Is the Scottish Government's Budget Flexible or Fixed?

NURSES across the UK have voted to go on strike for the first time in the Royal College of Nursing’s 106-year history.

Devolved health secretaries in Scotland and Wales have called on the UK Government to step up and provide more funding with their budgets already pushed to the limit.

Health Secretary Humza Yousaf told The National there was “no more money in the coffers”, with SNP figures on Twitter reiterating that the Scottish Government’s “budget is fixed”.

However, Unionists in Scotland have focused on the SNP/Green government, calling for increased funding and better pay deals. There have been various claims that it is a "lie" to call the Scottish Government fixed as there is "flexibility" in what can be done.

So which is it? Is the Scottish Government’s budget fixed, or is that untrue?

Modern Money Scotland analysed the claims:

The Facts

The Scottish Government's funds are mostly set by the UK Government through the "block grant". The size of the block grant is determined by the Barnett formula, which aims to give roughly the same spending change per-head of population each year. For example, if the English NHS was to receive an increase of 5% in spending, then this would roughly be reflected in block grants to devolved governments.

Other factors in the Barnett formula as considered, such as to what extent a service is devolved and the Scottish Government now receiving more tax raising powers, more recently in the form of income tax. To balance the Scottish Government's tax raising powers, the UK Government reduces its block grant. Other adjustments to the block grant include "reconciliations" if a forecasting errors occur, which are usually determined three years after the error. As of 2022, this funding process is under review and could change if policy recommendations are made.

Under current budget arrangements, if Scotland's growth rate of per capita tax returns is lower than that of the rest of the UK, then Holyrood is effectively punished for it. Scotland is pressured to compete with the rest of the UK to grow its tax returns in order to receive better funding than compared to the pre-2016 Holyrood budget arrangements. Holyrood has little control over employment, trade, and industry which are key factors to per capita growth.

The Scottish Government has no control over the size of the block grant, and since funding is largely set over Barnett calculations (which mirror UK government spending) we can determine this is fixed. However, the Scottish Government also has access to borrowing powers and raising taxes.

Borrowing Powers

Anti-independence activists argue that because the Scottish government can borrow money, it therefore can influence how much it spends each year and thus their budget is not fixed. However, this borrowing cannot be used for discretionary spending to support public services. Instead, the Scottish government can only borrow to make-up for forecasting errors through resource spending or capital spending.

Both these categories are fixed as to how much the Scottish Government can spend. On capital, the Scottish government can only borrow a maximum of £450 million a year, which is capped at £3 billion. On resource borrowing, the maximum borrowed per year is £600 million and capped at £1.75 billion. Therefore there is a fixed limit as to how much the Scottish government can spend between the block grant and borrowing overall.

Tax Raising Powers

One area of flexibility is tax raising powers. The Scottish government and local authorities having full control over Land and Buildings Transactions Tax (LBTT), Landfill Tax, and council tax, and Non-Domestic Rates. Income tax is mostly devolved, with the Scottish government setting rates and bands, whilst the UK government controls different reliefs and allowances.

Aggregates-Levy, Air Departure Tax, and VAT are supposed to be fully devolved to the Scottish government, but has not yet happened. In regards to VAT, the Scottish government has no power to change it, but a proportion of its revenues raised in Scotland will go towards the Scottish budget.

There have been some concerns over behavioural changes if the Scottish government raises the top rate of income tax. The risk comes from higher earners shifting their income through dividends (which is taxed at lower rates to income tax), thus revenue would instead go to the UK government since it is a reserved policy lever. However, under the current circumstances there is little option for the Scottish government but to raise rates to mitigate the cost-of-living crisis.

For the Scottish government to spend more, it is recycling already existing pound assets in the economy. This means the Scottish government is a currency user. In comparison, because the UK government operates as a monetarily sovereign entity (control over its own central bank and currency), it does not need to recycle already existing pound assets. Instead, every time the UK government spends it is newly created net-financial assets - public money. Therefore the UK government is a currency issuer.

Westminster also sets the lower threshold at which earners participate within the tax system. Because there are key differences in income distribution between Scotland and the rest of the UK, Westminster making a decision to raise the tax threshold would actually damage Scotland's tax returns. As Economist Jim Cuthbert points out, in 2021/22 the marginal rate of income tax, on top of national insurance, for those earning between £43k-£50k was 53% in Scotland. Compared to the rest of the UK this was 20% higher than marginal rates for employees with similar earnings in the rest of the UK.

Whilst the Scottish government as a currency user does not have a strict fixed amount on what it receives in tax revenue, it is still heavily restricted on its spending in real terms. Further, the Scottish Government cannot adjust tax rates in year until the next wave of annual budget decisions.

Conclusion

Whilst it is correct to say there is a degree of "flexibility" to the Scottish budget, alternative policy tools are themselves limited or fixed.

The block grant and borrowing powers for the Scottish Government are either fixed by fiscal calculations or are capped. Spending done via tax revenue recycles already existing pound-assets, whilst other monetarily sovereign countries do not face similar constraints.

As such, it is misleading to state that Scottish Government spending is not largely fixed.