The forecaster said Scotland faced a £1.7bn drop in income tax revenues over the next five years as growth was expected to stay below 1%, keeping Scotland behind the rest of the UK.
Much of that resulted from slow productivity growth as well as a working-age population that is expected to start shrinking this year, fuelling calls from the Scottish Government for Holyrood to be handed control over immigration policy in order to boost GDP and tax take.
Critically, wage growth expectations, one of the key determinants of income tax revenues, have been downgraded. The commission puts nominal hourly wage growth at 1% in 2017-18, below historic norms and “a notable downward revision” from the body’s last, more optimistic, forecast at the end of last year.
Since then, the commission said it had been examining in detail the relationship between real wages and productivity in Scotland over the past decade.
“We concluded that real wage growth has been low, even relative to what one might expect in relation to productivity,” it said. “As a result, we dampened the link between productivity and real wages.”
David Eiser, who leads the Fraser of Allander Institute’s work on fiscal policy, said there was now a substantial gap between predicted wage growth in Scotland and the rest of the UK.
“That kind of difference is not something we’ve seen historically,” he said. “The commission’s view of what will happen to wages in Scotland is quite different to the Office for Budget Responsibility’s view of what will happen in the rest of the UK.”
The consequences of that divergence for the Scottish budget could be significant. “The Scottish budget is determined not only by the revenues raised in Scotland but also the size of the block grant adjustment, which depends on how quickly tax revenue has grown in the rest of the UK,” he said. The bad news for Scotland is that while the commission’s revisions to Scottish revenues were down, the OBR’s revisions to UK revenues were up, leaving a £389m deterioration in Scotland’s budget outlook.
Questioned by the Scottish Parliament’s finance and constitution committee, finance secretary Derek Mackay admitted to being “surprised” by the shift in the commission’s income tax forecast since the end of last year. “It is curious that the analysis of the impact on wage earnings, which is a key issue, was not fully explained by the SFC,” he said.
“Some people have described the OBR as quite optimistic and the SFC as quite pessimistic, and the gap between the forecasts increases the volatility that we are dealing with.” However, he downplayed the significance of that gap for the Scottish budget, pointing out that the SFC and OBR used different methodologies in their forecasts, neither of which were final.
“We will have the best, up-to-date information closer to the time of the UK and Scottish budgets, and we will have more hard data, which will be better than having just forecasts, which is what we have now,” he said.
If Mackay does end up with fewer resources than expected in 2018-19, his options will be to reduce spending, use borrowing powers, or draw down from the Scotland reserve. The commission has warned that the Scottish Government can only continue to borrow at its current rate until 2022-23. After that, the aggregate cap of £3bn will be reached, limiting future borrowing.
According to Mackay, the Scottish Government is hamstrung by its lack of fiscal freedom. “We need more levers in addition to the borrowing powers and having a reserve, because there are caps on how much I can draw down from that reserve,” he said. “We need more flexibility in the event of a worst-case scenario.”
