Chamber and committees

There will be a further meeting of officials in the new year to examine where we have got to. I mentioned that the evidence that this committee has heard will be an important part of that. The outcome of those discussions will be considered at a future meeting of the joint Exchequer committee. The best outcome would be that, working together with Treasury officials, officials put some joint recommendations to us and then a decision is made. As I said earlier, I am happy to keep the committee updated.

I am very clear that the uncertainty associated with the proposed approach to VAT assignment, along with your point about no additional fiscal or policy powers being granted to manage it, is an inherent and currently unmanageable risk to the Scottish budget.

A lot of the work that has gone on has tested some of that. In the fiscal framework review, we got to an acknowledgment of the complexity and risk. The concerns then really need to be addressed by both Governments. Officials have met following the conclusion of the review to establish where both Governments stand on the matter and to discuss next steps.

There will be another meeting early in the new year at which I think that evidence from this committee will be part of the discussion on whether the conclusions on VAT assignment are now clear in relation to the recommendations by all the experts and the evidence heard at this committee.

The outcome of those discussions will be considered at a future meeting of the joint Exchequer committee. My intention would be to keep the committee updated on that outcome. The process would need to come to a position that is acceptable to both Governments in relation to what happens next, rather than only one Government giving its view. I am very aware of that and I would like to get to an agreed position on what we do with the issue.

However—in total agreement with the convener—I would not countenance taking on that inherent risk without any of the policy levers. To be charitable, it was perhaps simply not fully understood at the time that the inherent risk and the impact on the budget was going to be borne totally by the Scottish Government. In light of all the evidence that we have now, I would like to think that we would come to a pragmatic and sensible conclusion.

That is a fair comment and a fair assessment, and we would have to consider that. The principles were a set of compromises that emerged from a political negotiation. We have probably learned from that process. In relation to what we just discussed about VAT assignment, it is necessary to be clear and careful about what is part of that negotiation. Some of those areas were inserted into the Smith commission at the last minute.

The principles would need to be looked at. We would be in a completely different era with a completely different set of arrangements, so we would have to look at it in the round.

That point has been made on a number of occasions. There is scope and a need for a discussion of those fundamental issues. We would have liked to have got into that space, but, as I said at the start, when you are in a negotiation, you can only negotiate within the parameters of the other party’s willingness. In this case, those parameters were narrow, so a judgment had to be made.

Those issues remain on the table. As you have pointed out, the prudential borrowing powers of local authorities are markedly different compared with those of the Scottish Government and other devolved Administrations across the world, and that is not acceptable. Those matters remain live and we want to get into the space of further negotiation on them. However, this negotiation was very limited in scope.

We had to be pragmatic. I would not want to underestimate the gain that was made with the adoption of the indexed per capita block grant adjustment methodology on a permanent basis. In my opening statement, I set out that that could be worth around £500 million per year by 2026-27, so that was important. I was also mindful of the potential negative tax reconciliation quantum for 2024-25. We are now in a different space with the quantum, but at the start of the process, we did not know what it would be and it would have had a material impact on our budget next year. Therefore, being able to increase our resource borrowing powers from £300 million to £600 million was important, and that will be able to cover all the negative tax reconciliation for next year. Those things were uppermost in my mind. I accept that, if we had started with a fresh negotiation, other matters—some of which you have mentioned—would have been on the table. However, in order to secure some immediate benefit, I made that judgment and that was our conclusion. The negotiation took place within a limited window of opportunity.

Thank you, convener, and good morning. I am pleased to have the opportunity to attend this meeting to discuss the recent fiscal framework review.

The agreement with the United Kingdom Government to publish an updated version of the Scottish fiscal framework on 2 August fulfilled a key commitment in the First Minister’s policy prospectus. Since the fiscal framework was agreed in early 2016, it has been thoroughly stress tested as Brexit, the pandemic and the cost of living crisis have unfolded. Therefore, it was right to review arrangements and consider improvements.

The new agreement with the UK Government includes a balanced set of changes that strengthen the financial management tools that are available to the Scottish Government and provide the Scottish Parliament and the Scottish Government with greater long-term funding certainty. That said, I want to be clear that the review was not as broad in scope as the Scottish Government would have liked it to be. That reflects the fact that the scope and process for the review and its outcome were subject to agreement with the UK Government. Nonetheless, under the circumstances, the revised agreement represents meaningful progress and a good outcome for Scotland.

The adoption of the indexed per capita block grant adjustment methodology on a permanent basis is a significant win for Scotland. The authors of the independent report estimated that the use of the indexed per capita methodology for calculating income tax block grant adjustments alone could be worth around £500 million a year by 2026-27 compared with the use of other methodologies that were considered in 2016.

The agreement also provides a substantial increase in the Scottish Government’s resource borrowing powers to manage tax and social security forecast errors—the amount has doubled from £300 million a year to up to £600 million a year of borrowing capacity. That greatly improves the Scottish Government’s ability to manage and smooth funding volatility driven by forecast error.

The removal of drawdown limits on the Scottish reserve is also an important development. It provides a significant increase in reserve flexibility and improves the Scottish Government’s ability to manage funding across financial years.

The agreement to uprate borrowing and reserve limits in line with inflation ensures that the effectiveness of those powers will be maintained in real terms, which makes Scotland’s financial management arrangements more sustainable.

Taken together, and within the context of the narrowly scoped review that was on offer, those are meaningful improvements to the framework and the financial management tools that are available to the Scottish Government.

That said, we should not lose sight of the scale of the fiscal challenge in the aftermath of the pandemic, the on-going cost of living crisis and the urgent need to tackle climate change. Although the changes to the framework are welcome, they are not of the magnitude required to offset that broader fiscal challenge. That requires action by the UK Government and I hope that the Chancellor of the Exchequer will heed calls from the Scottish Government to take action on public services, fuel poverty, net zero and the cost of living as part of tomorrow’s autumn statement.

I also understand the concerns that the committee expressed about the process surrounding the review and its timing. The Scottish Government’s preference had been for a process involving broad stakeholder involvement. However, when a window of opportunity emerged earlier this year to conclude an agreement with the UK Government on changes to the framework, I was mindful of the value of securing borrowing powers ahead of the 2024-25 budget and that we were dealing with a UK Government that is likely to go into election mode soon. In that context, I judged that it was appropriate and prudent to conclude a deal when it became possible to do so.

I hope that the committee recognises the improvements that have been secured through the revised agreement and I look forward to discussing the detailed arrangements.

Matthew Elsby, do you want to come in on that? I think that it is fair to say that risk is inherent in every decision. I guess that our starting point was to minimise that risk for the Scottish Government and what came out of the review does that.

As you can imagine, we pushed on a number of fronts to try to get the maximum benefit and best deal and were more successful in some areas than in others. Getting indexation was better than getting nothing on capital, but we would clearly have wanted that to go further.

The biggest challenge that we face comes from capital borrowing limits. As part of the budget, I will lay out the full implications of that for the Scottish budget and for infrastructure projects. It is a real challenge and links directly to the economy, economic growth and the ability to invest in Scotland’s infrastructure. Capital borrowing limits are crucial and will be a major impediment to growth. We got as much as we could achieve, but were just not able to expand the basket of measures that were being looked at.

You are right that the outlook goes beyond the next budget. When I set out the medium-term financial strategy—the MTFS—I was clear about the projections of the gap that had to be addressed and the levers that we would use to do that. It is about ensuring that we make decisions that prioritise and target, that we grow the economy and the tax take from that, and that we take the decisions that we need to take in order to close that gap. However, that is very challenging, given the headwinds that are here and those that will come at us next year and beyond. I cannot overestimate the impact of inflation in all of that. Its impact is profound in every single part of the public sector.

No tax system is perfect—let us put that out there as a point of agreement. When the Parliament and its tax powers were established, the starting point was the UK tax system, so we did not start from a blank sheet of paper. With the additional tax bands, we have tried to bring some fairness and more progressivity to our system by recognising that it is not fair to have such a wide-ranging income band in the UK tax system that is taxed at the same rate. That is very difficult to defend. By bringing in the additional bands, we have tried to make the system fairer and more progressive.

We continue to look at what needs to be done. One of the reasons why we established the expert group, which has met twice now, was to look at a number of issues around a longer-term view of the tax system and what it will look like. It was also established to take a more strategic approach to tax, which the UK certainly has not done—we are at the foothills of trying to do that—and to try to get more transparency in people understanding what the tax system does. There is still some confusion about the interaction between the UK and Scottish tax systems, so there is a genuine attempt to try to make that more visible and to be quite frank about some of the decisions, and the consequences of those decisions, on what we do with our tax system. As I started off by saying, the revenues generated by taking decisions that are different from those of the UK Government have been important in really difficult financial times. If we had not done that, we would have to have made even more difficult decisions.

Public sector reform is really important. I lead on that across Government in order to ensure that a strategic view is taken across the whole of Government. First, there is some low-hanging fruit that all public sector bodies should be aiming for around efficiency and digitisation. There are some great examples of organisations that have become far more efficient—in difficult financial times, that is important—and that are able to deliver an improved service to the public, but for less money. All those things should absolutely happen.

We then get into the more complicated territory of potential mergers and amalgamations and of whether people can share services or buildings. That brings us back to our earlier discussion. All those things are on the table, along with the workforce level that each public sector body requires and, frankly, a bit of a presumption against new public bodies. We now have a system of needing explicit ministerial approval for the creation of any new public bodies. There are still some in the pipeline, because parliamentary decisions lead to the creation of new public bodies. I am not pushing back on those decisions or saying whether they were right or wrong, but I guess that there is a role for Parliament in taking a step back and looking at the multitude of public bodies that we have that are in the parliamentary space. For example, we have a number of commissioners, some of which overlap. There is a bit of a need—which should not be pushed by Government—for Parliament to look at what makes sense in that landscape.

We all have to be acutely aware of the need to leave no stone unturned when it comes to how can we extract better value for every public pound, every public sector body and every commissioner’s office, given that the finances are so constrained. Not only the Government but all of us have a responsibility to consider such matters.