Finance and Constitution Committee

Meeting date: Wednesday, June 12, 2019

Official Report 692KB pdf

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Medium-term Financial Strategy

Good morning, and welcome to the Finance and Constitution Committee’s 14th meeting in 2019. I give members the usual message about turning off our mobile phones.

Agenda item 1 is evidence on the Scottish Government’s medium-term financial strategy from Derek Mackay, the Cabinet Secretary for Finance, Economy and Fair Work. Mr Mackay is joined by Scottish Government officials Lucy O’Carroll and Daniel Hinze. I welcome our witnesses to the meeting and invite the cabinet secretary to make an opening statement if he wishes to do so.

Thank you, convener. I will be brief. The MTFS will help the committee and others to scrutinise Scottish Government budget planning by setting out the very real limits to our funding, clearly laying out the consequences of the United Kingdom Government’s choices on Brexit, austerity and our public finances and providing a clear picture of the impact of the fiscal framework on future Scottish budgets. Alongside the latest economic and fiscal forecasts, it sets out a framework for the Scottish Government’s spending review, as well as the fiscal principles and policies that will guide the use of our borrowing and reserve powers.

In line with the written agreement between the Scottish Government and the committee, the MTFS sets out the economic and political context for the spending review, the criteria that will govern the assessment of budgets and the process and timetable for review. Irrespective of the UK Government’s decisions about its spending review, we plan to undertake a review of spending in 2019 to beyond 2020-21, with a focus on addressing Scotland’s long-term challenges, notably climate change and child poverty.

I welcome questions from the committee.

Thank you for that short opening statement, cabinet secretary. The Scottish Fiscal Commission has told the committee that, next year, as part of the first income tax reconciliation, we can expect a reduction of £229 million in the Scottish budget. It has also informed us of further potential reductions in income tax because of reconciliations in future years, which, if its forecasts prove to be accurate, will amount to £608 million in 2021-22 and £188 million in 2022-23. The commission has told us, quite pointedly, that the Scottish Government will have to adjust its spending plans or increase taxes to deal with the forecast reductions. Therefore, I think that it is fair to ask you whether you think that those figures are accurate. How does the Scottish Government intend to manage what appears to be a very challenging picture?

Convener, I will answer that question in three parts, addressing the accuracy of the figures, how the commission has arrived at them and how we manage reconciliations, which is the right question to pose.

Our budget and the resources that we deal with are, of course, driven by the SFC’s and the Office for Budget Responsibility’s numbers. I have looked very closely at the SFC’s report—as members would expect me to do, since it informs the MTFS—and also at the evidence that it has given to the committee on the accuracy of the figures and its explanation of them.

It is important to point out that some people confuse forward forecasts with specific reconciliations. It does feel perverse that, when income tax is rising, overall tax take is up, gross domestic product is performing positively, unemployment is low and earnings growth has been increasing, we will have negative reconciliations over three years, as you have described, convener. However, that is down to relative forecast accuracy, as the Scottish Fiscal Commission has explained. It has said that its forecast error was “inevitable”. In new information that has appeared in the course of its giving evidence to the committee, it has also said that the average absolute forecast error could be around £500 million a year, positive or negative. The figures must therefore be seen in that context.

On the forecast errors, I note that we are dealing with two different forecasters that have two different methodologies and two different sets of assumptions. We then arrive at the figures on outturn. As we get more outturn data, we will have the exact figures. At present, the figures are still forecasts, but we will have the outturn data for the first financial year in July.

The SFC’s commentary and analysis says that the reconciliation is not about the performance of the UK or Scottish economy but about the accuracy of the forecasts. That is what this is about—the accuracy of the forecasts, which are reconciled on outturn. The explanation for that is given by the SFC, and we follow its analysis. Although an increase in income tax is forecast for Scotland, there is a block grant adjustment, and the income tax in the rest of the UK has increased by more than the income tax in Scotland, making our net position worse than was forecast. Of course, at the next fiscal event, we will get further updates to the forecast.

Beneath that, there has been stronger-than-expected growth in UK receipts, which was not forecast by the OBR, and that explains the divergence in the figures from the OBR and the SFC. What they are not sure about is whether that is a distributional or a cyclical issue. The SFC has pointed out that the negative reconciliations may well be followed by positive ones. I have read in the Official Report the commentary that it gave to the committee, and I note that, to explain why it believes that that has happened, it said:

“the rest of the UK has a higher concentration of higher-rate taxpayers and ... the recent growth in UK income tax revenue has been concentrated among them.”—[Official Report, Finance and Constitution Committee, 5 June 2019; c 5.]

From my point of view, that has increased the inequality in the rest of the UK between higher-rate taxpayers and others. As responsible forecasters, the SFC and the OBR will look at the outturn data, and their analysis of that data will inform future forecasts with a deeper understanding of the tax composition in Scotland that is based not on estimate but on fact.

That is the explanation of how the position has arisen, and I will now turn to what we are going to do about it. I think that it is prudent and fiscally responsible for me to assume that the reconciliations are right, although there will be further amendments, and work through the consequences of that.

The Fraser of Allander institute has said that many factors that are materially significant to Scotland’s economy are outwith our control. Those include the contributions of oil and gas to the economy, migration, Brexit and other matters. However, as we look at the potential reconciliations, the tools that we will have to manage the position will include the resources that are available at the time. We should bear in mind that, although we have the ability to draw down from the reserve and we have the borrowing powers, as is set out in the MTFS, the majority of funding will still come from the block grant and the Barnett consequentials. They are still significant to Scotland’s budget, as are UK fiscal policy and UK tax policy as they relate to Scottish tax policy. Those things will be determinants of the resources that we will have available. We also have resource borrowing of up to £300 million available, and we can draw down from the reserve to manage the reconciliation on the scale that has been set out.

A range of factors will have an impact. Those include the block grant, Brexit, austerity and, in relation to future resources, the tax policy of the UK Government, because that will determine the resources that we will have under the fiscal framework. We will also have the forward look. All of those will set the context in which I will manage the reconciliations as part of the budget process—which I will, of course, explain at budget time. I do not think that it would have been right to set out individual scenarios. I know that there has been some criticism of that and some comment on how I could have done that. However, I have set out the principles that I would deploy in using the borrowing reserve.

Politics changes from day to day, and the UK Government’s tax position is very likely to change. One of the Tory party leadership contenders will ultimately become Prime Minister, and whatever tax policy they have will be materially significant to the fiscal framework and the relative position for us in terms of tax.

I will take a prudent, fiscally responsible approach to managing the substantial reconciliations. That is not helped, of course, by the Brexit uncertainty. However, that is the explanation on forecast accuracy, which is all that this is about; on how it has been explained by the SFC; and on what the Scottish Government will do to manage the process. I agree that the reconciliation that is required is quite substantial.

The two things that the Fiscal Commission mentioned to us were adjusted spending plans and increased taxes, but you did not mention them in your comments, cabinet secretary.

That is because, in the much fuller explanation, we need to consider that what the Fiscal Commission does not know, what I do not know and what the UK Government does not know right now is what its budget will look like, whether it will have a spending review, whether it will use the fiscal headroom of £26.6 billion or what its tax policies will be. We need to bear in mind that the block grant, which is the largest determinant of Scotland’s budget, is determined by the UK Government, which is in a volatile and uncertain financial position. Those matters are materially significant to the Scottish budget and will set the context for the other things that we do. How much revenue we raise will be determined by what UK tax policy is and what Scottish tax policy is—that is the point of the reconciliation in terms of tax.

We may have to look at spending as well as at all the other determinants in setting the Scottish budget. There are many unknowns around what the UK Government might do in its fiscal policy, which will drive much of Scottish fiscal policy and how we will respond, because of the nature of the fiscal framework.

Good morning, cabinet secretary. We have in front of us a very stark set of forecasts from the Fiscal Commission. We know that they are only forecasts, but you have just said—and I agree with you—that the prudent thing to do is to assume that they are correct.

That is right.

The prudent thing to do is to assume, for the purposes of our conversation this morning, that the forecasts are correct. The forecast is that you have a £1 billion black hole in your budget—

No.

Let me ask the question, cabinet secretary. You have a £1 billion black hole in your budget, and the Fiscal Commission says that there is not enough in the Scottish reserve and your borrowing powers to cope with that. It says:

“this will mean the Scottish Government having to adjust its spending plans or increase taxes”.

Those are the Fiscal Commission’s words, not ours, and the prudent thing to do is to assume that that is correct.

When we turn to the medium-term financial strategy to discover what your spending plans are to cope with that £1 billion black hole or, indeed, what your proposed tax increases might be in a range of scenarios, we find absolutely nothing on either score. That homework was marked by the Fraser of Allander institute and you failed, did you not, cabinet secretary?

No. I think you will find that I have successfully passed three budgets in a row. I have balanced the books and I continue to do so in a fiscally responsible way. I have set out the principles that I will deploy so to do.

The economic indicators for Scotland right now are record low unemployment, on which Scotland is outperforming the rest of the United Kingdom at 3.3 per cent, whereas UK unemployment is higher; record employment; record export increases; and sustained GDP growth that is better than the SFC previously forecast. As I said, our exports are on the rise, outperforming exports from the rest of the United Kingdom, and our foreign direct investment is second only to London and the south-east of England. Income tax is rising and earnings growth is on the up in real terms. Those are strong economic indicators and foundations.

You still have to find £1 billion, though.

I will turn to that specific question, but it is important to contextualise. I am being accused by the Conservatives of economic mismanagement, which is somewhat hypocritical given the continuation of austerity and the Brexit chaos, which is impacting on the economy and, as the SFC has stated very clearly, will have a profound impact on the UK and Scottish economies.

On the £1 billion reconciliation, let us stick to the facts. The figures are driven by the SFC and the OBR, and they are reconciliations around not economic indicators but forecast error. The SFC has said that very clearly. Does it present a challenge to the Government and the Parliament? Of course, it does. Of course, I would prefer that I had £1 billion of positive reconciliations to make, but we have to work within the figures that are presented to us. Nevertheless, to describe the situation in the pejorative language that Mr Tomkins used is unfair. It disregards the past 15 minutes of evidence that I have given, saying that there is more to the Scottish budget than those income tax reconciliations—there are the financial envelope, the block grant and the other levers that we have around borrowing.

09:45  

I accept that, at £608 million, the forecast reconciliation from income tax year 2018-19 that applies to budget year 2021-22 goes beyond what could be deployed through drawdown of reserves or the borrowing power that we have. Even if we maxed both of those, that would not reach £608 million. My point is that we have to consider all the levers—the totality of Scottish Government resources at the time—and we do not know what the block grant will be in the budget year 2021-22. A number of material considerations will come into play; therefore, it is not true that it will require just spending and tax adjustments. The main driver of the Scottish budget continues to be the block grant.

I made it very clear last year, in the medium-term financial strategy and costed policies, that I will be undertaking a spending review. The UK Government committed to undertaking a spending review, but it seems to be prevaricating on that. I have written to the chancellor and the Treasury, asking whether they are going ahead with the spending review, and I have not had a reply to my letter, which was dated April, I think. I know that there is uncertainty in the ranks of the UK Government at the moment, but it has not confirmed whether it will carry out that review, which will be important in giving us the necessary information for our spending review. There are no costed new policies because we will conduct a spending review and budget process to produce those. The MTFS is not meant to be a mini budget.

I read the Fraser of Allander institute’s commentary with great interest. It has welcomed parts of the medium-term financial strategy, such as the principles, the approach to the spending review and the capital elements, for which I have given more detail of the borrowing requirements and the principles. The Fraser of Allander institute may be frustrated that I have not set out a full-scale spending review or costings of more policies, but I have not done so for the reasons that I have just given. What the MTFS does is contextualise the financial challenges that we face and the approach that I will take to address those challenges.

I reassure Mr Tomkins that I am taking the forecasts seriously. Those are the assumptions that we will be working to.

We are some way through the looking glass if you think it is all rosy in the garden while we face a £1 billion black hole in those reconciliations, cabinet secretary. It is interesting that you say nothing in your medium-term financial strategy about growth below trend, about real earnings being lower now than they were a decade ago or about productivity lagging behind that of key competitors. Wherever we look in the medium-term financial strategy, it has been condemned as being not fit for purpose and failing to meet the tests that were set for it in the budget process review. Whether we look at what you say about economic and fiscal risks—particularly social security spending—or at spending priorities, it has been condemned not by the Conservative Party but by the Fraser of Allander institute.

Let us focus on just one element of the MTFS that is focused on in the SFC’s comments, to which you have still not responded adequately, cabinet secretary. In contrast with last year’s MTFS, this year you say nothing whatever about spending priorities. You say nothing about what areas will be prioritised and, in particular, nothing about your strategy for non-priority areas. Clearly, you will not want to share with the committee what your future tax policies will be, so what do you have to say about spending, particularly in non-priority areas, in order to address that potential £1 billion black hole?

I disagree with the premise of the question. The report that the SFC has produced, driven by the budget process review group, includes the financial forecasts over the five-year period, proposes a funding trajectory, includes the significant determinants, outlines the fiscal disputes that we have with the UK Government and sets out the principles for the spending review. The spending review is the point at which we will produce further costed policies, and we will then set out our priorities within those. We are also delivering on policy commitments that the Government undertook in its manifesto. We are working our way through those.

Adam Tomkins raised some matters that he did not want me to address, but it is not fair of him to raise them and then refuse to allow me to address them. He was factually incorrect: real wage earnings and income tax take in Scotland are on the increase, and our economic performance is strong. Those things are all threatened by Brexit. Mr Tomkins is shaking his head.

They are threatened by the performance of the rest of the UK.

I am sorry, Mr Tomkins, but where does the SFC report say what you are saying? Nowhere. The SFC says very clearly in its report that it is the threat of Brexit that is impacting and subduing our economic performance—nothing else. There are key factors: population and productivity are areas for us to focus on, although some of that is outwith our control. That is what the SFC’s report says. Rather than complaining about what is not in the report, perhaps Mr Tomkins should have read it. He would then have been better informed for this morning’s questions.

Cabinet secretary, in your answers to the convener’s opening questions you accepted the position that is set out on page 46 of the medium-term financial strategy of a £1.025 billion gap between what is set in budgets and what is forecast in future revenue and block grant adjustments. The scale of the problem is stark. It is surprising that there is no detail in the document about how that will be dealt with.

In the cabinet secretary’s constituency, in the Renfrew South and Gallowhill ward, child poverty is at 35 per cent. I know that that will concern the cabinet secretary greatly. However, it is galling that although the document has a reference to reaching outcomes on child poverty, there is no assessment of the fact that there is a £1 billion forecast gap and no mention of how that will be dealt with to address the unacceptable levels of child poverty, not only in Renfrew but throughout Scotland.

The document covers the medium-term financial strategy. Last year it had costed policies. We will take policies from budget to budget. The Cabinet Secretary for Communities and Local Government will make a statement on the child poverty targets in June and there will be far more detailed analysis and debate on child poverty specifically at that point.

The MTFS is not meant to be a comprehensive spending review or mini budget, rather it sets out the medium-term strategy and latest forecasts. We must not confuse the child poverty targets, actions and policies with the medium-term financial strategy. As I said in setting out the principles for the spending review, I look forward to making child poverty a priority in the Government’s spending plans. I believe that we have used the tax and spending regime in a progressive and fair way.

On the tax forecast, from memory I believe that only one member of the Finance and Constitution Committee said that I should depart from the SFC forecast—I believe that it was James Kelly. It is just as well that I did not depart from the SFC forecast, because that would have compounded the issue of a £1 billion reconciliation.

I have said in answer to your question, convener, and to Adam Tomkins that we assume that those figures are correct for the purpose of having a plan to work our way through the reconciliations with the various tools at our disposal. However, it speaks to the inadequacy of the fiscal framework in dealing with that scale of reconciliation. If it is true to say that there will be a pattern of negative reconciliation and if it is true to say—as the Fiscal Commission has done through new information—that the absolute error of potential could be £500 million a year, that shows the inadequacy of the resource borrowing powers and the ability to draw down, with all the other complications and the welfare powers.

However, no matter what happens, I will balance the books and give Parliament a fiscally prudent and responsible budget every year, by targeting spending in a progressive way through tackling child poverty and promoting sustainable economic growth. I am sure that that will reassure Mr Kelly. Contrary to what Mr Kelly said in the press this morning, the reconciliation numbers are down to forecast error by the forecasters, not Government economic policy.

In relation to the new budget approach that we are all now following, the whole point of a medium-term financial strategy is not only to produce and note the numbers, but to assess their implications. The document that you have produced completely fails to do that. It is not fit for purpose, so would it not be better to rewrite the document so that it can better inform committee members and other politicians throughout the Scottish Parliament of the issues that we face?

I struggle to take lectures from the Labour Party, which has not produced competent budgets during my time as finance secretary. My medium-term financial strategy sets out the principles that we will deploy, the financial scenarios that we face, the issues that will determine the Scottish budget and the approach that we will take to tackle the reconciliation. Further to the medium-term financial strategy, I am giving evidence to the committee this morning on how I intend to approach those issues, including the reconciliation. There is a lot of detail in the medium-term financial strategy.

The Labour Party cannot produce competent budgets and I cannot follow the approach of the prospective Prime Minister, Boris Johnson, whose tax plans do not last five minutes. That is compared with the enduring nature of our fiscal forecasts and budget approach. Our strategy includes the necessary information, and I am happy to take questions on it. That is why I am here.

I want to bring you back to a figure that you shared earlier on the fiscal headroom. Will you confirm that the figure is £26.6 billion?

That is correct.

The figure is, in effect, the UK Government’s Brexit piggy bank that is to be smashed open in the event of our hurtling over the cliff after a no-deal Brexit.

In essence, it is the sum that the chancellor could deploy while keeping within his fiscal targets, but he has chosen to hold back that spending. At first, he said that he was holding it back in the event of a deal, and he has also said that it might be required to deal with the Brexit catastrophe. There are few areas on which I agree with the Treasury, but I agree that its warnings show that a no-deal Brexit would have a catastrophic effect on the UK and Scottish economies. Therefore, the chancellor might deploy the money to deal with that.

The Scottish Government has argued that the resource should be deployed now to end austerity, which would mean real new investment in the economy. Some people go as far as saying that, if the money from the fiscal headroom was deployed, it would end austerity. Instead, it might be used as a bandage for Brexit, and who knows what a new Prime Minister might do? They might use the money as some form of bribe to the electorate. Some people might want to use it to fund tax cuts for the richest in society—although Boris Johnson seems to be in reverse gear.

We have proposed that the money be deployed to end austerity by investing in our public services and the people of our country.

Indeed. I raise the matter because there has been some interest in the committee in a potential £1 billion reconciliation. On the basis of Scotland’s population, our share of the £26.6 billion works out at about £2.1 billion. What impact would that money have on the Scottish budget? What material change could it make to public services and the lives of the people of Scotland?

That speaks to the point that I made earlier. If the money was Barnettised as part of the block grant, we would receive that resource. The limitations on us relate to the block grant, as well as to our borrowing power and the drawdown. Mr Arthur can count and has indicated that, if our share was more than the income tax reconciliation that is required, we would have that extra resource. That would be the impact.

We have had on-going austerity from the UK Government. If it started to deliver the money from the fiscal headroom, the money could have a positively transformational effect by undoing some of the damage that the UK Government has done over the past number of years. As well as the money going to the devolved Administrations, it could be spent on social security, given the particularly punitive and pernicious attacks on some of the most vulnerable people in our society. That is why it is perverse to say that, if that fiscal headroom is to be increased, it should be increased for higher-rate taxpayers. It should be for delivering better-quality public services and making a substantial difference to Scotland’s fiscal position. The exact amount that Scotland would receive would depend on how the money is spent by departments and then Barnettised.

10:00  

Would it be fair to say that, rather than hypothetical black holes around future reconciliations, the real black hole in Scotland’s budget has been caused by the UK Government and austerity holding back that resource?

My views on austerity are well recorded and I am constantly sparring with the Conservative members of the committee on that. Austerity has subdued the economy. That is why the UK has among the lowest GDP growth rates in Europe. Austerity has subdued the economy, impacted on services and society and made inequality worse. Of course, I would welcome it if that fiscal headroom was released to invest positively in our country, and Scotland would get a share of that.

If we got a share of the Northern Ireland bung, that would suit Scotland to the tune of £3.3 billion. You can see how those multibillion figures are stacking up—the fiscal headroom and the contribution that Northern Ireland got but which Scotland did not. Those are substantial figures. We are not talking about tens of millions of pounds; we are talking about Scotland losing out on billions of pounds.

That adds up to almost half the national health service budget.

This will be your final question, Tom.

Thank you, convener.

My final question is about the fiscal framework. One of the key drivers for difference in performance regarding higher earners in the Scottish and UK economies, and perhaps more generally, is population growth. Ultimately, we will be at the mercy of population growth, especially growth in the working-age population. Is it fair that that can have such an impact on the money that will be made available to Scotland via the fiscal framework given that we have no power over immigration to combat the Tories’ hostile environment, which can put people off wanting to come and work in this country?

When it was asked about the comparison to the OBR UK forecasts, the SFC said:

“We are forecasting a weaker economic outlook for Scotland compared to the OBR’s forecast for the UK. This is primarily because of slower growth in population and productivity in Scotland than in the UK.”

Of course, we do not control population although we would like to. We would like to have more powers around migration, because it is having an impact. When you look at the structure of the economy and the population, you can see that a shrinking working-age population and a lower number of people paying taxes have a disproportionate effect on Scotland. That is materially significant to the Scottish Government’s budget and it affects our tax revenues, so it is a structural issue.

We said that we would revisit the fiscal framework after one full parliamentary session of evidence and operation. However, if we look at the levels of reconciliation, some of the factors that are outwith our control and some of the new information on average forecast error and what might be a structural issue around higher-rate taxpayers and deepening inequality in the rest of the UK, we might want to consider revisiting the fiscal framework earlier, as well as the other concerns that I have raised around VAT and air departure tax. That is all adding complexity and volatility to a situation that I think all members are concerned about.

Cabinet secretary, you raised the issue of the fiscal framework. I know that Patrick Harvie is interested in that. Is your question a supplementary or is it on a separate point, Angela?

I have two questions: one on Brexit and one on child poverty.

In that case, we will go to Patrick Harvie.

That is fine.

I will follow on a little bit and then link to the longer-term issues about the fiscal framework.

Notwithstanding the fact that we do not know what the UK Government will do, we know that there is a real chance that the next couple of budgets will have to absorb a substantial impact from the result of a reconciliation. I agree with some of the criticisms that have been made of the medium-term financial strategy, which sets out an analysis of why we are where we are but does not really say what we are going to do about it, which is what a strategy ought to do.

However, there should also be a political strategy associated with this, because the Government will still be a minority Government in the run-up to those two potentially challenging budgets. If you are in a position of trying to figure out how to do stuff that you do not want to do—stuff that none of us would want to do—as a result of challenging circumstances, how will you set out a Government approach to achieving wider buy-in for responding to those challenges, not just from within the political spectrum but beyond? If this is just a matter of Opposition politicians shouting, “You’ve failed your homework” and you shouting, “I’ll take no lessons from you”, we will get nowhere. How will you achieve wider buy-in to the potentially challenging decisions that you might find yourself forced to propose to Parliament?

Patrick Harvie raises a fair question. In fairness, it is not a question for just the finance secretary—I am one of 129 MSPs, and all MSPs will have to behave responsibly and carefully consider our collective priorities.

On the question of how I propose to make headway, one of the areas that I touched on was the spending review. We will set out our policy priorities—I mentioned child poverty and climate change as examples—and find out where the collective priorities are in Parliament, so that the parliamentary arithmetic will allow a budget to pass in challenging circumstances.

It is not fair to say—as Patrick Harvie did—that we should discount the block grant; that is, and will continue to be, the largest component of the Scottish budget. We cannot therefore discount it and scenario plan everything else.

I am not suggesting that we should discount it.

We have outlined a range of scenarios, including an upper assumption and a lower assumption for the overall financial envelope within which we think we will be working, and levels of probability around that. However, fundamentally, all those other factors are materially significant for the budget that we will set.

As I have always tried to do, I will take an inclusive and engaging approach to the budget, so that we can agree on priorities. Although there will be challenging reconciliations, for the reasons that we have discussed this morning, they are not the only fiscal factors that determine the budget or the overall financial envelope. I agree with Patrick Harvie that the Parliament also has to mature and recognise that it is not about just throwing about accusations as to who is responsible for the Fiscal Commission’s forecast error—because, actually, the Fiscal Commission is responsible for its forecast error. We, as a Parliament, are responsible for passing a budget, and I am responsible for the Government’s finances and for proposing that budget. I have delivered balanced budgets, and I intend to continue to do so.

When we approach the budget, we will set out our spending priorities and how we propose to tackle the reconciliations in each year. However, that will draw all our attention to considering further fiscal discipline and ensuring that we are getting value for money, as well as using the borrowing powers and the drawdown in a responsible way.

You mentioned the spending review. Are you fully committed to that spending review taking place, regardless of whether the UK Government does one?

It depends on how much information the UK Government gives us. If it gives us absolutely nothing, it would be very difficult to set out a comprehensive and credible spending review for the Scottish Government—it would be more illustrative than credible.

Irrespective of the UK Government’s decision about its spending review, does the Scottish Government plan to hold a multiyear review of spending?

The medium-term financial strategy report goes on to say that it will be determined by the information that the UK Government makes available. In any event, because it is the right thing to do, I intend to focus on our spending commitments and priorities, and on issues such as cross-departmental expenditure, outcomes and wellbeing. We might also be able to set out multiyear spending on capital. Although it is my intention to do a spending review, I am sure that all members understand that it is easier to do that if the UK Government is conducting the equivalent spending review, because it influences so many of our numbers.

I will move on to the longer-term future of the fiscal framework, of which a review is due in the coming years. If I understand the process for that correctly, if it is to be delivered after the 2021 election, the work on a report to advise both Governments will probably have to begin—or at least be framed—in the next year.

It seems that the fiscal framework that was arrived at between the two Governments—some of us expressed concerns about it at the time that it was being presented—has put Scotland in the position of having partial fiscal autonomy for double the uncertainty. That uncertainty is coming from not one set of fiscal forecasts, but—as the cabinet secretary said earlier—from two: two different methodologies by two different organisations. Any normal Government would have some uncertainty from its set of forecasts, but it would be able to manage that with greater fiscal autonomy. We seem to have half the autonomy for double the risk. Is that something that we got wrong with the fiscal framework, and does the way that it is reviewed need to be addressed?

I have a lot of sympathy with that analysis, especially as I am the person who is responsible for making the system work. As it happens, I had a meeting yesterday with the Organisation for Economic Co-operation and Development, which is conducting a review of the Fiscal Commission’s functions. The OECD will produce a report, which I am sure will be made available.

Frankly, independence has to be easier than the fiscal framework as a way of running a country’s finances. It would also give us more levers and powers to deliver a more successful nation. However, the framework is based on the political agreement of the time. It is complex and involves volatility and uncertainty, with a lot of unforeseen consequences. The Brexit outcome was not anticipated, and it is having an impact.

On some of the procedural and technical issues, again, new information has emerged. The resource borrowing power is capped at £300 million and there is an overall borrowing limit. There are good reasons for having parameters for that capacity but, if the average potential forecast error is £500 million a year, that shows that the current parameters of the fiscal framework are increasingly inadequate as we get new information and as delivery of the Smith agreement unfolds. If we add to that uncertainty my concerns about VAT and the legal issues with air departure tax, that shows that we need an engaged UK Government to make the necessary corrections. We are trying to abide with the agreement on the fiscal framework review and the timescales for it, but that is clearly proving to be challenging.

To be fair to the Treasury, there has been some accommodation. For example, that happened with the baseline for the starting position on income tax, which was a very technical issue. However, key principles are being challenged as the fiscal framework operates. I therefore have a great deal of sympathy with what Mr Harvie says, and I intend to raise those issues further with the Treasury. We are dealing with a volatile situation and an uncertain level of risk.

It is a fair guess that one of the losing Tory leadership contenders will end up as the next chancellor. Does any of them strike you as being up for that discussion in a constructive spirit?

I would love you to answer that, cabinet secretary, but I want to move on. Mr Harvie has made his point.

That is more than fair enough.

Obviously, I will follow closely how the Government takes forward its commitment to tackling child poverty—as will other members, as we would expect. I am among those who complain loudly about the limitations of devolution and the fiscal framework. In short, it is a bit of a dog’s dinner, and I do not know of any country in the world that has a remotely comparable arrangement.

However, the bottom line is that, although Parliament has signed up to ending child poverty and has introduced statutory targets with very challenging interim targets, by 2023-24 total public spending will be £183 billion less than it would have been if it had remained on a par with 2010-11 spending. That is where we are starting from and that is the scale of the challenge, which we all share.

How will we have a discussion about our priorities, what we can and cannot do, and how to use the powers that we have to maximum effect? How do we have a grown-up discussion about what levers we could use better and what additional levers we need, so that we have, as a minimum, a more coherent package of powers that will make our lives a little easier in respect of tackling child poverty?

That is a good question, but I want to ensure that I heard you correctly on the figure on UK Government austerity. When we make the comparison, as we traditionally do, between investment levels at 2010-11 and those in 2023-24, which is the end of the forecast period, we find that we will have £18.3 billion less than we would have had if spending had remained at 2010-11 levels. That is the figure on austerity and the reduction.

With regard to on-going austerity, the issue is not just to do with the resources that the Scottish Government has available. We also need to bear in mind the wider impacts of policies on some people—those impacts are significant. The policies include the benefits freeze, the two-child cap and the cash freeze on working-age benefits. Those UK policies are impacting on child poverty, and on poverty in general.

10:15  

On what we can do about that, I have covered the MTFS and the financial disputes that I have with the UK Government—it could address extra resource needs. We need to focus on the national performance framework, which is about outcomes, and not just inputs. We need to align and calibrate our efforts around the sense of wellbeing and outcomes that we are trying to achieve, as a country. Of course, people will then say that what is spent in those areas is important, and will judge people by their spending commitments, so the spending review will also set out the areas where we want to focus on outcomes. That focus will expressly and explicitly include child poverty.

As I engage with Cabinet colleagues on the spending review, I will, of course, ask the SFC what we are contributing to sustainable economic growth, but I will also ask about child poverty, specifically.

When we look at spending in the areas in which we have social security powers, we can see that, over the forecast period, it will reach a peak of £3.5 billion. There might be further volatility. If we are saying that we will have a system that is based on dignity and respect—many of our payments will be more generous than the analogous payments from the UK Government—we will invest in that, and we will do so specifically in relation to child poverty targets.

I think that the Cabinet Secretary for Communities and Local Government will—there is certainly a report on this—be making a statement to Parliament on the targets for child poverty, assessment of those targets and what more we will do to address them. We will look at the affordability and deliverability of social security policies, too.

We will look at all policies in the round in order to address child poverty, recognising that some are financial and some are non-financial. Child poverty will be foremost in our minds, as we look at future budgets and the overall spending review.

I hope that that is of assistance.

I am glad that the finance secretary corrected my figure.

I will move on to Brexit. My question is similar to the previous one on powers, options and limitations. We know that the Scottish Fiscal Commission has based its position on there being an orderly Brexit—whatever that is. It said in evidence to us last week that the probability of an orderly exit has reduced, and that the probability of a no-deal Brexit has increased. What happens if we crash out without a deal? What will be the impact on your work? What are you doing about it? What could you do? What thought have you given to where your priorities will be? Would having increased borrowing powers help? I know that there has been some discussion and thought from the Scottish Futures Trust on other finance models, including on the mutual investment model that the Welsh use. You must have in your head the priorities in which having increased powers would help.

Brexit is, I think, a deep concern for us all. Any form of Brexit will damage the economy and lead to lower economic growth, lower gross domestic product, lower earnings and higher unemployment.

The SFC report describes an orderly Brexit as some form of deal with transitional arrangements, which is why the forecasts are so subdued. It is true to say that, if there was no Brexit at all, the financial forecasts would have been far more positive, which would in turn have been good for our revenues, our economic health and achievement of our outcomes.

The Prime Minister tried and failed to get a Brexit with a deal—she has lost her job because she could not get that orderly Brexit through the Westminster Parliament. It seems that there is little prospect that an orderly Brexit will be delivered. It is politically pertinent to say that unless there is a change of leadership—and a change of heart in many people—it does not look as though any Tory contender will deliver where Theresa May has failed, but who knows? If there is an alternative deal, we would need to analyse it.

The no-deal Brexit that is in prospect would be economically catastrophic. The economic analysis of a no-deal Brexit includes unemployment soaring from its current record low of 3.3 per cent, with up to 100,000 people being made unemployed. There would be business failures and lower exports, GDP would collapse and the economy would go into recession, which would have a significant impact. All that has been factored into the Scottish Government’s resilience thinking.

What, specifically, am I doing about it? As well as preparing as best we can for finance and the economy, we have contingency plans for the public sector. We have been working across the public and private sectors to produce those contingency plans. We have made resources available and we are considering the economic response in the event of a no-deal Brexit, because it would be economically so catastrophic. We have also been working with the banks, because access to finance would be an issue.

We are also looking at business support to try to mitigate the impact. However, no Scottish Government or Scottish Parliament can totally mitigate the impact of a no-deal Brexit which—also according to the SFC—now feels more likely.

I am testing the convener’s patience about time, but members are asking serious questions, and I have a final point to make. If there was to be a change in fiscal policy by the UK Government, either it could unlock the £26.6 billion fiscal headroom to invest in public services, or it could use it to put out the fire that will start if we have a no-deal Brexit. It will be up to the UK Government how it uses those resources; we will have to reset the Scottish budget accordingly.

I come back to the Fraser of Allander institute’s report, which can be summarised by its title: “Where’s the ... strategy?” Specifically, it says that

“what is striking was the lack of analytical assessment about the economic outlook—the key risks and opportunities we know that are coming from demographic change, automation and climate change—and how this might impact upon the public finances.”

Does the cabinet secretary think that that is an accurate assessment of his lack of assessment?

I have said that I understand the Fraser of Allander institute’s frustration at the Scottish Government’s not having presented either a full-scale spending review or a mini budget. However, the report was not intended to be either: rather, it sets the financial parameters and it sets out the forecasts and projections. A further round of forecasts will determine the next big fiscal event, which is the Scottish budget. Before that, there will be a UK budget. If there is an emergency budget, there might even be two.

We are in uncertain times, so I have not set out illustrative scenario planning, which would just be speculation on a range of possibilities. I have set out the conditions and principles that I propose to deploy and the figures within which I am working. I defend the document that I have produced and the evidence that I am giving today, which show that we are focused on the financial challenge that we face.

That might be the case, but there is still a lack of assessment of some of the numbers around population and demographics. Last week, I put this question to the Scottish Fiscal Commission. Population is obviously a combination of birth rates, mortality rates, people leaving and inward migration, but net UK inward migration numbers remain steady, so does the cabinet secretary think that even if we stayed in the EU single market, that would completely close the growth gap between the UK and Scotland?

Mr Burnett is asking good questions, but part of the challenge is that we do not control migration; we do not have a policy that determines how many people can come to Scotland.

Working-age population—the composition of the tax base—is important. When it comes to tax take, the numbers of people in the working-age population shrinking is the biggest issue for Scotland’s economy. We can do much around economic performance and attracting people to Scotland, but we do not control migration. The projections say that the population in Scotland can grow only through positive inward migration.

Who wants a hostile environment in relation to migration to Scotland and the rest of the United Kingdom? The UK Government wants it, so that migrants do not come to Scotland and the UK to contribute financially. The cause of the problem is not the Scottish Government, but the UK Government’s migration policies—hostile and mean-spirited policies that deter people from coming to the UK. We will have economic growth only if we have a growing population and a growing working-age population. We need to achieve that through migration. Mr Burnett is aware that the biological route would take more than a year or two to improve the working-age population profile.

I thank the cabinet secretary for saying that I ask good questions, but there is a fundamental point of disagreement. Migration is not the whole solution. Even if we were to remain part of the EU single market, it would not be the full solution. Although migration might be part of the cabinet secretary’s proposed solution, the real issue is that we are not creating the right skills base in Scotland and are not training our young people as we should be. If we rely purely on migration and on increasing the population, we will not improve our productivity figures. That was borne out by the evidence that we took from the Scottish Fiscal Commission last week.

That characterisation bears no relation to the evidence that I read in the Fiscal Commission’s report. I read out a quote from its report in relation to population growth being the main driver of the GDP forecast. On GDP per head of population, we are reaching the point of convergence with the rest of the United Kingdom. Per head, Scotland does well on GDP growth—in some quarters, we have outperformed the rest of the United Kingdom. We are outperforming the rest of the United Kingdom on reducing unemployment and on exports, and we are second only to London and the south-east of England on foreign direct investment.

However, on migration, which we do not control, the UK Government is discouraging people from coming to work in the UK and—by association—Scotland. There is the magnetic appeal for migrants of London and the south-east of England, so we need to work harder in Scotland, which is why we want an approach to migration that is suited to Scotland’s economic needs. Who has refused to take such an approach? The UK Government has.

There has been progress in productivity over the course of devolution: progress has been faster than in the rest of the United Kingdom. There has also been growth in wage earnings. To dismiss matters of migration and population is to totally dismiss the evidence from the independent forecasters, to whom Mr Burnett has asked me to look in order to inform my view.

In relation to the skills base, I point to our economic action plan and skills plan. We have brought down youth unemployment and are enhancing the skills agenda. We are doing more work on productivity through the national manufacturing institute. We are also investing in education so that we have more graduate apprenticeships, and more young people are going to positive destinations.

I am afraid that Mr Burnett’s characterisation is a total distortion of the facts. However, the fundamental question was right—we need to look at population as a factor in Scotland’s economy.

Last week, Professor Smith spoke about worries about the skills of native Scots. Does the cabinet secretary share—

No, he did not say that. Do you want to read the quotation properly? Then, I will read what I have from the Official Report.

Professor Smith said:

“Obviously, that is not to say that we do not need to worry about the skills of native Scots—of course, we do.”—[Official Report, Finance and Constitution Committee , 5 June 2019; c 22.]

Does the cabinet secretary share Professor Smith’s concern about skills?

Professor Smith said that we need to focus on the skills of Scots. I accept that, which is why we are investing in the measures that I have just listed. The SFC’s report, which relates to the overall economic drivers, to the financial forecasts and to GDP, says that the difference in the forecasts is down to population and productivity. It is as simple as that.

We are investing in productivity, but we do not control matters relating to the population. Are we investing in our education, skills and apprenticeship systems? Are we delivering jobs? We can educate people, but the crucial issue is whether we are creating jobs. Given that unemployment is at a record low, at 3.3 per cent, it looks as though we are. By some definitions, that is full employment. Employment is at a record high.

The only divergence is coming from deepening inequality as a result of wage increases having been higher for higher-rate taxpayers in the rest of the UK than they have been for others. That point of divergence speaks to issues of inequality and is worthy of consideration.

I am interested in issues relating to complexity and potential conflict resolution. One of our papers says that the fiscal framework sets out provisions for a memorandum of understanding between a multiplicity of agencies, including the OBR, the SFC, the Department for Work and Pensions and Her Majesty’s Revenue and Customs, to support effective operation of the framework. That appears to contribute to the complexity of the fiscal framework, and we know that that causes different projections, based on forecasts and estimates. I am sure that the complexity causes conflicts, so how do you resolve them? What could be done to make the framework less complex? The first thing that comes out of everyone’s mouth is, “It’s complex.”

10:30  

It certainly is complex.

I mentioned the meeting that I had with the OECD yesterday. The OECD will produce a report, which members will be able to scrutinise once it is finished. I do not want to put words into the OECD’s mouth, but it is fair to say—this goes back to the point that Patrick Harvie and Angela Constance made—that the framework is about as complex as a system of devolved finance can get. Even the OECD has not seen anything as complex. However, there we have it: it is a political agreement, and there are technical agreements.

Good relationships are important. The committee has taken evidence from HMRC, and we have engaged with it through our service-level agreement. In the technical areas, we try to get as much pragmatic resolution as possible. However, the framework is based on a political agreement on what powers would come to the Scottish Parliament, and there are then technical issues that are discussed between officials on how the system operates between the Treasury and the Scottish Government. We are doing our best to make the political deal work, but as I have said throughout the meeting, as we look at the figures and the concerns that members rightly have about the scale of reconciliation, and the prospect of those issues continuing over a cycle of a few years, I feel increasingly that, taking all those issues together, the current parameters are inadequate and the current agreement needs to be revisited.

The timescale that has been set out for the review, by agreement between the UK and Scottish Governments, is that it will be done by the end of this session of Parliament. The details of that are yet to be arranged, and those would go through the joint exchequer committee in any event. However, I think that we need an earlier review. The Treasury will need to engage with us earlier because of the complexity that is emerging, how the system is developing and the fact that we are dealing with things issue by issue. Clearly, the complexity is giving us much food for thought.

The joint exchequer committee governs the implementation, operation and review of the fiscal framework. Does that process need to be engaged with more regularly to support a further review?

I do not know who will be the Chief Secretary to the Treasury once there is a new Prime Minister and, potentially, a new Chancellor of the Exchequer and ministers. However, in the most recent discussion that I had with the current Chief Secretary to the Treasury, Liz Truss, she said that she was looking at reviewing the joint exchequer committee as part of a review of intergovernmental relations. There is the prospect of a review of the joint exchequer committee, but that is a commitment from the current Chief Secretary to the Treasury when I last met her. The next time I meet her, we will raise the issue again.

In your foreword to “Scotland’s Fiscal Outlook: The Scottish Government’s Medium-Term Financial Strategy”, which is the document that we are discussing and which you published two weeks ago, in the final sentence of the fourth paragraph, you state:

“In Scotland, we have used the limited powers at our disposal to protect key services, despite the £2 billion real-terms reduction to our block grant since 2010.”

Is the latter part of that sentence true?

Yes.

It is not true, is it?

It is true.

According to the Scottish Parliament information centre and the Fraser of Allander institute, it is not true. There has not been a £2 billion real-terms cut in our block grant since 2010. Our block grant has increased in real terms since 2010, as you well know. Why did you publish a document with an untruth in it?

It is true. This is the periodical debate that Murdo Fraser and I have. If levels of investment had been sustained at 2010-11 levels, we would not have lost out on the resources that we have lost out on. It is true that, over the period of austerity, the UK Government has failed Scotland and the whole of the UK through that on-going austerity. This is the issue that we have around fiscal resource—

The statement is untrue.

No, it is not.

You have previously made the point that your limited resource budget has been reduced—I might disagree with your figures on that—but, in the statement that I read out, you say that the “block grant” has been reduced. However, the overall block grant is up, and SPICe and the Fraser of Allander institute will confirm that. Will you take the document away and correct it, because you are misleading Parliament? What you say is untrue.

On the contrary, I am happy to give Murdo Fraser more information on how the fiscal resource departmental expenditure limit has been reduced in real terms as a consequence of—

With respect, the foreword does not refer to the fiscal resource DEL; it refers to the “block grant”. If you had said that the fiscal resource DEL had been reduced, you might have had a point, but you do not make that point; you say that the “block grant” has been reduced. The statement in the document is untrue.

While we are on this important subject, can I just say that I think that that is the first admission ever from Murdo Fraser that the total fiscal resource DEL has indeed been reduced?

No—if you check the Official Report, you will see that I qualified my comment.

No, I think that you have just conceded that point, Mr Fraser. The point that I am making—

There is an important point here—

Let us stop this discussion now. It should be one person speaking at a time, please—one person should ask a question, then the other one should answer. You can go back to that format, or I will end this bit of the session and move on to Willie Coffey.

Okay. I think that I have made my point, which is that there is an untrue statement in the document—

No.

—and that you need to be more careful.

Let me move on, because I want to follow up on the questions that Tom Arthur asked about the Scottish budget. Can you remind us of the total value of the annual fiscal transfer to Scotland from the rest of the UK under the Barnett formula?

I have been taking the questions all morning, but if you want to go into specific details, I will ask officials to cover that.

I do not have that specific number to hand, I am afraid, but I would be happy to supply it.

You can check the annual “Government Expenditure and Revenue Scotland” figures that are published by the Scottish Government but, from memory, I think that that figure is in excess of £10 billion a year. That is a fiscal transfer to the Scottish budget from the rest of the UK. Perhaps the cabinet secretary will recognise that figure.

Does Murdo Fraser want to get to his question?

I was simply wondering whether you knew what your GERS figures said.

I am more than happy to debate GERS, but it is something of a sideways step from the medium-term financial strategy. GERS presents the notional estimates of what is raised and spent in Scotland. It is true that, as in the rest of the UK, there has been a notional deficit. Mr Fraser is well aware of the growth commission, of which I was a member; we show how we can address that notional deficit, make different policy choices and grow our economy to reduce that notional deficit. In the most recent GERS publication, the notional deficit was down.

There are many years in which Scotland would have been in a better financial position relative to the rest of the UK, but there are others in which that will not be the case. If we were an independent country, we would not be dealing with the Brexit madness, and we would not have had austerity and subdued economic performance. We would be performing like most small advanced economies around the globe and growing our economy. The conclusion that I take from GERS is that it is the current constitutional position that has given us an estimated notional fiscal deficit.

You mentioned Brexit. You said earlier in the session that you regretted the failure of the Prime Minister to get her orderly Brexit deal through the House of Commons. Do you now regret that Scottish National Party members of Parliament voted down that deal?

No. I am happy to correct the record, if that is what I said. I regret the failure of the Prime Minister full stop. The Prime Minister has been a failure, she has fallen on her sword and she could not even do that right. As far as delivering Brexit is concerned, it would have been better if she had delivered the result in Scotland, which was, of course, to remain in the European Union.

The point that I was making was that all the analysis shows that a no-deal Brexit would be economically catastrophic. We have also analysed what the impact on Scotland’s economy would have been if there had been a deal—there would have been growth foregone. The best economic and social outcome for Scotland, and for the rest of the UK, is to remain in the EU. However, no potential replacement Prime Minister looks as though they will do any better for the UK or Scotland and no new chancellor will give us coherent tax policies, from what I have seen of Boris Johnson’s commentary.

Willie Coffey will take us back to the medium-term financial strategy.

Thank you, convener. This might be helpful in leading us into our next round-table discussion. Page 16 of the strategy document talks about EU funding and programmes and says that those are worth about £5 billion to Scotland over the 2014 to 2020 period. To set some context for the discussion that is coming up, can you tell the committee where we are with those programmes, which are worth a substantial amount of money to Scotland? We have had three years to plan for whether they will continue as they are or whatever. What is your understanding of the current arrangements with the UK Government concerning the continuation of the EU programmes?

The figure that Mr Coffey gives is right—in the current budget round, EU funding is worth more than £5 billion to Scotland. That supports jobs and infrastructure, sustains rural communities, provides valuable support to the farming and fishing industries and delivers research for universities. Those are some of the areas that have benefited from that £5 billion.

We have no certainty about what the replacement funding from the UK Government would be in the medium and longer term. The Scottish Government’s position has been that there should be no financial detriment to Scotland’s economy or public finances as a consequence of exiting the EU. However, we have no guarantees from the UK Government and no detail on some of the specific funding streams. I am sure that that will all be revisited after the takeover that is happening in the Tory party right now.

We have had three years to try to set some terms of reference for what will happen but, for the past three years, those in the UK Government have been fighting among themselves like ferrets in a sack and no work has been done in this area. The EU programmes are crucial for the future of Scotland.

The Scottish Government has been trying to work on the matter, but it is hard to deliver successor schemes when we do not know what will succeed the existing EU schemes.

Commitments have been given on some elements of funding, but not specifically on what Scotland would receive, which would determine how we could deploy those resources. Our principle has been that there should be no detriment; I am not sure that that will be delivered.

If we look at the current persuasion of those who are vying for the support of the Tory membership, they do not seem to be too mindful of Scotland’s economic needs, and I doubt that making sure that Scotland and the other devolved Administrations get a fair deal—recognising that Scotland did not vote for this mess but will be paying for the financial consequences of it—will be foremost in the next Tory Prime Minister’s mind.

I am sure that work has been done at UK Government level, but there have been no decisions on the medium and long-term continuity of the funding, and no details on what funding we will receive post-exit.

I thank the witnesses. I suspend the meeting briefly before we move to the next item, which is on EU structural funds.

10:41 Meeting suspended.  

10:51 On resuming—