Fiscal Framework Review: Deputy First Minister statement

I am pleased to open today’s debate on the revised Fiscal Framework Agreement, and I move the motion in my name.

On the 2nd of August, following a joint review, the Scottish and UK Governments published an updated version of the Scottish Fiscal Framework - fulfilling a key commitment in the First Minister’s policy prospectus.  

This Government believes that Scotland’s future of course lies as an independent country, and that it would be best served by the full range of fiscal powers and choices that independence would bring. 

But until such a time as the people of Scotland choose a different constitutional path, we are committed to working with the current framework, and working to improve on it.

The changes agreed with the UK Government are balanced and pragmatic. This new agreement strengthens the Scottish Government’s financial management levers, and provides the Scottish Parliament and Government with greater long-term funding certainty. 

But we need to be clear that, despite improvements to the framework, the fiscal position facing the Scottish Budget remains extremely difficult.

A situation of course made worse by decisions imposed by the UK Government in last month’s Autumn Statement.

Once again, the UK Government has chosen to pursue an austerity budget that will have a profound consequence for Scotland’s public services.

As the Institute of Fiscal Studies has said of the Autumn Statement: “The tax cuts are paid for by planned real cuts in public service spending”.

Even with the Fiscal Framework in place, levels of funding for the Scottish Budget remain closely tied to spending decisions by the UK Government. 

Decisions to starve services in England hit our budget in Scotland – as the UK Government’s failure to invest in services in England means that the devolved administrations in Scotland, Wales and Northern Ireland do not receive adequate consequentials.

A cursory look at the UK Government’s Autumn Statement for 24-25 shows the devastating impact of Tory austerity being forced on services.

Even using lower estimates of inflation, UK frontline resource budgets are seeing real term cuts.

For example, if planned UK day-to-day expenditure on services in 2024-25 had grown in real terms since 2022-23, then compared to Conservative plans in England, Health and Social Care spending would be over £8 billion higher.

The UK Government’s approach means that it has provided almost no funding to cover the costs of this year’s pay deal in 2023-24 – never mind the cost of a 2024-25 pay deal.

The lack of provision for the cost of NHS pay deals amounts to treating pay increases as though they were a one-off costs, which of course they are not.

Prior to tax and welfare block grant adjustments Scotland’s resource budget from the UK Government in 2024-25 will be over £700 million lower than if there had been funding in line with real terms over the two years.

Changes to the Fiscal Framework cannot compensate for the scale of the UK Government’s failure to act and invest in public services at this time.

So returning to the Fiscal Framework Review – while the revised agreement has delivered important improvements, I want to be clear that the Scottish Government’s preference would have been for a review that was broader in scope, and that in some places the agreement does not go as far as we would have wished.

The scope of the review and its outcome was of course subject to agreement with the UK Government.

I also want to address the timing of this agreement.  Throughout discussions with the UK Government on arrangements for the review, my predecessors and I have sought to balance the need to keep Parliament informed with the need to maintain a confidential space for negotiations.

In weighing whether to conclude an agreement during recess, I had to consider the benefits of securing improved borrowing powers in advance of the 2024-25 Budget, and that we were negotiating with a UK government that will probably go into election mode soon.

Considering these circumstances, I concluded that it was appropriate and prudent to agree the revised agreement when the opportunity arose.

The Scottish Fiscal Framework plays a central role in determining the funding for the Scottish Budget, and has been key to enabling the devolution of new tax and social security powers provided for in the 2016 Scotland Act.

The original Fiscal Framework was agreed in 2016 and was the product of negotiations between the Scottish and UK Governments.

Those negotiations were of course guided by the principles and recommendations articulated by the cross-party Smith Commission, which published its findings in 2014.

And that remains the case for this revised agreement. The Barnett formula continues as the basis for calculating the block grant, and the framework continues to be bounded by the principles outlined by the Smith Commission.

Those include principles of economic responsibility, sustainability, and no detriment as a result of devolution.  

Since 2016, the Scottish Government has used the tax and social security powers underpinned by the framework to pursue policies better tailored to Scotland’s needs.

For example, the Scottish Government has delivered the fairest and most progressive income tax system in the UK, while raising extra revenue to invest in public services and Scotland’s economy.

And with devolved social security powers, the Scottish Government has ensured additional support to the most vulnerable in our society.

Since the unanimous passing of the Social Security Act in 2018, we have introduced thirteen benefits, seven of which are brand new and only available in Scotland.

This year we will invest £405 million in the Scottish Child Payment, improving the lives of over 300,000 children across Scotland – and as a result of the Scottish Child Payment and Scottish Government policies, 90,000 fewer children will live in relative and absolute poverty this year.

However, it is also the case that the Fiscal Framework has been stress tested since 2016. The agreement preceded the EU referendum and subsequent chaos and uncertainty that accompanied the UK Government’s hard Brexit.

And we have of course seen extraordinary fiscal upheaval as a result of the pandemic, the ongoing cost of living crisis, and the UK government’s economic mismanagement.

Given this political and fiscal upheaval, the review provided an opportunity to take stock and consider elements of the Fiscal Framework that required change.

The centrepiece of the Agreement in 2016 was the Block Grant Adjustment arrangements that account for the devolution of new tax powers and social expenditure to Scotland.

Under these arrangements a total of £16.1 billion was deducted from the Scottish Block Grant in the 2023-24 Budget to reflect the devolution of various tax powers and the corresponding revenues now retained by the Scottish Government.

Similarly, £4.4 billion was added to the Block Grant for 23-24 to reflect the transfer of responsibility for a suite of social security benefits to the Scottish Parliament.

The methodology used to calculate these block grant adjustments therefore had a material impact on the funding available for the Scottish Budget.

Securing the Indexed Per Capita Block Grant Adjustment methodology on a permanent basis is a significant win for Scotland.

The Scottish Government pressed hard for the Indexed Per Capita methodology as part of the original Fiscal Framework.

And the 2016 Fiscal Framework said that the Indexed Per Capita methodology would apply on an interim basis, with a permanent arrangement to be reviewed and agreed at a later date.  

Having now completed that review, the agreement to apply the Indexed Per Capita methodology on a permanent basis is a positive step, because it removes uncertainty and protects the Scottish Budget from the impact of slower population growth in Scotland, which has been the historic trend over the past fifty years. 

An Independent Report, jointly commissioned by the Scottish and UK Governments ahead of the Fiscal Framework Review, estimated that the ongoing use of the Indexed Per Capita methodology for calculating Income Tax Block Grant Adjustments alone could be worth around £500 million a year by 2026-27 -  when compared with other methodologies that were considered, such as the Treasury’s preferred comparable model.

In my view, it is right to protect the Scottish Budget in this way. The Scottish Budget should not be penalised for lower population growth, which of course is out-with Scotland’s control because we don’t have the key levers over things like migration and other levers that would be required.

The agreement also provides a substantial increase in the Scottish Government's resource borrowing powers to manage funding volatility associated with the operation of the framework.

Specifically, it increases the Scottish Government’s ability to borrow to address tax and Social Security forecast errors - doubling from £300m to up to £600m per year of borrowing capacity.

These forecast errors are a normal part of the way the fiscal framework operates, but this change greatly improves the Scottish Government's ability to manage and smooth funding volatility driven by forecast error. 

This in turn will provide a more stable and predictable funding environment for the Scottish Budget, and the programmes and services that it supports.

These new borrowing powers will take effect from 2024-25. I will set out how we intend to use these powers at the forthcoming Budget, but in principle, these new powers would allow us to borrow in full to cover next year's income tax, and other, reconciliations, which amount to £338 million.

The ability to borrow in full effectively spreads the impact of the tax reconciliations across multiple years, rather than requiring that that cost is absorbed in a single Budget.

Another important development involves changes to the operation of the Scotland Reserve.

Alongside borrowing powers, the Scotland Reserve provides the Scottish Government flexibility to manage its funding position across financial years, and to respond to unforeseen circumstances.

However, the Scottish Government’s ability to draw funds from the reserve was previously constrained, we were limited to a maximum of £100 million for capital, and £250 million for resource funding. That amounts to around 1.5% of the total Scottish capital Budget in 2023-24, and 0.5% of the resource Budget.

I am pleased to report that this new agreement sees those draw-down limits removed altogether -  significantly increasing reserve flexibility and the Scottish Government's ability to manage funding across financial years. 

As you would expect, specific decisions on the use and application of these bolstered powers will be outlined as part of the Scottish Budget.

More broadly, we have also agreed that in future all borrowing and reserve limits will grow with inflation each year.

Previously, annual and cumulative limits for borrowing and reserve limits had been set in nominal terms, eroding their power and effectiveness over time with inflation. So securing uprating ensures that the powers continue to be viable and sustainable, and that limits are protected in real terms.

In keeping with this approach, and recognising how circumstances have changed since the Fiscal Framework was introduced in 2016, we have agreed to increase the baseline adjustment to the block grant which accompanied the devolution of responsibility for managing Crown Estate assets.

The adjustment will increase in increments reaching £40m in 28-29, where it will remain fixed in nominal terms.

To avoid any further delays in the Scottish and UK Governments concluding of the revised agreement, it was jointly decided that arrangements for implementing VAT Assignment would be further considered at a future meeting of the Joint Exchequer Committee. And I very much appreciate the work that the finance committee has put into looking at that matter.

Viewed in the round, this agreement protects funding for the Scottish Budget, updates the framework to reflect changes since 2016, provides greater certainty on future funding, and equips the Scottish Government with a set of strengthened fiscal levers.

But as I said, while the revised Fiscal Framework agreement represents good progress and puts in place arrangements that better reflect the scale and complexity of the Scottish Budget, the changes are not on a scale required to offset the broader fiscal challenge.

At the Autumn Statement the Chancellor failed to provide the funding that devolved governments need, with little consideration of Scotland and the specific challenges we face. That will be very challenging indeed, and I will set out the consequences of that at the Budget on the 19^th of December.