Ross Stupart

Written by: Ross Stupart

Ross Stupart

Partner

How do you fill a £1bn hole in Scotland's finances?

The latest economic forecasts issued by the Scottish Fiscal Commission (SFC) indicated weak expected growth in both real wages in Scotland and Scotland’s GDP. Against challenging economic and political conditions this seems in line with wider sentiment of business in the UK. The same SFC report did however unveil a forecast deficit in the Scottish Budget over the next three years of £1.025bn. 

Should these forecasts be realised, the Scottish Government will have some difficult decisions to make in the very near future. Will they activate austerity measures and cut back on spending or will they seek to raise revenues by increasing taxes? Perhaps a combination of both. Borrowing amounts of this level is not feasible, therefore either way given the sums involved, fiscal decisions will need to be made that could have a wide-ranging impact on the people of Scotland.

With Scottish Parliament elections taking place in May 2021, cutting spending will be unpalatable for a Scottish Government led by the Scottish National Party, who have campaigned strongly on anti-austerity measures.

Therefore, one would think that Derek McKay and his team may focus on raising taxes to fill the hole forecast by the SFC. The Scottish Government currently has the power to raise revenues from Landfill Tax, Land & Buildings Transaction Tax (LBTT) and via the Scottish Income Tax. They should have the power to raise taxes from Air Passenger Duty (will be known as Air Departure Tax in Scotland) and Aggregates Levy in the foreseeable future. However, based on the 2017/18 Scottish Government Expenditure and Revenue report, Landfill Tax raised £149m; LBTT £546m; Air Passenger Duty from Scotland (estimate) £275m and Aggregates Levy from Scotland (estimate) £57m.

These numbers may lead to a conclusion that in order to raise the significant revenues required, the Scottish Government will need to principally focus on the Scottish Income Tax. However, increasing the Scottish intermediate rate of income tax (income up to £43,430) by 1 per cent so that most taxpayers earning up to £43,430 pay additional tax could only raise in the region of £500m in additional revenue. Adding 5 per cent to the top rate of tax paid by those earning over £150,000 would only raise in the region of £200m. 

What all of this suggests is that there is no easy solution to filling the hole in Scotland’s finances that the SFC has forecast. It would appear that a combination of tax rises, perhaps over the range of taxes under the control of the Scottish Government, and spending cuts will be required. 

To make the biggest dent in the shortfall, it may be that raising the intermediate rate of income tax (perhaps even the basic rate (income up to £24,944)) is the most effective tool. However, that would likely be a deeply unpopular move with Scotland’s middle earners, who are already squeezed by the lower starting point for higher rate tax than south of the border. 

What also remains to be seen is once Scottish revenues start to be influenced by the VAT revenues raised in Scotland, whether the fiscal gap forecast widens or narrows. A flat economy could lead to a larger hole. However, measures to provoke growth and spending could serve to narrow the gap via VAT receipts. 

What also remains to be seen is once Scottish revenues start to be influenced by the VAT revenues raised in Scotland, whether the fiscal gap forecast widens or narrows. But here too there are complications. The Scottish Government has now confirmed that it may seek to delay the assignment of VAT revenues to Scotland because of a lack of clarity over how much VAT is actually raised in Scotland. This presents a further problem because the devolution of all remaining social security benefits is due to commence in April 2020.

A flat economy could lead to a larger hole. However, it is to be hoped that measures to provoke growth and spending would serve to narrow the gap via increased VAT receipts.