The Scottish Budget 2018-1918 December 2017

Part 1: The economic context

Backdrop was always going to be economy

Scottish growth slipped to

just 0.1% in Q2…….

……in 5 of the last 6

quarters, Scottish growth

has been less than 0.1%.

Scotland’s current annual

growth rate is just 1/3 that

of the UK as a whole

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2013 2014 2015 2016 2017

% c

ha

ng

e

Quarterly Growth Annual Change (on same quarter 12 months ago) Source: Scottish Government GDP Series, Oct 2017

Strong headline labour market……

Scottish labour market

continues to hold up

well……

….despite fall in

employment in recent

months…….near record

levels (since LFS was first

conducted in 1992)

But there remain questions

about the nature of much of the work being created

66

67

68

69

70

71

72

73

74

75

76

77

0

1

2

3

4

5

6

7

8

9

10

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Em

plo

ym

ent r

ate

(1

6-6

4)

Une

mp

loym

ent ra

te (

16

+)

Source: ONS LFS , Dec 2017

….but hiding weakness in productivity

Scottish productivity had

been catching up with

UK….

….but productivity has been

weak since 2008 (and

catch-up with UK largely

driven by pace of job

creation at UK level)

Productivity – in terms of

output per hour – falling for

7 consecutive quarters

95.0

96.0

97.0

98.0

99.0

100.0

101.0

102.0

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2015 2016 2017

Ind

ex (

20

15

Q1

= 1

00

)

Qu

art

erly c

ha

ng

e (

%)

Change in output per hour (LHS) Output per hour (RHS)

Source: Scottish Government Productivity series, Nov 2017

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2018 2019 2020 2021 2022

% c

ha

ng

e in

GD

P

Bank of England OBR FAI SFC

The SFC’s economy forecasts

Source: SFC, OBR, BofE, FAI Dec 2017

Both OBR and BofE had

revised down forecasts for

UK – Brexit uncertainty and

weak productivity outlook

Growth below trend: <2%

Our latest forecasts are also

for below trend growth

SFC predicting much weaker

growth…..less than 1% to

2021

To put this in context…..

If this forecast from the SFC

turns out to be true…..

…..longest run of below 1%

growth in 60 years

Source: Scottish Government GDP Series, Oct 2017-4%

-2%

0%

2%

4%

6%

8%

10%

1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

GD

P G

row

th

Long-term trend growth

Why are the SFC pessimistic?

Reason 1:

SFC more pessimistic than

OBR on current output gap

Despite weak growth for

over 2 years, they believe

that Scotland is ‘operating

above capacity’

Limits potential for ‘bounce-

back’ in growth

Big judgement call – believe

slowdown all ‘structural’

Source: Scottish Fiscal Commission-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

% o

f tr

en

d G

DP

Output Gap: production function

Output gap: cyclical indicators

Why are the SFC pessimistic?

Reason 2:

Scotland’s working age

population projected to

decline over next few

years…but rise in UK

SFC use 16-64 projections –

(we use ‘working age’ which

is more optimistic)

SFC also use ’50 percent

EU migration variant’ – OBR

use principal projection

(again which is more

optimistic)

Source: ONS population projections96

97

98

99

100

101

102

103

104

105

106

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Index 2

016=

100

16-64 Scotland 16-64 UK Working age Scotland Working age UK

Why are the SFC pessimistic?

Reason 3:

Like OBR, SFC believe

slowdown in productivity

over last few years will

continue…..

….even then, more

pessimistic than OBR for UK

With little growth in

participation or hours

worked, growth potential of

Scotland much slower

Source: SFC, December 2017

-1.0

0.0

1.0

2.0

3.0

1993-94 1996-97 1999-00 2002-03 2005-06 2008-09 2011-12 2014-15 2017-18 2020-21

co

ntr

ibu

tio

ns to

po

ten

tia

l o

utp

ut (%

)

Population Participation rate Trend hours worked

Trend unemployment Trend productivity Trend output

Differences with OBR

By the end of the forecast

horizon, the two key drivers

of the gap between Scotland

and the UK are –

1. Weaker productivity

forecasts

2. Weaker population

forecasts

Source: SFC, December 2017

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

2017-18 2018-19 2019-20 2020-21 2021-22 2022-23

Re

lative

co

ntr

ibutio

n to

po

tential o

utp

ut S

co

vs. U

K (

%)

Population Participation Trend unemployment

Hours worked Productivity Potential output

Key driver of difference = population

Combined, this leads to

much weaker forecast for

Scottish growth than UK….

Source: SFC, December 2017-0.5

0.0

0.5

1.0

1.5

2.0

2016 2017 2018 2019 2020 2021 2022

% c

ha

ng

e o

n y

ea

r e

arly

OBR UK GDP SFC Scottish GDP

OBR UK GDP per capita SFC Scottish GDP per capita

Key driver of difference = population

….gap slightly smaller when

viewed in per capita terms

But still weak outlook

SFC forecast real household

incomes to be below 2007

levels even by 2022….

…marking at least 15 years

of a squeeze on households

Source: SFC, December 2017-0.5

0.0

0.5

1.0

1.5

2.0

2016 2017 2018 2019 2020 2021 2022

% c

ha

ng

e o

n y

ea

r e

arly

OBR UK GDP SFC Scottish GDP

OBR UK GDP per capita SFC Scottish GDP per capita

Under the fiscal framework, Scotland’s relative performance to the UK is crucial for

Scottish budget….

….but SG insisted on comparisons being made on performance per capita

Budget confirms why this was so important, as weaker population growth rates don’t

feed through to growth in per capita income tax

At the same time, SFC believe that weaker productivity growth will be offset by slightly

better participation rate and earnings propped up by tighter labour market

Implications for Scottish budget

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Ta

x r

ate

An

nu

al G

DP

pe

r ca

pita

gro

wth

Basic rate highest marginal rate GDP per capita (LH-axis)

The economic impact of tax rises

Needs to be put in context:

1) 0.11% of Scottish GDP

2) Tax rise offset by

spending rise

3) Not all behavioural

changes lead to change

in economic activity

4) Other policy measures

can – in theory – help

offset (but take time and

not guaranteed)

But perception importantSource: FAI calculations

Policy measures (largely flowing from Barclay Review) cost £96m in 18/19 – offsetting

60% of income tax cut

These include Business Growth Accelerator and some new reliefs

Continuation – in 18/19 – of transitional relief for businesses in Aberdeen (costing £15m)

Policy to uprate bills by CPI rather than RPI brought forward from 2020 to 2018,

following UKG announcement of same (arguably revenue neutral as associated with

Barnett consequentials)

Some Barclay Review recommendations (raising revenue) not yet implemented

Policies to support growth - NDR

Policies to support growth - capital

Substantial additional capital

spending – combination of

rise in CDEL & FT’s

Targeted at housing &

economy - 30% cash terms

increase in housing capital

spending

Plan to use borrowing in

full….by 18/19 government

will have used up nearly

50% of borrowing cap

Source: Scottish Government, Dec 2017-100

-50

0

50

100

150

200

250

300

Health Finance Education Justice Economy Communities Env & c-change

Rural (incdigital)

CTEE

Ca

pita

l sp

en

din

g (

inclu

din

g F

Ts)

-ch

an

ge

on

17

/18

, £

mill

ion

EJFW up £260m in real terms.....……95% in the form of capital and FT’s (£115m capital

& £130m FT’s)

£340m capitalisation over 2019-2021 of National Investment Bank. £70m in 2018-19 on

‘Building Scotland Fund’

Small real terms increase in colleges vs. further small real terms cut in higher education

£2.4bn on enterprise and skill support system….. “A key priority for the Strategic Board

will be development in 2018 of a plan”….. “to help to inform the decision-making process

for budget allocations in future years”. How radical are government prepared to be?

Policies to support growth - spending

Scottish Fiscal Commission very downbeat about outlook for Scottish economy

Driven by weak assessment for productivity and working age population – and belief that

recent slowdown is structural rather than cyclical

The Scottish budget is protected – at least in short-term – from some of these effects

under the fiscal framework……but growth vital to long-term sustainability of public

finances

Tax and pay measures – “apart from the change to public sector pay policy, the

Commission’s judgement is that these policies are not of a large enough magnitude to

have a significant aggregate impact on the Scottish economy….”

Summary

Part 2: The tax view

The Scottish Budget – the tax view

Charlotte Barbour, MA CA CTA (Fellow)

Director of Tax, ICAS

18 December 2017

© Copyright ICAS 2011

Overview : Scottish Budget

Scottish income tax

• Rates and bands 2018/19

• Take home pay

• Interaction with UK taxes

• Administering SIT

Devolved taxes

• LBTT, SLfT and ADT

• Non domestic (business) rates

Tax thoughts for the future

© Copyright ICAS 2011

Scottish rates and bands for NSND income

Band of NSND income Name of rate/band Income tax rate

Over £11,850* –£13,850

Starter rate 19%

Over £13,850 – £24,000 Basic rate 20%

Over £24,000 – £44,273 Intermediate rate 21%

Over £44,273 –£150,000**

Higher rate 41%

Above £150,000** Top rate 46%

© Copyright ICAS 2011

SIT take home pay in 2018/19

Earnings Scottish Tax Liability in 2018/19

Difference in Scotland between 2017/18 and 2018/19

Difference with rest of UK for 2018/19

£15,000 £610 £90 more in your pocket in 2018 Scots £20 better off

£24,000 £2,410 £90 more in your pocket in 2018 Scots £20 better off

£26,000 £2,830 £70 more in your pocket in 2018 – due to UK personal allowance increase

Scots no better or worse off

£30,000 £3,670 £30 more in your pocket in 2018 Scots £40 worse off

£33,000 £4,300 No difference Scots £70 worse off

£60,000 £13,115 £15 less in your pocket in 2018 Scots £755 worse off

£90,000 £25,415 £315 less in your pocket in 2018 Scots £1,055 worse off

© Copyright ICAS 2011

Income tax rates and bands 2018/19

UK Personal allowance - £11,850

• Applies to the whole of the UK; can’t be changed in Scotland

rUK: and also for ‘Scottish’ taxpayers – these bands are relevant for

establishing the rates of tax chargeable on savings and dividend

income

• £11,850 - £46,350 - basic rate

• £46,350 – £150,000 – higher rate

• Over £150,000 - additional rate

© Copyright ICAS 2011

SIT: interaction with UK tax

• Rates and bands set by Holyrood

• Reliefs and allowances set by Westminster

• Personal allowance

• What is the basic rate?

• Gift aid

• Pension contributions

• Marriage allowance

• National insurance contributions

© Copyright ICAS 2011

Administering SIT in 2018/19

• HMRC

• Identification of ‘S’ taxpayers

• Responsible for collection

• Employers - PAYE

• Software houses

• Self employed

• Taxpayer reaction

© Copyright ICAS 2011

Devolved taxes

LBTT

• Rates remain unchanged

• A first time buyer relief - £175,000

SLfT

Increase in rates – in line with the UK

ADT

• No progress in its implementation date

• Delay due to state aid issues

© Copyright ICAS 2011

No domestic (business) rates

• Most of the Barclay review recommendations adopted

• Inflationary uplift: capped at CPI (3.0%) instead of RPI (3.9%)

• Three yearly revaluations

• Small business bonus scheme

• Implementation plan published

• Removal of some charities reliefs

© Copyright ICAS 2011

Tax thoughts for the future

• The direction of Scottish tax policy

• Making Tax Digital

• Simplification…….

• Employment status and the gig economy – the tax issues

remain and at some stage will need to be addressed

• Brexit

• How does a government grow the tax take?

Part 3: The fiscal context

2017/18 2018/19 2018/19 change

cash real % £

Block

grant 26,679 26,860 26,469 -0.8% -210

The resource budget (£m)

Revenues minus BGA:

LBTT 79 -12

SLfT -38 12

IT 30 366

Total 71 362

Total

resource

budget26,750 27,222 26,826 0.3% 76

Block grant down £200m

(0.8%) real terms

But income tax revenues

forecast to outperform

BGA by £366m in

2018/19

Result: resource budget

up £76m (0.3%)

Scottish income tax

forecast revised down

throughout forecast period

But income tax BGA

forecast also revised down

Result: Scottish budget

better off than without tax

devolution (and compared

to last yr)

(But forecasts not always

‘right’!)

Changes to the income tax forecasts

£10,000

£10,500

£11,000

£11,500

£12,000

£12,500

£13,000

£13,500

£14,000

£14,500

£15,000

2016/17 2017/18 2018/19 2019/20 2020/21 2021/22

£ m

illio

n

SG revenue forecast (Feb17)SFC revenue forecast (Dec17)BGA forecast (Nov 16)

BGA forecast (Nov 17)

The £366 gap between forecast Scottish income tax revenues and the income tax BGA

in 2018/19 is largely explained by:

• Additional forecast revenues of around £140m from the decision to set Higher Rate

Threshold at £44,273 rather than £46,350

• Additional forecast revenues of £164m from this year’s tax policy announcements

• Residual largely explained by effect of faster public sector wage growth on Scottish

revenues

Implicitly, underlying tax base grows as fast in Scotland as in rUK

Why gap between Scotland’s

IT revenues and BGA in 18/19?

Income Marginal rate No. of taxpayers

Personal Allowance Up to £11,850 0%

Starter rate £11,851 - £13,850 19% 250,000

Basic rate £13,851 - £24,000 20% 1,031,000

Intermediate rate £24,001 - £44,273 21% 893,000

Higher rate £44,274 - £150,000 41% 332,000

Additional rate >£150,000 46% 18,900

Total 2,500,000

Income tax policy

Relative to what taxpayers

would pay in 18/19 had

there been no policy

action, those earning

<£26k pay less/same

Max saving per taxpayer =

£20 per year

3% change in Band D

council tax = approx £35

per year

Income tax liabilities - comparisons

-£200

£0

£200

£400

£600

£800

£1,000

Diffe

ren

ce

in

lia

bili

ty

Difference to 18/19 baseline

Difference to rUK

Forecasts for residential LBTT revised up due to faster than expected growth in prices

and transactions in 17/18

Zero rate introduced for first time buyers from £145k -£175k

Reduces FTBs average tax bill by £290 (for those within band) and £600 (for those

above band

SFC estimate policy will result in an additional 150-200 FTB transactions per year…

…at a revenue cost of £5-£6m per year

Non-residential revenue forecast revised down slightly

Over remainder of forecast period, LBTT revenues now forecast to marginally

outperform BGA

Land and Buildings Transaction Tax

The resource block grant falling 0.8% (about £200m) in 18/19

Underlying income tax base forecast to grow at same per capita rate in Scotland as rUK

As a result of income tax policy decisions taken this year and last, income tax revenues

forecast to be higher than income tax BGA by £366m

For both LBTT and LfT, revenues broadly forecast to match BGA

Net result is Scottish resource budget up 0.3% (£76m)

But remember, forecasts might not be ‘right’

Revenues: summary

Resource budget up about £75m (0.23%) in real terms but government announced

spending increases of £250m (0.9%) – the result of ‘draft budget to draft budget’

comparisons

Health resource budget up £400m (almost 2% real terms). But matching pay policy

could cost £170m, and budget has to increase 1%/yr just to match demographic trends

Resource allocation to police ahead of commitment, but not sufficient in itself to match

pay policy

Additional investments in childcare to support expansion, and in Pupil Equity Fund/

Attainment Fund to close education attainment gap

Spending commitments

Discretionary resource grant (GRG + NDRI) down 2% (£183m) real terms

Including specific grants, total resource settlement is ‘flat cash’ (1.4% real terms fall)

Within this total, at least £150m for delivering specific policy commitments

On back of real terms decline in resource funding of 8% since 2010 (compared to 5% for

SG)

SPICe estimates cost to LG of implementing SG pay policy at £150m

Increasing council tax by 3% could raise around £77m

On capital, discretionary budget down £63m but extra £150m specific grants to support

childcare

Local government

Unprecedentedly weak economic outlook for next five years

But growth in devolved revenues largely forecast to keep pace with ‘block grant

adjustments’…

…with income tax policy announcements in 17/18 and 18/19 helping to raise a further

£300m revenue in 2018/19, offsetting fall in block grant

Budget emphasis on growth, through significant expansion in capital expenditure and

use of Financial Transactions, plus cuts to business rates

On track to deliver major policy commitments on health, policing, education and

childcare, but all settlements constrained especially in context of pay policy

Conclusions

The Scottish Budget 2018-1918 December 2017