Finance and Constitution Committee

Meeting date: Wednesday, September 9, 2020

Official Report 661KB pdf

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Pre-Budget Scrutiny 2021-22

Our next item is our first pre-budget 2021-22 scrutiny session, which focuses on the impact of Covid-19 on the public finances. We will hear from the Scottish Fiscal Commission about its fiscal update, which was published last week. I welcome our new adviser on fiscal matters, David Phillips, and thank him for his helpful briefing paper. I also record our thanks to David Eiser, our previous adviser, for all his hard work.

I welcome our witnesses from the SFC: Dame Susan Rice, who is the chair; Professor Alasdair Smith, who is one of the commissioners; and Claire Murdoch, who is the head of social security and public funding.

Before we move to questions from members, I invite Dame Susan to make some opening remarks. I remind members to direct their initial questions to Dame Susan.

Good morning, and thank you for asking us to give evidence. I will start with a few comments about the five publications that we released in the past week and a half. Do not worry: in the words of Henry VIII to each of his wives, I will not keep you long. You will need time for questions.

I will speak first about our fiscal update report. As you will be well aware, the coronavirus pandemic has had a profound effect on the fiscal and economic outlook in Scotland and the United Kingdom. In our second fiscal update last week, we set out the latest position of the Scottish budget, we discussed the potential variations in the budget that the Government will have to manage this year and we considered the effects of Covid-19 on the economy. I will say something about each of those three areas.

The Scottish budget has increased by £3 billion since the Scottish Government presented its summer budget revision in May. The budget now includes £6.5 billion of guaranteed funding from the UK Government for spending related to Covid 19. That funding largely addresses one of the concerns that we raised in our previous fiscal update in April, when we highlighted that uncertainty about the level of funding from the UK Government could make it difficult for the Scottish Government to balance its budget.

Although the guarantee, along with the fixed funding for income tax for the year, provides greater certainty, there are still elements of the budget in which the Government continues to have uncertainty. Land and buildings transaction tax, landfill tax revenues and devolved social security spending vary in-year, although we expect variations largely to be offset by changes in the block grant adjustments. We do not yet know what those will be, but when we get to the Scottish budget—probably in December—we will have updated forecasts of Scottish revenues and spending and updated forecasts from the Office for Budget Responsibility to inform the BGAs. At that point, we will have a clearer picture of the Scottish budget.

Our report also sets out our initial expectations for the Scottish economy. The latest data suggest that the economy shrank by almost a quarter between February and April. Since then, we have seen a gradual resumption of economic activity and we expect gross domestic product to rise rapidly as economic activity resumes more fully.

However, we anticipate that GDP will remain below its pre-crisis level until 2023. That is because, over that period, unemployment is likely to be elevated and earnings will be lower for many people. We expect some permanent damage to the Scottish economy: it is probably fair to say that the economic and fiscal effects of the crisis will be felt for years to come.

Our report highlights the large increase in UK Government borrowing to fund the UK-wide response to the crisis. We note how, at some point, that will need to be repaid, which will potentially also affect the Scottish budget.

Our report also noted that, next year, the Scottish Government will need to manage the income tax reconciliation relating to 2018-19. The relevant outturn data will be published on 23 September and we will publish an evaluation of the data on 5 October.

That is enough about our fiscal update. I turn to our annual forecast evaluation report for 2019-20, which mainly covers the period before the impact of Covid-19. Although there is individual variability, our forecasts of devolved tax revenues and of social security spending, taken collectively, were within two per cent of the outturn.

In the world of forecasting, that is pretty good, although the technical way of saying so is that that outcome would be considered reasonable. However, we know that Covid-19 will significantly alter the world, and the forecast errors for the current financial year are likely to be greater.

The third publication is our “Statement of Data Needs”, which sets out the areas in which we believe that improved information would support our work. Relevant to the fiscal update that I have just spoken about, we highlight how our work on the Scottish budget has developed, and describe a variety of ways in which it would be improved through better or more timely provision of data or information.

Alongside those three publications, in the past 10 days we have published two policy costings to accompany Scottish Government legislation relating to social security. The first is for the child winter heating assistance scheme and the second is for the Scottish child payment. Our forecasts take account of the large increases that we have seen in universal credit claims since March.

With that, I hand over to you, convener, for the question-and-answer session.

Thank you, Dame Susan. I will start the questioning. As a result of the Covid-19 pandemic, there will be risks to the Scottish budget. I am interested in what the differential effect might be on Scotland in terms of the impact on the Scottish economy and on public expenditure, including devolved social security benefits, relative to the rest of the UK. As we all know, the fiscal framework is very much about relativity. What consideration has the SFC given to any potential differential effect and what that might mean?

That is a good question. In looking at the economic impact, we have initially looked at the change to our economic activity and to GDP in comparison with what is happening across the UK. So far, we have seen that our changes have been roughly in parallel with what we see in the rest of the country. That does not mean that that will continue forever, but we have not seen a big divergence.

Obviously, lockdown has, in some respects, been handled differently in Scotland and in England; indeed, the four nations are all showing differences in how they respond to lockdown. In Scotland, the cessation of work in the construction sector was wider and longer than it was elsewhere. We may also see differences in the timing of recovery, because those activities have to come on board and work has to begin to have an impact. Those are a few areas in which we have considered what the differences might be.

Perhaps Professor Alasdair Smith or Claire Murdoch would like to augment my comments.

I am happy to come in, although I do not have much to add. As Susan Rice said, when we have looked at the differential effects, they have not turned out to be significant so far. Nonetheless, we have recognised that there is a risk, and we will need to keep a close eye on it, given the limited powers that the Scottish Government has to borrow in order to meet particular needs, in the event that those needs should differ from those that are funded through UK Government funding.

On the fiscal side of things, you are exactly right, convener—the effect of the Scottish budget depends on the performance of Scotland relative to the rest of the UK.

We are still pretty early on in this period, in terms of the data that we have on tax and social security. I turn to tax first. The taxes that affect the budget this year are the land and buildings transaction tax and the Scottish landfill tax, which have a direct effect in-year.

On LBTT, we have some evidence that transactions in Scotland took slightly longer to return to higher levels than they did in England, because the housing market took slightly longer to reopen. On what that means for tax revenues over the year, we will need to see how that plays out. It is still pretty early in the year, and a month’s difference in the opening of the housing market might not make a huge difference over the whole year.

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On social security, the largest benefits are administered by the Department for Work and Pensions. Those are on pretty much the same rules as the UK Government ones, so we expect the changes that happen there to be broadly similar in Scotland and the rest of the UK. It is the smaller benefits, which are administered by Social Security Scotland, where we might expect there to be a differential impact, and those benefits do not have block grant adjustments.

An example is the best start grant, which is paid to families who are on low-income benefits—they may be on universal credit, for example. We do not have the data yet, but we expect that, as Scotland has a higher number of families receiving universal credit, more people will be paid that benefit. However, it is still quite early to see that in the data.

We will have more information by the time we get to our next forecast. We will update our forecast and the OBR will update its forecast, and we will have a better picture of what is happening in Scotland and in the rest of the UK, and the effect on the Scottish budget. You are absolutely right to say that that relative performance will affect the Scottish budget.

I have concerns about the £6.5 billion guarantee—not about the amount, but about how the Parliament and, indeed, the Scottish Fiscal Commission will be able to scrutinise exactly what is going on there. In particular, any additional funding for England will not generate additional funding for the Scottish Government until the Barnett formula implies that the total amount received should be greater than £6.5 billion. According to our adviser, that implies that just over £8 billion can be announced in England before the Barnett formula will apply such that the Scottish Government receives more than the £6.5 billion funding guarantee.

There is potential for lots of announcements creating confusion, because the UK Government might announce new money that would not apply to Scotland until that figure of £8 billion of new money had been reached, in which case we would be over the £6.5 billion mark in Scotland. How will the Scottish Fiscal Commission go about scrutinising that, and the amount that comes into the Scottish budget, or otherwise? What advice would you give the committee on that?

Thank you for putting that challenging question. I remind everyone that the offer of guaranteed funding in relation to actions around the pandemic followed a request that came out of discussions between the Scottish and UK Governments. As we all know, the Scottish Government has to have a balanced budget, and the complete uncertainty around all the extra funding was beyond anything that was reasonable, so the guaranteed funding was welcomed.

The understanding is that, if the UK Government spends less, the £6.5 billion to the Scottish Government will not be reduced, but if the UK Government spends more, more will come to Scotland. The timing of that is a political matter and not something that we could speak to.

What matters to the Scottish Government is the budget for each year. I know that you asked about scrutiny, but I think that it is helpful to understand the framework around this. If the UK Government said that it was going to spend a lot more, more would go to Scotland. However, if it did so towards the end of this year and the money came next year, that might cause some issues as well. It is a matter of understanding the mechanism as well as the actual amounts.

I do not want to lean on Claire Murdoch too much, but I ask her to comment as she has quite a keen understanding of this space.

The amount that the Treasury has guaranteed the Scottish Government so far will not go down, but if the UK Government makes further announcements, the Scottish Government will receive extra funding. You are absolutely right, convener. If announcements continue to be made, no new funding will come out of that at first, but, after a certain point, more funding will come to the Scottish Government. That could potentially happen quite late in the financial year. When the supplementary estimates are presented to the UK Parliament—normally in February—there could be revisions to the figure. That is quite late in the financial year for the Scottish Government to deal with. That is why the UK Government made the offer to guarantee the funding—that would provide a minimum level of certainty. However, if there are further announcements involving higher spending in England, the Scottish Government might receive extra funding quite late in the financial year. If it cannot spend it in that financial year, it can put it in the reserve and manage it that way.

On the £6.5 billion, is the point not just that that gives the Scottish Government some certainty in terms of budget planning, so that it is not relying on rolling announcements of Barnett consequentials, it knows what the overall envelope will be in this financial year and it has an assurance that that will not go down? Is that not the key issue?

Yes, the £6.5 billion that has been given to the Scottish Government will not decrease. I also point out that certainty comes from having fixed revenues or expenditure, so, in addition to knowing that £6.5 billion is available, income tax is a fixed number for the budget year. Obviously, it becomes reconciled a couple of years later, but that means that quite a big chunk of the Scottish budget for the financial year is also fixed.

There are variables, which involve something moving in-year, such as housing transactions—the revenue from LBTT comes at the point of each transaction, so it is sporadic and periodic. Furthermore, social security expenditure also happens in-year and can change in-year. However, because the payments are monthly, the situation is a little more certain. The Scottish Government is not relieved of all uncertainty, but the combination of the certainty around the £6.5 billion and around income tax, which is nearly double that amount, gives it a fair amount to work with.

Sorry to interrupt, Murdo, but, before we move off that point, I would like to ask a question in order to get absolute clarity. I welcome the guarantee—it is a good thing to have—but, currently, the maximum Barnett room that the Scottish Government has is £5.7 billion. We will not necessarily reach that guaranteed amount; it is just there if we need it. Am I right about that? If so, I want to ensure that that is on the record, just so we are all clear on that point.

I believe that you are, but you can perhaps speak for the Parliament and the Government, whereas the Fiscal Commission cannot tell you exactly what you have spent. However, my understanding is that the £6.5 billion has not all been allocated yet.

I have a couple of questions that lead on from the convener’s question about differential impacts.

We know that levels of public spending per capita in Scotland are much higher than the UK average, which means that the public sector is a larger part of the economy in Scotland than it is in the UK as a whole. Is that factored into your assessments of any likely differential impact of Covid on Scotland and the economic consequences of that?

Again, that is a good question to ask. With regard to the devolved areas that we deal with, some of the social security benefits that have gone live under the Scottish Government’s jurisdiction—most of them have, at this point—have been changed in terms of eligibility and the ease of applying, and the child payment is a new payment.

The Scottish Government is making more available to its population under the social security heading. It is correct to say that we are aware of that. The Government’s job is to know what it is spending and to balance the budget. We have said in past evidence sessions with this committee that, if the Government needs or wants to spend more on one area, it might have to spend a little less somewhere else. I do not know whether that exactly answers your question, but we are certainly aware of some of those differences and consider them—[Inaudible.]—in what we do.

I have one more question. Your Scottish Fiscal Commission “Fiscal Update” paper talks about the prospects of what is called, rather dramatically, a “Scotland-specific economic shock”, stating that the likelihood of that

“being triggered is greater than in a typical year”.

Of course, that would trigger additional borrowing powers for the Scottish Government, which I am sure it would welcome. Do you have any sense of the likelihood of our getting into that territory?

I can turn to either of my colleagues on that question, but my response is that we have not forecast or predict the likelihood of getting there. We are in extraordinary times this year, and we just do not know how the rest of the year will play out with the pandemic—nobody knows that at this stage. It is possible that that specific economic shock might happen, but, so far, we have not seen indices that say that we are on the verge of it. Alasdair Smith might want to add something to that.

Yes. There are two conditions that would trigger a Scotland-specific economic shock, one of which is the growth of Scottish GDP being less than 1 per cent. Sadly, that condition will clearly be met, as there will be negative growth this year. The second condition is growth in Scotland being more than 1 per cent less than growth in the UK. Growth in the UK fell by about 25 per cent in the first quarter of the financial year, and growth in Scotland fell by approximately the same. Not much divergence is needed in big numbers like that to get a 1 per cent difference between them. As Susan Rice said, there has not been a 1 per cent divergence so far, but it is easy to imagine that relatively small differences in the performances of the Scottish and UK economies could trigger a Scotland-specific economic shock. However, it would be unwise of the Scottish Government to assume that that shock will be triggered and that it will get access to the additional £300 million of borrowing, as we just do not know at this stage.

Thank you.

Good morning, Dame Susan. I want to follow up on what you just said about the extraordinary times that we live in with regard to Covid-19. The Scottish Government is funded in a retrospective way through the Barnett formula and other funding promises, so there is less flexibility there. I note that section 13 on page 4 of your “Fiscal Update” states:

“Before the COVID-19 crisis, the Scottish Budget had already increased in size and complexity”.

It then goes on to talk about the Scottish Government’s responsibilities, including the social security commitments and things like that. The great philosopher Stan Lee said in the 1960s, “With great power comes great responsibility.” However, the Scottish Government appears to have all the responsibility but very little of the powers to make the difference that it needs to make. Is there a better way of funding, so that the Scottish Government could be more flexible? We have talked about the Scottish Government’s borrowing powers previously. Is that the way forward? Or is there a better way for the Scottish Government to be able to act, so that, in dealing with this incredible crisis—this worldwide pandemic—it can deal with everything itself? I am just looking for some form of solution that allows us to deliver to the people of Scotland.

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I very much appreciate the sentiment behind your question, and I would answer it in several different ways. First, the question that you are asking would, to some extent, require a response on the political side, not from an independent fiscal body. We could not say that there is a better way to borrow or for the two Governments to interact.

There is power in Scotland, to some extent, because the devolved powers give Scotland the ability to collect some taxes and revenues in-year, and to keep those going, and to decide how it wants to spend on a number of social security programmes and benefits. There is power and the ability to make decisions in that sphere.

In these extraordinary times of Covid, even if both Governments were to decide that they wanted to have a conversation about shifting the way that things are working, my personal view is that this is not the moment to start making fundamental changes in how we do things. All of us, in our nations and collectively across the UK, have to get through this period as well as we can.

The guaranteed funding, which was one of the requests made by the Scottish Government to the UK Government, was granted, and it has helped quite a bit. I do not know whether either of my colleagues wishes to add anything to that.

The Covid experience is an interesting test of devolution powers. For perfectly understandable economic reasons, as endorsed by the OBR, the UK Government’s Covid response has largely been funded by borrowing, which is a reserved power at the UK Government level. One of the questions that ought to be asked in the near future is whether, looking back over this experience, a response to Covid that was largely funded by UK borrowing has been sufficiently responsive to the needs of Scotland.

As Susan Rice said, our feeling in the commission is that the time to consider that is when the fiscal framework comes up for review. At that point, it will be very interesting to look back at the Covid experience and ascertain whether the needs of Scotland and the needs of the rest of the UK were similar and whether the Scottish Government’s desired policy response was sufficiently close to the UK Government’s desired policy response that the fiscal framework worked well, or whether, alternatively, the fiscal framework did not give the Scottish Government enough control over its own response to the Covid pandemic. Those are questions for the Governments to consider when they review the fiscal framework in 2021-22.

Thank you, Professor Smith. That is extremely interesting, and I will keep that in mind as we move forward.

Dame Susan, I am in no way trying to get you involved in a political rammy; I am just trying to find a practical way of getting delivery for the people of Scotland. Even in your own paper, in paragraph 16 on page 4, you write:

“The Scottish Government’s borrowing powers were not designed to manage fiscal stabilisation which is the responsibility of the UK Government, who borrow on behalf of the UK and either allocate spending for reserved areas or transfer proportional funding to the Scottish Government for devolved areas. The Scottish Government is not able to borrow to fund proportionally greater spending on its COVID-19 response than the rest of the UK.”

Having read that, I would ask whether that is not part of the problem. Is that not part of the issue that we face? We constantly hear about political bickering between Governments, but if the powers were there, we would be able to deal properly with the issue. We still seem to have most of the responsibility yet none of the powers.

I am not sure how to give you a different response to that question. I understand your concern and why you ask the question in that way, but it is not within our capability to give you an answer. Quite honestly, as I and Alasdair Smith have said, trying to analyse this and come up with a solution in the middle of a crisis is not the way to get a good answer to the question that you are raising, because we need to see the denouement and how things play out. Soon—not too far into the future—if we look back, we will be able to come up with a much better view of what has and has not worked. That is the best response that I can give you. It is a personal view as to when one goes in to pull up the paving stones and look at what is underneath. Claire Murdoch may be able to give a more specific response.

The only thing that I can add is that the work that we are doing on how the Scottish budget is funded is explaining and trying to add transparency to how the budget works under the current arrangements. It is for others to talk about whether the current arrangements are suitable or should be changed. Our focus is on trying to improve people’s understanding of how the Scottish Government is funded, because it is not super easy to understand. It is not a simple process, especially as we add in all the new tax and social security devolution, which, as we highlight in our report, has added further complexity to the Scottish budget. That is our intention.

That might not address the question that George Adam asked, but I hope that it explains where we are coming from.

I and others feel frustration because we are living in extraordinary times—this is a worldwide pandemic and health situation in which people are dying. I understand your point that we need to look at it at a later date, to get all the facts and figures together, but, for me, the concern is how we deal with it in the here and now, because it is about life and death. It is not just an academic study; we need to deal with it here and now.

Two strands are coming out of your comment, one of which is the health strand. This is a pandemic and a matter of health around the globe. Ultimately, I believe that science will get us there and that we will have the mechanisms, such as super-fast, easy and cheap testing and vaccinations, to see us out. We are in a tunnel but, at some point, we will come out of it.

The other strand to what you are asking about is the impact that the pandemic is having on economic factors now. Although I cannot comment politically, I understand that many businesses have benefited from the broad schemes such as the furlough scheme and the loan guarantee scheme for small businesses. More recently, the Scottish Government has offered support to the arts and culture sector. People sometimes think of that as a side issue, but that sector is essential to having thriving cities in Scotland. Therefore, the Scottish Government has found places where it can focus and create some of its own programmes as well. I do not know what else we could say to you—within the limitations and constraints of our remit—that would take the conversation further. I am sorry about that.

Of course, when we are talking about issues of life and death, we must remember that health responsibilities are devolved and that the Scottish Government has had responsibility for many aspects of the response to the Covid pandemic in Scotland, such as lockdown policies and so on. The question for the Fiscal Commission, and perhaps the issue behind Mr Adam’s question, is whether the Scottish Government gets adequate funding to support its devolved responsibilities. As Susan Rice said in her introduction, so far, the indications are that the available funding has matched in a reasonable way the Scottish Government’s programmes. However, that can be reviewed at the end of the year, when we will have a better overall picture.

There is no doubt that we are likely heading for a position of falling tax receipts and increasing spending. I want to focus on social security, because I am conscious that the reconciliations for social security happen in-year, and therefore there is an immediate impact on the budget. I understand that disability benefits account for the main element of social security spending. Can you give us an order of magnitude for that? Can you also comment on what you expect might happen as a consequence of the coronavirus restrictions? Will the budget go up? If so, by how much? That is the million-dollar question.

If we knew the answers to all questions like that, we would be in a different place. In my opening comments, I talked about the small response that we made recently on costings. We have factored in the increase in uptake of universal credit compared to March. Universal credit is a trigger for some social security benefits and, as we know, there has been an increase in uptake across the UK, and certainly in Scotland. That will potentially lead to greater eligibility for some of the specific benefits or social security programmes in Scotland.

I will turn to Claire Murdoch, because her remit, as one of the most senior people in the commission, is on the public policy side and on social security, so she knows that area inside out. Perhaps she can give a more specific response.

In our report, we talk about a number of the ways in which we think social security spending could be affected. Jackie Baillie is absolutely right that disability benefits account for the bulk of the £3.5 billion of devolved social security. The main change that we think is going to happen on that is through the changes that the Department for Work and Pensions has made in how it administers benefits. Because of the Covid crisis, the DWP has suspended face-to-face assessments, paused some reviews and made other changes to the administration. We think that those changes will potentially lead to increases in spending in Scotland and the rest of the UK.

We do not fully know what the effects of Covid will be on people’s health, but we could see increases in demand for benefits if people’s health is affected. Sadly, the majority of people who have died from the virus have been older people, who are more likely to have been in receipt of attendance allowance, so there might be an effect that potentially reduces spending.

We will take all those factors into account when we produce our next forecast, in December. Most of the effects will be across Scotland and the rest of the UK, so when the OBR produces its updated forecasts, we will get an update of the block grant adjustment position, which we think should largely offset that.

Obviously, that applies to the majority of spending, which at present is administered by the DWP, but there are also the benefits that are administered in Scotland, and there are several changes that we will factor into our forecast in that regard. The first one is that universal credit applications have increased a lot, which we think will push up spending on the low-income means-tested benefits that are administered by Social Security Scotland.

Yesterday, we published a costing of the new Scottish child payment. The Scottish Government originally planned to launch the child payment before Christmas, but it will now make the first payments in February. In producing that forecast, we took account of the increase in universal credit claims, which pushes up spending across our whole forecast horizon. We also made the assumption that take-up will increase because more people are aware of the support that is available to them. All those factors will affect spending; the majority will push up spending slightly while some will dampen spending.

It is still very early for us to make a forecast. At the moment, we are just making comments on what we think the effect will be. At the time of the Scottish budget, we will have a much better estimate of the position in-year for the Scottish Government. We will also have a better estimate of the forecasts across the next five years and how spending will evolve over that period. I hope that that answers your question.

11:30  

It does answer my question and is very helpful. I am very conscious that we are coming up to an autumn budget revision and I am sure that the majority of this will not be reflected in that revision, but will happen towards the end of the year. However, I am concerned that as the job retention scheme starts to unwind we will see massive spikes in unemployment and a consequent impact on a range of devolved benefits, from the best start grant that Claire Murdoch referred to earlier to council tax reductions, the statistics for which were published yesterday. Are you saying that it is too early to get an order of magnitude and that I need to wait until December?

I am afraid so. In December we will have to make forecasts, even if we do not have much more information. At that point we will be able to present you with a better picture than we are able to produce at the current time.

That is helpful.

I want to ask the SFC about the fiscal trends highlighted in the most recent “Government Expenditure and Revenue Scotland” figures, which show a gap between revenue and expenditure in Scotland of more than £15 billion, which is an increase of £2 billion from the previous year. On the expenditure side, the GERS figures reflect only a few weeks of the additional expenditure from the UK Government on the Covid response, which may be part of the reason for the increasing deficit, but are there other reasons on the revenue side to explain that? For example, are we seeing a decline in the income tax base or in revenues from the income tax base in Scotland and is less revenue being generated from other devolved taxes?

I begin by reminding everybody that GERS takes a snapshot, or estimates the value of, all public spending and public revenue in and on behalf of Scotland, which covers local government, the Scottish Government and the UK Government. It goes beyond the envelope of devolved taxes and benefits. For example, it includes UK-wide expenditure on defence, and local government expenditure where different decisions may be made in different bodies around the UK. I just wanted to remind everyone of that point. When Mr Lockhart talks about the differential, given the numbers that he referred to, I am not sure whether he is referring to overall GERS values or simply to that part of the bigger picture that relates to devolved taxes and benefits.

I am looking at the role of the revenue generated from devolved taxes in the overall component of the deficit. I appreciate that the SFC does not look at UK Government spend in Scotland. I am interested in the role of the revenue arising from devolved taxes in that overall increasing fiscal gap.

Thank you for the clarification, Mr Lockhart. Alasdair Smith is probably ready with the response on that.

The most important devolved tax is income tax, which accounts for about £11 billion of annual revenue to the Scottish Government. Therefore, that is the area where one might have the greatest concern about whether the amount of tax that is being raised within Scotland is falling behind the UK.

As Susan Rice said in her opening remarks, we will get an update on the 2018-19 outturn later this month—on 23 September—and we will produce a report at the beginning of October, after which some of our colleagues will appear before the committee. We will look more closely at whether the income tax base in Scotland is or is not diverging from the UK tax base and, at that point, we will be in a position to answer your question more fully.

In anticipation of next month’s outturn figures, perhaps you could provide a summary of the main trends in previous outturn figures; I am thinking, in particular, of the overestimation of the number of Scottish taxpayers at different bands. Could you give us the highlights of those trends and say what impact that overestimation has had on Scotland’s public finances?

We had a discussion about that the last time that we appeared before the committee, and the committee produced a very interesting paper on it. There is some evidence that the expected divergence in 2018-19 is a result of unexpectedly rapid growth of the tax base among the highest taxpayers in the rest of the UK—frankly, we are probably talking about the highest taxpayers in London and the south-east. We and the committee will certainly want to look more closely at that issue when we have the 2018-19 figures and the 2021-22 reconciliation later this month.

The headline question is to what extent income distribution changes have led to divergence in income tax. We will probably not be able to provide a full answer on that in October, but we will do some initial work on it, and we will probably all want to come back to it subsequently.

That was helpful—thank you.

I have a final supplementary question. Do you have anecdotal or other evidence of the impact that Covid might be having on behavioural change or on the mobility or movement of the higher-rate taxpayers within the UK market?

I think that I am correct in saying—oh, sorry, Alasdair; go ahead.

I am sorry to cut across you, Susan.

At this point, we simply do not know enough about that. There is evidence that people with higher incomes have done better during the Covid crisis than people with lower incomes, because their jobs have been more secure, they have had a greater opportunity to work from home and, as a result, they have been less exposed to the risk of unemployment.

In considering what might have happened to the tax base of the rest of the UK, we need to look at what has happened right up at the very top of the income distribution, and we simply do not know—I should not say, “We”; I certainly do not know anything about how the Covid crisis has affected the very highest earners in the UK. That information is not available now, and it will not be available next month, either.

Do you have anything to add, Dame Susan?

No—Alasdair said what I was going to say, probably much more elegantly.

I direct members to my entry in the register of members’ interests.

To start with one of the many levers that are under Scottish Government control, namely LBTT, we can see that it accounts for the majority of the shortfall in the devolved taxes. However, in the introduction to the update, you point out that the majority of that shortfall cannot be attributed to Covid. What are the fundamental reasons why that tax is not raising as much as it should be?

I will ask Claire Murdoch to talk about that. There has been a lot of variability in our forecasts in the past couple of years. We overpredicted LBTT revenues by about 3 per cent, mainly because we overestimated how many transactions there would be in the top two bands, which is where the largest amount of receivables comes in. It is not just the overall number of transactions that matters; it is where they fall in the various bands.

As Dame Susan has just highlighted, we had a forecast error on residential transactions. I should say that we are not saying what revenues should have been raised; we are saying what was raised compared with what we thought would be raised. We overpredicted residential LBTT revenues by 3 per cent, which is £9 million, but our largest forecast error was on the non-residential side. That is because non-residential revenues are highly concentrated on extremely high-value transactions. If you have slightly fewer of those extremely high-value transactions, you raise quite a lot less revenue. You do not have to get it very wrong to end up with a revenue forecast error that is slightly larger.

We forecast that there would be 550 transactions that were worth more than £2 million in the past financial year but, in fact, there were 506. That accounts for a big chunk of that forecast error. Obviously, we will take account of that when we produce our next set of forecasts. Of course, what happened last year will not be a perfect predictor of what will happen this year or next year, given that quite a big crisis has happened since then. I hope that that answers your question.

Yes; sensitivity in certain bands can have a major impact.

Paragraph 3.21 says that you have underestimated the number of transactions and, therefore, your forecast should have been higher. Are you also saying, therefore, that the shortfall is also higher, so the situation is worse than the figures show?

I will need to find the exact figures but I think that, on the residential side, we underestimated the number of transactions but we slightly overestimated the price assumption—prices were not quite as high as we thought that they would be. When you take those two things into account, those forecast errors on the residential side slightly offset themselves.

The OBR has not formally updated its forecast, but it has produced updated scenarios—optimistic, central and pessimistic—for tax revenues and spending, which go on to inform its other costings. Why have you not produced any fiscal scenarios along those lines? Is it a resource issue? Do you have any expectation that there might be higher transaction volumes towards the end of the year?

I think that Susan is going to answer that.

Sorry—perhaps the convener can tell us who should answer.

Claire Murdoch was on the ball there, so we will let her keep going. If you want to come in after that, Dame Susan, let me know.

Alexander Burnett asked why we have not produced updated scenarios. We set out what we think is happening broadly in the Scottish economy, given that context. With regard to the Scottish budget, what really matters for the budget position is not just what we think is happening to Scottish tax revenues but what is happening to Scottish tax revenues relative to the rest of the UK. The OBR scenarios are helpful with regard to giving that broad indication of what is going to happen. However, the OBR has not produced forecasts that can be used to calculate the block grant adjustments.

If we produce a forecast that says, for example, that LBTT revenues are going to fall, and then present that in the Scottish budget, it would make the position look pretty bad. However, once the updated block-grant adjustment figures are known, we will be able to see both those figures together, so we will know the funding position and the revenue position.

At that point, we will have a much better estimate of what is happening to the Scottish budget. We will be doing that alongside the Scottish budget, which is now expected to be in December.

11:45  

I would simply add that the OBR has done its scenarios and, I believe that the Fraser of Allander institute has done scenarios as well. In terms of informing thinking more generally, there are other scenarios available.

Dame Susan, you mention transparency in the data needs paper, and the issue of the Scottish Government not making information public, which unfortunately seems to be a recurring theme at the moment. Are you making any progress on that?

We noted in the report that there has been a lot of progress. We believe that we have a very good dialogue with the Scottish Government about data needs, and those discussions have improved over time. We are simply adding each year what would be even more helpful.

Because of our commitment to transparency, and because we try in our forecasts to enable anyone who looks at our work to understand what lies underneath it, we want to use public data to the fullest extent possible. Sometimes Governments—this one or other ones—want, for various reasons, to hold back data before they ultimately make it public. That might be because they are not certain about it and are waiting to check it when it comes in. It is just that we have a timetable, so we are looking at how to match our needs for our analysis with the Government’s needs for handling its data. Overall, there has been some progress there.

For simplicity, I will ask Dame Susan my first question and she can decide whether to delegate it to one of her colleagues.

The question concerns the sustainability of UK debt. I raise that issue with reference to paragraph 21 of the fiscal update report, which refers to the possibility that the UK Government may wish to rebalance its fiscal policy by increasing devolved taxes, which would have a knock-on impact on Scotland.

I appreciate that your remit is fiscal policy in Scotland, but given that intimate connection, can you perhaps sketch out what an objective definition of sustainable debt would be? Is the UK Government’s current position vis-à-vis its debt sustainable, or would it necessitate intervention through the use of fiscal levers such as increasing income tax at a UK level?

That is a big question. We would not be in a position to comment on the last part of it, on the sustainability of the UK’s approach to its debt. Alasdair Smith has put his virtual hand up. Alasdair, I wonder whether you want to respond more specifically.

Yes, I am happy to do so. As you said, Susan, the Scottish Fiscal Commission has no responsibility for commenting on the fiscal sustainability of the UK Government’s policy, and it is at the UK level that fiscal sustainability arises as an issue because, as we discussed earlier, borrowing is a power reserved to the UK Government.

Turning to what the OBR has said, I would not want to put words in the OBR’s mouth, but my interpretation would be that it is relatively relaxed about the growth of UK Government borrowing in the short run in the context of the Covid crisis. The OBR seems to be quite relaxed about additional borrowing of £130 billion or £150 billion at a time when interest rates are very low.

It is right to assume that borrowing eventually has to be repaid, and it is quite right that when the UK Government seeks to bring its borrowing back down, it will need to raise taxes or cut expenditure. Cutting expenditure or raising taxes in devolved areas will have a direct impact on the Scottish Government’s budget in the future. That is partly the way in which Scotland’s share of the borrowing that is being done at the UK level, by the UK Government, gets repaid in the long run—through the impact on Scottish taxes and Scottish expenditure.

Can you clarify something, please? You can correct me if I have misunderstood, but I think—if I understand you correctly—that you are suggesting that there will ultimately be a choice between, or a combination of, public expenditure cuts and increases in taxation.

I presume that, given the gravity of the economic crisis that we are facing, you think that there is no possibility that the UK’s fiscal position will become sustainable simply through economic growth. I ask that as an objective question of economic analysis. You are saying that it is simply beyond the realms of possibility that the UK economy as a whole would grow to such a level as to generate revenues that could bring public finances on to a sustainable footing, and therefore a fiscal intervention is required.

It would be a very happy future—well, not very happy, but certainly optimistic—if rates of economic growth were high relative to rates of interest on the debt. To the extent that—[Inaudible.]—one can be relaxed about the debt burden. Nonetheless, it is probably prudent to assume that when the Government takes on a large amount of additional debt, as the UK Government is doing this year, not all of it will be repaid as a result of economic growth.

I do not disagree with the assumption that underlies your question. If we could be very optimistic about economic growth, we could be less worried about the burden of future debt—that is absolutely right.

My second question is a process question, which we often come back to in exchanges with you in committee. The SFC is a relatively young organisation. With the new social security spending coming online this year, it may take a period of time—as has been acknowledged in previous exchanges—for the commission to build up sufficient knowledge in order to make its predictions as accurate as possible.

What has been the effect of the disruptive impact that Covid has had, and the significant financial interventions that there have been, on the robustness of your forecasts looking forward over three years? Will it delay you in getting to the point at which you will be confident that you can accrue that early learning to enhance the accuracy of your forecasts?

You describe the SFC as a relatively young organisation. We are young—and finely formed, I would say on behalf of the whole team in the organisation.

Back in January and February, the SFC responded wisely and quickly to what we saw was likely to be coming. We equipped all our teams to be able to work effectively, and in a collegiate way, from their home bases. You talked about process—we have the capability, equipment and all the rest of it to enable us to do our work, and we have not missed a beat. That is really important.

On the accuracy of forecasts, I offer a small reminder that forecasts are never right, as we know. We always try to get them closer and closer, and we try to understand each year why the outturn or the actual figures varied from the forecasts.

To get back to the process question, some of that relates not only to our work. We continue to refine our models—that is an example of the work that we have carried out over this period, as well as doing whatever else we do. As the models mature, and as we understand things better, that should help with accuracy.

You mentioned social security benefits specifically. With regard to some of the newer benefits coming on stream, and our forecasting accuracy in general, our forecasts for the benefits that came in first were in a very good range. For the benefits that came in more recently, our forecasts were not as good, sometimes because of the nature of the way in which they were introduced, and sometimes because of the timing of when they were introduced, which sometimes changes for eligibility reasons.

When we have a new benefit coming online—I suppose that this would also apply to a new tax that comes in at any point—there will always be greater uncertainty. We all—those who collect and administer, as well as the SFC—can learn from an analysis of that.

Alasdair Smith may want to add to that.

First, I add my compliments to those from Susan Rice to the staff of the Scottish Fiscal Commission, who have worked tremendously well over the past few months in these very changed circumstances.

On the substance of the question, yes, forecasting is going to be difficult over the next year or so, because information about what is going on in the economy is coming in only gradually. There are very unusual circumstances, and it is harder to speculate about how things might evolve over the next year or two; there are many more unknowns.

Nonetheless, we will produce forecasts to accompany the Scottish Government budget, which we expect to be issued in December. We are limbering up to do that. Those forecasts will be subject to much greater uncertainties than our forecasts in the past. We will all be astonished if our forecast evaluation report on our 2021 forecasts turns out to be as good as our report for this year.

It is perhaps most important to reiterate—as Claire Murdoch has reminded us a couple of times—that one of the big uncertainties for the Scottish Government budget concerns the differences between UK and Scottish revenues and expenditures. Large parts of the budget are set on the basis of forecasts from us and from the Office for Budget Responsibility, and both organisations will be doing their best in December to produce the most accurate forecasts possible.

However, with the best will in the world, divergences between the outturns and our forecasts, and between UK outturns and the OBR forecasts, will be greater than normal. In the context of what we have learned about Covid and the fiscal framework, we have to consider whether the framework makes enough provision for adjustments arising from forecast error in circumstances in which—with the best will in the world, as I said—there are likely to be much larger forecast errors than there have been in the past.

I will add a footnote to the discussion. We were previously asked about data and data availability. In a process sense, that is essential to the efficacy of our forecasting ability. As you will know, we are part of an international Organisation for Economic Co-operation and Development network of independent fiscal institutions. A couple of months back, Claire Murdoch and I joined a virtual meeting. A number of other countries were saying that, during the pandemic, in the early months in particular, they were simply not able at all to get the data that they would normally get, and the fiscal institutions in those countries were saying that that was a great worry.

It is fair to say that we have done quite well in Scotland—and in the UK, I think, although I have looked specifically at the bodies in Scotland that give us data. They have done a good job of keeping us pretty much up to date through all this, which has been very helpful.

Thank you. As much as I would like to continue this exchange, I am conscious of time, so I will conclude there.

Before we go to Alex Rowley, I want to continue that exchange. Alasdair Smith said something pretty important about the impact of Covid on the economy—the uncertainty, the destabilising effect of that and the turbulence that is effectively created— and we need to pick up on that.

You are signalling that a significant danger point is potentially coming in relation to understandable forecast errors—because we simply do not know what the Covid situation will throw up—and the potential for significant divergence between what the OBR and the SFC believe. I am not saying that that will happen, but the potential is there. Does that not signal a danger point in relation to the potential impact on the Scottish budget, which we need to be very aware of?

12:00  

It is not so much an immediate danger point for the Scottish budget as a risk around how the forecasts that go into the Scottish budget turn out. I am sorry—there is inevitable difficulty in talking about two forecasts and two divergences from the forecast.

What Bruce Crawford called “turbulence”—which was not my word—arises not so much from the fact that the budget depends on our forecast and the OBR forecast and that, if they diverge, it has budget effects. The bigger risk is that our forecast errors might diverge from the OBR’s forecast errors when we see the outcome. As such, although our forecasts might have been quite close together, if it turns out that the Scottish outturn is different from our forecast in one direction and the UK outcome is different from the OBR forecast in the other direction, reconciliations would be required, which might tax or put strain on the Scottish Government’s borrowing powers.

Although I recognise that it is not an immediate danger point, we need to be aware of it for future purposes.

I will ask a question about capital. Before I do, however, I go back to the point that Tom Arthur made. In your update, you quote the OBR fiscal sustainability report of July of this year, which said:

“It seems likely that there will be a need to raise tax revenues and/or reduce spending (as a share of national income) to put the public finances on a sustainable path”.

Are we clear that that would be a political choice, just as austerity was a political choice as we came out of the last economic downturn? The options are there for Government; that is simply one of them. Are we clear on that?

I am sorry—were you addressing that question to Claire Murdoch or to the panel generally?

Yes.

A great deal has been borrowed, because it is in the hands of the UK Government to borrow for a crisis like this one. The assumption is that, at some point, the borrowing needs to be redressed or paid back—whatever term one wants to give it.

There are choices as to how that happens and, I assume, as to when that would happen. You asked whether those are primarily political decisions; I think that those choices would be political decisions.

Some commentators have talked about the post-war consensus and the Keynesian approach of driving the economy and growing our way out of debt, rather than trying to cut our way out of debt. That is what I was trying to refer to—that austerity is a political choice.

On capital expenditure in Scotland, do you have any idea of the current position on capital programmes? Is there underspend and, if so, what is the scale of that underspend? You speak about flexibility, and the precedent of the Scottish Government being able to borrow more capital—to exceed the capital limits—is there. Looking forward, is that a possibility for us if we took the political choice to grow the economy to pay back the debt?

There are two parts to that question. The first part is about whether things have slowed down in relation to capital investment. The second part—which is a good question—is about whether the capital can be used in some way to help grow the economy.

I do not have numbers to hand, but I suspect that my colleague, Claire Murdoch, will. Nonetheless, the fact that construction ceased—that everything ceased—in the early part of lockdown means that things will have slowed down; there is no question about that. Although a lot has started up again, there was certainly a very big hiccup at that point. Claire Murdoch perhaps has some more specific numbers with which to respond to the question.

In our report, we set out the level of funding that the Scottish Government currently has for capital spending. We also highlight that the OBR, in its report, expects underspends across departments this year, particularly on capital. It is likely that the UK Government will spend less.

The question of whether capital underspends are expected this year in Scotland is more for the Scottish Government when it presents its autumn budget revision. We will obviously pick that up in our December report, alongside the Scottish budget, at which point we will know more.

Alex Rowley talked about capital borrowing. The Scottish Government can borrow £450 million a year for capital spending. It planned to borrow the maximum this year, but we will see whether that happens. He also talked a bit about the flexibilities. In the past, Treasury has allowed the Scottish Government to draw down more from its capital reserve, because it received very late negative consequentials from the UK Government in the financial year. Treasury allowed it to fund that gap by drawing down from its reserve. Obviously, it has used money in the reserve; if it has underspends this year, it can put it back into the reserve and use it in another financial year. Those options are available to the Scottish Government.

I thank our witnesses—Dame Susan Rice, Professor Alasdair Smith and Claire Murdoch—very much for their evidence today. That concludes our business for today. Thank you, colleagues.

Meeting closed at 12:07.