1Introduction
1.The relationship between Scotland and the rest of the United Kingdom is changing. The Smith Commission, set up in the wake of the 2014 referendum on Scottish independence, recommended that further powers be devolved to the Scottish Parliament. The UK Government accepted the Commission’s recommendations in full and transposed those powers into legislation in the form of the Scotland Bill 2015. The Bill is currently being considered in the UK Parliament and soon the Scottish Parliament will do the same when it is invited to scrutinise and give its consent to the legislation.
2.However, the Scotland Bill 2015 is only part of the process of further devolution. In order for the tax and spending provisions contained in the Bill to be successfully devolved, the way in which Scotland is funded must change. The Smith Commission recognised this and recommended:
The devolution of further responsibility for taxation and public spending, including elements of the welfare system, should be accompanied by an updated fiscal framework for Scotland, consistent with the overall UK fiscal framework.1
The fiscal framework for Scotland underpins the devolution settlement. The success of this latest round of devolution will depend to a large extent on the outcome of negotiations over the framework. Both governments have agreed not to comment on the negotiations while they are ongoing but this has led to concerns of a lack of debate over the appropriate degree of risk and incentives that Scotland should face as a result of the new settlement. As we aim to set out in this Report, these questions are fundamental to the whole process.
What is a fiscal framework?
3.The UK Government defines a fiscal framework as “the set of rules and institutions that are used to set and coordinate sustainable fiscal policy.”2 In the Command Paper which accompanied the publication of the draft Scotland Bill, the UK Government identified two key elements to a fiscal framework:
- Fiscal rules–these are designed to constrain fiscal policy, typically by setting limits on borrowing and/or debt over a defined period, in order to ensure fiscal responsibility and debt sustainability; and
- Fiscal institutions–these are non-governmental bodies responsible for overseeing fiscal policy decisions of the Government. In the UK this role is performed by the Office for Budget Responsibility (OBR), which also produces official economic and fiscal forecasts.3
The UK’s fiscal framework is set out in the Budget Responsibility and National Audit Act 2011. The Act requires the Government to lay before Parliament a ‘Charter of Budget Responsibility’. The purpose of the Charter is to improve the transparency of the
Government’s fiscal policy. The Charter must set out the Government’s approach to fiscal policy, management of public debt and its objectives for fiscal policy.4 The 2011 Act also established the Office for Budget Responsibility.
4.The UK’s fiscal framework stipulates that devolved authorities must work within the constraints imposed by the UK Government’s fiscal policy while at the same time being allowed to exercise their devolved powers.5 Scotland’s fiscal framework—as defined by the Scotland Act 1998 and amended by the Scotland Act 2012—sits within the wider UK fiscal framework.
5.Scotland’s existing framework states that the Scottish Government must run a balanced budget, that its funding is primarily derived from a block grant determined by the Barnett Formula and that Scotland has tools to manage volatility including the ability to operate a cash reserve and limited current borrowing powers to allow the Scottish Government to cope with variations in forecasts. The framework also allows the Scottish Government to borrow to fund capital expenditure. The Scottish Government has created the Scottish Fiscal Commission to scrutinise the reasonableness of its forecasts for devolved taxes. The Smith Commission notes that the revised framework should encompass a number of elements including:
the funding of the Scottish budget, planning, management and scrutiny of public revenues and spending, the manner in which the block grant is adjusted to accommodate further devolution, the operation of borrowing powers and cash reserve, fiscal rules, and independent fiscal institutions.6
Why does Scotland’s fiscal framework need revising?
6.The Smith Commission process will see the amount of revenue the Scottish Parliament is responsible for raising double to approximately £16 billion. It will also be assigned a further £5 billion in VAT revenues. Together, these revenues will account for over half of the Scottish Government’s annual Budget and around 40% of all revenues raised in Scotland. However, the Scottish Parliament will not just be taking on more responsibility for raising revenues, it will also be taking on the Scotland-specific fiscal risks associated with them. As the Scottish Government’s reliance on revenues increases then its exposure to volatility in its income base also rises. In order to be able to manage those risks effectively and be able to smooth any fiscal shocks the Scottish Government will need greater borrowing powers. This has been recognised by both the Smith Commission and the UK Government. Determining what those powers should look like is one of the key elements of the inter-governmental negotiations on revising Scotland’s fiscal framework.
7.The second key part of revising the fiscal framework concerns the question of how to adjust the block grant to take account of the devolution of tax and spending powers. Different methods of adjustment can lead to substantial differences in the size of the block grant and the level of risk to which Scotland might be exposed.
8.Aside from borrowing powers and the block grant adjustment, in this Report we also discuss other important areas of the fiscal framework including the assignment of VAT revenues, the devolution of welfare powers, scrutiny arrangements and the operation of the Smith Commission principles of no detriment. The section of the Smith Agreement which relates to Scotland’s fiscal framework is set out in the Appendix.
Accountability and powers
9.The Smith Commission and the devolution of further powers to Scotland are as much about making the Scottish Parliament and the Scottish Government more accountable to the people of Scotland—by making them more responsible for raising the revenues they spend—as it is about devolving to the Scottish Government levers to grow the Scottish economy and develop a distinct welfare policy. As we will discuss in this Report, having more powers does not automatically translate into economic prosperity but it does expose Scotland to greater risks. Whether the Scottish Government will have the tools to manage those risks effectively and whether it will be able to use the further powers to its benefit will largely come down to the design of the fiscal framework.
10.The stability of the devolution settlement is dependent on both governments getting the fiscal framework right. We had originally hoped to examine the framework once it had been published in the autumn. As this did not happen we have instead chosen to consider what we perceive to be the most important elements of a revised framework and in this Report we set out our views on what they should look like. This will give us a base from which to judge the framework when (or if) it is finally agreed.7
1 The Smith Commission, Report of the Smith Commission for further devolution of powers to the Scottish Parliament, 27 November 2014, Para 94
2 UK Government, Scotland in the United Kingdom: An enduring settlement, Cm 8990, January 2015, para 2.2.3
3 UK Government, Scotland in the United Kingdom: An enduring settlement, Cm 8990, January 2015, para 2.2.4
4 Budget Responsibility and National Audit Act 2011, Part 1; the most recent Charter was published in September 2015. It sets out the UK Government’s current aims for public sector net debt to be falling as a percentage of GDP, a target for a surplus on public sector borrowing by the end of 2019–20, and a cap on welfare spending.
5 UK Government, Scotland in the United Kingdom: An enduring settlement, Cm 8990, January 2015, para 2.2.7
6 The Smith Commission, Report of the Smith Commission for further devolution of powers to the Scottish Parliament, 27 November 2014, para 95
7 At time of considering this Report some clear differences in opinion between the two governments remained to be resolved.
© Parliamentary copyright 2015
Prepared 9 February 2016