Finance and Public Administration Committee
Fiscal Sustainability Report
Letter from the Chair of the Scottish Fiscal Commission to the Convener of 6 September 2021
Dear Convener
Towards the end of the last session the Finance and Constitution Committee established a Legacy Expert Panel to consider the scrutiny challenges your committee would face. The Panel recommended that you consider inviting the Scottish Fiscal Commission to publish “a long-term fiscal sustainability report at least once during each session of the Parliament.”
The annex to this letter contains a more detailed outline of how the Commission could approach producing a fiscal sustainability report for Scotland.
We propose that we start work in earnest in March 2022, publishing a consultative paper later in the year and the first report in 2023. We would need to approach the Scottish Government for additional resources as part of our annual multi-year spending ask in October.
We would welcome the Committee’s view as to whether they would find such work helpful.
Yours sincerely
Dame Susan Rice DBE
Annex: A Fiscal Sustainability Report for Scotland
1. In this Annex we briefly describe the need for more analysis of fiscal sustainability, what a fiscal sustainability report is, examples of the longer term fiscal risks faced by the Scottish Government and we consider how a fiscal sustainability report could be developed.
The need for more analysis of longer term fiscal sustainability
2. In 2019 the OECD carried out an independent evaluation of the Scottish Fiscal Commission’s work as required by our founding legislation. The OECD noted that there were “considerable fiscal risks to the Scottish budget in the longer-term” and that “stakeholders expressed a view that they would like to see in-depth analysis that better captures the scale of these risks”. The OECD recommended that the SFC consider embarking on this analysis noting that the majority of other independent fiscal institutions published longer term fiscal sustainability reports. [1]
3. Towards the end of the last session the Finance and Constitution Committee set up a Legacy Expert Panel to consider the “scrutiny challenges the committee would face in the next Parliament and how it should evolve to meet those challenges”. Quoting the OECD’s views the Panel recommended that the new “Committee considers inviting the SFC to publish a long-term fiscal sustainability report at least once during each session of the Parliament.” [2] In addition the Parliament’s Budget Process Review Group had earlier recommended that budget scrutiny should include a longer term outlook that addressed fiscal constraints and increasing demand for public services. [3]
The Commission’s current fiscal analysis
4. Since the Commission was established as a statutory body in 2017 we have gradually expanded our work on the Scottish Budget. Our remit requires us to assess the reasonableness of the Scottish Government’s borrowing plans, we comment on borrowing plans, the use of the Scotland Reserve and the funding arrangements for tax and social security, in particular on income tax reconciliations.
5. Since January 2020 we have also reported on the Scottish Government’s overall funding position in a new Fiscal Update publication, considering the level of UK Government funding through the Block Grant as well as tax and social security funding arrangements, borrowing plans and Non-Domestic Rates distributable amount. We monitor how the funding position is changing through the year and identify risks the Scottish Government must manage.
6. Our work on the Scottish Government’s funding is a foundation for considering fiscal sustainability. Currently we look at social security spending in detail. To consider fiscal sustainability we would also need to develop expertise to model and forecast the other major spending components of the Scottish Budget such as health, local government, housing, education and transport.
7. We think that steady development work over the next two years would be needed to produce a report in 2023, as suggested by the Legacy Expert Panel. We agree with both the Expert Panel and the Budget Process Review Group’s view that the Commission’s current powers to report on “fiscal factors” would allow it to produce a fiscal sustainability report.
8. The Expert Panel also noted that producing a fiscal sustainability report would have resource implications for the Commission and we will need to ask the Scottish Government for additional resources if we are to extend our analysis to cover long term fiscal sustainability.
What is a fiscal sustainability report?
9. A fiscal sustainability report typically looks at the likely path of spending, tax revenues and other balance sheet items over the next 30 to 50 years and considers whether major alterations will be required to adjust for changing circumstances and to meet any fiscal rules which the government is subject to. Typically these reports will also identify particular pressures on spending or revenue arising from, for example, population growth or new policies and factor these risks into their commentary on sustainability. The Office for Budget Responsibility publishes its Fiscal Sustainability Report for the UK as a whole every two years, with the next report due in summer 2022. [4]
10. As part of its written agreement [5] with the Parliament, the Scottish Government publishes an annual Medium Term Financial Strategy (MTFS) that feeds into the annual budget cycle. This report sets out the Government’s broad financial plans for the next five years including projections for revenue and expenditure.
11. Although the MTFS does make use of the Commission’s forecasts to form a central scenario the report is very much the Government’s assessment of the economic and funding risks that it will need to consider over the next five years. In contrast, as the typical fiscal sustainability report considers a 30 or 50 year horizon, the length of time over which long term fiscal risks evolve, so has quite a different focus.
Longer Term Fiscal Risks
12. The OECD noted that under the current fiscal arrangements the Scottish Budget must be balanced and the Scottish Government is constrained in its ability to borrow. This means that the usual problems of medium to long term debt sustainability caused by accumulated budget deficits do not apply in Scotland. Yet the OECD did still point to considerable fiscal risks to the Scottish budget in the longer term as a result of spending pressures and limited ability to raise additional revenue or borrow.
13. The current operation of the fiscal framework means that fiscal risks do not arise if changes in revenues and spending in Scotland are mirrored in the rest of the United Kingdom. But should there be different pressures on spending or different changes in tax revenues these could present sustainability issues for the Scottish Budget.
14. As the largest component of the Scottish Budget, health spending would be a focus of any fiscal sustainability report. If upward pressure on health spending was mirrored in the rest of the UK the Block Grant would increase, providing additional resources in Scotland. On the other hand, if the pressures in Scotland were greater than those in the rest of the UK (arising from say a relatively older or less healthy population) this could result in a fiscal risk.
15. On the revenue side potential risks arise if revenues grow more slowly in Scotland compared with the rest of the UK. For example, income tax is a significant revenue source for the Scottish budget. If there was persistently less income growth among the highest income taxpayers in Scotland compared with the rest of the UK this would reduce the level of funding for the Scottish Budget arising from income tax. But if income growth patterns were similar there would be no risk.
16. As well as differences arising between Scotland and the rest of the UK because of demographic or economic factors, there may also be effects on fiscal sustainability because of significant policy differences between Scotland and the rest of the UK.
17. For example, the Scottish Government is redesigning social security as new payments are launched and administered in Scotland, because of changes to the processes for applying, award reviews and appeals we expect spending to increase. Over time, this is likely to increase spending in Scotland above the funding received through the Block Grant Adjustments. How the costs in Scotland develop relative to the rest of the UK will depend on demographics and policy decisions by both Governments, but based on the current trajectory this presents a fiscal pressure which will need to be funded from the Scottish Budget.
18. Another example of policy difference is the commitment to net-zero greenhouse gas emissions in Scotland by 2045 in the Climate Change Act 2019 which is five years earlier than the corresponding UK commitment. While the OBR have typically excluded legislative targets from their fiscal sustainability work preferring to concentrate on explicit government plans, the statutory requirement to produce emission reduction plans would give us scope to consider the long term costs of climate commitments. This may add asymmetric pressures on the spending side of the budget which may be exacerbated by a less energy efficient housing stock and other infrastructure differences between Scotland and the rest of the UK.
19. As these examples demonstrate there is scope for long term pressures on the public balance sheet in Scotland. Because the Scottish Government has limited borrowing powers these pressures will manifest themselves in different ways to other countries, typically by the need to prioritise some areas of spending over others or to raise revenues from devolved taxes. This was an issue flagged by the Budget Process Review Group. [6]
Scope of proposed fiscal sustainability report
20. To assess fiscal sustainability in a Scottish context we will need to consider spending pressures in devolved areas relative to pressures elsewhere in the UK. As well as the examples we have mentioned so far, we will need to consider areas such as social care, education and local government finance in so far as they impinge on the Scottish Government’s balance sheet.
21. The review of the fiscal framework is due to take place following production of an independent report in 2021. Any changes to the Scottish fiscal framework could have implications for fiscal sustainability which we would need to consider.
22. We envisage that our reports would primarily focus on fiscal sustainability within the context of the fiscal framework and constitutional arrangements in place at the time of publication. Since fiscal sustainability reports consider the prospects for a country’s public finances over long time horizons, we would consider including additional analysis depending upon the situation at the time we published.
Timing and next steps
23. The Legacy Expert Panel’s suggestion of producing the first Fiscal Sustainability Report in 2023 or roughly half way through the Parliament is helpful as it allows us to scope and consult on coverage as well as deepen our expertise on public spending. It also means that we could make use of the next set of long term fiscal projections for the UK due to be published in the summer of 2022 by the OBR in its next Fiscal Sustainability Report. [7]
24. The long term nature of the analysis means that the substantive conclusions do not change sufficiently to justify annual reports. We would hope to provide an overview of fiscal sustainability in the 2023 report and consider one or two aspects of sustainability and fiscal risks in depth. It is unlikely that the first report would be able to cover all long term fiscal risks in depth and subsequent occasional papers and reports could cover other areas. While the OBR produces a report every two years our initial view is that this may be too high a frequency in Scotland.
25. Our plan would be to produce a detailed scoping paper during 2022 that considered the potential nature and coverage of a Scottish Fiscal Sustainability Report in more depth. In part this paper would be explanatory, but it would also form the basis of consultation on the scope of the first report.
26. In order to develop the work on fiscal sustainability and consult on scope we envisage requiring two additional full-time analysts. Our permanent staffing requirements would depend on the outcome of the consultation, and how much demand there was for focused work on specific areas and how often reports would be published
Scottish Fiscal Commission
6 September 2021
Notes
[1] OECD (2019) “OECD Independent Fiscal Institutions Review: Scottish Fiscal Commission”, paragraphs 152-155 and 163.
[2] Scottish Parliament (2020) “Legacy Expert Panel: Report to the Finance and Constitution Committee“ paragraphs 76- 78.
[3] Scottish Parliament (2017) “Budget Process Review Group: Final Report”.
[4] OBR (2020) Fiscal Sustainability Report – July 2020.
[5] Scottish Parliament “The Budget Process Session 5 Agreement between the Scottish Government and the Finance and Constitution Committee”.
[6] Budget Process Review Group (2017) Final Report.
[7] The 2020 OBR report only contained a limited long term analysis (the bulk of the report considered medium term coronavirus scenarios) and the last substantial set of UK projections was published in 2018.