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

4. Broad spending outlook

This section of the MTFS sets out spending scenarios for 2021-22 and beyond in a context of increased volatility and growing demand for public services as a result of the pandemic and existing deeper structural trends. To a significant extent, our ability to set a robust budget that best delivers our ambitions to not just continue to manage the public health crisis, but to ensure we build back fairer and stronger, has been hampered by the UK Government’s approach. The UK Spending Review in November 2020 did not provide the necessary detail to provide assurance to the Scottish Government regarding the direction or certainty of spending and resource-raising trajectories, including UK tax decisions, final BGAs and full allocation of identified COVID-19 funding. It also raises the prospect of quickly unwinding the current levels of COVID-19 related business and social support, which would in turn have damaging consequential effects.

4.1 Resource and capital spending context

4.1.1 Resource spending: the 2021-22 resource budget baseline

Published alongside this MTFS is the Scottish Budget 2021-22. Despite the limitations caused by the delay to the UK Budget and the lack of information contained in the November 2020 UK Spending Review, we have progressed our budget planning on the basis of clear ambitions of recovery and renewal. The Budget document reinforces the commitments set out in the Programme for Government (PfG), and sets out how we will invest to build our economy back fairer and stronger.

The two biggest spending areas within the Scottish Budget 2021-22 are Health (£16.9 billion in 2021-22) and Local Government (£9.8 billion in 2021-22).

Public-sector pay in these areas accounts for a large part of this expenditure. Around half of employees in the devolved public sector in Scotland are employed by Local Authorities with a further third employed by NHS Scotland.

The next biggest spending area is Social Security (£4 billion in 2021-22). The remaining available budget (£44.8 billion in 2021-22) funds a wide range of other commitments across all Scottish Government portfolios. Taken together, Health, Local Government and Social Security represent almost three-quarters of the available budget in 2021-22.

Within a fixed budget envelope, increasing spend on one area means decreasing spend in another or raising the difference via tax revenues. The picture is further complicated for 2021-22 by the UK Spending Review’s provision of non-recurring resource funding for COVID-19 on top of the ‘core’ baseline settlement, extending the approach from 2020-21, which makes budget planning across years all the harder.

4.1.2 Capital spending: the Capital Spending Review

Investment in infrastructure is key to Scotland’s economic recovery from COVID-19, and also in supporting public services, delivering our transition to net zero, and meeting the needs of people and communities across Scotland.

In the 2018 PfG, the First Minister announced a National Infrastructure Mission (NIM) to increase annual investment in infrastructure by 1% of 2017 Scottish GDP by 2025-26. This is the level required to match the ongoing investment of our key OECD competitors.

To support delivery of the NIM, Scottish Ministers established an independent Infrastructure Commission for Scotland. The Infrastructure Investment Plan (IIP) will adopt and build on the recommendations of the Commission in its Phase 1 report. It will set out our long-term vision and the pipeline of investment in public sector infrastructure over the period 2021-22 to 2025-26.

We will shortly be publishing our Capital Spending Review (CSR), which sets out capital spending plans over the same period, providing assurance on the affordability of the activity set out in the IIP and providing sight of those capital lines which do not deliver large infrastructure projects but are rather used to support jobs or research and development.

Importantly, expenditure in the CSR reflects our Climate Change Plan Update, published in December 2020, which details the policies and investments we are taking to support a green recovery and set Scotland on a pathway to a just transition to net zero. This includes introducing, boosting and accelerating more than 100 policies and proposals to cut greenhouse gas emissions across all sectors.

Infrastructure investment provides assets for the long term. Consequently, we plan for long-term trends that affect the nature of the infrastructure needed. The Infrastructure Investment Plan focuses on three core strategic themes for guiding investment decisions in Scotland:

• enabling the transition to net zero emissions and environmental sustainability
• driving inclusive economic growth
• building resilient and sustainable places

As part of the new approach to infrastructure investment outlined in the IIP, a new Scottish Government-wide prioritisation hierarchy will be introduced to support planning and decision-making. We will prioritise enhancing and maintaining our existing assets over new build in order to protect our environment and ensure value for money. In future, a higher proportion of investment is likely to be directed towards the initial steps in the hierarchy than in previous years. As part of this strategy, we will be addressing backlogs by working towards doubling investment in maintenance and asset enhancement over the next five years.

Our capital plans are set in the context of the need to support our economy to recovery from the shocks caused by both the COVID-19 pandemic and the UK’s exit from the EU, whilst driving forward a transition to net zero.

4.2 Our medium-term strategic spending priorities

The PfG 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

There is much we wish to achieve within these priorities. The Scottish Government must reach a balanced resource budget, so carefully considered decisions are required and spending will need to be prioritised effectively to maximise impact across multiple outcomes. The section below sets out our strategic spending priorities for the medium term in broad terms, alongside the risks and opportunities they might present. Given the longer-term focus of this document, we have chosen to draw out Climate Change as a separate priority to the ones listed in the PfG, as well as to better reflect our spending priorities for both resource and capital over the medium term.

4.2.1 New, good and green jobs

Central to our economic recovery is creating new jobs, good jobs and green jobs – with a particular focus on our young people, as well as supporting retraining and investing in our Green New Deal to tackle climate change.

The economic opportunity for both individual citizens and our communities is obvious – the real risk is not doing enough to maximise the potential of our people.

The Programme for Government highlighted a package of employability and skills support. The draft Scottish Budget has confirmed the continuing priority to support young people and all those affected by the pandemic.

The Scottish Government committed £100m of new investment for employability and skills support. The main focus of this financial support is the delivery of the Young Person's Guarantee, with other investments being made in redundancy support through the Partnership Action for Continuing Employment (PACE) initiative, a National Transition Training Fund targeting help at those in sectors where there is the greatest risk of job losses. The Flexible Workforce Development Fund in 2020-21 will ensure that both levy payers and SMEs across Scotland can continue to invest in their existing workforce and respond to the impacts of the COVID-19 pandemic.

It is already evident that the pandemic is having a disproportionate economic effect on our young people, reducing job opportunities just as they are starting out in their careers. An additional £60m has been provided for the Young Person’s Guarantee which will not only help relieve the current high levels of youth unemployment, it will also serve to support structural reforms in the medium to longer term by preventing the long-term scarring effects and detachment from the labour market usually associated with economic downturns. Evidence from the financial crisis of 2008 illustrated the significant cost of youth unemployment, and its associated scarring effects for public finances.^[33]

The National Transition Training Fund will support access to retraining for those aged 25 or over whose jobs are at risk as a result of COVID-19 or who have been made redundant. In addition, Individual Training Accounts (ITA), offer up to £200 to people of all ages who are unemployed or earn less than £22,000 who wish to upskill. We also continue to provide support for individuals affected by redundancy through our PACE initiative. Through providing skills development and employability support, PACE aims to minimise the time individuals affected by redundancy are out of work. We are investing an additional £5 million to scale up and enhance our support for those made redundant.

Investing in our people is also likely to yield longer-term benefits for the public purse. In the short term, the immediate costs of these programmes are likely to be recouped to some extent through lower spending by the UK Government on unemployment related benefits and higher Scottish Income Tax receipts. While the immediate benefit to the Scottish Budget might be limited, investing in skills, infrastructure and innovation, including green technologies, will boost productivity and growth, and ultimately Income Tax receipts, in the longer term. Additionally, unemployment can be a driver of ill-health and other vulnerabilities which drive demand and cost pressures on the wider public purse. There are also wider non-fiscal benefits to people and society of alleviating worklessness for anyone out of work. Employability plays an essential role in delivering the Scottish Government’s aim of tackling poverty, supporting inclusive growth and wellbeing, promoting social justice and creating a fair and prosperous Scotland.

In addition to employability and skills support, a £100m Green Jobs fund will support new and increased opportunities for green job creation across Scotland. This is part of our wider commitment to invest in a net zero economy. The Scottish Government will take advantage of all available tools in pursuing this aim. This will include implementation of the Scottish Green Ports model, driving regional economic growth while creating exemplars of fair work practices and the highest standards of environmental protection. This will support growth and the creation of new, good and green jobs while meeting our ambition to deliver a net zero economy

4.2.2 Promoting lifelong health and wellbeing

Delivery of high quality, timely health and social care services is pivotal to the health and well-being of the nation and requires both significant investment and ongoing reform. Published in 2018, the Scottish Government’s Health and Social Care Medium-Term Financial Framework^[34] considered drivers of demand growth and the approach to secure financially balanced and sustainable health and care services.

There are three key factors that drive demand growth in health and social care:

• price effects: the general price inflation within health and social services
• demographic change: this includes the effect of population growth on the demand for health and social care services as well as the impact of a population living longer
• non-demographic growth: this relates to demand-led growth, generated by increased public expectations and advances in new technology or service developments, for example, expenditure on new drugs

The Financial Framework showed that over the ten-year period from 2006-07 to 2016-17, NHS expenditure increased by 4.2% year-on-year, while social care expenditure rose by 3.8%.

While it is too early to fully assess the impact of COVID-19 on spending trajectories for 2020-21 and beyond, it is clear that the epidemic has caused significant additional costs and impacted on non-COVID-19-related healthcare in order to provide the necessary capacity in the system. Recovering from wider impacts of COVID-19 will take time and will also come with additional costs that create pressures on medium-term spending growth for the sector. Every additional percentage point of spending adds more than £150m in pressure to the health and care budget.

We are currently revisiting the performance and financial assumptions that underpin the Financial Framework. This will set out the anticipated next steps in the financial arrangements for our health and care services for future years, and will provide further detail on our delivery of the outcomes in the PfG and the Scottish Budget for 2021-22.

4.2.3 Promoting equality and helping our young people fulfil their potential

Tackling poverty and inequality is a key priority for this government and underpins our wider ambitions for a fairer and more prosperous Scotland, including our commitment to tackle the poverty-related attainment gap.

As outlined within the most recent child poverty progress report, investment targeted to support households on low incomes reached almost £2 billion^[35] in 2019-20. This includes £672 million of spend targeted to support the children living in those households. These estimates do not include the cost of universal services that we all benefit from – including free tuition and free prescriptions.

Social Security is a key responsibility for the Scottish Government. It is an investment in the people of Scotland and provides clear value for money for the public purse. With dignity, fairness and respect at the heart of Scottish social security, we are supporting low income families, young people entering employment, carers, and people facing a bereavement as well as delivering the ground-breaking new Scottish Child Payment for children under six. The latest spending forecast from the SFC projects that spending on the Scottish Child Payment will increase from around £9 million in 2020-21 and is estimated to be around £182 million in 2025-26. This flagship commitment has been described as a ‘game changer’ in the fight against child poverty by anti-poverty campaigners, but it is just one element of the Scottish Government’s anti-poverty strategy.

Our second Tackling Child Poverty Delivery Plan, to be published in March 2022, will outline the action we will take across 2022-26 to deliver further progress on our ambition to eradicate child poverty.

The demand for spending, both on children and low-income households more generally, will increase in future years in line with the strong recommendation of the Poverty and Inequality Commission stating that “the [child poverty] targets can be met, but … substantial investment will be required to do so”. This will have to be managed as part of the future Resource Spending Review.

In 2021, Scotland is also introducing the first of the newly devolved disability benefits, the Child Disability Payment. This will be followed by the Adult Disability Payment in 2022. Once our programme of benefits delivery is fully delivered, Social Security Scotland will directly deliver 17 benefits, of which six are completely new forms of assistance. As demand-led payments, these commitments will put increasing pressure on resource budgets over the medium term and additional headroom will have to be identified. Despite this, we are determined to promote a rights-based approach to social security, and to ensure that all those entitled to help will be able to receive it.

4.2.4 A just transition to a green economy

Scotland is taking world-leading action to tackle climate change. We have made several significant, multi-year, capital investment commitments to accelerate our just transition to net zero and deliver a resilient and green recovery from the COVID-19, investing an additional £2 billion over the next Parliament in transformational green infrastructure and investment. Our Climate Change Plan update details the policies and investments which will deliver this acceleration and the opportunities that our transition can capture.

The overall scale of cost is subject to very considerable uncertainty and will be determined to some extent by currently unknowable factors, such as the availability and cost of future technologies and the future actions and investments of UK government and other parts of the economy.

The Climate Change Committee (CCC) is relatively optimistic. In its recent report on the UK’s sixth Carbon Budget,^[36] it argues that the net annualised cost for the UK to reach net zero over the period to 2050 will be less than 1% of GDP per year, as the initial upfront investment costs are steadily mitigated by fuel savings over the longer run. This figure is less than the CCC had previously forecast.

Reaching net zero, and all of the intervening annual emissions-reduction targets, provides substantial opportunities for transforming and enhancing the long-term resilience of the Scottish economy in every year from now until 2045. Targeted in the right way, this spending can also reduce inequality, promote innovation and enhance Scotland’s competitiveness.

It is clear that the Scottish Government cannot fund the transition to net zero alone, but will set the conditions for attracting private investment. Businesses and households, along with other parts of the public sector and private investment mechanisms, will need to directly finance a large part of these costs, while ensuring that costs don’t fall to households that can least afford it.

This may happen as a result of regulatory changes or, potentially, as a simple result of market-led choices as the costs of low-carbon technologies fall and the cost of carbon is increasingly internalised into prices, for example through the operation of the emissions trading scheme and other carbon pricing mechanisms.

Even where the costs are borne directly by business and households, the role of government remains of central importance, through setting the regulatory and legislative frameworks and the provision of specific and directed funding and investments at key moments and in critical markets in order to generate demand, to kick start new markets and to develop pace and momentum for change that can then be picked up by the private sector.

There is also an opportunity to drive whole system benefits, with Government action providing confidence, which can in turn leverage private investment, encouraging investors to diversify into green technology and innovation. In turn, these investments will create new products, markets and supply chains, all of which create and protect jobs.

The Scottish Government has committed to publishing its private Capital Investment Plan: Investing with Purpose, Scotland’s Private Capital Investment Plan. The Plan seeks to align Scotland’s strategy to attract internationally mobile private capital investment with the strengths in our economy; and link this explicitly to the recovery and economic transitions towards wellbeing and Net Zero. It responds to the independent Advisory Group on Economic Recovery (AGER) recommendation from Benny Higgins’ report to support an investment-led recovery.^[37]

Private capital is of course deployed in many sectors and assets of the economy, and the purpose of the plan is to set an agenda to optimise its deployment to generate wider spill-over benefits to communities, the environment and the economy. In that context, this plan seeks to support the investment priorities of the Climate Change Plan, the forthcoming Housing to 2040 strategy, and the unfunded needs and opportunities identified through the Infrastructure Investment Plan to mobilise capital to build a future facing economy and to deliver our ambitious targets for climate change.

In 2020, we launched our Green Investment Portfolio which showcases commercial green investment opportunities to investors. Scottish Development International are leading the delivery of this initiative, utilising Scotland’s extensive network of global offices.

4.3 Medium-term resource expenditure outlook

To help understand the impact of a range of possible fiscal futures for resource expenditure, we have projected forward spend data for health, local government and social security, which together represent around three-quarters of the budget, along with the resource costs of repaying borrowing.

In this document we have not undertaken a scenario analysis for capital spending. In contrast to most resource spending, capital expenditure is mostly ‘one-off’ expenditure that does not represent an ongoing spending commitment (other than for maintenance). Therefore, capital spending decisions tend to be more flexible and entail fewer medium- to long-term fiscal risks, which are the focus here.

The nature of the devolved funding system means that the Scottish Government cannot set its spending independently of funding, which is largely determined by UK Government spending decisions. The three resource expenditure scenarios shown below are therefore broadly aligned with the resource funding scenarios, given that the Scottish Government has a very limited ability to diverge from its funding settlement through borrowing or mobilisation of the Scotland Reserve. It should be stressed that these scenarios are illustrative only, and not predictions or forecasts.

Health spending accounts for about half of the Scottish budget. This means that decisions on health spending significantly determine the availability of funding for other priorities. Additionally, the government is committed to applying a Barnett uplift (i.e. the addition to the Scottish Block Grant generated by increases in UK spending through the application of the Barnett formula) to the health resource budget for this Parliamentary term.

In the upper and central scenarios, health spending grows in line with the funding growth assumption (5.5% and 4% per annum, respectively), reflecting the Government’s commitment to pass through all health consequentials. However, in the low spending scenario annual health spending growth is only reduced to 3% to capture the unavoidable spending pressures caused by an ageing population.

Communities and local government spending grows by 5.5%, 4% and 2%, respectively, in the three scenarios. A large part of social care spending (which, like health, has shown trend growth of around 4% per annum) is covered by the local government budget. The assumption on the local government budget growth is the same as in the health scenario for the upper and central scenarios and spending is again ‘protected’ in the lower scenario, albeit at a lower rate of 2%.

Future social security spend is modelled by the Scottish Fiscal Commission (see table C2 in Annex C) and we are committed to fully funding demand-led Social Security benefits and the surrounding administration required to issue them – this spending therefore remains the same in all scenarios. There is of course a possibility that actual spend could differ from the forecast, which is covered in section 4.4.4.

The growth rate for the remainder of the budget is chosen so that overall spending is broadly in line with the funding scenarios – only for the lower scenario a lower bound of 1% growth is applied. Otherwise, this part of the budget would have to be reduced to accommodate the lower funding scenario, given the assumptions on health, local government and social security spending growth.

This means that:

• the upper scenario assumes 5.5% annual growth in health spending, local authority funding and 5.5% annual growth in the remainder of the budget (in line with growth in the upper funding scenario)
• the central scenario assumes 4% growth in health spending, local authority funding and 4% for the remainder of the budget (in line with funding growth)
• the lower scenario assumes 3% growth in health spending (above funding growth), 2% growth local authority funding and 1% growth for the remainder of the budget

Note that that any cost pressures, such as increases in paybills, inflationary uplifts or increase in demand-led provision, must be met from within these budgets. They also include a significant element of non-discretionary spend, including a range of statutory and contractual commitments across frontline services.

Table 5: Illustrative Resource Spending Scenarios (£ Million)

	2020-21	2021-22	2022-23	2023-24	2024-25	2025-26
Upper Range	34,431	36,472	38,129	40,243	42,402	44,660
Central Scenario	34,131	35,972	37,141	38,720	40,295	41,915
Lower Range	33,831	35,472	36,050	37,004	37,917	38,839

Table 5 shows upper, central and lower expenditure scenarios. For 2020-21 and 2021-22 the upper and lower scenarios show ±£300m and ±£500m short-term uncertainty, respectively, to reflect the extent of active budget management that is always required to accommodate changes in the fiscal situation. The triggering of the conditions of a ‘Scotland-specific economic shock’ results in greater flexibility around the use of the Scotland Reserve and resource borrowing for the 2021-22 budget. This, and one-off increases in 2021-22 are assumed to be unwound in future years.

Figure 2 illustrates the data; for each year there are three stacked bars for each of the three scenarios.

For 2020-21 and 2021-22 the upper and lower ranges reflect a relatively small assumption on the uncertainty around:

• extra spending opportunities that may arise due to extra Barnett consequentials late in the year
• in-year underspending
• volatility in demand-led spending like social security or pensions

Ultimately, the Scottish Government is required to match spending and funding numbers and deliver a balanced budget by the end of the fiscal year.

4.4 Resource spending risks and pressures

4.4.1 Pay

Pay is a key driver of public expenditure and makes up around half of the Scottish resource budget. As of 2020 Q3, 515,700 individuals, representing around 19% of all Scottish workers, worked in the devolved public sector. The Scottish public sector is proportionally larger than the UK average of 17%, with the average in England being 15%.

Sources: Public Sector Employment (Office for National Statistics); Public Sector Employment in Scotland (Scottish Government)

The relative larger size of the Scottish public sector carries with it a greater fiscal risk to the Budget, particularly in the context of the Barnett allocation, which is determined by population share and must be distributed over a comparatively larger workforce. A good example of this was the changes to employer pension contributions in 2019, part-funded by Barnett consequentials with a resulting £110m annual shortfall, in part due to Scotland having a larger workforce.

The Scottish Government pay and reward policies are distinctive, fair and progressive. Fulfilling our commitment on pay restoration, so that earnings for the lowest paid reflect a real terms increase in pay since 2010, demonstrates the value placed on the public sector while generating additional spending power to play a part in Scotland’s wider economic recovery. The Scottish Government is also committed to exploring with Trade Unions and employers further opportunities for developing non-pay benefits, such as a shorter working week, as part of shaping the future of work. In the long term, this could be an opportunity to lessen the cost burden of pay awards to employers, act as a lever to improve productivity, optimise the role of automation and digitalisation of services, while creating high value job opportunities and contributing to the wellbeing economy.

In designing our pay policy, we must balance economic, fiscal and social factors. We will need to consider:

• changes to the cost of living (CPI Inflation 0.5% in September 2020)
• trends on private and public sector earnings (recent ONS data indicates a 7% pay premium for the public sector)^[38]
• wider unemployment levels (expected to reach 7.6% during 2021, as the job retention scheme ends in April)

The affordability of pay uplifts, consistency across the industrial relations landscape and recognition of performance across public services contribute to a fair and fiscally sustainable approach to public sector pay. This is crucial given it accounts for half of the Scottish Government resource budget.

All of the devolved public sector workforces (including Health, Teachers, Police, Fire and Further Education (FE) Colleges) use the Scottish Government’s Public Sector Pay Policy as a reference point and will negotiate new pay deals in 2021-22. The 2021-22 Public Sector Pay Policy is a single-year deal. Other public sector workforces typically follow the approach taken by the Public Sector Pay Policy in making their decisions on whether single-year or multi-year deals are most appropriate and offer value for money.

Decisions on pay to support public servants as a result of their efforts in the pandemic will need to be balanced with the demand for funding available to support wider civil society and the economy. The 2021-22 Public Sector Pay Policy was announced alongside the Scottish Budget, continuing the progressive principles of recent years. Specifically, it outlined a 1% basic award supplemented by measures to address low-pay, namely a £750 cash underpin for salaries up to £25,000, the continuation of Scottish Ministers commitment to the real Living Wage of £9.50 per hour, alongside a cash cap of £800 to those earning £80,000 or above.

To illustrate the potential future costs, we have modelled three theoretical public sector pay award scenarios (see Table 6).

Table 6: Illustrative Cumulative Paybill Costs (£ Billion)

		Baseline	2021-22	2022-23	2023-24	2024-25	2025-26
Illustration of 1% pay award	Total	14.8	15.0	15.1	15.3	15.4	15.6
	Additional cost including Basic Award		0.15	0.15	0.15	0.15	0.15
Illustration of 2% pay award	Total	14.8	15.1	15.4	15.7	16.0	16.3
	Additional cost including Basic Award		0.30	0.30	0.31	0.31	0.32
Illustration of 3% pay award	Total	14.8	15.2	15.7	16.2	16.7	17.2
	Additional cost including Basic Award		0.44	0.46	0.47	0.49	0.50

Note: This is the cost of the basic award including employer on-costs

4.4.2 Public service pensions – a mandatory workforce cost

Within the UK, policy is largely reserved to Westminster in respect of public service pensions and wholly reserved in respect of state pensions, private sector pensions, and pensions taxation policy. Public service pensions are both an important element of current and future Scottish Government obligations and a key part of public servants’ terms and conditions.

Employer pension contributions are paid on employees’ pensionable pay and total costs increase with workforce size. Pension costs are an element of the public sector paybill and are taken into account when assessing affordability of pay deals. Scottish Ministers remain committed to public service pensions which are affordable, sustainable and fair to Scotland’s public servants and the communities they serve.

Employer pension contributions, along with the those paid by scheme members, are used to meet the cost of pensions in payment. Scheme cash shortfalls are met through UK Government funding mechanisms (Annually Managed Expenditure or AME) in the case of the NHS and Teachers’ schemes, or through Scottish Government resource budget in the case of the Police and Firefighters’ schemes.^[39]

UK Government decisions on overarching policies, such as the discount rate used to value scheme liabilities as part of quadrennial scheme valuations, affect the Scottish public service pension schemes. For example, when the UK Government announced the 2018 discount rate decrease, which led to increased employer pension contribution rates from 1 April 2019, the annual cost across public sector employers in Scotland was in excess of £500 million. The Scottish Government received Barnett consequentials to cover some of this cost and has provided additional funding itself to help make up the shortfall for employers.

In the medium term, the upcoming round of public service pension scheme valuations – the 2020 scheme valuations – is the next pension event that could change pension costs for employers. The 2020 scheme valuations are likely to include the outcome of HM Treasury’s review of the methodology for setting the discount rate (expected in 2021) as well as any changes to the rate itself. The employer pension contribution rates set in 2019-20 will remain in effect until new rates are set and implemented.

4.4.3 Ageing is a significant driver of public service expenditure

An ageing population puts increasing pressures on public expenditure, in particular pensions, health and social care. The predominant portion of a person’s health care is required in old age and, in particular, the year and months before death. The Scottish population is ageing, with the population share of over 75-year olds increasing from 8.6% in 2020 to 13.2% in 2040. At the same time, as the proportion of working-age population decreases, this means that public services and welfare payments for all need to be funded on a smaller active economy. Equally, as medical research and advancement allow, people are living longer. While this is obviously worth celebrating, it is accompanied by higher and more complex care needs, with the incidence of comorbidity on the rise. While these changes are gradual and not necessarily significant over the period of this MTFS, policy interventions are required early in order to maintain the affordability of health care and the pension system over the long term. For health, this requires both more efficient service delivery as well sustained and concerted action to reduce demand through self-care, prevention and health improvement.

4.4.4 Demand-led volatility risk

Expenditure on social security benefits is variable, being determined by the number of eligible people who apply for support, as well as how successful we are in rightly ensuring that that those eligible benefit from this entitlement, all of whom must be paid at the rate set in the policy. We will have to meet this expenditure as it arises, even if it differs from the forecast used to set the Budget initially.

The SFC forecast that social security expenditure will have reached £3.5 billion in 2021-22, and that this will gradually rise to over £4.2 billion by 2025-26. The economic and social impacts of COVID-19 add to the risks for managing benefits expenditure.

Most of benefits expenditure is demand-led and budget allocations for these are based on SFC forecasts rather than spending limits. This introduces in-year volatility to the Scottish Budget. Given the potential for variability, the SFC reported a 2% variation for 2019-20^[40], which if replicated in 2021-22 would be over £70 million, expenditure that will have to be funded by the Scottish Government.

Over 90% of social security benefits expenditure is funded through BGAs, which are based on OBR forecasts of benefit expenditure in England and Wales, at the time the Scottish Budget is set. Once outturn data are available, reconciliations are made to the Scottish Budget to ensure that the funding available ultimately corresponds to the BGAs based on the outturn data. If expenditure in England and Wales is ultimately higher than forecast, a positive BGA reconciliation (i.e. an addition) will be made to the Scottish Budget to reflect these changes, and vice versa.

Changes between actual and forecast Scottish expenditure, and the BGA reconciliations, are managed within the Scottish Government’s budget management processes, in line with the principles and policies on the use of borrowing and reserve powers as set out in Chapter 5. Further information on the BGAs and reconciliations is set out in Annex C.

The Scottish Government will continue to manage any variance between actual and forecast expenditure or BGAs, in a competent, responsible and balanced way as part of the annual budget process, in line with the principles and policies set out in the MTFS.

4.5 Approach to a Resource Spending Review

In setting the annual budget each year, the Scottish Government has to make careful choices in the prioritisation of commitments and expenditure in order to reach a balanced budget position, taking into account the key demand pressures set out above.

The UK Government has indicated it will undertake a multi-year Spending Review later this year addressing spending from 2022-23. Building on the forthcoming Scottish multi-year Capital Spending Review, it will be the role of a Scottish Resource Spending Review and/or future Budgets – after the 2021 Scottish Parliament election - to balance the spending ambitions of the new Scottish Government within its fiscal constraints.

As in previous years we will explore a wide range of options, including:

• looking to deliver efficiency savings across portfolios including through the use of digital technology
• prioritising expenditure to ensure that there is a clear line of sight from spend to our core purpose and National Outcomes and the priority to build back fairer and stronger from COVID-19
• looking to build on the learning from the response to COVID-19
• identifying options to reduce demand in the longer term through early intervention
• considering options for public service reform to allow us to protect the delivery of public services at a time of continuing financial restraint
• options for generating additional revenues (beyond taxes)

Fiscal sustainability, value for money and an outcomes-focus will underpin the approach – keeping a clear line of sight from spending decisions to the Government’s Purpose and the National Outcomes in order to drive a fair and strong recovery from COVID-19 and to re-set progress towards meeting our statutory commitments on child poverty and climate change.

The final framework and timing for the spending review will be a decision for the new administration following the Scottish Parliament election in May 2021. A number of new spending commitments will likely follow from manifestos and difficult decisions will have to be made to create the financial “headroom” necessary to fund these commitments. Initial work is starting to consider how officials can provide support to the new administration to make progress on this work.