How will the general election result and new tax powers affect the Scottish budget?
Published: 20 February 2015
Author: David Eiser
Elections tend to be a time for breezy promises and easy pledges but, says David Eiser, the outcome of this year's general election will affect Scotland's budget for many years to come.
With all the recent discussion about the Smith Commission and devolved taxation, it’s perhaps easy to forget that the block grant from Westminster will continue to account for the major part of the Scottish budget for the next few years at least. But how will the spending plans of the next UK Government affect the size of the Scottish grant and therefore the Scottish budget? And to what extent will Scotland’s new tax powers enable the Scottish Parliament to vary its budget further?
To answer this question, we first need to know about the spending plans of the parties which might form the next government. The spending plans of the UK Government affect the grant to the Scottish Parliament, via the Barnett Formula. What is important in this respect is not only the parties’ plans for aggregate spending, but also how planned spending is distributed across different UK departments, as different departments are associated with different ‘consequential’ changes for the Scottish budget.
In a separate blog post we set out in further detail the spending plans of different UK parties, and describe the process through which these plans influence the Scottish budget. The figure below shows the implications for Scotland’s DEL (Departmental Expenditure Limit) budget based on the spending plans of the UK parties, and making standard assumptions for the growth of council tax and business rate revenues in Scotland, which are of course already devolved (the DEL budget covers the bulk of devolved spending in Scotland other than spending on public pensions, which are funded separately).
If the plans set out in the Westminster Government’s Autumn Statement 2014 (AS2014) are implemented, this would result in a real terms fall in Scotland’s DEL budget of £2.5bn over the period to 2019. The Conservative plans imply a somewhat lower fall, and the Labour plans imply a relatively small real terms decline in spending. We have not shown the LibDem plans as these are not particularly different from those of Labour, but we have illustrated the implications for the Scottish budget if the next UK Government increases UK DEL spending by 0.5% per annum in real terms, the case for which was made by Nicola Sturgeon in her speech last week. So the Scottish budget could look quite different by 2019/20 depending on which party forms the UK government and how their spending plans are implemented.
The analysis thus far ignores the implications of the devolution of the Scottish Rate of Income Tax (SRIT, the 10p flat tax) which is due to be implemented in 2016/17. To what extent might this change the picture? First of all, note that if revenues from the SRIT grow at the same rate as revenues from the comparable tax base in rUK, then Scotland’s budgetary position with the SRIT is the same as it is without it. This is because of the way that Scotland’s block grant is likely to be adjusted to reflect the new tax (the reduction to Scotland’s grant will be indexed to grow at the same rate as the growth in comparable revenues in rUK).
But what if incomes in Scotland grow by 1% more each year than they do in rUK? This additional income growth in Scotland would feed through to higher income tax revenues which would be available to the Scottish budget. The figure below shows how much difference this differential tax base growth would make to Scotland’s budgetary position under each UK Government spending scenario. The message is that 1% differential tax base growth will not be sufficient to offset the spending decisions of the UK government, equating to an additional £100m by 2019 (it is worth noting that a 1% per annum differential in income growth is actually quite significant – the average annual differential between the UK and Scotland since 1997 has been 0.3%). Of course the flipside is that slower tax base growth in Scotland would result in a lower DEL budget.
Notwithstanding the excitement about additional tax powers for Scotland, in the immediate term the spending plans of the UK government remain the most significant determinant of the Scottish budget. Furthermore the differences between the UK parties’ spending plans are greater than is sometimes assumed.
An important caveat is that all these scenarios are based on the projections in the OBR’s Autumn Statement as regards the growth of productivity, incomes, and revenues. There is clearly uncertainty around how these might evolve. Thus this analysis should not be thought of as a projection of what the Scottish Government’s budget will be in 2019, but an exploration of the way in which various factors might affect it.
For further details on the calculations behind these numbers and the assumptions underpinning them, please see this slightly longer version on the Scottish Fiscal and Economic Studies (Scotfes) website.
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