Professor David Bell, Professor of Economics, Stirling Management School, University of Stirling

At a time of unprecedented cost of living pressures, the size of the Scottish Government budget has never been more important. Economist and University of Stirling Professor David Bell, who contributed to a recent review of the fiscal framework, explains why.

The UK and Scottish Governments have just completed a review of the fiscal framework that was agreed in 2016 and has since largely determined the size of the Scottish Government budget.

This review is of substantial importance for the Scottish budget and therefore for the services it delivers to the public during the cost-of-living crisis.

Why, then, has the review attracted so little interest, from the public and the media, other than from the Finance Committee of the Scottish Parliament? Especially when our report  – produced alongside colleagues from the Institute of Fiscal Studies and the University of Strathclyde – shows that different approaches to the fiscal framework could cause Scotland’s budget to vary by hundreds of millions of pounds in the medium to long term.

In 2021-22, Scotland’s block grant from Westminster was £33 billion. Devolved taxes contributed only £19 billion.

The most important issue that the review addressed was how to adjust the block grant from Westminster in the light of the tax and social security policies that have gradually been introduced following the 2016 Smith Commission. The block grant is still partly determined by the Barnett Formula, with “consequentials” arising when UK spending is increased in “comparable” areas such as health. But the fiscal framework specifies how the block grant is to be cut for each new tax (and increased for each social security benefit) for which the Scottish Government takes responsibility. The rationale for these adjustments is that the UK Government loses its tax base in Scotland for each transferred tax but also loses its obligation to pay for each transferred social security power.

But how should the size of these adjustments be determined in the future? Could they be based on the principles set out by the Smith Commission in 2016? The most important of these were “no detriment” and “taxpayer fairness”. “No detriment” means that neither the Scottish nor the UK Government should be better or worse off because of the transfer of tax or social security powers to Scotland.  “Taxpayer fairness” means that the benefits or costs of policies introduced in one territory should not adversely affect the taxpayers of the other. Our report showed that it is not possible to satisfy these principles simultaneously.

The method currently most closely aligned with the “no detriment” principle has been applied to tax powers since 2016 as a “stop-gap” measure, with the Treasury arguing that an alternative, more closely aligned with the “taxpayer fairness” principle, should be applied after the review. However, the outcome of the 2023 review is an agreement to continue with the current methods of determining the tax adjustments. Our report shows that, had the “taxpayer fairness” driven approach rather than the “no detriment” version been applied, and based on reasonable assumptions about population and revenue growth, the adjustment to the block grant solely for income tax would have increased by around £500m between 2016/17 and 2026/27, leading to an equivalent fall in the Scottish Government’s budget.

Within the options under consideration, the decision to continue the focus on the “no detriment” principle is beneficial to Scottish Government. However, the Treasury will be satisfied that the review’s additional provisions relating to borrowing are quite modest relative to the overall scale of UK Government borrowing and that the debate has not widened into a more general debate on what is meant by a “fiscal union” within the UK, any rationale version of which would likely involve a questioning of the Barnett Formula.