Scottish finances ‘at risk’ because of reliance on forecasts for budget

25 Jan 19

Scotland’s finances are exposed to “substantial risk” because of the way its budget is determined, according to a parliamentary report.

Members of the Scottish Parliament’s cross-party finance and constitution committee warned Scotland’s finances were vulnerable in particular because of the the weight given to questionable forecasts.

They warned that the budget was subject to volatility because, under the terms of the fiscal framework which accompanied the devolution of tax and welfare powers, it had been increasingly determined by the performance of the Scottish economy relative to that of the rest of the UK.

In addition, there had been “substantial movement” in the revenue forecasts provided by the Scottish Fiscal Commission which informed a large part of the budget, the committee said.

The commission had defended the accuracy of its predictions, saying that an analysis of average revenue forecasts across the UK over the last 30 years showed it was “not unreasonable” to expect an average one-year ahead error in its own forecasts of around £530 million.

“While this may not be unreasonable in forecasting terms, it presents a substantial risk to the Scottish Government’s budget which may or may not be offset by similar forecast error by the Office for Budget Responsibility,” the committee said.

The risks inherent in the fiscal framework had been exacerbated by uncertainty over Brexit, which had had a negative impact on business investment and economic growth, it said, and in particular the prospect of the UK leaving the EU without a deal.

“The committee is strongly of the view that a no-deal Brexit would be damaging to the Scottish economy and public finances and, therefore, is clearly not in the national interest,” it said.

In a debate on the Scottish Government’s draft budget on Thursday, finance and constitution committee convener Bruce Crawford said that because the budget was subject to a much greater degree of volatility and uncertainty, the risk to the public finances from forecast error was now “very real”.  

He also raised concerns over the risk to the nation’s finances posed by the fact that Scotland’s population is ageing faster than that of the UK as a whole.

“Does the Scottish Government have sufficient policy levers to address this risk, and does the fiscal framework sufficiently recognise demographic divergence?” said Crawford, suggesting that both questions should be addressed as part of the review of the framework due to take place in 2021.

Finance secretary Derek Mackay said he acknowledged the financial risks to the budget.

“The budget process is complex, particularly in its reliance on accurate forecasting and the increased uncertainty that comes from managing increasing demand-led budgets, such as our new social security programme,” he said.

“I look forward to working closely with the finance and constitution committee as our experience under the fiscal framework grows and we reach that review point.”

He also defended his income tax proposals, under which he opted to freeze the higher rate threshold for taxpayers in Scotland. The move signalled a further divergence in tax policy between Scotland and the rest of the UK, where the higher rate was raised by chancellor Philip Hammond in his last budget.

“In not following the Tories on their tax proposition, we are not passing on the tax cut for the highest earners in society, so I believe that our tax system is fair and progressive,” said Mackay.

A spokesperson for the Scottish Fiscal Commission said that over the last 30 years the average difference between the UK’s ‘one-year ahead’ forecasts and actual tax revenue had been 3.3%. “If applied to our Scottish tax forecasts, this could mean a difference of around £530 million,” she said.

“As the future can be difficult to predict, it’s normal that our forecasts will contain a degree of inaccuracy.”

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