Money

Slower growth and grant cut give SNP budget headache


Even as she predicts slowing economic growth and a £1bn hit to the Scottish budget, Susan Rice, chair of Scotland’s independent forecaster, flinches slightly at the suggestion she is the bearer of bad news. 

“Bad news in the eyes of the beholder,” Dame Susan told the Financial Times at the Scottish Fiscal Commission’s offices in a former prison governor’s tower perched on a crag in central Edinburgh. 

But for the Scottish government, the commission’s forecasts hardly looks good. Last month it cut its forecast for Scottish economic growth to below 1 per cent for both of the next two years. 

And it predicted that over the three years from 2020-21, £1bn would be sliced off the block grant Scotland gets from the British government under complicated new fiscal arrangements between Edinburgh and London. 

The Scottish Fiscal Commission’s forecast for gross domestic product fuelled concerns that the country’s growth is set to slip behind the unimpressive pace set by the UK as a whole. 

Meanwhile, the expected cuts to the Scottish block grant present a budget headache to Scottish National party ministers in Edinburgh.

Scottish onshore GDP, which does not include North Sea oil output, expanded 1.3 per cent in 2018, almost matching the UK rate.

But the Scottish Fiscal Commission cut its forecast for this year to 0.8 per cent from the 1.2 per cent it predicted in December, and expects growth to only slightly accelerate to 0.9 per cent in 2020. Scottish growth will lag well behind the UK until 2023 at least, it suggested. 

Alongside the dampening effect of Brexit on business and consumer confidence, Dame Susan said this year’s expected slowdown reflected the waning impact of the boost to Scotland’s net trade from a weaker UK pound. “That’s now been bedded in . . . we don’t see any other effect that will keep that net trade more buoyant,” she added. 

Not everyone is as downbeat. Economist Tony Mackay, a veteran Scottish GDP forecaster, advised the government to ignore the Scottish Fiscal Commission’s forecasts. “They are far too pessimistic,” he said. 

How Scotland’s economy performs over the next few years will have unprecedented implications for the Scottish budget. 

After the establishment of the Scottish parliament in 1999, the vast bulk of its funding came via a block grant from Westminster. But legislation passed in 2016 for the devolution of additional powers to the parliament, including the ability to set Scottish rates and bands for income tax, came with a new fiscal framework. 

Dame Susan Rice, chair of Scotland’s independent forecaster, has downgraded growth forecasts © Robert Ormerod/FT

The core block grant from Westminster continues to be calculated by the British government using the so-called Barnett formula, which has allowed consistently higher public expenditure per person in Scotland than in other parts of the UK.

But since the devolution of more powers to the Scottish parliament, the block grant has been reduced to reflect the tax revenues forgone by the UK government. 

If Scotland’s tax take grows relative to that of the rest of the UK, Edinburgh gets the benefit in higher revenues. But it bears the cost in lower revenues if Scotland’s tax take lags behind the rest of the UK because of economic weakness.

The process is complicated by the reliance for each year’s Scottish budget-setting exercise on separate forecasts for UK and Scottish tax revenues made by the Office for Budget Responsibility (OBR), the British fiscal watchdog, and the Scottish Fiscal Commission.

Differences between forecasts for taxes by the two bodies and actual revenues must then be settled in Scottish budgets up to three years later, a process known as “reconciliation”. It is this process that has led to what opposition parties in Edinburgh dubbed the “billion pound black hole” in the Scottish block grant.

The Scottish Fiscal Commission said in a report last month that the block grant could be cut by £1bn over the three years from 2020-21 because of two key factors.

First, the commission has reduced its forecasts for the amount of Scottish income taxes raised in the three years from 2017-18. Second, the OBR has increased its forecasts for the UK income tax take excluding Scotland over the same period.

Derek Mackay, the Scottish finance secretary, last month published the SNP government’s medium term financial strategy promising to set out the “key financial challenges” facing the economy.

But Stirling university’s Fraser of Allander economic research institute said the document lacked any assessment of the causes of the diverging tax performance between Scotland and the rest of the UK, and of the expected cut to the Scottish block grant. 

“You might also think that a medium term financial strategy document might detail how it will manage such a hit to [block grant] revenues. But it doesn’t,” said the institute.

The Scottish government does have financial reserves and some borrowing powers that could be used to counteract tax revenues falling short of expectations.

But the Scottish Fiscal Commission said these arrangements would not be sufficient to cover the expected £1bn reduction in the Scottish block grant, and therefore the government would have to cut spending or increase taxes.

Dame Susan noted that future forecasting errors for taxes were as likely to result in money being added to the Scottish block grant as taken away.

And even with rapidly improving data on the economy and tax system to help forecasters, potentially hefty surprises would be a continuing feature of the Scottish budget. “I think everyone has to get used to it,” she said.



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