Finance and Public Administration Committee

Meeting date: Tuesday, August 31, 2021

Official Report 664KB pdf

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Scottish Fiscal Commission (Economic and Fiscal Forecasts)

We will hear from two sets of witnesses today. The first panel is from the Scottish Fiscal Commission, with whom we will discuss a number of recently published reports, including the commission’s economic and fiscal forecasts. Members have received copies of those reports, along with a private briefing paper from the financial scrutiny unit and the Scottish Parliament information centre.

I welcome from the Scottish Fiscal Commission Dame Susan Rice DBE, chair; Professor Alasdair Smith, commissioner; and John Ireland, chief executive. We will also be joined remotely by Professor Francis Breedon, who is also an SFC commissioner. If members have any questions for Professor Breedon, or if Dame Susan wishes to bring him in at any point, they should make that clear so that our broadcasting operators can activate Professor Breedon’s microphone.

I intend to allow 75 minutes for the session. Before we open up to questions from members, I invite Dame Susan Rice to make a short opening statement.

Good morning, and thank you for the invitation to give evidence to the committee. I am joined by Professor Alasdair Smith and by our chief executive, John Ireland. Francis Breedon joins us remotely.

We published our most recent economic and fiscal forecasts last Thursday, following a recommendation made by the previous session’s Finance and Constitution Committee. We also published the second part of our forecast evaluation report, covering income tax and non-domestic rates. Along with the report that we published in July, the committee now has the full statutory annual evaluation of all our forecasts. Our third and final publication last week was a fiscal update that looked at the evolving budget position for this and the previous financial year. We hope that the reports will assist Parliament in its pre-budget scrutiny.

We are all struck by the success of the Covid vaccines in weakening the link between case numbers and serious illness, which has led to a clear shift in Government policy since the January forecast. Although case numbers have been climbing steeply this month, hospital admissions and deaths remain low and public health restrictions in Scotland are minimal. We are taking a far more positive outlook for the economy than we did at the start of the year. We now anticipate that gross domestic product will reach its pre-pandemic level by the second quarter of 2022, which is almost two years earlier than we previously forecast. Prospects for a long-term recovery are also good. We have reduced our January estimate of 3 per cent long-term scarring or damage to productive capacity to 2 per cent.

However, there are on-going risks to the recovery. We are all mindful of the current rise in case numbers and the longer-term possibility that vaccines may not be effective against new variants or that the protection that they offer may wane over time. The First Minister is clear that, in the event of significant pressures on the national health service, heightened health restrictions would be considered.

Many of our tax forecasts have also been revised significantly upward since January, which is due both to the improved prospects for the economy and to rising inflation. For example, our income tax forecast for this year has been revised upward by around £900 million. However, that significant increase in expected income tax receipts will not feed into this year’s Scottish budget. That element of the budget was fixed earlier in the year, using our January forecast, and the offsetting block grant adjustment was set using the Office for Budget Responsibility’s March forecast. The most recent estimate of this year’s net income tax position, accounting for our new forecast of Scottish receipts and the same block grant adjustment, is £1.3 billion. That large difference is the result of a significant improvement in the economic outlook between March, when the OBR made its forecast, and now, when we have made ours.

There is no evidence of a significant divergence between Scottish and UK economic performance that would support such a high net funding position. When the updated OBR forecasts are published in October, we expect the net funding position for income tax to be reduced significantly and to return to a level similar to that of previous years.

I turn to social security. We predict that spending on devolved payments will increase from £3.7 billion in 2021-22 to £5.2 billion in 2026-27, as more people receive support each year and payments are uprated by inflation. From next summer, the Scottish Government will gradually replace the UK personal independence payment with the Scottish adult disability payment. That is a major step in the devolution of social security. For the first time, we have estimated the additional spending. Although there are no changes in the overall structure of the payment, there are changes to the processes for application, review and appeals, as well as changes in how the payment is communicated. We expect that, by 2026-27, spending on ADP will reach £3 billion, which is £0.5 billion higher than would have been spent on PIP.

We also expect spending on carers allowance to increase as more people become eligible because of the larger number of adults receiving disability payments. The Scottish Government receives funding from the UK Government based approximately on what would have been spent on PIP in Scotland, so the additional spending on ADP will need to be met by raising taxes or reducing spending elsewhere in Scotland.

The forecast is, by its nature, uncertain. It is always difficult to estimate spending on new social security payments. In this case, we have only limited information to guide our estimates of how the delivery innovations will affect the case load and average payments.

I remind members, too, of other Scottish Government commitments to increasing social security spending, such as doubling the Scottish child payment, which we have yet to include in our forecasts.

Thank you. Before I bring in other members, I have some opening questions—that approach will be the norm for future committee meetings.

You talked about taxation, which is of great interest not just to the committee and the Parliament but to the wider public. Can you tell us a wee bit about the impact of fiscal drag inflation on taxation and whether the Fiscal Commission can specifically quantify its impact in comparison to the increased output as a result of the reduction in Covid pressures?

We can all say something, but Francis Breedon might be best placed to respond to that question.

Straight in at the deep end.

Yes, but I will have a go.

The short-term outlook is for significantly higher inflation than anyone was expecting, which will have fiscal consequences. Most of those will come out in the wash in the sense that higher inflation not only increases spending but increases revenue. However, you are correct, convener, that there is also some fiscal drag. In the main, that will be the same for the rest of the UK as it is for Scotland, so the actual net position will not be so large. However, the inflation will generate more real revenues. It will mainly be illusory—or nominal—but there will be a little bit of a real gain if higher inflation occurs over a long period.

That will mean that more people become higher-rate taxpayers.

Yes, but there is uprating of most of the thresholds, so some of that will be offset.

Thank you. SPICe produced an interesting document, which you might have seen mentioned in the press. It says that because of the Scottish Government’s tax policy, some £500 million was raised in taxation, but only £148 million benefited the Scottish budget due to block grant adjustments. We have an explanation from SPICe, but will you talk about that a wee bit?

The SPICe briefing is interesting and is a valuable piece of work, but it addresses a different question from the question that is in our remit. I understand that the briefing looks at what the Scottish income tax position would be if income tax responsibility had not been devolved, versus the current situation, in which a large part of it has been devolved and the Scottish Government sets rates. That is a hypothetical question about how the devolution of income tax has changed the system.

Our job is not to make judgments about the devolved income tax system versus other hypothetical alternatives but to look at how the devolved income tax system is working. We make income tax forecasts and we forecast the effects of Scottish Government policy changes—such as, notably, the introduction of new tax bands two or three years ago. We focus on a slightly different set of issues and we do not get into the business of judging whether it is better for income tax to be devolved and what the effects of that are.

I fully appreciate that, but do you produce for the Scottish Government forecasts of what specific tax levels could mean for the block grant adjustment, so that the Scottish Government has a clearer focus on what the result of a tax policy might be?

Yes. When tax policy is to change—as it has done in a number of years—we forecast the effects, and we have forecasts of the block grant adjustment. When the Scottish Government makes a proposal in a particular year, our forecast of income tax revenue will include the effects of that year’s policy change, which is compared with the block grant adjustment to give the net effect on the Scottish Government’s budget.

That is clear.

Your report says that house price stability will be established in the current financial year and that prices will grow in subsequent years. How did you come to that conclusion? House prices appear to be rising quite significantly.

House prices have been rising for a while; the average house price is now a little over £200,000, and we expect the figure to rise to an extent.

The convener is right that, as our graph shows, there has been upward movement in house prices in the past year. As Susan Rice said, we have now breached the level of £200,000 for the average price. We expect the figure to remain reasonably steady over this financial year as a whole, and we are already part of the way through the year. In the subsequent years of our forecast, we expect house prices to continue to rise, because of the growth that we expect in nominal income. There is almost a gentle point of inflection in this financial year. We have seen some data, and we expect prices to remain stable for the rest of the year.

I have pages of questions, but I will let other committee members in after my next question, which is on a different topic: international supply pressures. Your forecast says that

“we assume there are no future waves of rapidly rising ... deaths and hospitalisations”

but that

“There are ... ongoing international supply pressures which combined with domestic recruitment challenges present risks to our forecasts.”

The impacts are from not just Covid but Brexit. How do you quantify the risks from supply pressures? We have heard about significant rises in raw material prices, for example, which could have an impact on the ability to deliver the Scottish Government’s capital programme.

The two pressures certainly exist. I make it clear that the supply pressures are not simply directly in relation to Brexit; they come from countries around the world. We have previously mentioned that China is undertaking a huge building and construction plan, so it is using rather than exporting a lot of its supplies. The supply pressures come from a lot of places. John Ireland might be able to give you the detail of how we quantify the pressures.

09:45  

We have thought about the mechanism by which those supply constraints are likely to impact on the Scottish economy. That is taken into account in our forecast in two ways. We have built that into our judgment about output. We have thought about the potential impact that supply constraints might have on production this year. You can see that reflected in the path of output. Although output is rising rapidly this year, it does not bounce back as quickly as it might have done in the absence of supply constraints.

We have also looked at inflation. In common with the Bank of England’s latest monetary policy report, we judge that inflation will peak at 4 per cent by the end of this year. We are seeing a price effect, which is also built into our forecast.

Those are the two mechanisms by which we have attempted to quantify those supply constraints.

The quotation that the convener read out also mentioned a blockage in job recruitment. That is a slightly old situation, which I expect will change in the coming months. There seem to be many jobs, as businesses begin to gear up in hiring, yet there are many stories about companies’ inability to hire lorry drivers and therefore to make deliveries. Something funny is happening in that part of the labour market.

The UK-wide furlough scheme is coming to an end at the end of September. There is some speculation that people may have stayed on that scheme. We will see then whether employers are still viable businesses. Workers might decide to, or might have to, look for another job at that point. There is some stasis, which may last until we reach that cliff edge. We do not know, but that is our speculation.

There is a significant mismatch in the labour market between skills and geographic location.

Notwithstanding the better news that you published last week, when you said that you felt that the scarring to the economy was not as bad as had originally been anticipated, you also said that there are significant risks ahead. You have said that that is partly due to the difficulty in predicting future consumer and business behaviour. All of that is tied to the significant pressures on the budget. Public spending and public sector debt are rising, and tax receipts are likely to fall because some businesses are failing.

It is not your job to hint at Government policy, but can you tell the committee where you see the most significant future risks to the economy?

All my colleagues can answer on that. When the economic forecast talks about risks, we have dealt only with downside risks; we have not called out any upside risks. The downside risks draw from the economic impact of unknown or possible changes in health policy that would then impact on economic activity.

We have already seen that households that have managed to save money are beginning to spend again. There has also been a lot of home improvement and there are shortages in many of the trades that serve that sector. They have full order books and it is difficult to get work done. That activity will continue.

A couple of downside risks are worth mentioning. We give significant attention in the report to the future risks of Covid. There might be vaccine escape, for example. Our forecast is based on the assumption that there will not be another period of significant economic restrictions related to Covid, but none of us can discount the risk that that might be too optimistic. We all understand what the implications of that might be.

On the economic side, as Susan said, our outlook is considerably more optimistic than it was in January. That is not just because the situation with the pandemic has eased with the roll-out of the vaccination programme, but because the bounce-back of the economy as restrictions were removed has been faster and healthier than we, and pretty much everyone else, had expected it to be.

If we think about economic scarring, for example, it is possible to contrast our situation now with the situation in the 1980s and 1990s, when economies were responding to the decline of heavy industry, coal mining and so on. Those declines left a lot of scarring in the economy that lasted for a long time. There were people who lost their jobs and never came back into employment. Communities lost economic opportunities, and new economic opportunities did not arrive.

At the moment, our view and the view of many others is that Covid does not look as if it is going to be like that. The bounce-back is going to be reasonably healthy. Young people will have difficult labour market experiences for a year or two, but we can hope that that will not last too long.

With all of these things, we have to be realistic and recognise that we might be making an overly optimistic judgment and that the long-term damage to the economy could be greater than we are forecasting. That is one other significant risk that we need to think about.

There have been a lot of interesting articles and debates recently about the play between inflation and economic growth, following one of the interesting comments that the governor of the Bank of England made a couple of weeks ago. In your overview of the Scottish economy, are there areas that you think have good potential for relatively quick economic growth? In terms of tax revenue coming in, what areas could be helpful for the Scottish economy and Scottish budget?

That is a big question. Francis Breedon might have thoughts on that.

As you will see in our report, we looked a bit at a structural breakdown. It is clear that one important aspect of the economic effects of this situation is that it has hit certain sectors much harder than others. Many sectors have been unaffected, while others have taken a very significant hit. We are hoping and expecting that those that took a significant hit will be a major part of the bounce-back and that that will be an important part of where the economic growth and tax growth comes from.

Following on from what Alasdair Smith said, one thing that we expect to happen as a result of Covid is that a bunch of structural changes in the economy will be accelerated. For example, although I could be in a room with all of you now, I am not because we can meet through screens. That sort of change will change the structure of the economy and where growth comes from in the future. The slightly more optimistic view that we have of scarring is partly because people generally expect—and the research certainly shows—that some of those structural changes will be beneficial in the longer term.

However, it is fair to say that forecasting structural change, and trying to work out which of our sectors will benefit and which will lose, is actually very difficult, because structural changes are very difficult to predict.

I will add a closing sentence to Francis’s comments: It is not so much sectors as were, but sectors as will be. For example, the agriculture sector, which is a big part of Scottish economic activity, might reinvent itself to some extent in anticipation of changes in eating habits and diet because of net zero sensitivities. Sectors will change according to what is happening in society more widely. It is a little hard to pinpoint which ones will change and change quickly.

Following on from some of the topics that have already been touched on, I have a question that is by and large about some of the short-term elements that we been discussing and some of the longer-term ones that you have just touched on with Liz Smith.

In the shorter term, your forecast has us returning to pre-Covid levels in quarter 2. Given what you have just set out, how safe is that forecast? Furlough is coming to an end and we can see from what has been happening over recent months the phenomenon of unexpected savers who are spending money on things that they would not otherwise have bought. I saw a report yesterday showing that used car prices are up by 15 per cent and you just highlighted spending on home improvements. It strikes me that those spending patterns cannot be sustained into the medium or long term. If that is true, is it safe to straight-line our economic performance from quarter 2 of this year? That is what your forecast appears to do, on the basis of your report. Should we not at least have a sense, if not an expectation, that there is a risk of more of an oscillation in our recovery or that there may be some head winds resulting from some of those effects?

Absolutely. There will always be head winds, but one of the factors that encouraged us to bring that timeline earlier was the fact that in the second lockdown in January we found that businesses overall and in general had figured out how to operate during a lockdown and the funny times that we have had for close to the past year and a half. They had worked out how to sell online and all of those services had improved. Therefore, we saw the economy coming back up to speed sooner than we had thought previously because the economic activity was stronger. That was one of the factors behind our thinking. I turn to Francis Breedon, who has a lot of thoughts on that.

First, Daniel Johnson is right that we highlighted in the report that one of the tricky moments for the economy will be when the furlough scheme ends. However, we are encouraged by the fact that there are significantly fewer people on furlough than there were even a few months ago. That makes us slightly more confident that we can negotiate that particular tricky moment better.

I think it is right that we will have a period in when spending patterns will flip around. It is understandable that people’s excess savings are going mainly on durable long-term goods, in the sense that that is a way of investing those savings. However, we are expecting that to be replaced by more standard consumption patterns as the economy recovers, so we will see sectors such as hospitality and recreation stepping up to take over where spending has been dominated by durable consumption at the moment.

Daniel Johnson’s question raises a good point about those transitions in consumption and the economy. Each one of them is necessarily uncertain, so there are definite risks as the economy comes back on to an even keel.

To follow up that point, I challenge what was said about businesses having figured out how to operate through Covid. The businesses that I speak to have managed to get through Covid but, although they are trading, their trade is significantly down from where it would have been. For a lot of consumer-facing businesses, 60 to 80 per cent is not unusual and it is not sustainable for them. Furthermore, most of those businesses have got to that point by accumulating significant sums of debt, whether that is through Government schemes, deferred payment of rent to landlords or other arrangements. It has even been reported that small business owners have cashed in their pensions. I am told that a lot. It strikes me that those businesses are operating under a very different set of circumstances from those that existed pre-Covid, and that, too, must imply a degree of fiscal headwind when you start looking at those figures, or certainly the overall economic performance of the country.

10:00  

Your point is absolutely correct. I was not implying that it has been a good road for all businesses.

No.

It is just that, compared with our earlier expectations, businesses have rallied overall—not every one but on average—and functioned somewhat better. The other factors that we considered earlier this year included schools opening up a little sooner, which meant that there was more economic output relating to that; and the vaccination programme, which had barely started by the time of our January forecast, being rolled out with a speed and success that I am not sure many people anticipated. That added to output on the health side. What helped us change our view on economic activity and the speed of recovery was simply that things happened a little sooner than we expected.

I will ask a final question about the longer-term impact. I accept that it is difficult to predict right now what the long-term structural changes in the economy will be, but I agree that there will be some. Are some of those, even if we are not able to safely predict them, a good bet? It is very likely that there will be structural changes in relation to the consumer-facing economy, especially retail, and I declare an interest as a former retailer. Those patterns of spending have permanently changed—I do not think that anybody in the retail industry thinks otherwise.

To what degree are you starting to consider or identify those changes so that you can embed them in your forecasting as soon as possible and anticipate them? Some of those changes are very likely. Likewise, in relation to changing patterns of work, having a screen and being able to work over Zoom is all well and good if your work involves things for which that is suitable, but if you are a retail worker or a delivery driver, it is somewhat more difficult to do those things by Zoom. Not only sectorally but in terms of types of employment, the recovery might well look very different depending on where you are and what industry you work in. Are you starting to identify that and embed it in your forecasting?

I will make a quick comment about delivery. We all receive an awful lot of deliveries at home that we did not receive before the pandemic. There will probably be a rethink about how deliveries are done, for example using small hubs where different organisations can have an exchange from large-scale lorry containers to last-mile delivery. There is a lot of work being done on that, but it is still to develop.

Things will change as well. We need to remind ourselves that they will not just go back to the way they were before. Alasdair, do you have any views on that?

I am afraid not. I do not have any further wisdom to add.

The only thing that I would add is that, as well as looking at the sectoral industry-based factors that Dame Susan Rice has talked about, we prepare our forecast by looking at very high-level output series. To some extent, within that there is a cancellation of the effects that you talked about. The sectors with strong growth will to some extent be mitigated by the sectors with slower growth, so we might see some greater stability at the aggregate level than we would if we look at the detail underneath.

I will follow on from Daniel Johnson’s point about the high street and non-domestic rates. From your forecast for 2022-23 to 2026-27, non-domestic rates are due to go up by 17 per cent. How realistic is that considering how much the high street will have changed through the pandemic? Should we also consider how different businesses will pay NDR in future, or is that not part of your forecast?

The bounce back in NDR that you mention is really just the end of the relief, so that is somewhat baked in. However, I think that you are right about the longer-term issues with regard to commercial property. We have looked at that very carefully, and we have tried to use contacts with industry and trade bodies to get a feel for whether a change in the use of commercial property will have a big impact on that tax revenue. You are right to highlight potential structural change as an area that we might need to keep an eye on. At the moment, we do not have strong indications of structural change in the use of commercial property but, clearly, we are keeping a close eye on that, because it is a pinchpoint for the structural changes that we anticipate.

A lot of information about NDR still needs to come out. There were a large number of material change of circumstance appeals, and everything has slowed down in terms of the assessors coming to conclusions. We have to wait to see how the numbers play out, so there are some question marks over that, if not downside risks.

Income tax revenue is projected to move from just under £12 billion in 2020-21 to £17.3 billion in 2026-27. However, at the same time, the 16 to 64-year-old workforce is set to decrease by, I think, 60,000. I am trying to work out how there could be such a big increase in revenue when the workforce will reduce.

That is primarily driven by the economic growth in the forecast. As we have already discussed, there is an element of inflation in that and in part it is real growth. Yes, the Scottish workforce is expected to decline in numbers, but the overall Scottish economy is, nevertheless, growing. Income tax grows with a somewhat accelerated effect as the economy grows.

Also in the report, nominal earnings are due to rise by 2.1 per cent and then 2.5 per cent, which does not match the increase in income tax. I wonder whether I am missing something here. Do you assume that income tax bands are going to change—that people are going to pay more tax per person?

One factor is that most income tax is paid by a relatively small minority of better-off taxpayers, so there is not a straightforward one-to-one relationship between income and income tax. As I said, as the economy grows, one effect is that people who were not paying income tax are drawn into paying it and people already paying it are drawn into paying it at higher rates, which has an accelerating effect on tax revenues. The relationship between tax revenue and income in our forecast is a perfectly normal relationship that would be expected. We are not doing any fancy magical maths to get these effects.

Are assumptions made about the tax bands? Do you assume that they will stay as they are or that they will go up in line with inflation?

I think that embedded in your first question was the question whether we are expecting a change of tax bands or something of that sort. We work with what the policy is today. We do not think, “Ah, the Government may change tax bands,” so the answer to that is, no, we are not playing with scenarios of that sort. We work with what we have today.

We make assumptions about the indexation of bands. For example, the UK Government has announced that the personal allowance will be frozen for the next few years and we have built that into the forecast. We use policy announcements in that way.

As inflation has been mentioned a few times already, I do not want to spend a lot of time on it. However, as I understand it, you follow the Bank of England instead of the OBR on this matter, mainly because its forecasts are more recent. If inflation is at 4 per cent just now, how confident are we that it will fall to 2.5 per cent? If pressures such as shortage of labour were to continue in the longer term, would inflation continue to be higher in the longer term, too? Being of a slightly older generation, I remember inflation at 15 per cent, so 4 per cent seems reasonably low to me, but compared with recent years it is relatively high. Do you have any thoughts on that?

You are entirely correct that it is a risk. We very much agree with the Bank of England’s assessment that, on the current information, it is a short-term issue. However, short-term issues have a habit of becoming long-term ones. Indeed, if, as you have suggested, there are constraints on the labour market, that is where we will start to see longer-term pressures on inflation. Currently, a lot of the issues are to do with the supply chain, and we think that they will wash out over the coming period, but you are right to highlight that as a risk.

The ultimate bulwark against inflation going back to 15 per cent is the Bank of England itself. If it were to begin to perceive that risk of inflation, it would react. It has not reacted to the current temporary increase, but it will react the more it thinks that any increase is longer term.

On the wider question of population, our birth rate in recent years has been low. On the whole, immigration has made up for that, but there has been a bit of a reduction in that, too. What are your assumptions on population? How big an impact will the issue have, and should we be worried about it? My simple thinking is that if the population grows, the economy will probably grow, too, but if the population falls, it becomes very difficult to make the economy grow. Moreover, if the population of the rest of the UK grows while ours does not, where do we go?

It is a very important issue to think about. First, the fertility rate is dropping not just in Scotland but in countries all around the world, so it is a general phenomenon. Nevertheless, our fertility rate has been dropping. On your point about comparisons with the rest of the UK, I note that its population growth is a little bit faster than ours, and we expect that to continue to be the case.

The other factor in Scotland is the growth of its older population, many of whom are no longer working and are therefore no longer active in the labour market. Because fewer children are coming in, we expect fewer people to join the labour market in due course, and there will be more people in that older age group who might not be actively working but who might nevertheless be costing something. We look at both sides. Coming back to ADP, the fact is that more people will start to attract that benefit, and possibly for longer. It is a combination of things that balance each other, and it certainly matters.

Presumably, the birth rate will not change very rapidly, but things could change on the immigration side. There is demand from industry for immigration to be allowed for specific sectors, although the UK Government has said that it will not do that. How important would that be? If immigration were suddenly to be allowed, would that make a big difference to the forecasts?

One can only speculate, but one could say that, if immigration were to be allowed, what would matter most would be that immigrants were people of working age who started to create more activity in the economy.

I was interested that page 33 of my copy of your report—I am not sure whether it is the same page 33 for everyone—shows box 3.1, on uncertainty indicators, which I understand are a new measure that you are trying. I was fascinated by that and I wonder whether somebody will explain what that tells us.

10:15  

I am excited by what we have created, which is very good. Such measures are about political uncertainty—the impact of what is being thought about, discussed and debated in public. If that creates greater uncertainty, it might affect the decisions that people make and the behaviours that they show economically.

The Scottish uncertainty index has been created and it can go back any number of years to reflect events in society. We will continue to monitor that; I will not go into the detail of what it picks up.

We have taken methodology that other people, including the Bank of England, are using to look at policy uncertainty in the political sense. The measure is based on online searches of newspaper articles. We select a number of key words and the index picks up how many times those words occur in articles. In a sense, the approach is simple. It takes a bit of time to do but, fortunately, it is all automated, which makes life easier.

If we look at box 3.1, it is fascinating to see that the first independence referendum and the European Union referendum feature in the index, and the impact in Scotland was greater than that in the UK as a whole. We can also see the effect during the Brexit negotiations in 2019 and 2020, when independence came back into the news.

We are interested in this. We need to do a lot more work to calibrate it to what is happening in the economy. It is a good starting point.

How objective is the index? We do not all have faith in how newspapers operate.

What matters is not necessarily whether the newspapers’ reporting is accurate—it might or might not be accurate; it depends on your faith in newspapers and journalists—but what people are talking about. The index captures the sense of what is in the news. Because other people around the world have taken this approach and the Bank of England has taken it for the UK for some time, we have faith in the methodology.

What is the impact on people’s behaviour? If there is more uncertainty, do people save more?

We could speculate almost anything—people could hold back on big spending decisions or they could consider where they live or whether it is time to change jobs and take a risk. There are lots of ways in which uncertainty could impact on decisions, and those decisions will have an economic impact.

We will keep an eye on that.

It is important to say that we are developing the index and that we have not taken the next step, which Susan Rice talked about, of looking at the impact on the economy.

I will ask about an area that has come up before. Are you getting the data that you need, with the quality that you need, from Scottish sources and the UK HM Revenue and Customs?

Thank you for asking that question. You have been on the committee for a while and know our journey along that road. The position is much better than ever before. We have developed good relationships with major UK agencies that provide us with data. Sometimes, it takes time for them to change reports; sometimes, time limits make a difference to us. As you know, we make every effort to use publicly available data. Part of our approach to transparency is that we publish the sources of the data and what those data are.

We are in a much better space, but that does not mean that improvements could not be made. Because of a request from another parliamentary committee some years ago, we publish every year a statement of our data needs and we identify what would help us next. The situation has improved.

As Susan Rice says, the position is stable this year. For the past three years, we have produced a statement of data needs, after a recommendation from the Economy, Energy and Fair Work Committee in the previous session of Parliament. This year, we have decided to move that publication to every two years, because we have no pressing data needs at the moment. We have not produced that statement this year, but we will do it next year.

I have been listening to the contributions with great interest. The themes that keep recurring are around uncertainty and complexity. I appreciate the very difficult job that you have to do in reconciling what has actually happened with a forecast of what might happen, and I am interested in exploring that a bit further.

We have touched on some of the rationale that you use for your analysis when questions have been asked. I am interested in understanding the rationale for some of your analysis in your report. For example, we know that climate change will affect us, and net zero targets are being talked about a great deal. How do you reflect such issues in your analysis? Can you see a development of your report in which you reflect more on those issues?

That is interesting. I am looking at my colleagues. Francis, do you want to come in?

Obviously, we want to develop our thinking about those longer-term issues, although climate change is a current risk as well as a longer-term one. There are issues—we have raised them already in this meeting—about long-term population changes. We could usefully look at those issues, but they are not written about very much in the current report, because it has a specific focus on the shorter-term forecast and the budget implications of that. You raise an important question.

The only thing that I would add is what I said to Mr Johnson earlier. A lot of the things around net zero, such as the commitments and changes relating to energy efficiency and the production of energy, are the sort of things that go in the balances and changes underneath. At the top level, we forecast for five years, so you probably do not see an immediate impact, but there is important stuff going on underneath, which we need to keep an eye on. As Francis Breedon said, thinking about 20 years forward is very different from thinking about five years forward.

In that respect, I, too, was excited about box 3.1, which started to get into that sort of thing.

My next question follows on from that and is on the similar theme of GDP per capita. We know that there are endless debates about how effective that is as a measure, although it is internationally understood and you rightly use it. However, what, if any, thinking have you done about measures in addition to GDP per capita, given its known and understood crudity, and particularly as we start to move to the so-called wellbeing economy, which I know is somewhat amorphous at the moment?

That is a good question. Again, I see Francis Breedon nodding, so I will turn to him.

I was nodding in the sense that I agree that that is an important area and that GDP is a somewhat narrow measure. Sadly, from our point of view, because we have a significant focus on the budget and on money, GDP is actually the measure that matters to us for that particular job. It is not really in our world to look at those other measures, but I agree that they are valuable and important, and I would encourage others to think about them. If, like us, you are always looking at monetary and budget implications, GDP is pretty much the best measure for that job.

It is the best worst, as I think people would agree.

Yes.

We still have time, so I will let colleagues come back in again, but I will ask some more questions first. The first one is a follow-up to John Mason’s question about the uncertainty index. Where does the co-operation agreement between the Greens and the Scottish Government sit on the uncertainty index? Does it make the Scottish Fiscal Commission’s ability to forecast more or less certain?

We do not forecast political outcomes.

No, but the deal contains financial detail and specific components—for example, £500 million for the north-east and Moray and 110,000 more affordable homes by 2032.

In essence, our forecasting of Government expenditure is limited to social security. Some of the content of the agreement between the Greens and the SNP—for example, the doubling of the Scottish child payment—is in that portfolio. The direct impact for us is around the expenditure commitments that are in our remit, such as social security spending.

The other interesting thing about the agreement is how it will change the budget process. We have been used to operating in a world in which the budget process is two bites of the cherry—the initial budget and the negotiations about how to get it through Parliament. Obviously, that will go away and make a difference to how we approach our forecasting and that sequencing.

So in that regard, there will be a reduction of uncertainty.

Yes. It will be up-front uncertainty—a one-off, rather than a two-off.

This morning, members of the committee received a detailed letter from the Cabinet Secretary for Finance and the Economy. No doubt colleagues will ask questions about that in the second session. She says in that letter:

“there is logic for publishing the MTFS alongside the Scottish Budget and thereby basing it on the updated SFC and OBR forecasts. Publishing it before the OBR October forecasts would mean having to use OBR forecasts from March, the effect of which would be to give a misleading sense of the fiscal outlook.”

Does the commission agree with that statement?

The OBR forecasts affect the block grant adjustments and therefore affect our budget position. The OBR would be the first to say that the March forecasts are out of date. We expect it to produce an up-to-date set of forecasts on 27 October. The statement that the OBR forecast from March cannot be relied on because the numbers are out of date is legitimate.

It is very difficult, because we have not had sight of that letter from the cabinet secretary.

Yes.

I presume that the letter talks about this year’s medium-term financial strategy. There are timing considerations about when the forecasts are as up-to-date as possible and when they coincide. In all honesty, it would be better to read that letter and write to you to give you a considered reaction and a sense of our views about it, if that is okay.

I am sure that the clerks will let you have it. We only received it at 7 am this morning, so I am sorry for throwing that question at you.

I think that Alasdair Smith wants to add something.

As John Ireland said, we will not respond to a letter that we have not seen.

Uncertainties arise from the fact that the OBR forecasts are important to the Scottish Government’s budget because they affect the block grant adjustments. The current OBR forecasts are somewhat out of date, and we will have more up-to-date forecasts in October.

We have highlighted some areas in our report where that is significant. We clearly indicated that the current forecast of the net position on income tax should be considered with great caution because, although we have as much faith in our income tax forecast as we always do, the income tax BGA is based on an out-of-date forecast, so we should not attach too much weight to the net position.

There are other important elements in the social security budget—the adult disability payment in particular is a big element in it—in which uncertainty about OBR forecasts is not really a factor for postponing serious consideration of the issues.

You have talked about social security a couple of times, but no committee member has yet asked about it. Your figures predict a £1.5 billion increase over the next five years in social security spend, of which the adult disability payment will be a major component. Given the fact that that increase has been mentioned a couple of times, is that a cause for concern for the Scottish Fiscal Commission, or do you just want to ensure that we do not omit it in our deliberations?

10:30  

It is not our job to be concerned about policy—I say that somewhat tongue in cheek. We are trying to call out the fact that, because of the Government’s policy to make those social security benefits more widely available and easier to access for more people, there will be greater spend there, so there might be a difference between the spend and the funding that is available to the Scottish Government, some of which comes from the Department for Work and Pensions. As you know, the Scottish Government is required to have a balanced budget, which means that, if it spends more in one place, it needs to match that in some way from within Scotland, either by raising taxes in Scotland or by not spending on some other programme in order to fund that programme.

The thing about social security, particularly the ADP, is that it covers a large number and is somewhat open-ended because, once people qualify for it, they do not often come off it, and we do not know for how many years they will receive the benefit. It is not a one-off benefit at a certain point in time, which is easier to predict. Therefore, we raise that issue simply to bring out the possible need for thoughtfulness when looking at the budget overall.

The child payment could be £163 million a year. I think that you said in your opening statement and your report that about £0.5 billion extra would have to be found from the resource budget by 2026-27. Is that correct?

Yes, and there are still a tiny number of social security payments for which we do not yet have a clear policy on the Scottish side, so we have not costed them. Half a billion pounds is a big sum of money, so it has to be thought about and anticipated.

A not-too-distant date on the horizon is 1 October, which the Government is identifying for publication of the outturn report for the fiscal framework, which will lead on to the revision of the fiscal framework and the agreement. Are there things that you would like to see within the fiscal framework parameters that would make forecasting a bit easier?

That is a good question. A review of the fiscal forecast has always has been in the plans for this fiscal year, but it is not our job to shape or drive that; it is for the Scottish and UK Governments to do so between them.

However, are there things that would perhaps reduce uncertainty and help you to plan ahead with regard to forecasting?

If we are consulted, we will obviously respond, but one thing that we have raised before—I thought of mentioning this a minute ago—is a greater degree of certainty, expectation and planning around the timetabling of the MTFS and the budget and when those activities will happen. We require many weeks to produce our forecasts, so if we knew ahead of time when the MTFS and budget were coming, that would be really useful to us. We have been very open about that.

I think that Liz Smith was asking specifically about the physical outturn report. We have been working with the Government on that for many years and we think that, over the years, the quality of that report, the information in it and the transparency have increased enormously. Without saying that it is absolutely perfect, we are pretty happy about the way that the report has been going and the improvements in it over the years.

With all the additional forecasting that now goes on and the improvement in the use of the data, do you, as statisticians who predict the future by using that data, think that economic forecasting is getting more accurate? [Laughter.]

Just look at the most recent block grant adjustment—it was only £34 million.

It is complicated. Does Alasdair Smith want to say yes or no?

As Susan Rice said, the availability of data has improved over the lifetime of the Scottish Fiscal Commission. That has somewhat reduced the uncertainties that we face, but forecasting is inherently a business of dealing with uncertainties. We are not looking for magic solutions that will make our job easier. The issue about fiscal uncertainty is not about making our job easier. As John Ireland and Susan Rice said, it is not for us to propose what changes to the fiscal framework should take place, but the central question relating to the fiscal framework is whether the Scottish Government faces uncertainties in the current system that could be different in a different system.

I will put it in another way. If there have been improvements in the data over time, that implies that your job has become slightly easier—it is not perfect by any means, but it has become slightly easier. What you produce for the Government is therefore more accurate than it used to be, even though there are complexities. Is that fair to say?

I will be optimistic and say yes—that is fair.

“Accuracy” is a word that makes me take a deep breath, because forecasts are never really accurate. Since the commission has been in existence, given the better data and more sophistication, we have created and improved our forecast models, so we are now doing a much better job. We have our economy forecasts, which we created ourselves. Initially, we did not use them, but what we are doing now is better. We are using different data sources and we understand the impact of real-time information data compared with that of the data that we used to use from HMRC. All of that has led to improvements. However, the words “more accurate” make me hesitate briefly.

We will take that as an accurate answer anyway.

I want to return to the block grant, income tax revenues and the SPICe paper that the convener mentioned. I recognise what was said about not wanting to get into the hypotheticals of previous regimes. However, as I understand it, the paper sets out that the current fiscal framework relies on income tax growth, which seems to point to the fundamental issue that income tax receipts per capita in Scotland have grown more slowly than those in the rest of the UK. Is that conclusion supported by the data that you have? If so, what are the reasons behind that?

I ask those questions because we are all mindful that the fiscal framework is being renegotiated. Understanding the fundamentals of how the framework works and what we benefit from—as I understand it, income tax growth is critical in the current regime—is clearly important as the framework is renegotiated. Will you elaborate on the insight that you have on the growth of income tax receipts per capita in Scotland compared with that in the rest of the UK?

The fundamental point about the devolved income tax system is that Scottish income tax receipts depend on the income that is generated in the Scottish economy. In a non-devolved income tax system, Scottish income tax receipts would depend on Scotland’s share of UK income tax receipts. That fundamental feature means that, if the Scottish economy evolves such that the pattern of income is different from that in the rest of the UK, devolved income tax receipts in Scotland will be different from what the receipts would be in a non-devolved system. That is just a statement of the basic facts. It highlights that Scottish income tax receipts—and therefore the Scottish budget—depend on the performance of the Scottish economy and the growth of Scottish productivity, because high productivity basically means that there is a higher proportion of high income tax-paying jobs in the economy.

There is nothing magic about that, but it focuses attention on important questions about the long-term growth of the Scottish economy, the growth of productivity and the demographic changes that Susan Rice talked about—in particular, the ratio of the non-working elderly population to the working population. Those are the issues on which the future of the Scottish economy depends, as is the case for any other economy. Devolution focuses more attention than ever on the Scottish economy specifically.

To take the next step, I absolutely understand those points, but the key conclusion that is drawn in the paper is that growth has been slower in Scotland than in the rest of the UK. Do you share that conclusion? Do you have insight into that?

As John Ireland or Susan Rice said earlier—I am sorry that I cannot remember who said it—the SPICe report asks a question that is different from the kinds of questions that we ask. We are not going to take a position on whether we would line up with the SPICe report, because that is not our job.

I had better stop there. The SPICe report addresses a series of important questions, but they are different from the questions that we address. I am therefore not going to get into a detailed discussion on how the analysis in the SPICe report is drawn.

The fundamental point is that we want productivity to go up so that people are paid more and they pay more tax. That is the fundamental of what we are discussing, in broad terms.

I would not disagree with that.

Absolutely. Daniel Johnson is just warming up for the cabinet secretary—do not worry.

Exactly so.

I have a final question before I call this evidence session to a halt. Regarding the fiscal overview, the Scottish Fiscal Commission notes that the UK Government has not guaranteed any additional funding for Covid-19 for 2021-22 and that there are currently no arrangements for deferred funding. Given the Scottish Government’s requirement to maintain a balanced budget,

“large changes in COVID-19 funding late in the financial year may create difficulties for the Scottish Government’s management of its budget.”

Can you talk us through one or two of those difficulties?

Last year, there were several tranches of funding from the UK Government that were spread out and went to the nations, relating to Covid measures. They came at different points in the year. The numbers that are involved in that kind of funding are firmed up only towards the end of the fiscal year, usually in February. That makes it very hard for a Government that has to have a balanced budget and has to make decisions throughout the year on how to spend money wisely.

The Scottish Government spoke to the UK Government, and what came out of that—in early summer last year, I think—was a guarantee that the number that had been put on the table at that point was a minimum, so the amount would not drop below that. There were more tranches after that. One was announced in March with the UK budget, weeks before the end of the fiscal year. It would have been impossible for the Scottish budget to put that into place and for it to be spent. Scotland has a hard stop at the end of March in order to fund councils and confirm income tax bands. It does not have flex in time at that point. The UK Government—the Treasury, specifically—agreed to let that money be carried over to be used this year. That was a helpful form of support to ensure that the money could be used properly and thoughtfully by the Scottish Government—and, I assume, by the other nations.

This year, a little over £4.5 billion of Covid support funding has been put on the table, but there are no guarantees of that sort and there is no promise at this point about a carry-over. That number—which may go up if things get worse, or may stay the same—would possibly go down by the time the February supplemental estimates are agreed relatively late in the financial year. That is why we have pointed that out—there is not quite certainty about the extra funding.

It might help if I say that, last year, there was £1.2 billion-worth of late funding from the UK Government. Only up to £700 million can be used in the reserve. You can see that, even with the greater ability to use the reserve because of the Scotland-specific economic shock, there is that constraint of £700 million.

I thank our witnesses very much for their very interesting presentation and for answering our questions.

10:45 Meeting suspended.  

11:05 On resuming—