Scotland’s money November: 2016

Autumn Statement

The Economic Context New Chancellor announced significant downward revisions to economic growth & worsening of public finances over the course of the next five years Permanent hit to the economy from Brexit, leads to reduced tax revenues and higher expenditures

The Policy Context Modest fiscal giveaway £9 billion in 2020-21 New Productivity Investment Fund – well intentioned but impact marginal – very limited support for JAMs Fiscal Targets Abandoned Replaced by new fiscal rules

Modelling Brexit Broadly similar approach to most other forecasters – including ourselves Key Points UK leaves the EU in April 2019 Reduction in imports and exports Lower migration Savings from EU budget recycled into additional domestic spending

Economic Outlook. GDP forecast

OBR slightly more optimistic than average. GDP forecast

Reasons for the downturn Delayed/cancelled business investment – driven by uncertainty and anticipation of future trading relationships Reduced consumer spending as a result of higher inflation from sharp depreciation in Sterling

Key implications Unemployment rising to 5.5% in 2018 Sharp rise in inflation – peaking at 2.5% in 2018 Slower growth in wages – 2.2% lower in 2020 than forecast in March IFS estimate that real earnings will remain below 2008 levels by 2021 – unprecedented squeeze on living standards The upward revision to unemployment is 0.3pp

Critical will be what happens in the long run….. Future path of productivity and potential output will be crucial – OBR hedges its bets

Sharp Rise in Borrowing - £120 billion over 5 years

Brexit Borrowing

Implication for the Scottish budget

An increasingly complex funding settlement The Scottish Government’s resource budget: Block grant from Westminster Interaction between block grant adjustment for devolved taxes, and Scottish revenues from devolved taxes Devolved tax policy in Scotland Capital budget: block grant + capital borrowing powers Both block grant and block grant adjustments are determined by decisions taken at the Autumn Statement Scottish Budget used to be simple: all that mattered was Barnett-formula determined block grant With tax devolution it depends also on revenues raised in Scotland, but also on the way in which the block grant is adjusted to take account of the devolved revenues

Consequentials announced yesterday Spending decisions by UKG on areas that are ‘comparable’ i.e. devolved in Scotland generate consequentials Relative to the March plans, the Scottish resource block grant remains essentiall unchanged after yesterday’s AS: simply an additional £20m resource spending in each of the next few years On capital side, the announcments by UKG of new National Productivity Investment Fund will generate fairly substantial consequentials - £800m over four years

Outlook for SG’s resource block grant 3.5% real terms cut over the period to 2020/21, on top of 5% cut since 2016/17

The Block Grant Adjustments (BGAs) Barnett-determined block grant Adjustment to reflect rUK revenues foregone (BGA) Revenues raised from devolved tax in Scotland Scottish budget For each tax transferred, an adjustment to block grant. The BGA is counterfactual estimate of revenues that would have been raised by UKG, had tax not been devolved. Assumption is revenue would have grown at same per capita rate in Scotland as rUK. Implications: Scotland protected from shocks which hit entire UK. Yesterday, OBR wiped £67bn off its forecasts for income tax revenues between 16/17 and 20/21, mainly as a result of lower wage growth but also lower employment (partly through reduced migration) and higher inflation (which is expected to raise thresholds faster than salaries).

The effect of differential revenue growth Since 1999, Scottish revenues grew slightly (0.25%) faster in Scotland than rUK. If this trend continues, Scottish budget would be modestly higher in 2020/21 than with Barnett only. But this position could easily be reversed. Would need a substantial growth differential to make up the scale of planned consolidation. Mention impact of SG tax choices . Tweaks to HR threshold, may bring in up to £400m, but then cut to APD, so net Additional £200m, 1% of budget

Explicit spending commitments NHS resource budget – increase by £500 million more than inflation by the end of the parliament Police – protect the police resource budget in real terms over the course of the parliament Childcare – double the number of hours of free early years education and childcare by 2021 – £500 million per year by the end of the parliament Spending on these three areas accounts for over half SG resource budget Implication is that remaining (unprotected) portfolios will see cuts of 10-14% over the period to 2019/20, depending on Scottish revenue performance A number of further implicit constraints on the resource budget Snp manifesto made number of high profile spending commitments. Health spending rise from 38% to 44% of budget since 1999/2000. For ¾ year olds and vulnerable 2 year olds Extra £1.9bn on these commitments – increase 5% at a time when budget as a whole falling 3.5%

The outlook for capital spending Capital budget will grow by 15% over period but remain 8% below 2010 (which was a fairly high year for capital spending historically) Use of borrowing powers (£450m per year within £3bn envelope) would bring capital spending above 2010 level

Summary

Key messages - outlook Significant downward revisions to forecast economic growth Substantial uncertainty around likely scale of downturn… …But will imply lower wages, employment and living standards Substantial deterioration in public finances £120bn additional borrowing forecast, of which only £23bn due to policy announcements Further fiscal pressures coming, mainly relating to demographics

Key messages - policy Only marginal changes to resource and welfare spending £23bn increase in investment welcome in context of historically low borrowing rates… …takes public sector investment to historically high levels… …but will it achieve a step-change in productivity improvement? For Scottish Government, implication is 3% cut to resource budget over period to 2019/20 Given existing spending commitments, implies real terms cuts of 10-14% for unprotected portfolios More favourable outlook for capital spending, both through higher grant and borrowing potential Population ageing expected to add 0.7% of national income to borrowing between 19/20 – 24/25