Official Report 602KB pdf
Good morning, and welcome to the ninth meeting in 2026 of the Finance and Public Administration Committee. We have received apologies from Craig Hoy.
Under our first agenda item, we will take evidence from the Scottish Fiscal Commission on its report “Fiscal Sustainability Perspectives: what Scotland’s finances mean for the next parliament”, which was published last week. We will also take the opportunity to explore with the SFC issues to be included in our legacy report for our successor committee.
I welcome, from the Scottish Fiscal Commission, Professor Graeme Roy, the chair; John Ireland, the chief executive; and Claire Murdoch, the head of fiscal sustainability and public funding.
I invite Professor Roy to make a short opening statement.
Thank you, convener. I give apologies on behalf of my two fellow commissioners, Dr Eleanor Ryan and Justine Riccomini, who both had prior appointments that clashed with this evidence session.
The report that we published last week brought together our fiscal sustainability work with our five-year forecasts to set the context for the next session of the Scottish Parliament. It is a further development of our work to improve scrutiny, as it brings together many of the themes that we have raised over the course of this parliamentary session.
The incoming Scottish Government will face a number of structural issues. Our latest assessment is that the funding available to the next Government will remain tight. Current plans suggest that average annual growth in day-to-day resource spending will be just 1.1 per cent in real terms over the next five years. From 2027-28, the Government’s capital budget is projected to fall in real terms.
In contrast, demand for public services is expected to rise. By the end of the next parliamentary session, in 2031, we expect that nearly a quarter of people in Scotland will be over 65 and that a million people will be receiving disability payments.
At the same time, we point out how policy choices that have been made in this parliamentary session will have implications for the next parliamentary session, too. For example, the legislative targets for reducing child poverty by 2030 and achieving net zero by 2045 will require additional investment, particularly given that interim progress reports have pointed out that much quicker progress is needed if those targets are to be met.
Alongside financial pressures, there are pressures on public services, particularly on the national health service and local government services, which have yet to fully recover from the position before the pandemic.
Throughout our evidence sessions with the committee, we have discussed the size and cost of the public sector workforce. Available evidence to date suggests that there has been some limited progress in workforce reductions and pay restraint, but we highlighted the risks relating to the current Scottish Government’s pay assumptions for 2027-28 when we published our forecasts in January. Managing those pressures will require difficult choices to be made.
Our report calls on all political parties to be realistic and open when making new commitments ahead of the May election and to set out a clear and credible plan for how they will ensure fiscal sustainability.
The new Scottish Government will need to explain how it intends to address fiscal pressures, and that needs to be done in a way that enables the Scottish Parliament to debate and scrutinise the most effective responses.
That leads me to the legacy issues on which the committee has been taking evidence in recent evidence sessions. We agree with witnesses who have stressed the importance of shifting the focus of budget scrutiny to the medium and long terms. Progress has been made on issues relating to the presentation of the budget and budget revisions during this parliamentary session, but there is still work to be done. On-going questions about transparency and consistency in relation to the budget presentation detract from wider issues of scrutiny and evaluation.
I thank the committee for its work and the support that it has given to me and the Scottish Fiscal Commission over the past five years. I am conscious that, although some members are seeking to return, some are retiring, so I look forward to them reading our reports on the beach.
I thank Michelle Thomson for her work on improving understanding of Scotland’s budget within the United Kingdom framework. She has pushed us hard on issues such as diversity and tax-based performance gaps, which has been helpful and welcome.
I thank Liz Smith for her support on access to data. Her questions about policy and inactivity have also been helpful and welcome.
I thank John Mason for his healthy scepticism of any forecasts, projections or pay policy analysis, which has also been welcome.
Our work has evolved since 2021. We now publish regular reports on fiscal sustainability and we have expanded our commentary on the Scottish budget. All those developments have been thanks to the committee’s support. The committee’s persistence in pursuing improvements to the budget process and its recommendations on how our work can allow for better scrutiny have been invaluable in improving how we operate as the independent fiscal institution for Scotland.
I want a eulogy in case I do not come back. Unlike those folk, I have to go in front of the voters, along with Michael Marra and Patrick Harvie.
Anyway, thank you very much for that opening statement. It is actually very helpful. There are a number of issues that you did not touch on; for obvious reasons, I will probably move to those first. For example, in paragraph 1.23 in your report, you said in reference to the thresholds at which tax is paid that
“the divergence in the thresholds has led to the number of higher rate taxpayers in Scotland becoming larger, and rising faster than in the rest of the UK.”
You go on to talk about how, just a few short years ago, people working in the Scottish public sector were paid, on average, £400 a year more than people in the public sector down south. They are now paid £1,500 more, on average. Is that having an impact in terms of the number of people who are moving into the higher bands? They are getting paid more, but are they moving into a higher rate of tax at the same time.
You are right. The big change in tax policy over the past few years that has generated lots of revenue has been not so much about the additional rates and bands as about the effects of fiscal drag coming through.
Sorry—I meant the fiscal drag in terms of the threshold, of course.
Exactly, and you can see the particular effect of that. Because of where the income distribution is, you have more people in and around those middle-income ranges, so if you freeze those rates for longer, more people will move on to that higher rate. That now includes many more people who are working in the public sector, relative to where we were in 2016-17.
The average wage for a teacher, a charge nurse or a police constable is now around that level at which you start to move into higher rate tax bands. From that base, and if the thresholds remain fixed, in any pay future award, they will be paying the marginal increases of that pay award at the higher rate, and the Government will essentially recycle some of that back into the budget.
Okay. So, the proportion of people who are going to be higher rate taxpayers will exceed the proportion down south, whereas it used to be lower.
Yes, the percentage of higher rate taxpayers is now higher in Scotland than in the rest of the UK. The UK is also freezing thresholds, but we have frozen them lower and for longer. The key thing is that that is how the Government is raising revenue—the Government is choosing to do that in order to raise revenue to then reinvest in public services.
You did not touch on capital funding in your opening statement. We are going to be talking about the infrastructure delivery pipeline in the next session, but you say in paragraph 1.50 of the report that,
“In 2023, around half the projects in the 2021 Infrastructure Investment Plan had been affected by cost increases or delays.”
I was first elected in 1992 and I do not remember a time when that did not happen, not just in Scotland and the UK, but elsewhere. Where are we in relation to that particular issue? It seems to be almost built in—not deliberately, of course. It seems that delays and cost overruns are almost de rigueur in infrastructure investment. Is it a serious concern? Has the problem grown? Has it stayed the same? Has it become less of a problem in recent years? Where are we on that, and how do we compare Scotland to, for example, high speed 2, the rest of the UK, or whatever?
Claire Murdoch and John Ireland might want to come in on some of the specifics, but, in principle, there are always going to be delays and cost overruns, particularly in major projects and complicated projects.
That was not the case with the Forth road bridge project, so it is not inevitable.
There are exceptions to it, but part of the general problem is how this links in to funding and, in particular, some of the lumpiness of the funding coming through. We have spoken before about the previous UK Government’s decision to front load capital budgets into the early part of the spending review and then to have them fall away towards the end of the spending review. From a planning point of view, that can be quite difficult, because you are then trying to accelerate projects with potential costs. You are trying to move them on quickly, but then, as you see from our work, the real-terms capital budget falls over time. The ability to plan out a pipeline of investment is not just about what you do on the spending side of things; it is also about the overall funding projections, and that is where it gets quite tricky.
In paragraph 1.51, you point out that 93.5 per cent of the Scottish capital budget effectively comes from Westminster, so we are basically at the mercy of the decisions that are taken there. That was a big feature of your presentation last Thursday. I think that we all accept that we are having a real-terms reduction in capital, and it is probably deeper in real terms than you say, because we use a gross domestic product deflator, which I have talked about before. That means that delays and cost overruns have an even more adverse impact on maintenance and new capital projects, does it not?
The Government can try to smooth that out through what it does on the capital borrowing side. That is what it has done historically—it has moved capital borrowing up and down on the basis of particular trends. That is one of the things that the next Parliament will have to deal with, as we have highlighted.
The current Government has big commitments and big plans, including around infrastructure, with some big projects that need to be delivered. However, current funding projections mean that careful prioritisation will be needed. Some projects will not be able to go ahead if the overall budget declines in real terms.
You talk about the devolved public sector workforce having some 468,000 full-time-equivalent workers and how that figure has been growing by 100,000 or so under devolution. Some of that is accounted for by the extra powers that have been devolved, but a lot of it is due to the NHS, the ageing population, the need for a larger workforce and so on. People become older and frailer and need more support.
However, in paragraph 2.7, you highlight a reduction in the police and fire services workforce from 28,500 full-time-equivalent workers 12 years ago to 26,675 in 2024-25. Would one not expect that anyway? We went from having eight police boards to having just one, so we no longer have eight headquarters and all of that infrastructure, which meant having eight chief constables, eight deputy chief constables and so on. Is such merging of funding streams in order to be more efficient and have larger overall bodies not what the Scottish Government should do, given that it aims to reduce the workforce by 13,600?
That is partly right. There have been efficiencies and rationalisation in areas such as police and fire services. A key part of that goes back to what has been happening to the budgets overall. Earlier in the report, we talk about funding being relatively tight for the current parliamentary session. If we prioritise health and social security, it is simply arithmetic that other areas have to pick up the slack. Areas such as local government and justice naturally have to have less growth or find savings if other areas are prioritised. We then see falls in those workforces.
We make two broader points on workforce. The first is that the ambition to shrink the size of the public sector is different from the trends that we have seen since devolution. It is quite a different approach, and there are big questions about how we should do that and what the potential implications of doing it are. The second point is about how we do that strategically. We have heard about prioritising non-front-line workers, but what is a non-front-line worker and how might losing a non-front-line worker impact on services? We can probably list people who we think are front-line workers—nurses, teachers and so on—but what other roles sit around those that are needed to deliver public services? How do we concentrate and do that in a strategic way that fits with ambitions around public service reform and prioritisation of key portfolios?
Frankly, I am not convinced that such labels are helpful, because one cannot work without the other. I would have thought that it is always about a team approach.
You started your opening statement by talking about growth, and what you said seemed quite pessimistic. Both the UK and Scottish Governments are committed to growing the economy, but you expect only about 1.1 per cent growth in day-to-day resource spending over five years. Pre-crash, it was an average of 2.9 per cent, which seems like the sunny uplands compared with where we have been for the past 15 or 16 years.
There seems to be a clash. You say in the paper that, as we move forward, the workforce relative to the dependent population will decline because of demographic change and so on. At the same time, we also have new technology. I appreciate that, for folk who are working in social care, it is a lot more difficult to increase productivity than it is in some kind of advanced manufacturing facility. Why do you feel that growth will be stuck at 1.1 per cent? Is there no way to escape that fairly depressing trend?
09:15
If you look at our data, you will see a chart showing that living standards grew by about 3 per cent per year in real terms during the first decade of devolution but have grown by an average of less than 1 per cent per year since then. That is quite stark and shows some of the broader challenges of poverty, having high-quality jobs, and the ability to generate tax revenue for investment. We are in the situation that we are in because of growth challenges in the economy.
That challenge is not unique to Scotland but is faced by most high-income economies. Some of it is demographic and is caused by an ageing population, but the key factors are weaknesses in growth and productivity. Economists think that growth will bounce back at some point, but it has not done that yet. The next hope is that tech will get our productivity back up and running. There is lots of policy work: the UK Government industrial strategy really tries to focus on that, and the Scottish Government is doing similar things.
One reason why we do not know where tech will go or what the effects of it will be is that we do not know how much the revolution in artificial intelligence and the shift into tech will be what we call labour enhancing or labour replacing. We do not know how much it will make us more effective in what we are doing, leading to improvements in economic growth, and how much of it will just replace what we are already doing, with the effects essentially cancelling each other out. You only have to look at the current stock price of some big companies to see that people have placed a big bet on the first of those options and think that AI will be labour enhancing. However, if you look at recent stock prices, you will see that some people might be taking a slightly different view or feeling concerned about whether the payoff will be as big as we hope.
There is also the issue of broadening the tax base, which we might come to in a few minutes.
I found it really quite touching that you wrote in paragraph 3.1 of your report something that you have reiterated today:
“Political parties need to be clear about what the Scottish Government can afford and the impact on public spending for people in Scotland. Manifestos should make clear if any additional spending commitments set out would need cuts to other areas of spending or raising more revenue to fund them.”
I thought that it was quite sweet and innocent of you to write that.
We get to hold you to account at the ballot box.
I know that our manifesto will meet those criteria.
There is a really important principle.
Yes, there is.
We make two points. One is that we are facing a challenging fiscal situation, which sets the context and constrains the narrative. Our second point is about whether there is a long-term plan for fiscal sustainability. I do not have the expertise to know whether you can work on that in the heat of an election campaign, but, when the new Parliament and Government come in, they will see the reality of what is available in the fiscal envelope, and that is when the rubber will hit the road.
Parties err on the side of optimism because voters do not want to hear that things arenae really going to get much better for the next five years, which is effectively what you are saying. There is a real issue with trust and delivery and with whether everyone can say what they need to say.
One thing that shocked me is something that we have discussed before to some extent and that is stark in the figures that you have set out. When writing about social security and adult disability payment in paragraph 3.19 you say:
“We estimate the number of people receiving … ADP has increased from 320,000 in 2021-22 to 475,000 in 2024-25. The percentage of working age adults in Scotland reporting a disability rose from 19 per cent in 2020-21 to 28 per cent in 2023-24.”
That figure is still rising and you go on to say that you anticipate
“that the total number of people receiving disability payments in Scotland will exceed one million by 2030-31.”
I know that adult disability payment is not means tested, which means that people who are working can also be on that payment. People often get that payment for life, although it can be reviewed every two to five years. Why are so many people on that payment? Are so many people in society really suffering from a disability?
The number of people receiving the disability payments is lower than the number of people who report having a disability. That suggests that large numbers of people have a disability but are not in receipt of those payments. One feature of the trend that we are seeing is more awareness of the potential opportunity to access payments and of the differences in systems, which are now leading to higher inflows into the payments, not just in Scotland but across the UK.
As we have discussed before, we are seeing a rising trend of people saying that they have a disability, particularly in relation to mental health and wellbeing. In respect of young people, that is particularly worrying. We have previously spoken about child disability payments and so on. Again, the situation is not unique to Scotland. Lots of work has been done to examine the decline in mental wellbeing across different countries. It used to be that the graph of wellbeing was a U shape, with people having higher levels of wellbeing when they were young and then when they were old when they had relatively high incomes, and lower levels of wellbeing when they were working and in middle age. That U shape disappeared, and there are now relatively low levels of wellbeing at a relatively young age.
One interesting policy question concerns the long-term effects of that. If there are significant inflows of young people into disability payments, with young people reporting disabilities in mental health and wellbeing in particular, what are the long-term effects of that on society, public services and the economy? The data shows the inflows over the past few years, and the obvious questions are about what is driving that and what we can do upstream to improve policy or take action so as not to have that considerable inflow.
The rise seem to be inexorable. Are we really becoming a sicker society in such a short period of time? One could argue that there was a significant increase during Covid—I do not think that anyone would disagree with that—but Covid is now some years in the past. Of course we realise that it had an impact on the younger generation, but this is not just about younger people, is it? The data would not concern 28 per cent of those of working age if it was only about young people.
No, it would not.
There are two parts to it. First, in a chart in our report, we consider the uplift in—
It is in all age groups, is it not?
Yes—across all age groups.
There are two parts to it. First, the biggest uplift is among young people. That pressure is concerning. Secondly, with the proportion of people on disability payments rising with age—as we would expect, as we get older—there is a fiscal cost as our population ages, so even if we maintain the same levels of disability prevalence, but the population ages, it will cost more money and put more pressure on public finances. Because our population is ageing more rapidly than that of the UK overall, there will be a net fiscal challenge: the flows coming in will not match, because England and Wales do not have the same population profile.
That is an issue. You say at paragraph 3.37 of your report that
“the funding the Scottish Government receives from the UK Government because of its spending on climate change mitigation”—
this being in a somewhat different area from social security—
“would not be sufficient to cover the total costs faced by the Scottish Government.”
We are in a situation where we will potentially end up with a growing fiscal gap. Do you see that happening?
This is where the nature of the fiscal framework does not always link through to where some of the pressures may be. The largest part of the budget remains the Barnett payments, which are a population share of equivalent spending in England or in England and Wales, depending on the element. If more investment is needed in Scotland for climate change, for instance, a Barnett consequential of similar investment in England or in England and Wales will not match the additional spending that would be needed in a Scottish context.
I was down in London yesterday, and in the chats that I was having, a number of people kept pointing out that Barnett gives Scotland a higher percentage of spend in the first instance, but that just means that any growth from this point will only be a per capita share, while some areas will need a higher share than that.
In one of your Scottish Parliament information centre seminar presentations, which covered the long-term impact of climate change, you said that the UK cannot reach its climate goals unless Scotland reaches them because of the disproportionate amount of work that needs to be done on, for example, peatland restoration. Is that factor being taken into consideration?
You are right. We have said that it not just that the UK needs Scotland to meet its climate goals but that the UK needs Scotland to meet its climate goals earlier. The target in Scotland is important for the UK to meet its goals.
This is an issue in which there is an interconnectedness between Scotland’s fiscal framework and a shared policy endeavour with some policy responsibilities that are reserved and some that are devolved—we talked about that when we did our climate change work. For Scotland to meet its net zero target, decisions need to be taken by the UK Government on energy, the grid and transport. Scotland needs decisions by the UK Government to feed through. On the spending side of things, how much and when the UK Government spends on net zero and climate change mitigation will have an impact on how much money the Scottish Government has available.
Equally, you are right that what the Scottish Government does will have an impact on whether the UK will meet its targets.
This is a classic area in which such coordination and interconnectedness rub up against the fiscal framework. In the future, it might be an area in which there are genuinely shared policy priorities that require the two Governments to work in lockstep to meet the targets that are set out. Whatever people think about the constitutional settlement and the politics that are involved in that, it is a simple, mechanistic fact that certain decisions need to be taken at certain points in time by different tiers of Government—including local government—in order for collective targets to be met.
Thank you for that response. I have just two more questions. In paragraph 3.41, you stated that spending on the Scottish child payment will be £552 million by 2030-31, which will be an increase. Given that the birth rate is at a record low level, one might have expected that sum to fall, unless poverty is expected to rise. Why is the sum going up?
A large part of that—Claire Murdoch can correct me—will be due to the effects of inflation.
The sum is not in real terms, then.
It will largely be due to our assumption about rising inflation rather than falling—
Sorry, I just assumed that it is a real-terms figure.
It is a nominal figure.
Yes, it is a nominal figure.
Okay, that is fine—apologies.
In paragraph 3.28, on local government services, you stated that
“the Improvement Service reported that in 2022-23 and 2023-24”—
that is a couple of years back—
“(the most recent data available) more performance indicators declined than improved … 45 per cent compared to 39 per cent”.
Will you tell us what you think the reasons for that are? Is that balanced? For example, were the 45 per cent of indicators that declined in large or small areas of local government spending, or were they equally balanced? Some indicators might be quite small while others might be significant. Will you tell us a wee bit more about that picture?
The general point that we made is essentially twofold. One aspect is about the legacy for the next Parliament, which will face and inherit pressures, particularly in areas such as local government and health services. Local government is a particularly interesting area because it has been under pressure with regard to budgetary allocations in the current parliamentary session. The tight settlement in the spending review and the prioritisation of health and social security means that local government will again be under significant pressure. Simple cash and funding is one of the big factors that is driving the decline.
Claire, do you want to come in on some of the specifics?
Those figures are based on reports by the Accounts Commission and the Auditor General. We are highlighting their conclusions that the declines are important findings, that public services are under pressure and that performance is declining in more areas than it is improving.
Governments, wherever they are, always talk about reducing spending or keeping spending the same, and, if they increase it—I say that because, if we look at the big picture, we can see that there are real-terms increases—that increase might be less than is required. However, efficiencies do not always follow: the fact that you are spending less money in an area does not mean that it will become more efficient.
09:30
I agree. One of the really interesting things to pick up is that the Government has set out quite an ambitious efficiency-saving target. The spending review is underpinned by £1.5 billion of efficiency savings. The Government has started to set out in broad terms what that would look like in individual portfolios, but there has been no detail about what the savings will be and how they will be monitored over time so that, if there have been, for example, £1 billion-worth of efficiency savings in health, we can see what they have been and what the consequences of them have been. That will have to be considered at the start of the next parliamentary session.
We can say that we are going to make efficiency savings to get the budget to balance and then allocate all funds to the various elements. However, you are right to say that, if we just move on to the next budget and say that that is what we are spending and we will make some savings in certain ways, there will be no read-through to how the money has been spent and what the outcome of stopping spending money on certain elements has been.
It all comes back to outcomes.
Thank you for those responses. Michelle Thomson will ask the next questions.
Good morning, and thank you very much for your kind comments. I would like to confirm that I am not retiring—I will just send that signal to the marketplace. In return, I thank you very much for all your efforts. I have seen some great stuff emerging over this parliamentary session.
I want to take things up a level. Obviously, we are focusing on your publication, but our conversation now has to take place in the face of the considerable uncertainty introduced by global events over the past few days. We can be pretty certain that what is happening will flow through into the economy in terms of inflation, and that there will be a short-term impact on supply chains and so on. However, there might also be a longer-term impact in terms of increased defence spending. I would appreciate your thoughts on what the impact of the situation might be. We have some models to draw on, such as what has happened as a result of the Russia-Ukraine conflict. Have you started modelling scenarios? You might not have done that, but I would appreciate your thoughts, anyway.
That is a really interesting question. As is the case with the productivity assumption, we always hope that the next few years will be more stable globally, as that is one of the key things that will help economic growth to recover. Such shocks have an impact on growth in various ways, as they dissuade investment and create uncertainty, which acts as a brake on growth over the medium to long term.
There are probably two or three key ways that the current situation will flow through into the Scottish budget. First, you are right to say that Scotland will not be immune to any global economic slowdown that might occur and that there will be an impact on the Scottish economy and Scotland’s trade. There is always a slight quirk or disconnect with regard to the outlook for the Scottish economy when things occur that have an impact on energy. When energy prices rose after Russia’s invasion of Ukraine, we saw that that had an impact on Scotland, particularly in the north-east.
Overall, there will be an impact on economic growth, and there will be effects on individual sectors such as trade, tourism and the like. I mentioned the broader point about the drag on investment from the uncertainty that is created.
All of that is on the growth side. On the inflation side, you would expect that anything that leads to higher energy prices will flow right the way through into inflation. Inflation is still above trends—it is still sticky—so that might lead to more aggressive action from the Bank of England to try to pull down inflation, which might lead to effects on interest rates.
All those effects will impact on the economy, which, in turn, will have an impact on the UK’s fiscal position. Even before we think about the reprioritisation of spending, everything that I have set out means that the fiscal targets will be a little bit harder to meet. That is not so much the case on the spending side or the revenue side; it is more to do with the fact that the economy will not grow as much as we might have thought that it would, which gives us less fiscal headroom. That then feeds through into what might happen with future plans around spending, which might lead to shifts in where money is allocated. One of the reasons why the block grant is growing so slowly relative to the overall growth in public spending is that the Government is prioritising defence and security spending relative to other areas, which means that there is less money flowing through to education and such things, which in turn leads to effects on Barnett. Overall, it is still very early days, and we need to wait and see what happens, but those are the sorts of things that would act as headwinds for the outlook for the Scottish budget and the economy.
As to what we will do about it, we will monitor things. The Office for Budget Responsibility report is out today. It will probably not have much in it, because it will have been written before the weekend; the Chancellor of the Exchequer will probably provide an update on the Treasury’s assessment of how the situation will feed through. That will be the first signal of any UK-wide macro effects at the margin, but it will probably take a few months. It is the sort of thing that we will work on over the summer to see what the effects will be before we publish our updates later in the summer.
:Either way, the effects will not be good and will add to an already constrained situation in a number of different areas.
It is interesting to look at the analysis on living standards in the report. We show that there was growth all the way up to the financial crisis. Since then we have had the uncertainty around Brexit, Covid, the Russian war in Ukraine and the energy price collapse, and now we have the situation in the middle east. There has been a constant series of shocks that have had an impact on the Government’s ability to manage the public finances and grow the economy.
:Is there a risk—for a multitude of forecasting agencies, not just your organisation—in the wish that things would turn a corner and go back to a certainty that, in reality, is just not going to arise? Is that something that you are aware of in your organisation? As you said, post-2008 there have been non-stop productivity issues but there is an idea that we are going to return to a world that arguably no longer exists.
Yes. I was studying at uni when we were in the nice decade, everything was stable, and we had cracked macroeconomics.
:An end to boom and bust, I seem to remember.
An end to boom and bust, yes—there were all those good phrases. You are right—we have seen a general weakness in productivity plus the succession of shocks that feed through to the economy. The challenge for us—this is something for us to think about, and we have tried to do a bit more on it—is that we have to forecast a point estimate for the economy and for revenues, because that is what we are there to do, because that underpins the budget. You are right that, as of today, we do not know exactly what the economy will do next year, given everything that is going on. It is highly uncertain and there is a challenge for us about how we communicate that uncertainty and how we present it in a way that does not just say, “Well, it could be anything,” but gives people reasons why it is not guaranteed that growth will be 1 or 1.5 per cent. There is a lot of potential movement around that.
:It was good that the convener brought up the point about climate change, but the other issue is technology. There are many reports emerging with amazing projections around what AI will ultimately do to the labour market and how that will flow into the wider economy. I appreciate—I have probably asked you about this before—that it is impossible to forecast that with any degree of accuracy. However, there will be a tipping point where, without giving that consideration, we are all living in an utterly meaningless bubble because there is no certainty whatsoever. How do you manage that?
Some of this is about putting things into context. This is just a personal view, but I think that some of the stuff about AI—for example, how much it will radically change everything, at least in the short to medium term—has been overegged. However, it might well have an impact; indeed, we highlighted in January the OBR’s work on this and its suggestion that AI might boost productivity towards the end of the forecast period. We say in our commentary that we believe something similar.
The key thing—this brings me back to what I said to the convener—is whether the improvements that we are seeing in tech and digital at macro level are labour enhancing or labour replacing. That will be the key effect at that overall level. Within that, though, there is a really big distributional question: if AI replaces labour, who benefits? The answer is, not the workers who are being replaced, but the people who own the capital and who are doing the replacing. How we ensure that those effects are distributed fairly over the long term will probably be the big policy question, not just for Scotland but at the macro, global level.
:Getting back to the matter in hand, I want to ask about something that Liz Smith usually brings up—the behavioural impact of fiscal drag. I know that you routinely factor that in and make an assessment of it, but have you given any further thought to the quite stark differential between Scotland and the rest of the UK with regard to the number of people who are being pulled into the higher-rate tax band? Is that increasingly becoming a concern? How are you treating it?
We monitor that all the time. John Ireland might want to come on in this, too, but we always look at tax elasticities and check that they are still based on the right evidence.
The really important issue is the type of people who will pay the higher tax rates and what flexibility they have to change their behaviour. We tend to assume a much higher elasticity of response at the top end of the income distribution, because those people tend to have greater flexibility to adjust their tax affairs, whether it be to self-incorporate, to relocate or to work fewer hours. The vast majority of people affected by fiscal drag and the freezing of the higher-rate threshold will be those in salaried jobs who will have much less flexibility to take action or do anything in the short run.
In time, we might see certain effects at the margin—for example, the removal of things such as part-time working, flexible working and early retirement—but, for the most part, we are not likely to see radical or huge changes in behaviour, because of the nature of the labour force and the types of people going into the higher tax bands.
:That leads me to my final question. You talked at the start about my pushing on diversity; I did a routine keyword search of your report and I noticed that the word “women” is mentioned once, “disability” is mentioned 28 times, and “child” is mentioned 40 times. It was a bit hard to search for “ageing”, because you use different terms.
Thinking about the challenges that we face—particularly with the cuts to health and social care, which we know will have a disproportionate impact on women, given their caring roles, how many are in those sorts of professions, the poverty effects and so on—I have to wonder why we are blind when it comes to any such data in your report. I have highlighted this issue before, but can you tell me what your rationale is in that respect? I would like to understand it. Moreover, might you consider doing something about that in future, given the disproportionate impact that we are seeing in certain emerging scenarios? I do not think that your report gives us that data or that insight, which I am sure that you have.
It is a fair challenge. Partly, it is to do with the fact that we are looking at the macro effects. When we look at particular child or disability issues, it is because we have picked them up in the public finances. However, you are right. More could be done to look at the inclusive effects, the effects on growth and whether, say, cuts to local government budgets are having a disproportionate impact. We have said that, if there is a demand for that sort of thing, we might start to feed it in and look at it in, for example, our long-term fiscal sustainability work.
Part of it comes back to the quality of data, and we have talked about some of the real challenges with labour market data. That would be the obvious place to look at gender differences, but we have faced some really big challenges in that respect. I hope that that will start to turn around, which will mean that we can take a better look at different rates about effects on the economy and what sectors are most likely to be exposed to economic shocks. We would probably pick that up in our fiscal sustainability report.
09:45
:You could also help me in what has ultimately been my failed mission to get the Scottish Government to routinely disaggregate and collect data by sex. It does so in many areas, but not in others.
That is me, convener.
Thank you. We will go to Liz Smith, followed by John Mason.
Good morning. Thank you for your kind remarks. I also put on the record my gratitude for all that you, Professor Roy, and your colleagues have done for this committee. Your work has been extremely important to the Parliament, so thank you very much for that. I am not sure that the data that you have presented to us means that there is enough for all of us to retire, but thank you very much for all your work.
I will concentrate on the section in your report about the in-tray for the Scottish Government. The convener quite rightly pointed out paragraph 3.1, which says:
“Political parties need to be clear about what the Scottish Government can afford.”
That is absolutely true. All political parties should—they do not always do it, but they should—make sure that, when they are presenting their own policies in manifestos, those policies are properly costed. It is also important to note here, and this is a message for members in the next parliamentary session, that when Governments state their overall objectives—we have four from this Government: tackling child poverty, ensuring economic growth, having sustainable public services and addressing climate change—those are all ambitions and aims, not the specific policies that underpin what we are trying to do.
When any Government sets its priorities, do we have enough data to tell us which policies are providing the best outcomes when it comes to delivery, and do we have enough data on which policies have been deprioritised because they do not deliver in the same way?
The short answer is that we do not have that data. It is not routinely published or collected by the Government in that way. It is for the Government to evaluate and track policies. The climate change policies are probably a good example of that. We said what the Government needed to set out and that it needs to be able to trace through the policies and their effects on the reduction in emissions. We also told the Government that it needs to get that information to speak to the budget, so that we can open up the budget document and see exactly where the money is going and how it flows through to the policies, which then flow through to what is happening to emissions; however, that has not happened.
:I know that you cannot comment on what policies the Government should choose, but would your advice to those in the next parliamentary session be that greater care should be taken to set out in the budget what the priority policies are and to provide the evidence that underpins them, so that there is better delivery of the policy outcomes?
In general, anything that improves transparency or helps scrutiny is welcome. For example, for big-ticket items, what are your collective policies? How much are they costing? When will they be delivered? What is the effect? That can be done. You can do an appraisal of what you think the effects will be, you can monitor whether the effects are as expected, and then you can evaluate whether they have had the necessary impact. It is entirely possible for policy makers to do that.
:I am asking the question on the back of the comment that political parties need to be clear about what Government can afford. Part of making spending decisions depends on which policies we feel are making the greatest impact in what we are trying to achieve. Over my 20 years in this place, I have found that that is quite difficult to track, which makes it difficult for MSPs, but particularly for the Scottish Government and this committee, to be able to drill down sufficiently on where we are getting the best bang for the buck with public spending. Given all the challenges that you have set out in your report, it is vital that we try to do a bit more on that.
There are two parts to that. I understand that the Parliament and MSPs have limited resources to do that sort of dive, but the Government has the resources to do that if it wants to and that might give a future finance committee the opportunity to really scrutinise priorities. What we said about climate change was a good example of that. The committee could ask what the Government is spending and when, how that is being tracked, what the Government is not doing and what it is evaluating and could ask it to be open about how that works.
The medium-term financial strategy could do that and we have said that we think that we could have more of a role in the MTFS to track and to do a bit more scrutiny of Government spending. That will always be relatively macro, whereas you are talking about getting into the weeds to work out details such as whether an extra £100 million for tackling child poverty would best be spent by uplifting the Scottish child payment, by supporting breakfast clubs or by giving money to local government.
:That is exactly my point. We need to find more detail on that to ensure that we are spending money in the best way possible.
My other reflection is that the next Parliament will face several seriously big challenges and that one of those is to make a decision on universal payments. There is a lot of commentary at the moment about what universal payments deliver and how well they deliver it. Will it be easier in the post-election period—as opposed to now, during the pre-election period—to get cross-party evidence, or additional evidence from outside, to help us understand the universal issue? There is an argument that we cannot possibly afford all the universal payments that we have just now without considerable implications for the rest of the budget.
There will be a policy decision about the relative focus and we would not comment on whether that was the right thing to do. However, I can make a couple of general comments.
Universal payments cover a lot of things that have quite significantly different costs. It is important to work through what we mean and what the potential implications are, which goes back to your first question about evidence. What is the evidence that a universal payment is having the desired effect? Is it having a skewing effect? How much does it cost? What could be saved? What might be the opportunity cost of spending that money somewhere else?
Our numbers suggest that the next five years will be really challenging, so we may have to start having conversations about the fact that, from an arithmetic point of view, continuing as we are will be really challenging and that things will become more tricky if we do not take different actions. We might start to think about where we could do something different or about how much of what we do is a priority and whether we might spend the money somewhere else.
:That is very helpful.
My final point is about the fiscal framework, which, technically, is also in the next Government’s in-tray. I am not asking you to say what the policy behind that should be, but would you like the Scottish and UK Governments to address any aspect of the structure of the fiscal framework?
John Ireland and Claire Murdoch will want to come in on that, so I will be really quick.
There is the broad challenge of how the Government balances its budget every year, whether it has the levers that it needs for cash flow, budgeting and monitoring and whether those are flexible enough. In recent years, we have seen the Scottish Government increasingly using things such as ScotWind as balancing mechanisms. If the Government does not have enough in reserve, cannot borrow enough and does not have the ability to have an overdraft, it can say that it will use ScotWind as a balancing item. That just does not feel right, so there is a question about how much flexibility the Government has to manage the budget.
The timing of fiscal events will always be tricky. More certainty around fiscal events and more time between a UK fiscal event and a Scottish fiscal event, so that the Parliament has time for scrutiny, would seem to be obvious asks. I do not know whether Claire Murdoch and John Ireland have a wish list, too.
With many of the things in the fiscal framework, we can explain the effect of the way that they work, but, ultimately, those are matters for political negotiation. Both sides engage in political trade-offs that determine how the framework works.
Other than on the issues that Graeme has already talked about, it is a bit hard for us to make recommendations about how things should work, but, given the interlinkages that there are between the Scottish budget and the UK budget as a result of fiscal devolution, the point about timing is probably one of the most important ones.
:Thank you.
You said that I was healthily sceptical, so I will continue in that vein.
We have looked at all sorts of things, including commissions, and the point has often been made that there is a need for public inquiries because there is a lack of trust in the public sector. However, the confidence that people have in the SFC—along with others, such as the Auditor General—is exceptional. That is very commendable, and all of you are to be thanked for creating that position, which we want to continue.
Returning to my healthy scepticism, there is a section in your report on the impact of UK Government fiscal decisions. I am interested in that whole space, which we have touched on previously. We can plan all we like, and we can believe that we have a certain deficit or budget gap, only for the situation with regard to winter fuel payments, the two-child limit mitigation or welfare reforms to suddenly change. How do we get the balance right in that regard?
That is a great question. The first few years of the big tax and social security devolution measures were all about the Scottish Government doing things differently. A lot of our discussions were about what the Scottish Government had chosen to do, the cost of that and how the cost had increased. However, especially in the past year to 18 months, it has become evident that we are dealing with an interdependent process in which UK Government decisions have a big impact on the Scottish budget.
That has come through in relation to social security, in particular, but it could also have come through in relation to tax, because, back in October, there was talk about income tax changes at the UK level, which would have had an immediate and significant impact on the Scottish budget. That is the nature of the framework. If the UK Government takes decisions in areas that are devolved, that will have immediate consequences for the Scottish budget.
That brings us back to the point about the fiscal framework and what we should do about it. Are there things that could be done that would enable us to do more planning or to have greater certainty? Obviously, having only one fiscal event a year might help in that regard, as it would enable us to see potential effects. The £1 billion swing that we saw between our forecasts in June and our forecasts in January was largely to do with potential changes in UK Government policy. That is an example of what the Scottish Government has to deal with.
The point of principle is that Scotland should not benefit from or be negatively affected by decisions that will have an impact on England and Wales. That is how the framework works. However, from a public finance point of view and a management point of view, there is an issue with timing, which relates to the ability for such events to move around. That is a particular challenge.
:In an ideal world, we should ask the UK Government, as part of the fiscal framework, to always give us a year’s notice, say, before it makes any change, which would enable us to plan accordingly. Even today, the UK Government could make a dramatic announcement. It has hinted that it will not do so, but, if it did, that would immediately impact us.
Claire Murdoch might want to come in on that. The timing is key. If the UK Government decides to reform the personal independence payment to reduce payments for people in England and Wales, under the fiscal framework, it is entirely right that Scotland should not benefit from that. If savings are made in England and Wales, Scotland should not continue to receive the same funding. Savings should be made in Scotland, too. It will then be up to the Scottish Government to decide whether to mitigate that.
That is the framework working as it should. The question then is, how much time does the Scottish Government have to plan for that? Again, that comes back to the question of whether, within the framework, there might be greater ways of flexing money within a year. The Government can borrow only for forecast differences in social security that come through in-year, when the block grant is adjusted; it cannot structurally borrow—it cannot say, for example, “You told us about this change in December, but we were not planning for this. You should give us a grace period.” There is no mechanism by which it could borrow to deal with that issue and then pay the money back, with a year to plan and get ready for that.
10:00
:Am I correct in thinking that, sometimes, when a last-minute change has been made, we have been given a bit of extra flexibility?
There are some things that would be handled through the Barnett formula, which happened in the pandemic period, when things were done around certainties of payments and so on. There have been changes to different elements of flexibility. There is also stuff within the fiscal framework about delaying the effects of announcements that are made. However, I guess that your broader point concerns something that might be outside that grace period. If there was a big and significant change relative to what the Scottish Government had planned, adjustments would have to be made accordingly.
There is a bit of a strange issue in terms of timing. If the UK Government makes an announcement in the autumn and then we have our Scottish budget, that has to be factored in when the budget is set for the next year. However, if the UK Government makes a change today for next year and then there is provision in the fiscal framework, that means that the Government does not take the hit initially and the change will come through a bit later. The reality of those timing differences in terms of the Government having to manage the situation is pretty negligible, though.
There are small technicalities that relate to whether we have some adjustments. For example, outturn data from the Department for Work and Pensions came in a bit late last year, so the Government has deferred the final reconciliation until next year. That issue came through in the autumn, but we could still have some big changes coming through during the current financial year on social security or the fully devolved taxes that the Government has to manage in-year. There is a bit of imbalance about when the Government can access borrowing and when it cannot.
:Is that almost inevitable, or could we pin something down in a revised fiscal framework that would tidy it up a bit?
I think that Graeme Roy can answer that.
The one way that you could do it, from a technical point of view, would be to allow the Government to borrow on the revenue side, not for a forecast error but to address the impact of a major change in policy, or just to enable it to have some funds to manage the situation from year to year.
If the UK Government stuck to its system of having more regular spending reviews, that would be helpful. We had the UK spending review and we had the MTFS, and there have been changes since then. The Government should be planning over a three-year period, and you can see that those uncertainties and changes will have an effect on planning and the budget over that time. However, under the fiscal framework, the Government can borrow or make those adjustments only for the coming year’s budget.
:Earlier, the convener mentioned the £1.5 billion savings. Paragraph 1.45, on page 13 of your report, says:
“The Spending Review indicates the Scottish Government has identified £1.5 billion of savings”.
Is that just savings in a very general sense, with nothing specific being identified?
We do not know. We hope that the Government has identified specific savings. You may remember that, at the time of the spending review, the Government published a document whose name I cannot remember—it was something to do with portfolio efficiency plans—in which it broke down that £1.5 billion by the savings that it expected to be made within each portfolio. There are two ways in which that could be taken: it could be a macro imposition of how much portfolios must save, or it could be a bottom-up assessment based on what the people who work in the portfolios think could be saved, which adds up to £1.5 billion.
:On the issue of the population ageing, I am just wondering how much I should worry about that—obviously, I am ageing and am about to retire, so that is one angle. More widely, however, we have figures for the percentage of the population that is between 16 and 64, which traditionally was the working-age population. I guess that we will continue to use that demographic so that we can compare the situation with previous years? Is that right?
Yes.
:Practically everyone now works until the age of 66, and the age is gradually increasing to 66 years and two months, or something like that. Does that counteract the problem, or is it still a problem?
The main effect is on the spending side. You are right that the traditional working age is changing, which might have a marginal impact on income tax revenues over time as people move into retirement at 65 and above. The broader point—and what really matters from a Scottish perspective—is twofold. It is not so much about the population that is aged 65 and above as about the fact that the number of those who are aged 75 and above will increase, particularly in Scotland, over the next decade or decade and a half, which will affect Scotland’s share of the population within the UK. It is not just that Scotland’s population is ageing; it is that it is ageing more quickly than that in the rest of the UK. Scotland’s Barnett share of health spending is based not on age but on population, so we think that, over the next 10 to 15 years, Scotland’s age demographics relative to England’s and even Wales’s will create a particular pinch point. The population in England and Wales will catch up with ours in the future, but there will be a wedge over the next 10 to 15 years during which Scotland’s population will age faster and Scotland’s share of the UK population will increase.
:The fiscal framework is complicated enough as it is, but we could try to build that in. I presume that Governments could discuss whether they should tweak the fiscal framework.
In principle, you could vary the Barnett formula or do all manner of technical things. I was in London yesterday, and it was pointed out to me repeatedly that the Barnett baseline is higher in Scotland, per head, than in England and Wales, so you would open up a broader conversation about how needs assessment is done across the UK.
:That is fair enough. The convener also spoke about the performance level of several key public services falling. Let us take health as an example. There are long waiting lists. Is that necessarily because the health service is failing, or is it because people’s demands and expectations are increasing? It is good that there is more discussion about mental health than there used to be. There may not be an increased need for mental health services but there is certainly an increased realisation of that need. Obesity, which was not around so much when I started my working life, seems to have increased. Can we differentiate between demand increasing, on the one hand, and the service failing, on the other?
The reports go into some detail about the different aspects of that issue. Some of it is because of increased demand post-Covid and the effects of ill health feeding through; some of it is due to an ageing population. The average age of the population is quite different from what it was 20 years ago, which is adding more pressure.
We have spoken about this before, and the convener has raised it, but things such as productivity measures within the NHS have been under pressure and in decline, and they have been challenging in recent times. There have been challenges with delivery, delayed discharge and all those sorts of things. When you package it together, those things all mean that the outcomes have been under pressure and the NHS has faced a challenging situation. Added to that is the fact that health inflation is rising faster than the GDP deflator that is used, which is feeding through and adds to the pressure. The NHS may be getting more money, but the ability to spend it on stuff is under pressure, because drugs and treatments are more expensive.
:Is the health service different in that you have to put more money in almost to stand still, especially if we have an ageing population and all the other factors you have mentioned?
Yes. In a country where the population is ageing, even to maintain the same standard you will have to put more money in. We have made some charts that show that the average demand on the health service is increasing, particularly as people get above 75. So, if there are more people above 75, you need to put more money into the health service just for it to stay still. On top of that, things such as new treatments, new drugs and demand prevalence make the situation all the more challenging.
Of course, the real solution to all of that is not to stop us ageing, because that is a good thing, but—and it is easy to say—to ensure that we age healthily. That is the key thing that needs to happen, and it involves not just health spending but spending across all aspects of the public sector.
:On productivity, is it inevitable that the health service will always be more people intensive? I have an issue with my eye and, when I go in for a test, I see somebody to do with distance, somebody else to do with pressure and somebody else who gives me an injection. It is quite hard to see how the health service could cut down the number of people involved in such things.
Yes, it is labour intensive. We have talked about some of the effects of productivity in the health system and why it is different from elsewhere—Claire Murdoch might want to come in on that. In most other sectors and industries, technological improvement leads to efficiencies, reduces costs and has an impact on demand. However, historically, technological improvement in health has led to increased demand and cost. For example, a new drug discovery does not necessarily mean that the health service will save money. It might mean that it spends more money. That is the effect over time.
Claire, do you want to come in on that?
You have summarised it, and we covered it quite extensively in our report last year on health.
Those are assumptions, because, ultimately, society and politicians can make choices about whether they continue to fund health in that way. However, internationally, health tends to receive increases in spending beyond what an ageing population alone might imply and we do not see quite the same improvements in labour productivity, because health is more labour intensive.
:Are you saying that it is an international issue and that it is not just the case here?
Yes.
Good morning. I want to touch on two topics: local government and climate.
Your report picks out the expectation that local government is in line for a pretty raw deal over the coming years compared with other areas of Scottish Government spending. That is in a context where we already hear about severe pressures and about some councils facing a genuine risk that they will fail to meet statutory obligations. Quite a few of the witnesses who have spoken to this committee when we have been looking at our legacy issues have highlighted that in terms of the “broken” nature of the council tax—that is the phrasing that comes up most frequently; in other words, the idea that we do not have a functional modern tax system for local government. We have spoken in the past about the fact that you do not make the projections for council tax because it is a local tax, but that seems to me to echo the fact that the Scottish Government has a bit of a hands-off approach. It will set the financial context for local government, and then it is for local government to worry about the consequences. Will you comment on where we stand at the moment and on the likely impact of the spending reductions that you have highlighted on those services?
Will you also comment on how we grasp the challenge of developing a coherent approach to taxation generally? Assuming that there continues to be a majority in the next Parliament for progressive tax as a principle, an element of redistribution to fund universal services and so on, how can council tax, or local government taxation more generally, play its part in a coherent tax policy for Scotland when the current system is so wildly outdated?
I will pick up the point about tax and say something about what we think we can do in relation to that, partly in response to your question last time but also to give our sense of what we are seeing from other people in relation to local government.
10:15
You are right that we do not forecast council tax. There is a technical reason for that: it is not in our remit. However, when we look at the basket of devolved taxes, we can see that council tax is hugely important. You will probably know the reasons why better than me, but it always struck me that there is a broad consensus on wanting to reform council tax but we are never able to do it, and that goes way back—
:Yes, it is very tiresome.
—to the first coalition Government. For most people, council tax is the tax that is crying out for reform to make it more effective and to raise revenue. It is more for politicians and policy makers in the next session to think about what to do about that, but there is work that we can and are keen to do much more of, particularly on the spending side in local government. At the moment, we look at the overall outlook for the Government and what it will allocate to the local government budget and then we see that it will pick up the slack. We can do a lot more to look into that and to consider what aspects local government is funding itself and then trace that spending through to outcomes. That is an area that we are thinking about. It was part of the Organisation for Economic Co-operation and Development review of the SFC, and it has been part of our ask to expand our work into spending. That is one of the areas that we will probably focus on over the next year, namely, what more we can say to help the Parliament in that regard in relation to local government. You are right that we have not really looked at that, partly because it has not been in our remit. However, it is sufficiently within our remit, particularly on the spending side, that we can look into that and say much more about it.
:Would that work involve looking at the implications for local government services or for the rest of the public sector, too? For example, when local government cannot do X work to the standard that it would wish, that will have a knock-on impact on the health service; when the Scottish Government is trying to put an extra £100 million a year into culture, the danger is that that simply results in councils cutting their culture spending much more than they already were, because they know that the extra money is coming in from national Government?
There are two aspects to that. One aspect, which is interesting, is what is happening to the overall feed-through of spending, but the really interesting bit is how the areas interact. For example, in some of the big-ticket areas, how do we know what the different spending priorities will be and what the interaction is between those? For example, from the data that is published by the Scottish Government, do we know what local government is saving and which local government budgets are declining but also what else the Scottish Government is spending that is offsetting that? We would be really interested in doing work on that. Education is a good example, because we now have local government spending on education but the Scottish Government also spending money and transferring revenue. Tracing all that through the process will be quite a bit of work but important and interesting work.
:You have spoken about climate already a couple of times during the meeting, mostly in relation to the drive to net zero, how to achieve that, whether the fact that Scotland is behind schedule on that will put UK targets at risk, and the cost of catching up the lost ground and making progress towards the targets. However, the flipside is the cost of inaction. I do not know whether the commission has had a chance to look at the national security assessment of biodiversity loss and ecosystem collapse. If my memory serves me well, it was due to be published in August; a shortened, edited version of it was published by the UK Government in January; and, in the past week or so, the media got hold of and published the full version, which showed that environmental damage could cost up to 12 per cent of GDP by 2030. That will be within the term of the Parliament that we are about to elect, and that is a much more significant economic cost than was previously estimated. Has the commission looked at that? You are not an environmental adviser or regulator, but have you looked at the fiscal implications of the failure that we are already in, in relation to ecosystem collapse?
Yes, you are right. So far, we have looked at mitigation and what the Scottish Government is doing to transition towards net zero. That is important, because if the Scottish Government is serious about the transition, it will have to invest in mitigation, which will need to be part of the planning, particularly around capital. However, we have always been careful to highlight that it must also consider the adaptation piece and the damage piece. We have always started our climate reports by saying that the cost of inaction is significantly greater than the cost of action. I cannot remember what the number is, but we used an estimate from the OBR that basically showed that, when the damage costs are projected forward, the public finances become unsustainable. We start from that point and, based on those implications, assume that the Scottish Government will do something, then we set out what it needs to do and the investments that need to follow.
When we next do the climate work, we will look much more closely at adaptation. The reason why we have not done too much on it is that, when we did our work, the Government had not really set out any of the detail behind it. However, in our next set of fiscal sustainability reports in the next parliamentary session, we definitely want to update the climate work in order to look at the costs, the adaptation work and the different scenarios—including what happens if you do nothing—and trace those through.
:In a way, the point relates to the question that Michelle Thomson asked about whether a range of factors suggest that the old normal is gone and that we will not return to the period that you described—when you were at university—when there were assumptions that everybody worked with. The phrase “limits to growth”—the idea that breaching environmental thresholds will make growth unsustainable—is now older than I am. Do we need to confront the fact that the ecosystem thresholds have already been breached to such an extent that growth is unsustainable?
That is a subjective judgment and there are different opinions on that. Our general point is right—in the nice decade when I studied economics, the only thing that mattered was economic growth. You would let the economy rip and, although you might worry about that causing some damage, you would find ways to compensate for that. Now, however, there is a much greater understanding that such an approach is unsustainable. There are also differing opinions about whether we still need growth, what quality of growth is required, whether things can be done differently or whether the focus should instead be on the fact that we have already gone beyond our limits and we need to come back from that.
To bring the discussion back to our work, a useful point to consider in the next parliamentary session—this comes back to Michelle Thomson’s point about diversity—is that so much of what we do is driven by the available data and what the Government presents. One reason why we can work on net zero is that the Government has set out a plan, so we can work with it on the data and present our findings. The reason why we have not done so for adaptation is that the Scottish Government has not presented a plan. The challenge is to ensure that we have the data that is needed to support that work, so that we can consider what the Government is doing about what the costs will be if temperatures rise and what the effects will be on housing, the environment and so on. We can then do our work and think about the public finances that are needed for that work.
However, as you said, we are not environmental experts. To do our work, we need others to do the legwork and groundwork. Documents such as our statement of data needs set out the areas in which we will ask the Government to do more, so that we can carry out our work.
:Are you saying that you specifically need the Scottish Government to commission its own work in that area, or could, for example, the national security assessment from the Department for Environment, Food and Rural Affairs be drawn on to help you to understand the consequences for Scotland?
Yes. In principle, we use other people’s reports, and we do so when we can. For example, we use the OBR’s reports and we sometimes adopt the Climate Change Committee’s methodology.
What matters for us is the Scotland-specific stuff. I have not read that report, but if it includes something specific on Scotland, we can use it. However, if the Scottish Government can do its own work, publish the necessary data and share it transparently, that is good, because it will help to improve the debate. We will then be able to come in and look at the public finance implications—what the hit to tax revenues or the necessary additional investment might be.
:That is helpful.
I return to this year’s budget. You are concerned about the Government’s pay policy. You mentioned in your report that most NHS Scotland staff will receive a 0.78 per cent pay rise. You clearly do not feel that the Government’s pay policy is sustainable. Is that the case?
Do you mean for the next financial year?
:Yes.
You can see from the report that we choose our language quite carefully. The Government has set out a 9 per cent limit for the pay rise over the period. It is really close to that limit. In our report, we use the phrase:
“we think there is a risk that pay awards will exceed 1.1 per cent in 2027-28.”
That is why, in our income tax and earnings forecasts, we did not use those projections. When we were forecasting, we went back to our baseline assumption that pay awards will be at least in line with inflation.
Part of the outcome will depend on what is on the other side of the ledger in relation to the workforce and how the Government chooses to address that. Clearly, if the Government takes greater action on the workforce, that can allow it to be more generous within the overall pay envelope that it has set out on wages.
:The external commentators—the Institute for Fiscal Studies and the Fraser of Allander Institute, which you know well—are sceptical about the figures holding for the forthcoming year. They are both predicting the strong likelihood of there being an emergency budget, whoever forms the Government. Do you think that that is a likelihood?
The Government has said that it will revise its pay policy as part of the budget that it will publish in the autumn. The question is how quickly it will do that. Obviously, unions will have a role in that.
The obvious thing that we say is that, unless there is a change in the funding envelope, if the Government is to put more money into public sector pay, where would that come from? How will the overall portfolio allocations that it has set out in its spending review balance if it must put more money into pay? We need to remember that pay accounts for more than half of the budget.
:For 2026‑27, we will have another budget in which we are hoping that something comes along to bail out the Government before the end of the year. That is the distinct impression, is it not?
We need to keep our years straight. We are saying that the pay awards for 2027‑28 must come within the limit. For 2026‑27, the position is balanced and that will carry through. The issue is more about what will happen in 2027‑28 as to whether the policy will be achievable.
The broader point is that history has shown that Governments come back and add more money through the spending review—although, given what we have seen over the weekend, where that money is diverted to might be different.
One of the Government’s planning assumptions might be that more block grant Barnett consequentials will be coming down the line in 2027-28. The UK Government might have a more generous pay award settlement then, which might help out the Scottish Government. We will not know how the funding will flow until a later point.
:I will come back to those assumptions in a moment.
I am thinking about the broader legacy issues. We have talked quite a bit about ScotWind and how it has been drawn on at different times. As you have already said, it has proved quite useful to the Scottish Government as a second reserve. The reality, however, is that this has been created through a windfall. The political pressure is such that the Government is driving the budget to its limits every year, hoping that something comes along within the year to bail it out. That does not allow for any meaningful strategic planning. We heard that last week from those who are directly involved. It is not a particularly sustainable model for managing a budget, is it?
There are probably two things that I would say in response to that. First, on the broader point about Scotland, if that is being used as an additional fiscal flexibility, we return to the question of whether greater fiscal flexibilities are needed to manage it. Of course, if the Government is using it as a fiscal-flexibility tool, it is not using it for the purpose that it is hoping to, which is to invest in the transition to net zero and in climate measures. If it is simply uses it as a bank, the money will not flow through as it would want it to.
Secondly, on the point about—
10:30
:To me, it feels slightly worse than that, though. If it was an existing fiscal flexibility, the Government would be driving to the extremity of that as well. It is because it is not an existing fiscal flexibility that the Government is using it as a real flexibility. If an increased borrowing capability was put in place, the Government would just max that out, wouldn’t it? That is the character of what it does.
If the Government uses it as borrowing, it has to pay it back. If it wants to use it purely so that it does not overspend, a framework could be set up that would allow it to project spending with quite a high penalty in terms of the interest rate and a requirement for quick repayment. It would not have to be like the position on the capital budget. If the mechanism was purely about balancing spending, a high interest rate could be set, just as people have different interest rates for the overdraft on their current account and their mortgage.
You are right, but it is not surprising that the Government tries to maximise the spend. If it did not do that, it would have an underspend, and what would it do with that? Given the pressures that we see in the budget, going right to the limit is, in many ways, a strategy in its own right for managing the public finances, because the Government does not have the flexibility to save money, profile the spending and shift money between years according to relative priorities. The capital budget is a really good example of that. When the Government gets a big lump of capital, it really wants to spend it, because it cannot say, “We’ll hold on to that and spend it in year 4 or 5.” It has to spend it in the first year.
:We heard in evidence from the Cabinet Secretary for Finance and Local Government that she does not expect the spending review to last, and we heard evidence last week from various organisations in the public sector that said that they still do not have sight of or certainty about a budget. Is the spending review process performing its function correctly and adding grant certainty to allow public services to budget for their future? On one side, they are being told that the spending review is not going to work, and on the other side it is not giving them much certainty either.
We said that the spending review was a step forward in that there are at least broadly indicative outlooks for portfolios, which is better than what we have had in the past. However, the specifics could be a lot clearer. For example, information is still published at level 2. What does that mean for individual public services, public bodies and third sector organisations? How can the Government drill down into the detail and give them the certainty that they need?
We have said to the committee before that the spending review is not a one-off event but a way of planning the spending of Government. It is about how we track what is going on and give more information and more certainty over time. It is not about publishing the numbers and forgetting about them. The process is more important than the numbers, and the tracking through the year is crucial.
:That brings me back to our earlier conversation about whether the current model is fit for purpose in a world of radical uncertainty. It is not that the data is redundant, but it does not deal with the black swan events that are now far more common.
Is there a different model that the Government could use that would, in the long term, structure the devolved finances in the right way to deal better with the issues of radical uncertainty, given that you are highlighting as an institution some of the very long-term trends on climate change, the rate of technological progress and population dynamics? I would postulate that, globally, those are not results of the radical uncertainty but causes of it. However, what are we doing to shift that balance? Is there a different model that we could probe with the Government in discussing how it could approach the public finances to deal with that uncertainty?
It is a great question. I would like to have a think about that, but I will say a few things in response. What matters in our framework is that, in many ways, that radical uncertainty has a disproportionate impact on the UK relative to Scotland. Any shock will flow through both the UK and Scotland, but there is a protection mechanism in the fiscal framework.
The key for me is what can be done to beef up the MTFS in this context. Given that the budget process is so pressurised and is all about marginal changes and the Government setting out exactly what it will spend in 2026-27, I get that it is difficult to have some of those conversations and to think about all of that. The MTFS was meant to be all about setting out the things that the Government can be quite confident about and its priorities, to come back to Liz Smith’s point about the Government’s four priorities and what it is doing about them. We could have an MTFS that looked radically different; it could say, for example, “These are our four priorities, this is how much we are spending in those areas and this is the evidence that we have.” That would become much more of a report card and a tracking of how the Government is doing with its relative priorities. It would become more of an assessment of whether its spending commitments will run ahead.
What could the Government do to come forward with a document that was published through the year and did exactly those sorts of things that you are talking about in relation to Government trajectories and plans? Such a document might not go into the short-term minutiae about how a pay award is doing or what the Government is thinking about tax or how the tax revenue is going but would almost abstract that out into being much more about what the Government said it was going to do, what it is spending and whether that is having the desired effect.
:There is a reasonable consensus that we are looking at a low-growth, high-debt global context with huge uncertainty over the decade to come. It just feels to me that our political economy is one of driving budgets beyond their reality and trying to balance them, with no real foresight as to how we might plan to deal with the imperatives that sit underneath, such as climate adaptation, ageing demographics and the pace of change. Does it not need a completely different model?
Things such as the MTFS could be a way of doing that. Ultimately, what levers does the Government have on the spending side? The revenue side and the funding side will largely be determined through the budget. It comes down to what the Government is spending that £60 billion on and how it is spending it in a way that aligns with the priorities and the big challenges that you are talking about. That is the bit that is still to be filled in, and that speaks to the issues around spending reviews, details within spending reviews, allocations and evaluation about what is having an impact and what is not having an impact, and the quality of the data that lets the Government address all of that. That strikes me as being a different model. It is almost a separate process that sits aligned with and connected to the budget but which is much more expansive in what it tries to drill into and look at.
:I empathise with your economics qualification situation. I submitted my economics thesis at the London School of Economics and Political Science four weeks before the collapse of Lehman Brothers, so it felt like I had wasted all the money, frankly. However, all these years on, we are not really dealing with the consequences, so there is more for us to reflect on in that area.
Of course, it is not just global events. We touched on the fact that the UK Government’s policy decisions are having huge impacts. A year ago, we were facing an £800 million reduction because of what we thought were going to be disability benefit cuts, which did not take place, and we did not think that the mitigation of the two-child benefit cap was going to happen. There was a potential £1 billion loss because of income tax changes, and then we had the national insurance contribution increases. The UK Government alone toyed with up to £2 billion of potential detriment to the Scottish budget. That goes back to one of the cornerstones of the fiscal framework, which is no detriment. As we have already heard this morning, in the past year alone, there has been huge turbulence and uncertainty in Scotland’s finances because the no-detriment aspect of the fiscal framework has not really been adhered to. The Government could, on a whim, have deducted £1 billion from our budget, if it had decided to cut income tax, which, of course, it did not.
However, from a technical point of view, that is no detriment, working in the sense that—
Yes, from a technical point of view, but, in reality, at the end of the day, we are like a ship that can be tossed any way in a storm.
Yes, and there are two different points. From a point of principle, if the Government puts income tax up in England and Wales, should the Scottish budget benefit? The framework says no, because that would have an impact, so it should not happen.
You are right about the broader point: with the UK Government having that potential to pull levers, perhaps unexpectedly, how does the Scottish Government manage its budget? If there is a commitment to reduce social security payments in England and Wales, we plan on that basis. If the UK Government does not do that, however, that has an impact on what we have planned. If it toys with the idea of increasing income tax but without saying that it is going to do that, we now have to work things out. It is the budget management aspect that is challenging.
I do not think that that counters the point that Michael Marra was making. That is all there as noise, but there is still stuff that you can do. You have £60 billion to spend. It might be £59 billion or £60.5 billion, but you still have all that money to spend. Are you spending it on the priorities that you want to target, and are you able to achieve the outcomes that you are expected to achieve? That will not change, whether or not there are movements up or down.
We are still talking about big numbers in potential changes to the Scottish budget, whether they are up or down. It is very difficult to plan long term with that lack of stability.
We talk about how productivity is looking fairly bleak, but are there any models in a devolved context overseas that we could look to, to see what others are doing for productivity? I am not talking about Singapore, which is a country with no resources, which is independent and which has increased its per capita income some sixtyfold over the past 60 years, whereas Scotland has managed a threefold increase in the same period—which sounds ludicrous until we look at the figures. There are some countries that have done remarkably well from a poor base, but there are others, in Europe, that are in the same situation as us, as you have said. Germany is having real difficulties economically, for example. Where can we look to find somewhere that is managing its economy effectively at a substate level?
We have a good understanding of what drives productivity; the question is how we execute it in relation to the effects. A lot of that is quite simple—it is about education and skills. The question is whether you are educating your young people in a way that will let them go into high-productive jobs? Do you have a skills system that is fully aligned with the industry that you need to develop, not just now but into the future? There are some good examples at a sub-central level about where that applies.
In some German Länder, for example, universities and apprenticeships are much more linked up with the industrial base.
Although Germany is struggling just now.
At a certain level, yes.
My second point is that there are certain policy levers that you can use around education and skills; the other aspect is about what has happened to various sectors. Historically, that is where we have struggled, because of the hollowing out of manufacturing and the move into lower-productive sectors relative to our competitors. Germany has always done much better by having advanced manufacturing; it has done really well in that respect. It is struggling because those sectors are now not doing as well as they did in the past. The German automotive sector is lagging behind, with the investment by Chinese companies in electric vehicles having a disproportionate impact.
One factor is about the levers that you can pull, and a second aspect concerns different sectors. The UK Government has talked about industrial strategy, but how can you develop manufacturing, for instance? You have spoken a lot about investment in manufacturing and in high-quality jobs in Prestwick. That is the sort of thing that drives productivity. If you can do that at scale, that can potentially have a disproportionate impact.
We are well over time, which is probably a good sign, rather than a bad sign. It is always good when the committee is interested in what the Scottish Fiscal Commission has to say—that is always the case, frankly. On behalf of the committee, I thank you very much for all that you have done over the past few years to inform us. You have had a very important role to play.
While we may all be in pastures new post-May, I am pretty sure that you will be back before our successor committee. Thank you very much. It is important to have continuity, and I know that the Scottish Fiscal Commission will continue to provide that.
10:44
Meeting suspended.
10:51
On resuming—
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