Submitted by Bill Fernie
13th September 2026
The Scottish Government is heading towards its next Budget with less room for manoeuvre than it had expected.
The Scottish Fiscal Commission's latest update does not describe this as a conventional Government deficit but instead, it points to a combination of falling real-terms funding, higher spending pressures and a series of financial adjustments that are making the outlook for 2027-28 increasingly difficult.
The Commission's warning is fairly stark: the Scottish Government needs to be much clearer about how it intends to deal with the pressures building up in its spending plans.
And there is a particularly awkward number at the centre of the problem.
£720 million disappears from the next Budget
The Scottish Budget for 2027-28 will have to absorb a £720 million negative Income Tax reconciliation.
This is the largest reconciliation since Scottish Income Tax was devolved. It does not mean that the Scottish Government suddenly lost £720 million of tax revenue. The adjustment is correcting the difference between earlier forecasts and the eventual outturn for 2024-25.
Indeed, Scottish Income Tax revenue was only £209 million below forecast. The unusually large reconciliation arises because the comparison with the rest of the UK also affects the amount of funding Scotland receives through the fiscal framework.
The Scottish Government can borrow to soften the blow but there is a problem.
The Fiscal Commission estimates that the £720 million adjustment is likely to be larger than the Government's available resource borrowing capacity. On the Commission's current assumptions, that borrowing limit would be around £670 million.
Even borrowing the maximum therefore would not completely solve the problem.
There will have to be an effect on the money available for public services.
Funding is falling just as costs are rising
The problem is not confined to the £720 million adjustment. The Commission expects overall resource funding to fall by 1.2% in real terms in 2027-28.
It also expects the resource Block Grant to fall by about 1% in real terms. This is particularly significant because it would be the first real-terms fall in the resource Block Grant since 2022-23.
Capital funding is under pressure too.
The UK Government's increased defence spending is partly being financed by reducing other departmental capital budgets. The Commission estimates that this could reduce Scotland's capital Block Grant by around £87 million in 2027-28, although the final figure will not be known until the UK Budget in October.
So the Scottish Government is potentially facing the awkward combination of less money in real terms and more pressure on what that money has to provide.
The £563 million savings plan is another risk
The Scottish Government's 2026-27 Budget included £563 million of planned efficiencies. But the Fiscal Commission points out that 44% of these savings are expected to come from NHS boards. That is potentially uncomfortable.
Audit Scotland found that only 15% of territorial NHS boards achieved similar planned savings in 2024-25. If the savings built into the Scottish Budget are not delivered, the Government will need to find additional money elsewhere, increasing pressure on both this year's and future Budgets.
This is where budget arithmetic meets reality. It is relatively easy to put a saving into a spreadsheet. It is much harder to achieve it in a hospital, council service or public body without reducing the service, changing the way it operates or finding genuine efficiencies. Inflation has also changed the calculation.
Public sector pay could make matters worse
The earlier spending plans assumed pay awards below the rate of inflation. But the Fiscal Commission now warns that higher inflation increases the likelihood of greater pay pressures.
Some existing agreements contain inflation protection clauses which could be triggered. That could increase the public sector pay bill not only this year but in future years because today's pay settlements become part of tomorrow's spending base.
The Government also has a target of reducing the size of the public sector workforce by an average of 0.5% a year between 2025-26 and 2029-30.
But the latest figures show the workforce actually increased during 2025-26. That means larger reductions will be required in subsequent years if the target is still to be achieved.
There is some breathing space
It is not all bad news. The Scottish Government received additional funding during 2026-27 following UK Government decisions, including £533 million associated with spending on special educational needs and disability in England.
The result is that day-to-day funding is now expected to grow by 3.5% in real terms during 2026-27. The problem is that much of this additional money does not continue into 2027-28.
The Government therefore faces a choice: spend more of the money now or retain some of it in the Scotland Reserve to help next year's Budget.
The Commission points out that using more of the money in 2026-27 could leave the next Budget facing an even tougher squeeze.
There is also some additional room in the Reserve, although using it heavily would leave less flexibility for dealing with unexpected problems later.
And then there is the economy
The economic backdrop isn't particularly helpful either. The Fiscal Commission has weakened its assessment of the outlook since January.
Higher global energy prices, the continuing effects of geopolitical instability and risks to food prices from heat, drought and wildfires could all push inflation higher.
That matters because higher inflation increases the cost of running public services, puts pressure on public sector pay and increases inflation-linked social security payments.
At the same time, higher inflation can weaken real household incomes and therefore economic growth. Scotland therefore faces the familiar economic problem of trying to maintain public services while the cost of providing them rises faster than the resources available.
October will still matter
The UK Budget on 28 October 2026 will determine much of the eventual position because changes to UK taxation, spending and fiscal rules will feed through to Scotland's funding.
The Scottish Government will then have to produce its own 2027-28 Budget. The Fiscal Commission expects that Budget before the end of 2026. That means the Scottish Government has a relatively short period in which to decide what it can realistically afford.
It cannot simply borrow its way out of the problem nor can they assume that every planned efficiency will materialise.
And it cannot assume that the extra money available this year will still be there next year.
A difficult Budget, but also a choice
The figures are undoubtedly uncomfortable. But they also present the new Scottish Government with an opportunity. Rather than simply trying to protect every existing spending commitment, it could use the pressure to examine what government is actually doing, which programmes produce the greatest benefit and where services can be delivered differently.
The Fiscal Commission itself is calling for greater transparency about progress on efficiency savings, public sector pay and workforce numbers before the Budget.
That is important.
Scotland's financial problem is not simply that there is too little money. It is also that expectations have grown faster than the resources available to meet them. The next Budget will therefore be about more than finding £720 million.
It will be a test of whether the Scottish Government can make difficult choices about priorities while still protecting essential public services.
There is no easy answer.
But a difficult financial position can sometimes force governments to do something that good times allow them to avoid: decide what matters most.
That may be the most important challenge facing the Scottish Government as it heads towards its next Budget.