Good morning. Yet again, I thank you for the chance to give evidence on our work.
Last Wednesday, we published three reports, including our annual forecast evaluation report and statement of data needs, to which I will refer. I am also conscious that the convener wrote to me in June asking the commission to provide an evaluation of the Scottish Government’s forecast of 2017-18 income tax receipts. There is a detailed explanation in our report of why that forecast was £941 million, or 8.6 per cent, higher than the outturn that was published by Her Majesty’s Revenue and Customs in July. I will come back to that in a minute; I will also mention the implications for next year’s budget.
Before I do that, I want to highlight something that you have all been supportive of in the past and in relation to which I feel that we have made some progress. Our evaluation report gives some examples that show the importance of good-quality data sources and information. One source is income tax itself—Her Majesty’s Revenue and Customs outturn data were not available until last year. Now that we are able to make use of that new data source, our forecasts have improved.
We face similar challenges in forecasting the new benefits. We underestimated spending on the new pregnancy and baby grant by £2.5 million, or 59 per cent, because of an unexpectedly large number of claims in the first few days after launch. The early data on claims for the grant, combined with a better appreciation of the Scottish Government’s approach to launching new benefits, led the Fiscal Commission to increase its spending forecasts in May.
Although forecasting new and reformed benefits will always be difficult, as the benefits become established and we have new data sources, we would expect our forecast errors to reduce over time. During the next few years we should expect some volatility around and fairly large forecast errors for social security, as more benefits are devolved and the Scottish Government introduces reforms to them.
I am pleased that our second statement of data needs documents that we have made good progress since last year, including signing a memorandum of understanding with the Department for Work and Pensions. It also sets out our request for additional data and information for the coming year—we keep raising the bar.
I will now return to the income tax forecast for 2017-18, which was made by the Scottish Government in February 2017—this addresses the question that the committee posed to us. At the time—this was before the commission went into statute—the Fiscal Commission’s role was to scrutinise the Scottish Government’s forecasts. We did that for the 2017-18 forecast and judged it to be reasonable at the time. We know now that the forecast overestimated revenue by £941 million, or 8.6 per cent. That is a significant error and 2.8 percentage points higher than the Office for Budget Responsibility’s average two-year-ahead forecast error, which is a benchmark that we use.
We estimate that £820 million of that total £941 million error was due to what we have labelled the 2016-17 baseline error, which was the result of having to use an imperfect survey data source that was three years old to estimate 2016-17 income tax revenues as the starting point for, or baseline of, the 2017-18 forecast. Taking that amount away leaves £121 million of the £941 million still to be explained. Our report shows that roughly £90 million of the error was due to the Government’s economic forecasts—total earnings growth was overestimated by 0.2 percentage points. We describe that as quite a small forecast error. The remaining £30 million is explained by a combination of modelling issues, HMRC incorporations estimates and changes in the costs of United Kingdom policies.
We all know that the income tax forecast matters because it feeds into the £204 million negative reconciliation in next year’s Scottish budget. Our report takes some time to explain the reconciliation that arises from differences in both our forecast and that of the OBR. We hope that we have made a start in the report in helping a wider understanding of the complexities of how the fiscal framework operates. The committee has copies of our new graphics, which try to pick up on those issues. We are happy to discuss them in due course.
I know that the OBR has written to the committee with an explanation of its UK income tax forecast error. I will not stray too far into its territory. The key point in our explanation is that the £204 million reconciliation—I emphasise that it is a reconciliation between forecasts—has little to do with the £820 million 2016-17 baseline error that I have just described. That is because the £820 million error equally affects the amount of additional funding that Scotland receives through income tax and the amount of funding that is taken away through the block grant adjustment, so the net effect is zero. The reconciliation arises from the combination of the error in forecasting growth in Scottish income tax and the error in forecasting growth in the block grant adjustment, using OBR forecasts. We think that the block grant adjustment was underestimated by around £83 million and growth in the Scottish income tax revenues was overestimated by £121 million. Together that gives us the £204 million negative reconciliation.
I have just gone through many numbers, and that is a lot to absorb aurally. Members will find those figures in our report. I expect that we will go through them again as we answer some of your questions. I thank you for your attention and patience.