IFS - Scottish Government faces major medium- and long-term budget challenges

27 Jan 2023 09:17 AM

New analysis by IFS researchers shows the stark funding challenges facing the Scottish Government, and the public services it is responsible for, over the next five years and beyond.

In the next two financial years, the budget for day-to-day non-benefit spending looks very tight:

After taking account of in-year funding top-ups this financial year, which under current plans will not be available in 2023–24, funding will fall by 1.6% in real terms in 2023–24 compared with this year. Even after adjusting for major one-off costs this year, such as council tax rebates, the reduction will still be 0.8%.
Official projections imply that funding will fall by a further 1.6% in real terms in 2024–25, and then grow only modestly over the next three years. This means that funding is set to be almost 2% lower in 2027–28 than in 2022–23.

Such cuts would imply difficult trade-offs for the Scottish Government. Increasing spending on health to meet rising costs and demand, and boosting spending on net zero policies could require cuts of around 13% to other public service spending between 2023 and 2027.

These are among the key findings of two pre-released chapters from the inaugural IFS Scottish Budget Report, focusing on the Scottish Government’s funding outlook and devolved income tax revenue performance. Other key findings include:

Medium-term outlook

The baseline projections above rely on Scottish Fiscal Commission (SFC) forecasts of a significant improvement in income tax revenues. This largely reflects faster expected growth in Scotland’s underlying income tax base relative to the rest of the UK, rather than the effects of tax rises announced in the Scottish Budget last month. If this faster growth doesn’t materialise, then the Scottish Government’s choices would be harder still, with funding for non-benefits spending in 2027–28 still 5% below 2022–23 levels.
The faster growth in Scotland’s tax base forecast for the next few years follows a period during which the tax base has grown more slowly than in the rest of the UK. Because of this, SFC forecasts imply that even by 2026–27, almost one-third of the yield from Scotland’s higher income tax rates will be offset by slower tax base growth since the devolution of income tax in 2016–17. This would still be a substantial improvement from this financial year though, for which the SFC estimates that revenues from Scotland’s income tax policy changes since devolution will be more than fully offset by slower underlying growth in the tax base.

Long-term outlook

While the Barnett formula used by the UK government to allocate funding is often thought to benefit Scotland, in the long term it is likely to lead to relatively smaller increases in funding for Scotland than for England. The speed of this ‘Barnett squeeze’ depends on the rate of growth in spending in England (both real-terms growth and that which merely offsets inflation), and the rate of population growth in Scotland relative to England.
Using long-term projections for inflation and GDP growth from the Office for Budget Responsibility, assuming public spending is held constant as a share of GDP, and taking into account population projections from the Office for National Statistics, we project Scottish Government funding per person would increase by an average of 1.2% per year in real terms over the 30 years between 2027–28 and 2057–58. This compares to an average of 1.4% in England over the same period. Under this scenario, spending per person in Scotland would fall from 124% of English levels in 2027–28, to 121% in 2032–33, and to 115% in 2057–58.
Faster real-terms spending growth in England to meet the rising costs of health and social care (which are expected to grow faster than GDP) would result in bigger absolute increases in funding for the Scottish Government, making it easier for it to meet these costs in Scotland. However, it would increase the Barnett squeeze on funding levels relative to England – making it harder for the Scottish Government to maintain enhanced levels of service provision over and above those in England.

Bee Boileau, a research economist at the IFS and an author of the report said:

‘Additional funding from the UK government and a forecast boost to devolved tax revenues mean the outlook for funding has improved a little since last May’s Resource Spending Review. But the picture is far from rosy. Official projections imply that funding for non-benefit spending is set to fall over the next two years and then grow only slowly over the following three years. Indeed, it would still be close to 2% below 2022–23 levels in 2027–28. And that assumes a significant improvement in the performance of Scotland’s devolved income tax revenues – without that, this funding would be close to 5% lower than this year in 2027–28.

If either of these scenarios were borne out, the Scottish Government would likely need to make significant cuts to a range of public services. Further big increases in devolved tax rates would be one way to avoid such cuts. The Scottish Government will instead be hoping for additional funding from the UK government – which may not be in vain as the UK government would also need to make cuts to many services if it sticks to the plans for spending it has pencilled in.’

David Phillips, an associate director at the IFS, and another author of the report said:

‘The Scottish Government’s long-term funding outlook beyond 2027–28 will also be determined, to a large extent, by UK government spending decisions via the Barnett formula. This formula is often seen to benefit the Scottish Government, by providing it with a much higher level of funding per person than is available for comparable services in England.

But this is a misunderstanding of the nature of the formula and its purpose. Because it provides the Scottish Government with a population-based share of funding changes planned for England, and Scotland starts with a higher-than-population share of funding, it delivers a smaller percentage increase in funding for Scotland than England. This so-called Barnett squeeze will make it more difficult for the Scottish Government to meet rising costs and the demands on public services associated with an ageing population, and to maintain enhanced service provision relative to England, such as free personal care and free university education, in the longer term.’