Scottish Fiscal Commission Publishes Latest Forecast Evaluation Report

29th August 2023

The Scottish Fiscal Commission has today published an evaluation of its December 2021 economy, devolved taxes and social security forecasts used to set the 2022-23 Scottish Budget. Since Scottish income tax outturn data is published later, the report evaluates the income tax forecast used in setting the earlier 2021-22 Scottish Budget.

The Forecast Evaluation Report assesses the accuracy of the Commission's forecasts and highlights the reasons for any variation between forecast and outturn.

The December 2021 economy, devolved taxes and social security forecasts were published at a time of ongoing uncertainty due to the COVID-19 pandemic, though with rising numbers of eligible adults having received their booster or third vaccination doses. In common with other economic forecasts made at that time the Commission did not anticipate the Russian invasion of Ukraine, the subsequent energy price shock in early 2022 and the energy price cap. Despite these significant events, the Commission's forecasts of economic growth proved reasonably accurate with Scottish GDP growing by 2.0 per cent in 2022-23, compared to a forecast of 2.2 per cent, a forecast error of minus 0.2 percentage points.

Land and Building Transaction Tax revenue of £848 million was £99 million higher than forecast in 2022-23, an error of 13 per cent. Residential properties saw faster price growth and there were a larger number of high value transactions than was forecast. Spending on devolved social security payments in 2022-23 was £4,193 million, £127 million or 3 percent higher than forecast when the Budget was set. This was a result of higher spending on disability payments and the Scottish Government announcing policies after the Budget.

The report also evaluates the Scottish income tax forecast the Commission made in January 2021 and which was used in setting the 2021-22 Scottish Budget. This was at a much earlier point during the pandemic: the furlough scheme was in operation; a national Scottish lockdown was in place; and COVID-19 vaccines were just starting to be rolled out.

Scottish income tax revenues were £1,461 million or 12 percent higher than forecast for the 2021-22 Scottish Budget. This difference was primarily because the economic recovery from the COVID-19 pandemic in 2021-22 was stronger than expected and higher inflation led to faster nominal earnings growth. Income tax revenues in the rest of the UK were also higher than forecast by the OBR, with the net effect being for a negative reconciliation of £390 million to be applied in the 2024-25 Scottish Budget.

Notes
The Commission's Forecast Evaluation Report (Pdf 67 Pages) is published on its website. The report evaluates the Commission's forecasts for 2022-23 for GDP, fully devolved taxes (Non-Domestic Rates, Land and Buildings Transaction Tax and Scottish Landfill Tax ) and social security against available outturn data. The report also evaluates the Commission's forecasts of income tax revenues in 2021-22, as this data is only available with a one-year time lag. Background information is also available including spreadsheets with data for all the report's tables and charts.

Annex A of the report discusses the effect of higher earners on income tax revenues and forecasts, particularly those that pay tax through Self-Assessment. Annex B of the report provides an update on the breakdown of the factors contributing to the income tax net position in Scotland.

The Commission has also published a paper exploring how changes to productivity growth would affect the projections made in its March 2023 Fiscal Sustainability Report. The paper responds to a request from the Scottish Parliament's Finance and Public Administration Committee.

The Scottish Fiscal Commission is the independent fiscal institution for Scotland, established by the Scottish Fiscal Commission (2016) Act. Our statutory duty is to provide the independent and official forecasts of Scottish GDP, devolved tax revenue and devolved social security spending for the Scottish Government to use in its budget and financial planning. The Commission's forecasts also assist the Scottish Parliament's scrutiny of the Budget and Budget Bill.

The publications represent the collective view of the Scottish Fiscal Commission, comprising the Commissioners: Professor Francis Breedon, Dr Domenico Lombardi, Professor David Ulph, and the Chair, Professor Graeme Roy.

From the Report
Income tax net position
B.1 The income tax net position shows how much funding the Scottish Government receives from Scottish income tax revenues minus the income tax Block Grant Adjustment (BGA). The BGA is calculated based on growth in UK Government tax revenues per head in England and Northern Ireland.

B.2 The income tax net position is influenced by the relative growth of per person income tax revenues in Scotland and the rest of the UK. If Scottish income tax revenues per head grow faster than in the rest of the UK, the net position increases and there is more funding available for the Scottish Budget. Conversely, if Scottish income tax revenues per head grow more slowly than in the rest of the UK, the net position decreases and there is less funding available for the Scottish Budget.

B.3 Growth in income tax revenues is driven by the underlying performance of the economy and by divergences in Scottish and UK income tax policy. Over the last six years, Scotland's relative lower growth in employment and earnings have had a negative effect on the income tax net position. Successive changes to income tax policy in Scotland have so far largely offset these negative economic effects. Changes in UK Government income tax policy, such as above inflation increases in the higher rate threshold between 2016-17 and 2019-20, have also generally reduced UK Government revenues and therefore contributed to moving the net position in a positive direction.

B.4 In this section, we present illustrative analysis to demonstrate how changes in each of these factors relative to the UK are estimated to have contributed to the net position in the outturn. This analysis is illustrative as the exact contribution of each factor to the net position cannot be known with certainty and there may be overlaps in the contribution of different factors.

B.5 As shown in Figure B.1 slower Scottish earnings and employment growth have contributed negatively to the net position. This is offset by divergence in Scottish and UK income tax policy which has helped keep the net position positive in most years. In 2021-22 there was higher than expected relative growth in income tax paid by individuals at the top of the income distribution, which largely explains the ‘Other factors' component in Figure B.1. We discuss this further in Annex A.

B.6 We estimate that, in the absence of Scottish and UK income tax policy differences, the net position would have been -£667 million in 2021-22. By having relatively higher tax rates in Scotland and lower thresholds for higher rate taxpayers, the income tax net position shifts to an expected £85 million in 2021-22.

Economy factors
B.7 Since 2016-17, nominal average earnings have grown slower in Scotland than in the UK. Applying this earnings growth to the existing distribution of taxpayers in Scotland, we expect this to reduce the income tax net position by £590 million in 2021-22. We have also seen that growth in the number of adults in employment in the UK has been higher than in Scotland. We estimate that relatively slower employment growth in Scotland reduces the net position by £314 million in 2021-22.

B.8 The long-term structural decline in North Sea oil and gas activity feeds through to lower activity in the onshore oil and gas supply chain and has acted as a drag on Scotland's overall pay growth. Scotland's lagging earnings growth since 2016-17 has been exacerbated by much stronger earnings growth in the financial services sector in London and the South East in 2021-22.

B.9 The employment divergence is driven by lower population growth as well as different labour force participation trends. The participation rate for those aged 16 and over fell in Scotland between 2014 and 2021, while being broadly flat for the UK. Scottish employment linked to activity in the North Sea has also fallen, lowering the average participation rate in Scotland. These jobs lost were generally high paying, which has likely contributed to the divergence in average earnings between Scotland and the UK.

Policy factors
B.10 Since 2017-18, the Scottish Government has increased the higher rate threshold by less than it has risen in the UK, meaning more income in Scotland is taxed at the higher rate of 41 per cent. The five-band system introduced in 2018-19 means that lower income taxpayers in Scotland have paid slightly less than they would in the rest of the UK, while higher income taxpayers paid more. These policy changes have further increased tax revenues in Scotland relative to the UK.

B.11 We do not account for changes in the personal allowance as a policy divergence as they apply in Scotland and the rest of the UK. We do however note the agreement between the UK and Scottish Government that the UK Government's policy to increase the personal allowance above inflation had a spillover effect on Scottish income tax revenues. The two governments agreed a payment of £375 million for the spillover covering 2017-18 to 2021-22. This spillover has not been included in the net position or this analysis.

B.12 We estimate that higher tax rates and the changes to the higher rate threshold in Scotland have added £753 million to the net position in Scotland in 2021-22, with most of this coming from Scottish Government policy changes.

Other factors
B.13 We have outturn data on Scottish employment and earnings growth and can make reasonably accurate estimates of the effect of policy divergences to illustrate the effects on the net position. There remains a small part of the net position which cannot be explained by divergences in average earnings, employment and policy. These factors can be difficult to measure and may include information missing from our taxpayer data. This can include changes in the shape of the income distribution, for example large bonuses at the top of the income distribution, and changes in taxpayer behaviour such as avoidance or evasion.

B.14 We estimate that other factors increased the net position by £237 million in 2021-22 which is largely explained by higher than expected income tax revenue from those at the top of the income tax distribution. Outturn show there was much higher growth in income tax paid through Self Assessment (SA) in 2021-22 than we expected. There was a 20.1 per cent increase in Scotland compared to an 11.6 per cent increase in the rest of UK. We discuss SA further in Annex A.