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

5. Managing fiscal risks – current powers and options for change

This section brings together the funding and spending scenarios set out in previous chapters and discusses the different sources of fiscal risk that need to be managed and our ability to manage them with available fiscal tools.

The chapter outlines the current fiscal levers available in terms of budget management tools, borrowing powers and devolved taxation powers. It also discusses the forthcoming review of the Fiscal Framework and the potential this brings for increased flexibility and localised ability to manage fiscal risks.

The current devolved funding arrangements have clear limitations in terms of managing risk, particularly in the face of economic shocks precipitated by COVID-19. It is the Scottish Government’s view that the forthcoming Fiscal Framework Review should include greater fiscal flexibilities, alongside the devolution of further tax powers to Scotland, which would enhance Scotland’s fiscal levers, enabling us to maintain and expand the tax base, raise devolved tax revenues and support the delivery of a prosperous and green recovery. This chapter provides an outline of a strategic set of tax powers that could be further devolved which adhere to the Scottish Government’s principles of taxation and would better enable tax to serve the people and businesses in Scotland. Although the further flexibilities triggered by the ‘Scotland-specific economic shock’ provision of the Fiscal Framework are welcome, they are a temporary measure that fall short of the scale of flexibilities required to manage budgetary volatility.

The Scottish Government operates within a tight Fiscal Framework, with limited fiscal powers. Figure 4 below shows how the funding and spending scenarios compare, and illustrates the considerable fiscal uncertainty, even in the short term.

On the funding side, in-year consequentials arising from UK spending decisions, in-year reconciliations of devolved taxes as well as tax and social security BGAs create volatility that needs to be managed by the Scottish Government. The future budget trajectory is uncertain due to the delay to the UK Budget for 2021-22 and no lack of Spending Review settlement for subsequent years.

On the spending side, under- or overspending on budgets is a risk that requires constant management. Demand-led social security spending is a source of substantial uncertainty. These short-term volatility risks arise because the forecasts on which the budget is based can never fully reflect the contingencies occurring in real time. The Scottish Government’s financial management needs to be extremely nimble to accommodate these contingencies, with limitations on the use of our Reserve and without having access to any sizeable borrowing facilities.

The medium-term outlook for both our budget and our spending priorities, set out in the previous sections, depends heavily on the success of the COVID-19 vaccination programme and the degree of long-term economic scarring inflicted by the COVID-19 pandemic, as well as the on-going risks around the UK’s trade relationship with the EU.

The illustrative central and upper spending scenarios are chosen to broadly mirror the funding scenarios, reflecting the current commitment to apply all health consequentials to the health budget and the given limits in the current Fiscal Framework on diverging in any significant degree from the funding envelope.

The lower illustrative spending scenario represents a significant reduction in spending growth in all portfolios, but still exceeds the lower funding scenario, where the Block Grant grows more slowly and the net tax position deteriorates. If the lower funding scenario became reality it would require a drastic re-prioritisation of budgets in order to achieve budget balance.

Table 7: Summary Of Key Short-Term Risks To Fiscal Sustainability

Risk	Mitigation
In-year volatility caused by UK spending decisions	The devolved administrations in the UK are internationally in a unique position in having to manage such in-year volatility risks. The Scottish Government can use draw-downs and carry-forwards through the Scotland Reserve as well as reprioritising spending to manage this risk. However, it cannot use resource borrowing and the limits on the available powers are so restrictive that it is impossible to guarantee the ability to fully control for unpredicted UK budget decisions.
In-year volatility caused by forecast “error”	Forecasts are updated at various points in the year, which helps us understand the size of the volatility and put management measures in place. The Scottish Government can, subject to given limits, use resource borrowing and the Scotland Reserve to manage transitory volatility. Forecast reconciliations are sometimes in excess of the usual annual £300 million borrowing limit.
In-year revenue volatility caused by change in economic circumstances (linked to forecast risk)	A large portion of devolved revenue is directly related to Scotland’s economic success. The economic contraction caused by COVID-19, for example, has led to reductions in Income Tax revenue. This risk is mitigated through the operation of the Fiscal Framework – as long as Scottish and UK revenues change in the same direction - so that changes in Scottish revenues and the corresponding BGAs cancel each other out, to a larger or smaller degree.

Table 8: Summary Of Key Medium- To Long-Term Risks To Fiscal Sustainability

Risk	Mitigation
Reduction in Block Grant growth caused by UK spending decisions A key downside risk to the Scottish Budget over the medium-term – if the UK Government decides to consolidate public finances in the wake of COVID-19	The Scottish Government can make use of its limited reserve and borrowing powers to smooth the budget trajectory but that limits the ability to use those instruments for in-year volatility management. In the long term, affordability of spending is largely driven by UK Government decisions and spending, or taxes have to be adjusted to ensure that the Scottish fiscal position remains in balance.
Structural differences in UK and Scottish growth performance Scotland’s exposure to global commodity markets, in particular the oil price, is relatively greater and there are differences in the sectoral composition of the Scottish and UK economies	Our economic policies are the key long-term mitigation to ensure sustainable and robust economic growth and strong revenues. This means effective economic policies to enhance productivity and competitiveness in line with the principles of the Government Economic Strategy.[41] At this point, we do not believe there is a fundamental difference in growth performance between Scotland and the UK, although the different sectoral composition poses a risk in the medium term (see Annex B). Such divergences should be sufficiently reflected in the budget forecasts, allowing for timely budget planning.
Structural differences in UK and Scottish tax base Differences in the composition of the tax base can pose a risk to the Budget, in particular if economic growth and earnings growth is unequally distributed (see Annex B for details)	This risk can be mitigated through changes to the Fiscal Framework. There is a risk that the current BGA mechanism puts Scotland at a permanent disadvantage and this issue should be reviewed as part of the Fiscal Framework Review.
Pay agreements are a key driver of public sector costs and spending	The Scottish Government’s pay and reward policies aim to balance fairness and affordability, informed by dialogue with trade unions, alongside workforce planning that focuses on priorities
Demand pressures caused by an ageing population The fiscal pressures of an ageing population are most apparent in our health and social care system	We have committed to maintaining funding growth for health and social care at comparatively high levels. Nonetheless, we need to maximise the opportunities to mitigate the fiscal pressures. Driving down demand on the health system through public health improvement and prevention is a key element not only in improving people’s health for better outcomes but also in managing the financial risks of health demand pressures. We continue to shift the balance of care towards mental health, and to primary, community and social care. We know that in many circumstances outcomes improves and fewer interventions are required when care is delivered in a community setting.

5.1 Current levers for managing volatility and risk

The Fiscal Framework provides the Scottish Government with limited reserve and borrowing powers. In the usual operations of the Fiscal Framework, the Scotland Reserve is limited to £700 million, with an annual drawdown limit of £250 million for resource and £100 million for capital. This year, the ‘Scotland-specific economic shock’ provision means that there is no drawdown limit for the Reserve. The total limit for resource borrowing is £1.75 billion and the usual annual limit for its most likely use – forecast error under the Fiscal Framework – is £300 million per year. This year, due to the triggering of the ‘Scotland-specific economic shock’ provision of the Fiscal Framework, the annual borrowing limit is raised to £600 million. The total limit for capital borrowing is £3 billion with annual borrowing limited to £450 million.

It is worth stressing that the Reserve is the only mechanism for the Scottish Government to retain underspent funds for future years. The limitations on the use of the Reserve and the continual change in forecasts mean that it is neither feasible nor desirable for the Scottish Government to build up substantial balances in the Reserve. If the Scottish Government intentionally underspent its budget to carry forward funds to future years, there is a significant risk that the limit would be breached and therefore these funds would be lost permanently. Within these limitations, the Scottish Government uses the following guidelines when managing the budget.

5.1.1 Scotland Reserve policy

We will use the Scotland Reserve to prioritise any anticipated underspends for use in the subsequent financial year. This reflects the risk of funds being lost to the Scottish Government should excess underspends emerge in the provisional and final outturn process.

We want to ensure that the Reserve is built up using excess tax receipts or additional underspends emerging from the Provisional Outturn and Final Outturn Processes.

Our aim is to ensure that excess funds in the Reserve will be used as far as possible to smooth resource funding over time, to achieve a stable spending trajectory. However, this may be balanced against urgent and more immediate requirements such as funding COVID-19 emergent needs.

5.1.2 Resource borrowing policy

The use of resource borrowing is complementary to the use of the Scotland Reserve. The Scottish Government must balance the need for flexibility with the additional costs of borrowing compared to the Reserve to find a solution that is most appropriate to the circumstances.

Our resource borrowing powers will be used in a way that balances the principles of flexibility, stability and value for money.

The Scottish Government will assess all planned resource borrowing decisions to smooth the funding trajectory over five years. 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.

It is important to stress that this resource borrowing power can be used only for cash management and forecast error under the Fiscal Framework – it cannot be used to support additional Scottish Government borrowing in response, for example, to COVID-19.

Given the restrictions on resource borrowing, under the existing Fiscal Framework, the only risks created by borrowing itself are those on future years’ resource budgets resulting from borrowing repayments. It is therefore prudent to consider the medium-term impact on the Scottish budget of reconciliations, borrowing and borrowing repayments in totality. Given the annual limits and short repayment periods, there is no risk of breaching the cumulative limit, and there is also no re-financing risk.

Conversely, there are considerable risks related to forecast error, economic shocks and funding outlooks, depending on UK Government decisions. The resource borrowing powers to do not address these sufficiently.

All of this means that the current Fiscal Framework does not meet the guiding principles set out by the Smith Commission in ensuring that the Scottish Government has the tools and powers to manage funding volatility, particularly on forecast error.

5.1.3 Capital borrowing policy

The two key considerations for the medium term with respect to capital borrowing decisions are the headroom against the cumulative Fiscal Framework limits and affordability of ongoing borrowing repayments.

Capital borrowing powers will be used in a way that balances the principles of flexibility, stability, value for money and intergenerational fairness alongside supporting the delivery of the NIM.

The 2019-20 Budget sets out the baseline for the NIM in 2019-20 of £5.2 billion, which will increase by £1.56 billion by the end of the next parliament in 2025-26. In order to achieve this increase in investment, capital borrowing will be required as part of a combination of funding sources that also include capital grant, financial transactions and alternative revenue-finance models, including private finance.

The National Loans Fund currently remains the preferred source of capital borrowing. Given the medium term impact on resource costs, this remains the optimum compromise between value for money, resource cost impact and maximising the use of the Fiscal Framework limits.

The term-structure of borrowing will be chosen to strike the right balance between flexibility (requiring shorter-term lengths), value for money (requiring shorter-term lengths), and stability (suggesting longer-term lengths) and intergenerational fairness (term length corresponds to asset life).

The Scottish Government will ensure that a minimum of £300m capital borrowing headroom will be available to be drawn down in the year following the period covered by the NIM (2026-27). This is a small adjustment to the borrowing policy first set out in the 2019 MTFS,^[42] and is required to help us manage the impact of the higher degree of fluctuation we are now experiencing in UK funding. For example, the capital budget was reduced by around 5% between 2020-21 and 2021-22, including a fall of around two-thirds in Financial Transactions allocation.

Over the period of the NIM, our policy is to borrow between £250 million and £450 million annually to ensure that there is sufficient investment planned to support economic growth, and that investment increases overall year-on-year.

All borrowing drawdown decisions will take into account the in-year budget management position, the interest rate environment and impact over the five year term versus the assumptions made in the Scottish Budget.

5.1.4 Existing powers are too limited

It has been clear for some time that the scale of potential forecast error under the Fiscal Framework exceeds the level of flexibility provided by these powers.

The most obvious and initial problem is that the limits on Scottish Government borrowing and reserve flexibility have been fixed since the Fiscal Framework was agreed. Since the scale of the economy and tax revenues increase over time, the Scottish Government’s practical ability to manage risk has therefore been effectively eroded each year.

However, even if the limits had been adjusted over time, they would still have been insufficient to adequately allow the Scottish Government to manage the volatility inherent in the forecasting process.

In order to assess the adequacy of the resource borrowing powers, we have developed a framework for analysing the impact of forecast error on the expected reconciliation, full details of which can be found in Annex A. Even using relatively conservative assumptions, there is up to a 1 in 6 chance that purely on Income Tax, and not including the other devolved taxes and social security benefits, the Scottish Government would face funding volatility as a result of forecasting error that the current powers could not deal with.

The SFC have also undertaken a similar analysis, set out in their recent forecasts. Although they have a slightly different approach, they also find that Income Tax reconciliations are likely to exceed Scottish Government borrowing powers on a somewhat regular basis, potentially as frequently as four times every ten years depending on the assumptions made.

The current Fiscal Framework therefore does not meet the guiding principles set out by the Smith Commission in ensuring that the Scottish Government has the tools and powers to manage the inherent funding volatility generated by the use of forecasts in our Budget process. The review of the Fiscal Framework is a key opportunity to remedy current shortcomings and enable the Scottish Government fully to manage the fiscal risks it faces.

5.2 The need for a robust, comprehensive and timely review of the Fiscal Framework

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.

Given the significant changes in the political and constitutional landscape in the years since the agreement was made, and the recent and ongoing experience of COVID-19, the Scottish Government considers that the review, and the independent report which informs it, should take place as quickly as possible, and should be robust and comprehensive. However, as the arrangements for the review depend on joint agreement with the UK Government, we rely on their commitment to achieve this ambition.

The Scottish Government will continue to engage in good faith and set out a clear vision of what it wants the review to achieve. This will include arguing that the scope of the review, and the independent report which informs it, should be wide-ranging. It should consider not only how the Fiscal Framework has operated to date, but whether there is an appropriate balance between the risks to which the Scottish Budget is exposed, and the levers that the Scottish Government has to manage those risks, particularly in light of the COVID-19 pandemic.

It should ensure that the funding arrangements are fair, that budget volatility is minimised and that the Scottish Government has the powers and flexibility needed to manage the risks that we face and to support economic recovery in the years ahead.

Views from stakeholders other than the two Governments should be an integral part of the process, and the review should build on the issues identified in the joint working group report between the Scottish Government and the Scottish Parliament’s Finance and Constitution and Social Security Committees.^[43]

In particular, it is clear that the following topics should be considered as a minimum:

• VAT, Income Tax and further tax powers – extensive work has established a number of intrinsic difficulties with the VAT assignment methodology. As part of the Fiscal Framework review the two Governments should work together to determine whether the devolution of full VAT powers would present a better tool to protect and develop Scotland’s fiscal self-sufficiency and resilience. This should take place as part of a wider review of the tax powers currently devolved, identifying further powers that would make the tax system work more efficiently in Scotland, and serve the people and businesses of Scotland more effectively. More detail is set out in sections 5.3.2 to 5.3.5.
• BGA mechanism – we need to ensure that this delivers a fair funding outcome for Scotland, and that there is an appropriate balance between risks and ability to manage them.
• Volatility risk and budget management tools – our budget management tools need to be sufficient to manage the volatility inherent in the Fiscal Framework.
• Capital borrowing – supporting economic growth through infrastructure and investment is important now more than ever. There is a clear case for increased capital borrowing powers and we should also re-examine the merits of a prudential borrowing regime as recommended by the Smith Commission.
• Policy risks – as set out earlier in this document, UK fiscal and policy decisions have profound effects on our own policy decisions, revenues and expenditure, and the economy in Scotland more widely, and within the existing framework these have presented a number of fiscal and policy constraints. The review must consider how to minimise any friction between both governments tax and social security regimes, including through better policy co-ordination, to ensure that the Scottish Government has maximum flexibility in its policy choices and ability to manage the impacts of UK policy choices through the Fiscal Framework and vice versa.

5.3 Devolved and reserved tax powers – responding to fiscal challenges

Under the current devolution settlement, the vast majority of tax powers remain reserved to the UK Parliament. The Scottish Parliament has limited levers to enable the Scottish Government to make the tax decisions necessary to protect and grow the Scottish economy, to facilitate the efficient operation of devolved policies and to effectively mitigate some of the fiscal risks set out in tables 7 and 8.

COVID-19 has emphasised the limitations of Scotland’s devolved tax powers in responding to economic shocks. Scottish tax revenues are still highly dependent on decisions taken by the UK Government, and reserved tax policy can have significant impacts on devolved tax policy, for example the partial devolution of Income Tax. More robust and extensive tax powers are essential for the Scottish Government to support an economic recovery which delivers a fairer, greener, and more prosperous Scotland, thereby addressing possible structural fiscal risks. Indeed, the case for additional fiscal powers has been supported by a number of stakeholders who responded to the Scottish Government’s consultation on Supporting the COVID-19 Recovery.^[44]

Where the Scottish Government does have the devolved tax powers to act, it has done so quickly and decisively:

• To assist homebuyers and support Scotland’s housing market following the outbreak of COVID-19, the nil-rate band for residential LBTT was increased to £250,000 until the end of March 2021 and the time available in which to sell a previous main residence and claim a repayment of the Additional Dwelling Supplement was doubled for the most affected taxpayers
• To support businesses affected by COVID-19, additional reliefs were introduced to non-domestic rates as part of a comprehensive package of measures worth nearly £3 billion

It is evident, however, that the relationship between devolved and reserved powers creates the need for robust intergovernmental processes and governance structures to marshal the split and interplays of tax policy between the UK and Scottish Governments. We call on the UK Government to ensure that the impacts and consequences of UK tax changes, including on devolved revenues, are considered across the tax policy landscape in Scotland, with appropriate systems in place for collaborative policy development, consultation and advance notice. All of which is in the clear mutual interest of the UK and Scottish Governments, and would help to support the economic recovery from COVID-19.

5.3.1 Threats and opportunities in relation to the tax base and performance

COVID-19 will precipitate significant changes in the economy and the way we lead our lives in the short and long term. As we recover from the pandemic, and face other challenges in the future, such as the climate emergency, the opportunities for more effective tax policy in Scotland must be seized, alongside ensuring the risks to devolved tax revenues are managed.

In the medium term there will be new economic opportunities through technological advances and a re-balancing of the economy towards growth sectors. The workforce of the future will be more mobile than ever before, as some workers are no longer physically bound to their place of work, and flexible work arrangements bring new people into the labour force, such as working mothers. Our social contract, which offers the widest range of public services available in the UK, will be more important than ever before in helping to attract people from across the world to live and work in Scotland, and thus widen the tax base.

The COVID-19 pandemic has emphasised the need to tackle the challenges that existed before the outbreak, and will persist in our recovery. Our future tax system will need to support: a green recovery; financially balanced and sustainable health and care services; and enhance innovation and investment in Scotland which helps businesses recover and embed Scotland’s international attractiveness to live, work, study and invest in.

Non-Domestic Rates (NDR)

The Non-Domestic Rates (Scotland) Act 2020 delivered a number of reforms recommended by the independent Barclay Review of Non-Domestic Rates^[45] and was given Royal Assent on 11 March 2020, the same day that COVID-19 was declared a global pandemic by the World Health Organisation. As a tax on non-domestic property, Non Domestic Rates (NDR) has traditionally offered a stable source of revenues to the Scottish Government.

From the outset of the pandemic, the NDR system has been central to the Scottish Government’s business support response, with over £1.9 billion of immediate support provided through a combination of COVID-specific reliefs and grants administered on the basis of property data held on the valuation roll. At the same time, as a tax based primarily on the occupancy of non-domestic properties, COVID-19 has struck right at the heart of the NDR tax base. Since the beginning of the pandemic, in the region of 40,000 to 50,000 Material Change of Circumstance (MCC) appeals have been lodged. These appeals are claiming there has been a change of circumstance that warrants a change in the rateable value of a given property. Any impact of these appeals on future revenues would likely manifest during coming years, but at this stage any risks to public finances are unquantifiable. The Scottish Government is working closely with the UK Government to understand the potential risks to both Scottish and UK-wide public finances, and the implications of these.

In order to provide some certainty both to ratepayers and to the public finances, the Scottish Government has taken the decision to delay the next NDR revaluation by one year from 1 April 2022 to 1 April 2023, based on rental values one year earlier (1 April 2022). Prior to this decision, the default date for the next revaluation was 1 April 2020, and this would have delivered rateable values at the next revaluation that would have reflected pre-COVID conditions. The Scottish Government remains committed to three-yearly revaluations as recommended by the Barclay Review, but the decision to delay the revaluation will provide more opportunity for the commercial property market to stabilise following the pandemic and increase the likelihood that the revaluation process will deliver accurate rateable values in line with the Barclay Review’s desire to promote stability and avoid economic shocks.

Income Tax

As the devolution of tax powers is a relatively recent concept and Income Tax outturn data is only available with a significant lag, data on Scotland’s historic Income Tax performance is limited and so far only covers 2017-18 and 2018-19. This means that our understanding is constantly evolving as more evidence becomes available. Looking ahead, Scotland’s relative tax performance will depend on a number of factors, most importantly growth in income and employment.

If the Scottish economy is more severely impacted by, or takes longer to recover from, the effects of COVID-19 and Brexit, our relative Income Tax performance will suffer. In particular, Scotland’s Income Tax performance is more exposed to any drop in the global oil price. This is exacerbated by differences in the way that the economy, and therefore the Income Tax base, is structured in Scotland compared to the rest of the UK. For example, the way that the BGA currently works means that the Scottish Budget is worse off if higher earners see relatively stronger earnings growth than other taxpayers, due to Scotland’s relatively lower proportion of high income earners.

Land and Buildings Transaction Tax (LBTT)

For LBTT, COVID-19 and overall levels of economic activity may impact on the nature of the demand for both residential and non-residential property. This could mean changes in the current housing market property type sales mix, in the demand for commercial property and the geographical distribution of LBTT revenues. For example, if future property price trends for houses and flats, or for rural and urban areas, diverge from current trends then the make-up of LBTT revenues across Scotland will also change. Alongside this, any changes in terms of the willingness of the financial sector to lend to individuals requiring mortgages would impact on LBTT. UK House Price Index data shows that in the 12 months to August 2020, 68% of residential property transactions in Scotland required a mortgage to support the purchase.

Scottish Landfill Tax

Scottish Landfill Tax revenues will, as intended, reduce significantly in the run up to the ban on landfilling of biodegradable municipal waste on 31 December 2025 and beyond. In that context, key issues over the next five years will include the extent to which new incineration capacity comes on stream and its timing, the location of that capacity and overall levels of economic activity in Scotland.

Mitigating the risks to devolved tax revenues and their tax bases will be vital. We will work across the Scottish Government to ensure Scotland’s devolved tax base is protected, and where possible broadened, to help pool risk more effectively and support public services. This will be influenced by measures beyond tax policy, such as efforts to tackle unemployment, supporting the creation of high-value Scottish jobs, and attracting those around the world to bring their skills and talent and make Scotland their home to live, work and study.

5.3.2 Exploring further tax powers for Scotland

Tax policy is fundamental to any nation’s ability to protect its economy and rebuild after a period of crisis. The time is right to consider the devolution of additional tax powers to Scotland: we are beginning the recovery from a major global economic and social shock and the UK has left the European Union. The Fiscal Framework Review provides a prime opportunity to consider further tax powers in a wider and more strategic context, and we will press the UK Government to agree to include such powers within the scope of the Review.

The Scottish Government considers that, ultimately, all tax powers should be transferred to Holyrood. Increased tax powers would enable the Scottish Parliament to tailor taxation to reflect the Scottish economic and social context. We recognise that additional tax powers would bring risks alongside opportunities: we are confident that accepting these risks will be worthwhile in return for additional levers to promote economic growth. Provided further tax powers are accompanied by adequately flexible fiscal levers and balancing borrowing powers, we believe that they would enhance our ability to manage and mitigate fiscal risks.

We will consider as a priority the powers needed to resolve the existing technical and policy problems in the current tax system, and to bring balance to the Scottish Budget. This includes the devolution of full Income Tax powers and VAT powers, alongside other taxes which form a coherent package with these powers, for example Capital Gains Tax.

Box 3: Air Departure Tax And Aggregates Levy

The Scotland Act 2016 provided for the devolution of UK Air Passenger Duty (APD) and the Aggregates Levy.

The Air Departure Tax (Scotland) Act 2017 made provision for Air Departure Tax (ADT), the replacement for APD in Scotland. Introduction of ADT in Scotland has however been deferred to allow the issues raised in relation to the Highlands and Islands exemption to be resolved. The UK Government will maintain the application of Air Passenger Duty in Scotland in the interim. The Scottish Government remains fully committed to introducing ADT and will work with stakeholders and with the UK Government to find a solution for aviation that remains consistent with our climate ambitions.

Following the resolution of outstanding state aid issues related to the UK Aggregates Levy and the conclusion of a UK Government review, the Scottish Government will take forward work to allow for the future introduction of a devolved levy in Scotland. We will work closely with stakeholders to consider policy options and develop the necessary evidence base to support this, building on the research published by the Scottish Government last year. However, it will be for the next Scottish Parliament to consider the legislation that would be required to provide for a levy in Scotland.

5.3.3 VAT assignment and VAT devolution

The Scotland Act (2016) provides for receipts from half of the VAT raised in Scotland to be assigned to the Scottish Budget (known as VAT assignment). VAT assignment had been expected to commence with effect from April 2021, with full fiscal impact in the Scottish Budget for the year 2021-22.

Due to the current economic climate, in particular the impact of COVID-19, the Scottish Government has agreed with HM Treasury to delay implementation of VAT assignment until the Fiscal Framework Review. To ensure robust and prudent fiscal management, it is our belief that we must avoid introducing a new element of unpredictable volatility to the Scottish Budget at this time.

We will seek to agree with the UK Government that the Fiscal Framework Review presents a valuable opportunity to revisit the Scottish fiscal settlement in its entirety. This would include consideration of whether other options, including the full devolution of VAT powers, would allow us to set tax policies and adopt the fiscal levers which are meaningful and appropriate to the Scottish context.

When VAT assignment was initially devised by the Smith Commission in 2015, the ambition was to increase Scottish revenues as a proportion of the Scottish Budget, but full devolution was not possible due to EU rules. Following the end of the EU Exit transition period, full devolution is now a practical possibility and we believe it to be considerably more advantageous than the assignment method considered in 2015, it would provide us with funding, based on actual expenditure in Scotland, rather than purely an accounting mechanism, based on survey data, to transfer funding.

The Scottish Government understands the vital importance of stability and certainty for businesses. Therefore, simplicity and predictability must be core to all Scottish tax policy making after the devolution of any such powers. Crucially, if the Scottish Parliament did have the ability to control VAT levers, this would present an opportunity to tailor our arrangements to better suit the needs and circumstances of Scottish businesses and consumers.

5.3.4 Full devolution of powers over Income Tax

The Scottish Parliament currently has the power to set the rates and bands that apply to non-savings, non-dividend (NSND) Income Tax in Scotland (i.e. income from employment, self-employment, pensions, and property). The taxation of savings and dividend income remains reserved to the UK Government, as does the responsibility for defining the Income Tax base, which includes the tax reliefs and exemptions, including the tax-free Personal Allowance.

Since 2017-18, we have used our current powers over Income Tax to create a fairer and more progressive tax system in Scotland, protecting lower income earners whilst raising revenue to support investment in our public services and economy. In 2018-19, we introduced a new five-band structure for Income Tax. Outturn data published by HMRC in September 2020 shows that in 2018-19, Scottish Income Tax raised £119m more than the corresponding BGA, largely due to these tax policy reforms. We will publish a more detailed evaluation of our 2018-19 Income Tax reforms in the summer of 2021.

We have demonstrated that we have used our powers over Income Tax in a balanced and responsible way. Full devolution of powers over Income Tax would provide the Scottish Government with the full set of levers to respond to current and future economic challenges. It would allow the Scottish Government to design policies that better meet the needs of individuals and businesses in Scotland, that reflect our fairer and more progressive approach to taxation, and that tackle the aggressive forms of tax avoidance and evasion that still exist within the tax system.

We know that this would not come without challenges. The taxation of dividends is particularly volatile, and the continued uncertainties of having low interest rates pose a risk to revenues from savings taxation, certainly in the short term. Devolution, however, would provide an opportunity to improve the sustainability of these revenue streams.

5.3.5 Other reserved tax powers

We know that the devolution of certain reserved powers would create new challenges and interactions between the UK and Scottish tax systems. Therefore, as part of our preparation for the Fiscal Framework Review, we will consider other UK tax regimes that align closely, in policy or technical terms, with devolved policy powers and ambitions. This will entail a holistic review of the opportunities and challenges presented by each of the major existing reserved taxes.

For example, we know that both National Insurance Contributions and Capital Gains Tax have a close relationship with Income Tax and it is appropriate that we scrutinise how these could improve and protect the impact of Scottish Income Tax policy.

Capital Gains Tax is also a crucial lever in the taxation of wealth, and its design is skewed by the relatively higher values of assets in the South East of England. Devolution of this regime would allow us to tailor the policy as it applies to taxpayers in Scotland and ensure it operates as efficiently as possible.