Scottish Budget 2020-2021

Annex A: Scottish Government Fiscal Control Framework and Reconciliation of Available Funding to Spending Plans

Introduction

The Scottish Government is required to set a balanced budget each year.

The UK Government's decision to defer the UK Budget from 6 November 2019 to 11 March 2020 means that the tax and spending plans for Scotland set out in this document had to be set without certainty over key elements that determine our fiscal position next year. As a result, some pragmatic decisions have had to be taken when determining the funding available to support this budget. Therefore, there is less than the usual certainty in the funding envelope set out in the reconciliation below.

In May 2019 the Scottish Government published the Medium-Term Financial Strategy (MTFS),^[1] which included a Framework for the Spending Review to be published alongside Scotland's Budget in December 2019. Political, economic and fiscal uncertainties in the intervening period, most materially the UK Government's deferral of its own Spending Review, have forced us to re-consider this plan and postpone the publication of the Spending Review.

Specific Funding Issues for 2020-21

For this budget, assumptions have had to be made about the Barnett consequentials that will be added to the Scottish block grant as a result of the upcoming UK Budget, where in previous budgets there has been certainty. The level of consequentials assumed in the funding position set out in Table A.01 is derived from the costings document in the Conservative Party 2019 election manifesto.^[2]

We have taken a prudent assessment in estimating a £468 million increase in the funding envelope for 2020-21.

Tax Assumptions and Provisional Block Grant Adjustments

Decisions about devolved tax policy have been made without knowledge of future UK policy. The Scottish Fiscal Commission (SFC) has also had to produce forecasts before the UK Budget and accompanying Office for Budget Responsibility (OBR) forecasts, in contrast to previous years. Provisional Block Grant Adjustments (BGAs) have been used, based on the March Spring Statement OBR forecast.^[3] This means that the SFC forecasts of tax and social security include more up-to-date information than can be used for the BGAs used in the preparation of the budget this year. The approach taken by the SFC is set out in their report available at https://www.fiscalcommission.scot/

Updated BGAs will be calculated alongside the UK Budget on 11 March and these could be incorporated into the Scottish Budget during 2020-21 on request by the Scottish Government. Should Scottish Ministers choose not to do so, adjustments to the financial position will flow through as part of the normal operation of Fiscal Framework arrangements - so for income tax any change to the funding position will flow through as part of the reconciliation process in 2023-24.

Further Devolution of Powers

New social security powers over Attendance Allowance, Disability Living Allowance, Industrial Injuries Disablement Allowance, Personal Independence Payment and Severe Disablement Allowance are commencing in 2020-21, amounting to £2.9 billion in additional expenditure. Social security powers transferring to Scotland need to be managed within HM Treasury budget control limits (a change to how they are managed in the rest of the UK where any additional spend in-year over the budgeted amount is funded by HM Treasury). This introduces additional volatility into the Scottish Budget. Any increase in demand against what has been forecast by the SFC will need to be managed through a combination of drawing down funding from the Scotland Reserve, drawing on resource borrowing powers or in-year adjustment to other budgets.

The transfer of greater tax and social security powers requires the Scottish Government to manage much larger levels of fiscal volatility. The Fiscal Framework^[4] provides for borrowing powers and the Scotland Reserve to stabilise spending across years. Experience to date has demonstrated that limits on borrowing and the Scotland Reserve imposed by the Fiscal Framework are too restrictive to ensure stability in the Scottish Government's budget management. This year Scottish Ministers have decided to borrow £207 million to smooth the negative budget impact of forecast errors arising from tax and social security reconciliations. In recognition of the Climate Emergency a decision has been taken to borrow the maximum £450 million in capital borrowing to support infrastructure expenditure, rather than the £350 million indicated in the MTFS.

EU Exit

The SFC forecasts assume an orderly transition to a new trading arrangement with the EU. However, the risk of failure to negotiate a trade agreement by the end of December 2020 remains, and with it the potential need for substantial reprioritisation of budgets across the priorities set out in this document. The first impacts of Brexit are already reflected in changes to the funding arrangements for Farm Payments, with £472 million of funding for this now flowing to the Scottish Government directly from HM Treasury rather than from the EU. Fisheries funding will also be provided by the UK Government in 2020-21, and Scottish Ministers seek to be engaged on the design of the Shared Prosperity Fund which will replace EU Structural Funding in future.

Implementing Budget Process Review Group Recommendations

The implementation of the Scotland Act 2016^[5] and the associated Fiscal Framework have made significant changes to the structure of Scottish Government budgets and the sources of funding that support government expenditure. In addition, the report of the Budget Process Review Group^[6] included a recommendation that the Scottish Government budget process establishes as a core objective that any revised process should 'improve transparency and raise public understanding and awareness of the Budget'.

To improve budget transparency this Annex sets out a short overview of the fiscal control framework (the rules governing government spending) that the Scottish Government operates within, the key budgetary control limits within which Scottish Ministers must manage income and expenditure, and shows how the control limits link to the Spending Plans as set out in this document. In this year's exceptional circumstances, it also describes any additional assumptions that have been used in calculating the fiscal envelope available to the Scottish Government.

Scottish Government Funding

The devolved administrations' budgets are set within a framework of public expenditure control and budgeting guidance determined by HM Treasury. Once overall public expenditure budgets have been determined, the Scottish Government has freedom to make its own spending and tax decisions on devolved programmes, but those decisions must take place within the budgetary controls set by HM Treasury and in compliance with HM Treasury's Consolidated Budgeting Guidance.

Scottish Government total budgets are determined through the combination of block grant funding from HM Treasury, adjusted to reflect the transfer of social security powers, devolution of taxes and other income devolved to Scotland (through the Scotland Act 2012 and Scotland Act 2016), and any planned use of available devolved borrowing powers.

Changes in the Scottish Government's block grant continue to be determined via the operation of the Barnett formula. Under the Barnett formula, the Scottish Government's block grant in any given financial year is equal to the block grant baseline plus a population share of changes in UK Government spending on areas that are devolved to the Scottish Parliament. Detail of how the Barnett formula works is set out in the UK Government's Statement of Funding Policy.^[7]

As indicated above, this budget includes an estimate of consequentials that are expected to flow from the UK Budget 2020-21. The purpose of including this estimate is to limit as far as possible the potential variance between the Budget Bill implementing this budget, and the subsequent outcomes from the UK Budget on 11 March 2020.

The block grant is adjusted upwards to reflect the devolution of social security powers, and downwards to reflect the retention in Scotland of revenues from devolved and assigned taxes and other devolved income, leaving a residual block grant. The Scottish Government then retains all devolved and assigned Scottish tax and other revenues (forecasts of tax revenues for inclusion in the budget are calculated by the SFC). The Block Grant Adjustments - BGAs - are calculated by HM Treasury with reference to forecasts prepared by the Office for Budget Responsibility. The interaction of the Block Grant Adjustments for social security powers and the forecast expenditure on individual benefits are described in Annex G. The adjustments for devolved and assigned taxes are explained further in Chapter 2 of this document. The Fiscal Framework itself sets out in detail the operation of both.

In simple terms the available funding for the Scottish Budget is the Block Grant, plus the BGAs for social security, less the BGAs for devolved and assigned taxes and other revenues, plus devolved revenue estimates. For the purpose of this budget, provisional BGAs have had to be used. These have been provided by HM Treasury for this purpose. It will be open to the Scottish Government to use the updated BGAs that will be generated by the UK Budget should it choose to do so.

The total funding available to the Scottish Government is also dependent on decisions Scottish Ministers take on tax policy. Variation of Scottish tax policy relative to that of the UK will adjust the level of tax income received by the Scottish Government and the overall level of funding available to support spending plans. For the purpose of this budget, these relativities are drawn between existing UK tax policy and the devolved tax policy proposals advanced by the Scottish Government in this budget. No assumptions are made about possible changes to UK tax policy (including Non-Domestic Rates) that could be announced in the UK Budget.

The overall budget position for any given year is dependent on the interaction between the BGAs as provided by the OBR and the forecast of social security costs and tax revenues provided by the SFC. The forecasts underpinning both the BGAs, the costs of devolved social security powers and the revenues for devolved and assigned taxes will change over time until an agreed, reconciled, final outturn position is reached. The Fiscal Framework sets out the limited powers available to the Scottish Government to manage the impact of forecast errors between initial budget and the reconciled outturn position. This includes the power to undertake resource borrowing to smooth the budgetary impact of forecast errors.

The Scottish Government intends to use its resource borrowing powers under the Fiscal Framework to manage the forecast errors impacting on the 2020-21 budget limit. A decision to borrow to support capital spending will also impact on the funding available relative to the spending limits set by HM Treasury. The aggregate of the residual block grant plus devolved tax revenues plus agreed borrowing is a key control limit in defining the funding envelope within which Scottish Ministers must manage expenditure for a given year. Table A.01 below sets out the Scottish Government Budget Control Limits.

Table A.01: Scottish Government Budget Control Limits 2018-19 to 2020-21

SG Spending Limits - Cash Terms	2018-19 £m	2019-20 £m	2020-21 £m
UK Government Spending Review settlement - November 2015	30,620	30,870
UK Government Spending Round settlement - September 2019			35,728*
Subsequent Barnett consequentials and other additions	1,682	3,498
Anticipated Barnett consequentials			468
Total Budget Limit from HM Treasury (A)	32,302	34,368	36,196
of which:
Fiscal Resource Budget Limit	27,200	28,770	29,711
Non-cash Budget Limit	1,105	1,145	1,145
Capital Budget Limit	3,596	4,106	4,734
Financial Transactions	401	347	606
Block Grant Adjustment for Social Security (B)		290	3,203
Farm Payments (C)			472
Net Block Grant Adjustment	(12,472)	(12,193)	(12,991)
Scottish Income Tax	12,115	11,684	12,365
Land and Buildings Transaction Tax	588	643	641
Scottish Landfill Tax	106	104	116
Non-Tax Income**	25	25	25
Reconciliation to Outturn			(207)
Net Resource Budget Adjustment (D)	362	262	(51)
Resource Borrowing (E)			207
Capital Borrowing (F)	450	450	450
Total Scottish Government Funding (A+B+C+D+E+F)	33,114	35,370	40,477

* Confirmed by HM Treasury.
** Non-tax income is from Fines, Forfeitures and Fixed Penalties and Proceeds of Crime.
(A) Total block grant from HM Treasury.
(B) Details of devolved benefits covered by this Block Grant Adjustment are set out in the Social Security chapter (Ch14).
(C) From 2020-21 Farm Subsidy direct payments will be funded by HM Treasury (previously funding came from the EU).
(D) Net Resource Budget Adjustment includes the impact of Scottish Government decisions on taxes against the Block Grant Adjustment.
(E) Resource borrowing undertaken to offset the fiscal framework reconciliation impact for previous financial years.
(F) Capital borrowing up to the annual maximum.

Within these overall budget limits there are important sub-categories of spending subject to their own control limits. These sub-limits are imposed by HM Treasury as part of UK fiscal rules. These limits apply to:

• Resource budgets expenditure on the day-to-day costs of delivering public services, the total resource expenditure limit is sub-divided into a fiscal (or cash) limit - the largest element of government expenditure, used for example to pay public sector staff wages and purchase goods and services; and a non-cash limit - largely for depreciation of assets. It is not possible to use the notional non-cash budgets to support any fiscal spending.
• Capital budgets are used mainly to support the delivery of public infrastructure in Scotland. This is split between fiscal capital and a separate control for budgets that can only be used to support loan or equity investment in bodies outside the public sector - labelled as Financial Transactions. It is not possible within HM Treasury fiscal rules to use capital budgets to fund additional day-to-day expenditure; they must be used to support long-term investment. The overall capital funding available to the Scottish Government can be augmented by capital borrowing, the limits for which are imposed by the UK Government through the Fiscal Framework.

The Scotland Reserve allows the Scottish Government limited ability to manage spending across financial years. The Fiscal Framework sets out the limits of Scotland Reserve - up to £700 million in aggregate may be deposited in the Reserve. Maximum drawdown in any one year from the Reserve is £250 million of Resource budget and £100 million of capital budget (including Financial Transactions).

In summary, HM Treasury fiscal rules impose an annual limit on the Scottish Government's spending on public services that is equal to the aggregate of the residual block grant (after adjusting for devolved taxes), plus the devolved tax receipts themselves, plus capital borrowing.

Annually Managed Expenditure (AME)

Further to the defined budget limits set out above there are two other funding elements that support the total expenditure managed by the Scottish Government; firstly Non‑Domestic Rates which have been devolved since devolution in 1999, and secondly, funding for a number of demand-led programmes in Scotland. Specifically:

• Non-Domestic Rates income, responsibility for which is fully devolved and falls outside the scope of the block grant and Fiscal Framework arrangements controlled by HM Treasury. Details on the operation of Non-Domestic Rates in Scotland are available on the Scottish Government website.^[8]
• A small number of programmes that, whilst they fall within the devolved responsibilities of the Scottish Government, continue to be funded annually by the UK Government on the basis of demand (shown here as UK funded Annually Managed Expenditure or UK-funded AME). These budgets are ring-fenced for specific purposes - principally NHS and teachers' pension payments and Student Loans. HM Treasury fiscal rules prohibit the use funding provided for these areas to support other expenditure.

Spending Plans

The full spending plans for the year are set out in Table A.02. Portfolio chapters show the allocation of these totals across individual programmes.

Table A.02: Portfolio Spending Plans

2020-21 Scottish Budget	Resource £m	Capital £m	Financial Transactions £m	Total £m	UK Funded AME £m	Total £m
Health and Sport	14,805.5	428.0	10.0	15,243.5	100.4	15,343.9
Communities and Local Government	7,552.3	1,473.5	338.5	9,364.3	2,790.0	12,154.3
Finance, Economy and Fair Work	471.4	105.0	310.1	886.5	5,385.1	6,271.6
Education and Skills	2,727.5	395.5	55.0	3,178.0	392.5	3,570.5
Justice	2,673.5	158.0	-	2,831.5	-	2,831.5
Transport , Infrastructure and Connectivity	1,219.2	2,166.1	60.4	3,445.7	-	3,445.7
Environment, Climate Change and Land Reform	191.8	274.0	(4.0)	461.8	-	461.8
Rural Economy	839.8	109.5	(160.3)	789.0	-	789.0
Culture, Tourism and External Affairs	335.9	28.5	1.1	365.5	-	365.5
Social Security and Older People	3,719.0	60.0	9.2	3,788.2	-	3,788.2
Government Business and Constitutional Relations	16.1	-	-	16.1	-	16.1
Crown Office and Procurator Fiscal Service	129.5	4.3	-	133.8	-	133.8
Scottish Government	34,681.5	5,202.4	620.0	40,503.9	8,668.0	49,171.9
Scottish Parliament and Audit Scotland	113.0	1.1	-	114.1	2.0	116.1
Total Scotland	34,794.5	5,203.5	620.0	40,618.0	8,670.0	49,288.0

Reconciliation of Funding to Spending Plans

There are a number of differences between the aggregate funding control limits as set out in Table A.01 and the total cost of the portfolio spending plans. Published spending plans anticipate additional funding not yet reflected in those control limits (which reconcile to the latest published HM Treasury figures). Table A.03 reconciles the aggregate funding limits to spending plans for 2018-19, 2019-20 and 2020-21 (the current budget year and the comparator years shown across the document).

Table A.03: Reconciliation of Funding to Spending Plans

SG Spending Limits - Cash Terms	2018-19 £m	2019-20 £m	2020-21 £m
Scottish Government Funding	33,114	35,370	40,477
Barnett Consequentials	(435)	(1021)
Reserve	234	313	143
Machinery of Government Changes	(1)	28	8
Anticipated budget transfers	159	269	246
Unallocated Non-cash budget	(196)	(230)	(261)
Changes to Income Tax	62
Queen's and Lord Treasurer's Remembrancer	50	5	5
Total Reconciling Items	(127)	(636)	141
Scottish Government Spending Plans	32,987	34,735	40,618

Considering each of the reconciling items in turn

Barnett consequentials - the comparator figures across this document reflect the spending plans as set out at the budget for those years, to show a like for like comparison against 2020-21 plans. The budget figures in Table A.01 reflect the impact of any additional Barnett consequential on the budget limits for 2018-19 and 2019-20 flowing from UK Fiscal events since the relevant Budget. To get to the funding position that underpinned the spending plans shown in this document, the consequential budget impact of these subsequent fiscal events needs to be removed.

Reserve Drawdown - Spending plans are underpinned by anticipated underspend carried forward from the prior year through the Reserve.

Machinery of Government Changes relate to anticipated funding transfers from the UK Government not reflected in the HM Treasury control total but showing in portfolio spending plans.

Anticipated budget transfers reflect UK funding for specific areas of work, including funding for Administration costs of powers devolved in the Scotland Act 2016, that are not yet reflected in HM Treasury budget limits.

The HM Treasury non-cash budget allocation is anticipated to be more than is required to meet the current needs of the Scottish Government. Accordingly, not all of this is yet being allocated out to portfolios. As indicated above this budget cannot be used to support fiscal spending.

In 2018-19 there was a change to tax policy during the passage of the Budget Bill. This change capped the uplift of the Higher Rate Threshold for Scottish Income Tax and provided £62 million of funding to support additional spending.

The Queen's and Lord Treasurer's Remembrancer (QLTR) is the Crown's representative in Scotland who deals with ownerless property. In the Scotland Act 1998, the Crown's property rights in ownerless goods and the revenues raised from them were transferred to Scottish Ministers and the revenues paid into the Scottish Consolidated Fund. The £50 million shown for 2018-19 is the funding impact of the accumulated revenues, which sit outside of HM Treasury control aggregates. The £5 million shown against 2019-20 and 2020-21 represents the estimated receipts of each year.

Footnotes

1. https://www.gov.scot/publications/scotlands-fiscal-outlook-scottish-governments-medium-term-financial-strategy-2019/

2. https://assets-global.website-files.com/5da42e2cae7ebd3f8bde353c/5ddaa257967a3b50273283c4_Conservative%202019%20Costings.pdf

3. The Fiscal Framework sets outs (in paragraph C.47 of Annex C) that, where the Scottish Budget takes place before the UK Budget, the Scottish Budget will be based on provisional BGAs for budgeting purposes. The Framework also sets out that, where the UK Budget takes place less than three months before the start of the financial year, these provisional BGAs will then be applied to the block grant for that year.

4. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/503481/fiscal_framework_agreement_25_feb_16_2.pdf

5. http://www.legislation.gov.uk/ukpga/2016/11/contents/enacted

6. http://www.parliament.scot/S5_Finance/Reports/BPRG_-_Final_Report_30.06.17.pdf

7. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/479717/statement_of_funding_2015_print.pdf

8. http://www.gov.scot/Topics/Government/local-government/17999/11199