women, gender inequalities intersect with, and compound, racial inequalities, making them particularly vulnerable to cuts to benefits, tax credits and public services.

Fiscal commentators such as the Institute for Fiscal Studies (IFS),^[10] the IMF^[11] and the OECD^[12] have been clear that now is not the time for new fiscal targets or a detailed fiscal consolidation strategy to reduce borrowing, pointing to uncertainty from the impacts of COVID-19 and current economic conditions. Indeed, the head of the IMF has said that the UK must stand ready to spend more to support businesses and households.^[13] The OECD’s Chief Economist has warned that governments should avoid short-term fiscal tightening and numeric targets for public deficits and debt and instead consider long-term sustainability goals.^[14]

Internationally, countries are already committing to continuing fiscal support this year. The EU has suspended its fiscal rules for government budgets for 2021, and countries such as Germany and France have extended many of their financial support schemes to the end of the year. In the Financial Times’ most recent annual survey of more than 90 leading economists, there was broad consensus that tightening fiscal policy too early would damage the recovery.^[15]

Importantly, we know that the full effect of the COVID-19 pandemic will be felt over the five-year period covered in this document, with the Office for Budget Responsibility (OBR) suggesting it could take a full two years from now for output to return to pre-pandemic levels.^[16] To ensure a fair and sustainable recovery, we must invest in our people, communities, and businesses – a defining priority of the 2021-22 Scottish Budget, but one which requires the partnership and help of the UK Government within the current constitutional settlement.

When we emerge from the greatest economic shock of our lifetime, we must ensure that fiscal rules do not constrain the fiscal policy response, thereby weakening the economic recovery and doing more harm to the long-term fiscal position. Instead, we require a bold new approach from the UK Government as called for in our UK Fiscal Path – a new approach^[17] paper published in June 2020 and its update in November 2020,^[18] with fresh thinking on how to aid the recovery and deliver a fairer and greener economy that puts wellbeing at its core, while ensuring sustainable public finances over the longer term.

1.2 Delivering for the people of Scotland

The context for this year’s MTFS is far from normal or stable. However, we cannot simply sit tight and wait for these storms to pass. COVID-19 has shown up some of the fault lines in our economic, financial and societal arrangements, including the disproportionate negative impacts on some sectors and in some communities. But it has also reinforced the need for long-term ambition – the need to support the transition to net zero, improve biodiversity, invest in our national infrastructure, make our public services fit for the future, harness the economic and social opportunities of new technology, make homelessness history and lift children out of poverty. Rather than return to business as usual, we need to create a more resilient, stronger, greener and fairer country, with better outcomes for all.

The impact of COVID-19 calls for a renewed focus on reducing inequalities and delivering improvement on national outcomes. This focus is needed in all our public service delivery and economic recovery activities, as well as in policies and programmes centred on health, wellbeing and social renewal.

1.2.1 Building back fairer and stronger from COVID-19

Even before the COVID-19 pandemic, we recognised that significant work lay ahead to meet our long-term ambitions – to eradicate child poverty, become a net zero society, and reform and renew our health service, economy, and communities. In the face of the pandemic, those ambitions become even more important and challenging. But these challenges also come with opportunities to rethink how we live and work as a society, how we access vital public services, and the type of economy we have.

The Government has set out its ambition to build back fairer and stronger from COVID-19. The 2020-21 Programme for Government (PfG)^[19], published in September 2020, committed to:

• a national mission to create new jobs, good jobs and green jobs - with a particular focus on our young people, supporting retraining and investing in our Green New Deal to tackle climate change
• promoting lifelong health and wellbeing - by tackling COVID-19, remobilising and reforming the NHS and social care and tackling health inequalities
• promoting equality and helping our young people fulfil their potential

The PfG includes, among other things, ambitious commitments to provide support and retraining to people facing redundancy and unemployment; a Scottish Youth Guarantee to ensure every young person has the opportunity of work, education or training; a comprehensive remobilisation of health and social care provision; and a strong emphasis on digital connectivity. The PfG has also reinforced the Scottish Government’s commitment to achieving net zero by 2045, reducing child poverty to less than 10% of children living in relative poverty by 2030, and to building a wellbeing economy.

Our Climate Change Plan Update,^[20] published in mid-December, sets out our pathway to meeting Scotland’s emissions reduction targets over the period to 2032, but is also a strategic document on our green recovery from COVID-19. A green recovery is one that helps us toward net zero emissions in a way that is just, and that maximises the opportunities to deliver a thriving, sustainable economy, with a programme of £2 billion investment in green infrastructure over the next Parliament.

The forthcoming Capital Spending Review (CSR) and Infrastructure Investment Plan (IIP)^[21] will address the significant medium-term challenges presented by the COVID-19 pandemic, given the profound impact the virus has had on our whole way of life, and the role infrastructure has to play in helping businesses and communities to adapt and recover.

Recognising the long-term nature of infrastructure provision, and the need to future proof investment, the CSR and IIP will address key long-term trends, including:

• Tackling and managing climate change;
• Accommodating technological developments;
• Adapting to demographic change.

Delivering our ambitions in a difficult economic and budgetary context, and within a set of fiscal and financial flexibilities than does not currently give us the powers we need, will undoubtedly be challenging.

The Scottish Budget remains intrinsically tied to decisions made by the UK Government. Leaving aside the Fiscal Framework, which creates a close interaction between UK and Scottish tax decisions, the Scottish Block Grant continues to be determined by decisions on spending made by the UK Government. The funding scenarios in Chapter 3 illustrate the funding limits within which the Scottish Government must operate over the coming years.