A little over four years ago, as the age before Brexit drew to a close, the fifth elections to the Scottish Parliament were held. Along with the largest intake of new MSPs since 1999, Holyrood was set for an influx of new powers. While the majority of fiscal levers and social security spend would continue to be exercised at Westminster, the Scottish Parliament would gain significant, though incomplete, controls over income tax and social security.
Underpinning many of these new powers is the Fiscal Framework, agreed by the Scottish and UK Governments in February 2016. The framework seeks to reconcile greater fiscal autonomy for Scotland while retaining the longstanding Barnett Formula. This attempt to square the circle of Scotland’s constitutional divide has produced a system of fiscal governance described by the OECD as “complex” and “largely untested”. The inherent sophistication and novelty of approach taken within the framework was undoubtedly a factor in both governments agreeing that it should be reviewed following its first parliamentary term in use.
Ahead of the review in 2021, the Scottish Parliament’s Finance and Constitution Committee has been closely monitoring how the framework is operating in practice. One area of concern has been the framework’s opaque mechanisms, which create challenges in ensuring scrutiny and establishing political accountability. This concern was echoed by the OECD in their review of the Scottish Fiscal Commission (SFC), which stated that there is “limited public understanding” of how the framework operates. It should be noted, however, that any limits in understanding are not restricted to those beyond the Holyrood bubble, as evinced by the annual rounds of specious political commentary on blackholes, underspends and money cached in sofas.
Of more immediate concern are the rules restricting Scottish Government borrowing. With ministers required to deliver a balanced budget based on independent forecasts, it was recognised that taking on additional tax powers would directly expose public finances in Scotland to the caprices of forecast error. In mitigation, the framework provides for modest resource borrowing powers in addition to permitting the creation of a reserve fund of limited size and flexibility. The expectation was that these measures would enable ministers to manage divergence between forecasts and outturn at the reconciliation point, which takes place at a subsequent budget two years after the close of the financial year.
What has become increasingly evident is that these powers, however well intentioned, are insufficient. The SFC, the body charged with producing forecasts, including on income tax receipts, have indicated that forecast error of £500 million should not be regarded as particularly unusual. This is problematic.
The cap on annual resource borrowing for the Scottish Government is £300 million, some £200 million shy of what is needed to cover potential forecast error. Consequently, even when fully deploying existing borrowing powers, it could routinely be the case that a shortfall could only be met with funds gained at the expense of public spending, either directly at the budget where reconciliation takes place or indirectly through diverting cash into reserve in previous years.
To compound matters, only a maximum of £250 million in resource spending may be drawn down from the reserve in any one year. Taken together with resource borrowing, the maximum theoretical flexibility available to the Scottish Government to manage forecast error is £550 million, which is below the expected income tax reconciliation due in the 2021/22 budget.
Given the mismatch between risk and means of mitigation, an expansion in resource borrowing limits and increased flexibility over the use of the reserve were likely to have been key asks of the Scottish Government ahead of the Fiscal Framework review. As we face repairing the economic damage sustained in responding to Covid-19, likely to be exacerbated by a no deal or ‘low deal’ Brexit, recalibrating the framework is now a matter of urgency.
A straightforward change that could be made to the framework, even on a temporary basis ahead of next year’s full review, would be to enable the Scottish Government to borrow as required to cover any and all tax reconciliations in next year’s budget. This would effectively waive the arbitrary £300 million annual limit currently in place. Additionally, the repayment period for resource borrowing could be increased from the current five years to between eight and 10 years, reducing budgetary pressure. A further change would be to repurpose the redundant cash management powers to provide additional support, while staying within the statutory limit for overall resource budgeting of £1.75 billion. Greater flexibility could also be gained by temporarily allowing for the transfer of unspent capital to resource within the existing budget.
These are relatively modest measures that should be able to command support across parties and the constitutional divide. They do not fundamentally alter the fiscal framework nor prejudge the outcome of its full review and they are certainly not a Trojan Horse for full fiscal autonomy. What they would do, however, is provide the Scottish Government with additional flexibility as we face the most significant economic crisis of the post-war era.
There is also a need to review capital borrowing powers. Getting beyond the immediate crisis and creating a sustainable, green and equitable economic recovery will require a huge fiscal stimulus. The Scottish Government’s capital borrowing powers are not of the scale required to meet this historic challenge. Proposals to enhance Scotland’s capital borrowing powers need to be considered seriously. One example would be to enable the Scottish Government to issue bonds so as to finance game-changing investment in key sectors, as suggested by former MSP Andrew Wilson. Others will have different ideas – however, doing nothing must not be an option.
As this eventful session of Parliament draws to a close, it’s clear that existing borrowing powers represent only a start and as the OECD noted, the fiscal framework is “likely to continue to evolve.” As with devolution more generally, Scotland’s Fiscal Framework is less of an event and more of a process. Confronted with the twin challenges of Covid-19 and Brexit, we must now accelerate that process.
Tom Arthur is SNP MSP for Renfrewshire South and a member of Holyrood’s Finance and Constitution Committee