Update: Scotland's fiscal framework

A recent Audit Scotland report provides a no-holds-barred review of the operation of Scotland’s fiscal framework to date, as Donald Drysdale discovers.

The Auditor General

Audit Scotland was created in 2000 to give independent assurance to the people of Scotland that their public money is spent properly, efficiently and effectively.

Since 2012 Audit Scotland has been headed by Caroline Gardner, a former president of CIPFA. Her role as Auditor General for Scotland is to appoint auditors to 224 public bodies which include (amongst others) the Scottish Government, 75 central government bodies, 32 local councils, Revenue Scotland, Police Scotland, Scottish Water, 23 NHS bodies and 21 further education colleges.

The Auditor General is independent and reports to the Scottish Parliament on how these public bodies spend public money, helping them to manage their finances to the highest standards and checking whether they achieve value for money.

Operation of the fiscal framework

In October Audit Scotland published a report from the Auditor General entitled Scotland’s new financial powers: Operation of the Fiscal Framework.

This report summarises the main components of the Scottish fiscal framework agreed between the UK and Scottish governments, examines the risks now facing the Scottish budget, and considers how those risks should be managed.

Components of the fiscal framework

The Scottish block grant from Westminster remains the single largest source of funding for Scotland’s public expenditure. It provided 59% of the Scottish expenditure budget in 2017/18, but is expected to fall to less than 50% once the full range of the powers in the Scotland Act 2016 are devolved.

To reflect Scottish taxes, adjustments are made to reduce the block grant by the amount of the equivalent taxes that would otherwise have flowed to the UK Government. The net effect on the Scottish budget is determined by both the Scottish tax revenues and the associated block grant adjustment.

Land and buildings transaction tax (LBTT) and Scottish landfill tax (SLfT) together make up a relatively small proportion of the Scottish budget. They are fully devolved, and therefore wholly under the control of the Scottish Government.

Scottish income tax (SIT), which replaced the Scottish rate of income tax (SRIT) from 2017/18, makes up a sizeable chunk of the Scottish budget. Because SIT is partly devolved and applies only to the non-savings non-dividend income of Scottish taxpayers, its impact is complex – with a 15-month delay before outturn figures are known and further delay before budget adjustments can be applied.

Within limits, the Scottish Government has capital borrowing powers, and separate borrowing powers to bridge short-term gaps in its resource budget in defined circumstances – namely, in-year cash management, forecast error or economic shock. The Scotland Reserve allows a carry forward of fiscal resource and capital funding to future years.

Some Scotland Act 2016 powers have still to be implemented, particularly the assignment of VAT revenues from 2019/20 onwards and the devolution of certain social security spending by 2020/21.

Scottish Budget variables

The Barnett formula determines annual changes in the Scottish block grant. When a UK Government department’s expenditure budget is increased or decreased, generally at a UK budget or spring statement, the Scottish budget is adjusted using the Barnett formula. For the Scottish Government, such adjustments are not ring-fenced to particular spending programmes.

Relatively small in-year budget adjustments arise from LBTT and SLfT. More significant but delayed adjustments arise from SIT.

Audit Scotland wants to see clearer long-term policies and principles within which the Scottish Government’s capital borrowings will be managed. No resource borrowing has occurred yet and none is planned in the 2018/19 budget.

With the scope for budget adjustments increasing, Audit Scotland seeks a clearer distinction between, on the one hand, balances on the reserve committed to future spending priorities and, on the other, amounts uncommitted and available to manage volatilities between years.

Managing Scottish budget risks

Scotland’s economic performance will affect the budget available to the Scottish Government for pursuing its policy objectives. Where the Scottish economy performs relatively well, tax revenues will rise and pressures on spending will ease; where it performs relatively less well, the effect will be to squeeze the budget, cut available funding and increase spending demands.

Different tax and spending policy choices in Scotland compared to the rest of the UK
directly affect the Scottish budget. Furthermore, UK policy changes on taxes and social security spending, in areas where powers are devolved, also directly affect the Scottish budget.

Policy interactions can be complex. For instance, baselines for block grant adjustments in respect of social security benefits are especially difficult to predict now, at a time when the UK Government is undertaking a multi-year benefit reform programme. As another example, there may be ‘policy spill-overs’ – such as an increase in Scottish tax rates leading to more universal credit payments being due to Scots from the UK Government.

Budgeting always involves uncertainties, and the likely size of budget forecasting errors is affected by the extent of underlying uncertainty about the economy and other matters subject to forecasts.

As the Scottish budget becomes increasingly uncertain and volatile, Audit Scotland sees the Scottish Government’s management of its budget becoming more challenging, and it becomes harder to match spending to the available funding in any one year. Recent party-political criticism of the administration’s budget underspend of £339 million in 2017/18 is a topical illustration of this.

Conclusions

Audit Scotland concludes that the Scottish budget process faces new opportunities and risks because closer links between the relative performance of the Scottish economy and the public finances bring greater uncertainty, complexity and volatility.

A new budget process is being introduced this year to support a strategic approach to considering tax and public spending. This places greater emphasis on the longer-term effectiveness of spending programmes and improved public reporting, and gives Parliamentary committees a key role in scrutinising affordability, sustainability and value for money.

In Scotland as elsewhere, we are accustomed to tax laws being created by governments but administered by non-ministerial tax authorities, and it is crucial that these and other public bodies are subject to appropriate independent scrutiny.

Scots should all be grateful to Gardner and her team at Audit Scotland. In her role as Scotland’s Auditor General, she has justly earned her reputation by taking a fiercely independent view of Scottish fiscal arrangements.

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