The Scottish Government will either have to axe certain areas of spending, signal higher levels of taxation, or hope for extra funding or borrowing powers from the UK Government, according to an assessment from the Institute for Fiscal Studies (IFS) ahead of tomorrow's Resource Spending Review.
Prioritising public spending is essential to grow a stronger economy, as Scotland recovers from the pandemic and faces up to the cost of living crisis, Finance Secretary Kate Forbes has said.
The economic research organisation called the review "no easy task", as expensive policy commitments and relatively slow forecast growth in income tax receipts - not to mention the recent increase in inflation - mean that it is unlikely that revenues will keep pace with spending pressures.
Speaking ahead of the publication in Parliament on 31 May, Forbes said more focused government and public sector funds would achieve ambitions to tackle child poverty, reach net zero and deliver sustainable services for the future.
The Spending Review, which is not a budget, gives broad parameters for spending for the next four years and set out a series of government reforms.
“These are challenging times, and we need to be canny with our spending, but I’m confident that if we work together we can get through this cost of living crisis and still achieve our ambitions.
“We face a very difficult financial position over the next few years with funding increases below inflation levels and the challenge of recovering from the pandemic without the financial tools available to every other government in the world.
“The Resource Spending Review will detail the funding available over the coming years to achieve these goals, and it will be published alongside the Medium-Term Financial Strategy, which gives economic context to the challenges and opportunities which lie ahead."
A statement from the Scottish Government noted that it is already investing almost £770m this year in cost of living support and doubling the Scottish Child Payment to £20 per week.
Earlier this year it increased eight Scottish benefits by 6% - the rate of inflation at the time - and introduced a range of benefits not available elsewhere in the UK, alongside expanding free school meals and providing £150 council tax payments to low income families.
The IFS commented that the Scottish Government has made a number of expensive policy commitments, especially in relation to recently devolved social security powers.
Such measures mean that as of last December, the Scottish Fiscal Commission was forecasting that Scottish social security spending was set to exceed the funding provided by the UK government by at least £750m and potentially more like £1bn per year by 2026-27.
"This means less money for public services or higher taxes than otherwise would be the case," its analysis noted.
Even prior to the recent surge in inflation, the combination of underlying spending pressures, income tax revenue shortfalls, and expensive policy commitments, implied that the Scottish Government faced a funding gap over the next few years.
It projected a gap of £3.5bn in 2026-27 under its middle scenario: a sizeable amount equivalent to 8% of its projected budget for day-to-day spending in that year, or £640 for every person in Scotland.
The IFS stated that one way to address the funding gap is to cut back services deemed a lower priority, in order to focus resources on services and policies it is particularly committed to or that are facing the most acute pressures. The government may be forced to consider taking the axe to some of its policy commitments if it cannot find sufficient savings elsewhere in its Budget.
The devolution of income tax powers gives the government an important new lever to raise revenues. It has yet to confirm tax plans for 2023-24 and beyond, unlike the UK Government, which has said it will freeze the higher rate threshold (and personal allowance, which also applies in Scotland) until April 2026, but cut the basic rate of income tax by one percentage point to 19% from April 2024.
Mirroring the higher rate threshold freeze would raise around £500m by 2026-27, while not following the UK Government by cutting the income tax rate, could provide around another £400m in additional funding, because the block grant adjustment will fall following the tax cut in the rest of the UK but Scottish revenues would not.
"Income tax policy could therefore relatively straightforwardly yield almost £1bn, although the Scottish Government would then no longer be able to claim the lowest income half of taxpayers pay less than in the rest of the UK (although at a maximum of £20, this has always been more about the politics than the substance of the tax system)," the analysis pointed out.
It continued that Forbes could also choose to set spending plans that exceed expected funding under current policy in the hope that the UK Government either boosts its funding or gives it enhanced borrowing powers. "Some additional funding and borrowing powers may be forthcoming but unlikely on the scale required to close up the funding gap faced by the Scottish Government."
"Political considerations - including those related to the Scottish Government’s desire for another independence referendum - will undoubtedly play a role in whether those choices are made clear next week or not."
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