Scotland Act 2016 implementation: seventh annual report

9. Fiscal Framework Implementation

The Fiscal Framework is an agreement made by the Scottish and UK Governments that determines how the Scottish Government is funded, as well as underpinning the powers set out in the Scotland Act 2016. This chapter covers further areas of Fiscal Framework implementation relevant to this report; progress on policy spillovers, the review of the Fiscal Framework and the scope of the review.

Progress on policy spillovers

108. The Fiscal Framework includes a provision for policy spillovers. This is when one government makes a policy decision that has an impact on the tax receipts or expenditure of the other. When this happens, the government that made that decision should reimburse the other in cases of additional costs, or receive a transfer in the case of a saving. Both governments must jointly agree on any decision or transfer relating to a spillover.

Personal Allowance Spillover

109. The Scottish and UK Governments sought a resolution to the dispute regarding a spillover claim in relation to UK Government increases to the income tax Personal Allowance.

110. Both parties agreed that above inflation increases to the Personal Allowance reduced Scottish Income Tax receipts since 2017-18, constitutes a policy spillover.

111. An agreement was reached in July 2022, with a settlement of £375 million made to the Scottish Government, settling the historic liabilities^[20].

Social Security Spillovers

112. After carrying out analysis using the jointly agreed Social Security spillovers methodology, Scottish Government and DWP analysts agreed in November 2022 that the devolution of Scottish benefits produced no material spillover effects for either Government in 2021/22.

113. This analysis is underway for financial year 2022/23 and will again use the Social Security spillovers methodology to investigate if any passporting interactions between devolved and reserved benefits has led to any costs or savings for either Government.

Fiscal Framework Review

114. 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, informed by an independent report.

115. It was agreed between the UK Chief Secretary to the Treasury and the Scottish Cabinet Secretary for Finance and the Economy in 2021 that the independent report would focus on the Block Grant Adjustments (BGA) arrangements only. Both ministers agreed that the review will have a wider scope than the report and that preparations for the review can be conducted alongside the independent report.

116. Both governments were clear that the report should not explicitly make recommendations on the BGA options, but instead assess the underlying risks relating to different options, in line with the Smith Commission principles.

117. The Scottish and UK Governments jointly commissioned the independent report on 27^th June 2022. A first draft of the report, written by Professor David Bell, David Eiser and David Phillips has been submitted to both governments. No date has yet been agreed for publication of the independent report.

Scope of the Review

118. While the Scottish Cabinet Secretary for Finance and UK Chief Secretary to the Treasury have confirmed the review will be broader in scope, the exact details and timings of arrangements are still to be set, including the extent to which issues outwith the operation of the current framework are covered.

119. A key objective of the review for the Scottish Government is to ensure that Scotland has the required powers to manage the risks faced within the devolved responsibilities of the Scottish Government and Scottish Parliament, and to support economic recovery.

120. An important example of the limitations of the current arrangements, is the constrained borrowing and reserved limits, set at a £300 million annual borrowing for forecast error and a £700 million annual reserve limit with a £250 million drawdown cap. Forecast error can exceed these limits, and they are essentially being eroded over time by inflation. The Scottish Government are therefore keen to revisit these limits as part of the review.

121. The BGA methodology will be part of the scope of the review. The Scottish Government’s position is that the current Index per Capita (IPC) BGA arrangement is effective in mitigating the impact of differential population growth, in line with the Smith Principle of ‘no detriment’.

122. The 2016 agreement was clear that the BGA arrangements should be considered as part of the review of the framework, and that the ‘two governments will jointly agree’ the future BGA method as part of the review. The Scottish Government is clear that until such agreement is reached, the IPC model remains the default and continues as the basis for calculating the BGAs.