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Finance and Public Administration Committee [Draft]

Meeting date: Tuesday, June 10, 2025

Official Report 844KB pdf

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Scottish Fiscal Commission (Economic and Fiscal Forecasts)

Good morning, and welcome to the 20th meeting in 2025 of the Finance and Public Administration Committee.

The first item on our agenda is an evidence session with the Scottish Fiscal Commission on its May 2025 economic and fiscal forecasts. I welcome, from the Scottish Fiscal Commission, Professor Graeme Roy, the chair; Professor Domenico Lombardi, a commissioner; Michael Davidson, the head of social security and devolved taxes; and John Ireland, the chief executive.

I invite Professor Roy to make a brief opening statement.

Thank you for inviting us to give evidence on our latest forecasts, which were published last month.

First, I thought that it would be helpful to outline the process for our forecasts this time round. Members will recall that, in February, the Cabinet Secretary for Finance and Local Government advised that the Scottish Government intended to publish its medium-term financial strategy on 29 May. We proceeded on that basis, with the deadline for the inclusion of new data set at the end of April and the deadline for policy changes set for early May.

On 6 May, a day before our deadline for final policies, the cabinet secretary wrote to say that the Scottish Government was considering deferring publication of its MTFS until later in June. As I set out in my reply, a copy of which was sent to the convener, because all the necessary forecasting analysis and engagement with the Government had taken place, it was my view that publishing the core economic, tax and social security forecasts on 29 May as planned would aid transparency and enable us to give evidence to the committee. I note that that was welcomed by the cabinet secretary in her reply to me on 13 May.

As a result, our updated forecasts are based on current Scottish Government policy and the information that was available at the time. We will publish an updated report alongside the MTFS on 25 June.

In relation to the detail in our report, we estimate that the total funding available to the Scottish Government this year will be £59.6 billion—almost £800 million higher than in December, when the budget was set. That is mostly because of more United Kingdom Government funding, but also because the Scottish Government now expects to carry forward some money that was not spent last year.

Despite that increase, the pressures on the Scottish Government’s budget remain significant. Two key Scottish public sector pay deals that have already been agreed for this year have been above the Scottish Government’s policy of offering a 3 per cent increase, which is likely to create further pressure for on-going pay negotiations. The challenges regarding pay are added to by April’s rise in employer national insurance contributions. Although the Scottish Government has had some extra funding, that will cover only half to two thirds of the Scottish Government’s estimated costs.

Social security commitments are growing, and we forecast that, by 2029-30, spending on social security will be £2 billion more than the associated funding. A key reason for that larger gap is the UK Government’s proposal to tighten the qualifying criteria for personal independence payments, which will reduce spending in England and Wales and thereby decrease funding through the block grant adjustment by about £400 million in that year.

We have made a modest downward adjustment to our gross domestic product forecast for this year. Clearly, there remains significant uncertainty about the outlook for trade and the impact that any US tariffs might have on the global economy.

Thank you for that opening statement. You seem to be concerned about the delay to publication of the medium-term financial strategy. I can almost sense a level of irritability as you talk about that. What impact has that had on the Scottish Fiscal Commission?

I will say a couple of things. In setting our forecasts on tax, the economy and social security, we were working on the basis that those forecasts would be ready to sit alongside the publication of the MTFS in May. Ideally, you would want all of that to come out at the same time. Given that we had done all the work and the collaboration with the Government and had set our forecasts, it made sense for us to publish the forecasts when we had said that we would do so. If we had delayed publication until the end of June, we would have been sitting on forecasts that would have been going out of date, or, at the least, a significant period of time would have passed. I had also given a commitment to the committee in December, when the deputy convener asked when we would be publishing updated forecasts. If we had delayed publication to the end of June, that would not have given us the chance to come here and give evidence to the committee.

When the MTFS is published, we will provide an update on any changes to funding in order to give the committee information about the outlook. You will recall that we have also committed to publishing in August a new regular fiscal update, which will take a deeper dive into what the MTFS might mean for the outlook on spending and funding. I hope that that will provide useful information to help the committee to undertake its work in the run-up to the budget.

As I recall, this was not the reason that was given by the cabinet secretary, but David Phillips of the Institute for Fiscal Studies said that it would be more appropriate to wait until the spending review before publishing the MTFS, which is what the Government has done. That was not the entire reason that she gave, but she did touch on it somewhat. Is there an argument for that?

After the spending review, there will be much more clarity on funding. The Barnett consequentials will be set out tomorrow, which will give the Government more certainty about the overall outlook.

The general point is that we had made the commitment to publish our forecasts, so we followed through on that commitment. There will always be uncertainties, nuances and changes. For us, the important thing is to come back to talk about the big-picture stuff. For example, we mention the changes in the net tax position, which are important, and the changes in the social security funding position and in the outlook for the economy. It is important to be able to present and discuss all of that. That is why transparency is important.

As the Scottish Fiscal Commission does so well, it has set out income tax and social security forecasts in great detail for a number of years. Can you talk us through both of those forecasts?

First, let us look at income tax. I notice that it is projected that there will be a 23 per cent increase in income tax revenue during the next five years or so. How much of that increase will be down to fiscal drag and how much will be due to economic growth?

It is a mixture of both. Our baseline policy is that, as we get later in our projections, we assume that the thresholds will increase in line with inflation. That offsets some of the effects of fiscal drag. The majority of the growth in income tax revenue is due to growth in earnings across the economy. In any progressive system, there will be some fiscal drag, but we do not assume that everything is down to fiscal drag because the thresholds have been frozen.

I was just wondering what share of the growth was down to fiscal drag, which is a concern across the UK—it is not just a Scottish issue. The current UK Government and the previous one have, in effect, allowed fiscal drag to enhance their coffers, and the Scottish Government has done the same.

We can send you the specific breakdown on that.

In our supplementary figures, we talk about the costings for the tax policy changes, and we also discussed that in December. From a policy change perspective, significant amounts of revenue are raised by freezing the thresholds. More than £200 million is raised by freezing the higher-rate threshold, largely because a large number of taxpayers move into that tax band. Ultimately, fiscal drag is one of the key ways in which the Government raises revenue over time. The further we go into the future, the more significant that becomes.

It is projected that expenditure on social security will rise by 30 per cent over the next five years, which is higher than the projected increase in tax revenues. That relates to the overall Scottish budget, but, within the social justice portfolio, expenditure on adult disability payments is expected to increase by more than 50 per cent during that period. There are some really concerning figures from an economic point of view—year-on-year increases of 8 or 10 per cent. Can you talk us through that a wee bit?

There are a couple of things to separate out. Inflation is one of the key reasons why expenditure on social security payments increases towards the end of the period. We assume that the payments will be uprated by inflation. From a public finance point of view, it is important to note that that is offset by increases in the block grant adjustment, because it is assumed that the same will happen in the UK, so there is no net impact on the budget.

In figure 5.4 on page 58 of the report, we see that, according to the December 2024 forecast, the net position would flatten off once we got to 2026-27, following the changes in the delivery of social security payments and the introduction of new payments such as the Scottish child payment. Once the reforms were put in place, we said that the growth in expenditure on the payments would be offset by growth in the BGA and that, in essence, there would be no real change in the net social security funding position towards the end of the period.

In the most recent update, our forecast has changed. Our May update shows the net position increasing towards £2 billion by the end of the forecast period. That is largely because of the UK Government’s proposed changes to qualification for PIP, which will have an impact on the BGA. That is why the net position increases towards the end of the period.

Another good example relates to winter fuel payments, which we spoke about in December and which I am sure we will discuss today, given recent announcements. That was the first time that we started to see the interconnections between social security and the net position in Scotland, with that position being driven by decisions being made not by the Scottish Government but by the UK Government. The net position is dependent on both Governments’ decisions, because it is affected by funding as well as spending. Our May forecasts show that the UK Government’s changing plans will lead to an increase in the gap of about £400 million relative to what we said in our December forecasts.

You have said that, overall, the effect of social security spending will widen by £600 million. A third of that relates to the devolved Government lifting the two-child cap, and the remaining £400 million relates to UK Government policy and block grant adjustment funding.

I know that you have been liaising with the Office for Budget Responsibility, but your projections on the economy look to be fairly optimistic. You will have seen from this morning’s figures that unemployment has increased. From what was said on the news today, it seems that the combination of the increase in the minimum wage and the increase in employer national insurance contributions has had quite an impact. What is your view on that?

I will give a broader view and then Domenico Lombardi might want to come in specifically on tariffs. Overall, there is a lot of noise and uncertainty in the economy at the moment, which will have an impact. We try to see through some of that noise and look at the underlying trends in the economy.

A good example relates to tariffs. There has been a lot of discussion about them, but we have not yet seen their full effects. Similarly, there has been a slight increase in inflation relative to where we were. However, the overall trend is pretty much in line with what we had forecast. We have revised down slightly our forecast for this year based on some of that uncertainty, but we think that it will bounce back a bit next year. Overall, we have not really changed our forecast.

You put the tariffs in perspective in your report, which says that trade with the US accounts for only 2 per cent of Scottish gross domestic product. The concern is about the impact on specific sectors of the Scottish economy. In fact, the impact will be felt not only by certain sectors but by certain geographic areas—the obvious example is whisky. Obviously, you are keeping a very close eye on the matter.

You now project that GDP will increase by 1.2 per cent this year, instead of the 1.6 per cent that you predicted in December. Is that still likely to be the case? You also say, in paragraph 34 of your report, that there will be “broadly flat employment growth”.

09:45  

Growth of 1.2 per cent is relatively fragile; it is not that great. The key issue for us is whether that growth is asymmetrically different from that in the rest of the UK, and that is broadly what we are seeing. The numbers will always move around ever so slightly.

We are saying two things. First, uncertainty itself is having a slight impact on growth. However, we need to be cautious about overegging that. Tariffs will have an impact on the economy in the short run, but that needs to be put in the context of economic activity and where growth comes from more generally. The caveat to that relates to the importance of some key sectors and the impact of tariffs on them. However, on a macro level, the effect might be relatively limited compared with other shocks that we have had in recent times.

My second point, which is probably more important, is about what happens over the medium to long term. We really need growth to start to pick up over that period. That relates to all the stuff that we have spoken about previously about transforming productivity. We still predict that, in the long term, growth will pick up to about 1.5 or 1.6 per cent, which is still relatively fragile compared with our long-term historical average in Scotland.

Our long-term historical average will change if we are stuck with low growth, according to your projections. We are nowhere near where we were before the financial crash in 2007-08. It seems like we are still trying to recover from that situation.

Definitely. Productivity has not turned around. We now have a pretty good understanding of why productivity is so bad in the UK. About a third of the issue relates to our low capital investment relative to our key competitors. The other two thirds relate to what economists call total factor productivity, which, in essence, is how we convert our inputs into outputs. That is done through innovation, having skills in the right jobs and so on. We have a clear diagnosis of why productivity has been poor, but we have still not sorted it out or turned it around.

One side effect of employer national insurance contributions going up is that it might incentivise companies—as Toyota has said—to invest further in capital rather than in labour, which could result in long-term dividends, although whether that will happen remains to be seen.

Yes. There is a question about what the optimal tax structure is to encourage the right balance of labour and capital in the economy.

That is not to say that that was the reason for the rise to be implemented.

Exactly—there needs to be a much broader conversation about the optimal incentives and what we are investing in and trying to grow over time.

One of the interesting things that you say about tax in your report is:

“we have revised down our forecast of Scottish Income Tax in 2023-24 based on information we have received on growth in tax paid through Self Assessment.”

What has the change been there?

That is a really good question—it is something that we are keen to raise because it is important. You will recall that it is one of the challenges in forecasting income tax.

We can get quite good data on earned income—the income that people are paying through the pay-as-you-earn scheme—which we track through the real time information data. That is really good information; it is provided by His Majesty’s Revenue and Customs and it works out what we are collecting from employers. That is the main anchor that we use to forecast income tax. Then, there is the other component, which is self-assessment. You will recall from when we chatted after our forecast evaluation that that is exceptionally volatile. Not only that, but the real problem is that we get no data on it throughout the year. We have no idea what is coming from self-assessment, so we have to make a judgment, which is that we think that it will be broadly aligned with what is coming through the RTI data.

A couple of years ago, there was a huge growth in self-assessment tax, which then fell back. What we get now from HMRC, helpfully, is an early indication of what it thinks is going to come through self-assessment at the UK level, based on the information that it has for the year. In this case, the year is 2023-24, and the data suggests quite a low growth in self-assessment in Scotland, so we have adjusted our projection of Scottish income tax in 2023-24 down. That is the main part of that £240 million reduction.

The key thing is that that has not had an impact on the budget yet, but it might have an impact when we get the outturn data in July, because that data will help to confirm the reconciliation next year.

In paragraph 4.18 of the report, you say:

“The Income Tax net position is projected to be £616 million in 2025-26, which is £222 million lower than the December 2024 projection.”

Yes. A couple of important things are going on here. If you look at the figures for 2024-25, you will recall that we highlighted in December that there had been quite a change in the projection for the block grant adjustment, largely through changes in outturn data at the UK level, but also because of changes in the OBR forecast for earnings.

An important point that we need to keep emphasising is that the net tax position can change because of changes at the UK level, not just because of what is happening in Scotland. It is the net position—the relative position—that matters. That has had quite a significant impact in eroding the net tax position because of better data and forecasts coming through at the UK level. We have then seen the latest forecasts from the OBR, in which its earnings forecast is essentially aligned with our earnings forecast, and that has eroded the net tax position. That is, again, one of the risks in the system. We have not changed our forecasts for Scotland, but the OBR has become more optimistic about its forecasts for the rest of the UK, so the net tax position becomes weaker for us.

I just have a few more points, one of which is about pay. There is an underlying frustration with the Scottish Government’s pay policy, and we have discussed that on a couple of occasions. On average, it is an increase of 3 per cent over three years and 9 per cent in total. We already seem to be breaching that with national health service pay and, understandably, unions in other sectors are looking for similar pay increases. What impact would there be on those projections if, for example, pay settlements across the public sector mirrored those of the NHS?

We got what we needed for our forecasting around pay in terms of feeding that into our core elements. The point that we highlighted the last time is that, if you have a fixed budget and a pay policy, and then you allocate budgets to portfolios, pay can be up to about half of the money in those portfolios. If you choose to spend more money on pay, that means that you will have to spend less money elsewhere.

Or you will have to reduce the workforce.

Yes. Our point is that you need to explain and be transparent about what is happening with that. It is not for us to set pay policy. It is just to say that, if you have that pay policy, you have made the allocation on that basis.

I am just asking what you think the impact will be if we end up in that situation. In the past three years, we have had emergency statements in the autumn and I do not think that anybody is particularly keen on seeing that again. I do not think that the Government would want to be in that position. Is it a possibility, or are we not at that level?

There are two points there. First, we know that some of the pay awards at the UK level have come in slightly ahead—

At 2.8 per cent.

Yes, and that is slightly ahead of where the UK Government had set it and slightly lower than the pay policy in Scotland. Money might be coming through in the spending review that might help to ease some of the pressure for the Scottish Government.

The second point is that the pay deals have not been dramatically different from the pay policy set out by the Government. It comes down to how much scope and headroom there is in the various portfolios to be able to deal with that.

Hold on. If half of the Scottish budget—£30 billion—goes on pay, a 1 per cent increase is £300 million, is it not?

Yes, but again, the question is how far existing portfolios can cope with that and how much headroom they have. As we highlight, there is also the added pressure of national insurance increases. It is not as though the budgets did not have pressures of pay already, because a lot of them were having to take up the effects of national insurance.

You are talking about £300 million, but the budget is still £60 billion. The Government still has flexibilities within that, but clearly anything that you do in respect of pay that is above the policy level means that savings will have to be found and pressures addressed elsewhere.

My final question is about capital funding, which has had quite a significant boost—15.7 per cent in real terms, which is quite impressive. However, what I found bizarre about that is the fact that it has been boosted so much in the first year and then declines for the year after to 3.5 per cent. It goes up again slightly and then goes down again, and then it goes down for three consecutive years. In a previous report, you said that, by the end of 2030-31, it will be much the same as it was in 2023.

What do you think was the thinking behind that? What are the pluses and minuses? I would have thought that, if you have a big increase in capital very suddenly but you do not have the increased workforce to deliver capital projects, you end up with inflation in construction and all the other areas. If it then ends up going down, you are stuck with those inflationary prices, potentially, and you end up getting less bang for your buck overall. What is your thinking on that?

There are a couple of points to make. First, you will recall that the previous UK Government had a plan to cut capital spending significantly. We were talking about a 20 per cent real-terms reduction in capital spending by 2029-30, so this forecast looks quite different to the profile that was set out then. You are right that what was announced was essentially a big uplift in the current financial year and largely modest increases beyond that, so we are looking at a relative real-terms reduction.

Some of that is influenced by what the Scottish Government will do around capital borrowing and the use of ScotWind funds; hopefully, we will see a bit more clarity on that when the MTFS is published. Some money from ScotWind was meant to be spent last year but was not spent, so that gives the Government an opportunity to do more in the future.

We make a broad assumption that the Government will borrow around £300 million each year towards the end of the period, but that could change. If it wanted to, it could borrow towards the end of the forecast horizon to increase expenditure at the end. It could borrow less now, if it has more capital departmental expenditure limit, save some of that borrowing, and then borrow more towards the end of the period to try to smooth that out.

However, the general point that you make is right: the Government would want to have a plan for capital that is not just for one year but for a long period of time. That would involve what the UK Government needs to do and will do around setting out its priorities for the spending review over a period of time, and then what the Scottish Government does to follow suit with its capital investment pipeline and infrastructure pipeline. We are still waiting on the detail for that.

We are hoping to see that in September. Have you had any indication of when you are likely to see it? Might it be before then?

I have not seen anything. My officials have not, either.

Thanks very much. A number of colleagues are keen to come in.

I will concentrate on social security, if I may. I have two points for clarification.

Dr Roy, in paragraph 47 of your summary paper, you say:

“We forecast spending on the policy to mitigate the two-child limit will be £156 million in 2026-27, rising to £199 million in 2029-30”.

If I am not mistaken, that is an increase of around 27 or 28 per cent in a three-year period. Is that simply because of the number of youngsters that are involved? It is a quite substantial level of increase.

Is it the increase from £156 million to £199 million?

Yes.

Michael Davidson can explain how we calculate that.

There will be some uprating involved in that, because we expect the universal credit rates to be uprated over that time.

However, the bigger effect, as you say, is the number of children. At the moment, the application of the two-child limit is being introduced by age, gradually, so, the ages of the children not getting that extra allowance are increasing. That allowance will then be paid to families in Scotland, and increasing overall as the ages increase. I cannot remember the exact age, but I can get the caseload figures in a second—I will look now.

That would be very helpful.

Sorry—I have it now. In 2026-27, we think that there will be 43,000 applicable children. Over the period to 2030-31, that will increase to 52,000.

That does not reflect a 27 or 28 per cent increase.

Sorry—and the amount increases from £70 to £75 per week. Those two things combined should lead to that rise. On top of that, there is a bit of a behavioural response that builds up over time, but we think that that will amount to only around £10 million.

Can you explain that behavioural change?

10:00  

We think that more families than otherwise would have done will stay on universal credit, getting the Scottish child payment as a result and also getting the two-child limit mitigation allowance. Rather than thinking about the detail of individual responses, we have taken a broad-brush approach and have looked at the work incentives caused by the cliff edge. Someone in a family who makes a decision to take on more hours of work but then loses the entitlement to universal credit loses quite a small amount because universal credit is tapered by that point, but they also come to a cliff edge with the Scottish child payment and the two-child limit mitigation, and that means that they can lose around £8,000 a year. We do not think that many families will be affected, because they have to be large families, but those small changes can cost them quite large amounts.

I think that I got most of that.

Professor Roy, at one of your recent breakfast seminars you rightly spelled out the challenge of having an ageing population not only in this country but across the world, which is having a major impact on social security budgets. Are the statistics for comparative studies available, and how easy is it to do those studies and to find out whether we have any exceptional trends in Scotland?

First, I will quickly come back to the two-child payment limit. We can share with the committee the calculations and numbers that we used when we published in January.

It is difficult to make international comparisons, because it is not just social security that is different: taxes and the delivery of public services are also completely different. It is difficult make a comparison of the public finance element, although we can look at the strengths and weaknesses within that. That is why, a lot of the time, our comparisons are with what is happening elsewhere in the UK.

On population dynamics, it is worth reiterating the issues that we spoke about in our health report. First, Scotland is relatively unhealthy compared to the UK overall. That was built into devolution, when the idea of being no better or worse off underpinned the initial transfer. That idea is baked in, so that there is higher social security spending on disability per head in Scotland than in the rest of the UK.

What matters is what happens from this point onwards. If we can become healthier and offset the increases in some payments, particularly in the area of mental health and wellbeing that we spoke about, that has the potential to work in favour of Scotland’s public finances.

It seems to me, from what I could extrapolate, that the rate of increase in social security payments in Scotland is pretty high in relation to other countries. It is that rate of increase that should be interrogated and, if it comes down to Scotland being a less healthy nation, that is important in making policy.

Health is part of it. The second bit is that our demographic ageing in the next 10 to 15 years will be ahead of that in the rest of the UK and that the positive correlation between age and some social security payments will have an impact.

Your general point is about the key public policy question of why we are seeing a significant increase in the inflows into those payments. We have spoken about some of the numbers before. The rate of applications is more than double what it was before Covid and, for child disability payments, it is treble what it was.

We need to think about how much of that is because of what Government policy is trying to do. The policy is to encourage and support more people to apply. There may be people who should have had those payments in the past but did not because the process was difficult. We need to think about how much that will level off but also about how much of it is being driven by real concern in society about mental wellbeing, particularly among young people. Thirdly, we need to consider how it looks relative to trends that everyone else is seeing around the world.

That brings me to a point that was raised almost a couple of years ago, when the Scottish Fiscal Commission said that the introduction of the so-called light-touch reviews was a major factor in rising costs. It pointed out that 2 per cent of the reviews resulted in a claim being stopped, whereas the figure was 16 per cent for PIP in England and Wales. The Cabinet Secretary for Social Justice slightly rebutted that, saying that it was not the result of the soft-touch system but predominantly the result of awareness-raising campaigns and increasing public trust in applying. Do you have a more refined view on that, having had another two years of statistics?

Michael Davidson might want to come in on the specifics of the data. We are still seeing that trend of very low outflow from the annual award, at 2 per cent. That is the most recent data that we have. The number of claims being stopped in Scotland is still 2 per cent, compared with the 16 per cent of PIP claims that are disallowed and the 6 per cent that are decreased. I guess the point is that it is light-touch, not soft-touch—

I am quoting the cabinet secretary.

Sometimes the “light-touch” element can be seen as being negative. The policy of the Government is to make the process very supportive for people who are on payments to go through annual reviews and remain on those payments, and it naturally follows that more people would remain on those payments. That can be done through marketing campaigns, which are more to do with take-up than with remaining on the payments. Remaining on them has more to do with how the review process works and with the approach in Scotland being quite different to the rest of the UK.

As the statistics are just now, would you expect that 2 per cent, compared with roughly 16 per cent, to continue?

Yes. We expect the percentage for Scotland to increase slightly. I think that we have forecasted an increase up to 6 per cent.

Can I ask why?

It is to do with the mix. The majority of the reviews that have taken place so far are for cases that have been moved over from PIP to ADP, so it is part of the review process. There are people who have been in receipt of a disability payment for a long time, but we are now seeing more reviews coming in for new applicants to ADP in Scotland. Because those cases involve people who have been on the payments for a shorter time and perhaps have less severe conditions, they have a slightly higher rate of being decreased or disallowed at award review. The forecasted increase is due to the balance as that share of the overall caseload increases. We have assumptions where we think that the exit rate will stay as it is for the longer-term ones and stay fairly static for the new group, but the mix means that the overall average increases.

The key point of that is that it will still be different to the rest of the UK. There will still be fewer people outflowing relative to the rest of the UK. We have highlighted in our forecast the risk that the rate will increase—that is, that there will be more outflows. If that does not happen, it will add to—

That might happen. Presumably, it could be accentuated by the change to PIP.

The whole point about the relative difference is the key, and what that might mean for the net funding position.

Okay. Thank you.

I have a few points to ask about, following on from that. Is the fact that there was that delay and that you are having to redo forecasts to some extent in June causing you extra cost or work?

No. Nothing that is not within our capability.

Okay. That is reassuring. I suppose that you have a fixed budget, so you have to live within it.

You have already been asked about the pay increases, pay policy and inflation, and they are all tied together. I think that the pay increase of 3 per cent for a year or 9 per cent over three years was set when inflation was expected to be below 3 per cent, and it is now 3.5 per cent. Therefore, everybody is expecting a pay increase at least to match inflation—I believe that the NHS pay increase is 4.25 per cent. That will mean that we will get more tax, will it not? If the pay increases are all a bit higher, presumably in the private sector as well as the public sector, we will get some more tax. What is the timing of that? That tax coming in does not help this year’s budget, does it?

No. The budget will be set on income tax, and you would be looking at a reconciliation further down the line. However, crucially, it is the net tax position that matters for the funding position. If we have higher inflation and higher pay awards in Scotland and there are higher pay awards in the rest of the UK, both the UK and Scottish tax revenues would rise, and you would expect each rise to roughly offset the other, but we will not know whether that is the case for another three years.

Exactly. So, even if we expect more tax to come in, that does not help us in any way this year.

That is correct. As I said, the only thing that might happen is that, if there are higher pay awards at the UK level, the UK Government might respond by giving more money to departments to cope with higher pay awards because of higher inflation, exactly as you say, and we would get Barnett consequentials from that, which would open up the Scottish Government’s abilities in relation to pay increases, but that obviously depends on what happens tomorrow.

That is helpful. Perhaps related to that, paragraph 18 on page 7 of your forecasts document says that, when the UK gives pay rises, the level of funding that the Scottish Government receives depends on how those pay rises are funded. It says:

“Specifically, it depends on whether pay increases over and above the current UK budget plans are funded from new, additional money, or from existing departmental resources.”

Again, that frustrates me, because it is all so short term, but we are all trying to look at a longer-term plan. We are back to this living hand-to-mouth situation whereby we just do not know what is happening. Is that correct?

That comes back to the general point that, in an ideal world, you would set out very clear plans over four to five years about what you want to prioritise in spending, and within that you would have a clear pay policy that underpins that. Spending reviews are the ideal time to do that.

You are right that, at the margin, if you have pay awards in-year or for the year ahead that are different from your stated pay policy, what matters at a UK level is how you fund them. The Scottish Government does not have the luxury of funding those increases in different ways, because it cannot borrow more money or do a quick increase in a tax that it can then use to fund spending. Therefore, the level of funding that the Scottish Government receives depends on whether the UK Government says that it is going to give more money to Whitehall departments to fund those pay awards. If it does, Barnett consequentials will follow. If it does not and simply says to departments that they should deal with the increases from within their existing allocation, there will be no Barnett consequentials and the Scottish Government will have no additional money flowing through from that.

That also applies to welfare. If increased welfare spending is announced tomorrow, we will not know that until the UK Government tells us. Would we expect to know that tomorrow, or would it be some time before we would know where that money was coming from?

There are a couple of things to say on that. If, for example, the UK Government announces immediate changes to departmental spending for this year, Barnett consequentials would come through, and the statement of funding policy would work that through. If there was a change in the funding for social security, that would come through in the in-year adjustments to the BGAs. There are then technicalities about whether the Scottish Government could defer some of that. If I remember correctly, last year we could defer the winter fuel payment.

Yes, but that affected us negatively. However, I presume that if it affects us positively, we will take the money immediately.

Well, that is not for me to say.

Okay. You were asked about productivity and capital investment, and I want to press you on that. Is it the case that any capital investment will inevitably help productivity, or do you look at where the capital investment is going? For example, if we buy a new train, perhaps people’s comfort improves and things are a bit more reliable, but, actually, it is still moving 200 people from A to B, so it does not really increase productivity.

I wish that Professor Francis Breedon was here, because his big thing is capital investment and how we do it. You are right that some investment is particularly targeted at boosting productivity, whether it involves investment in skills or investment in infrastructure to deal with a bottleneck or something like that. That is where you would generally see a significant increase in productivity.

A lot of capital investment is in replacement, and is really just to keep things ticking over. Some capital investment might be done for very good reasons, but it is not designed to support economic growth. For example, building a hospital would create construction output, which in turn would boost the economy. However, the immediate aim of building hospitals is not to improve productivity performance in the economy—we do it for other reasons. Although public sector capital investment is one enabler of overall productivity growth, it is not the only one. Such growth depends on a multitude of other factors.

10:15  

Do you look below the line? At the moment, you do not have a lot of detail on where capital expenditure will be for, say, the next five years. If you were to get that information, would that have an impact on your forecast?

It might, or it might not. If we were to see a really significant change in capital investment, either upwards or downwards, that would likely be a material factor and we would change our view on the overall economic forecast. However, the numbers that we are typically talking about are a few hundred million pounds here or there. In the short run, that would not really have much impact on our forecast. Putting an extra £200 million-worth of capital investment into an economy worth £160,000 million would not change our view. Clearly, the point of longer-term capital investment is to turn up long-term total factor productivity. However, we would not immediately change our view unless either there was no money or the money were to treble.

My final point is on the 2027-28 negative reconciliation figure, which is £851 million. That sounds absolutely scary, because we have a limit of only £600 million or £700 million. That number will go up and down, though, and every other set of figures that we have mentioned, including those on social security, will impact on that, will it not? Is it correct to say that it is incredibly difficult to predict the reconciliation figure?

It is not incredibly difficult to predict the scale or the relative sign of it. However, you are right to say that the exact number will move. I think that it was at £700 million when we talked about it in December, and it has now gone up to £850 million.

It is important to emphasise a couple of points. The issue is partly caused by the nature of the framework. The figure moves around because of the specifics of the framework that we have. This is not passing the buck, because sometimes it is our forecast that changes, but the key reason for the reconciliation is that there is better outturn data at the UK level. HMRC has just collected better data at that level, and it found that UK tax performance was better than it had thought it would be. The OBR is changing its forecast to become more aligned with ours. Members will recall that we were previously more optimistic than the OBR. The two forecasts for that year have now essentially aligned. The tax richness of growth at the UK level is also a factor. There is earnings growth in the UK, but there are very rich taxpayers there relative to the situation in Scotland, which, in turn, leads to effects coming through. If we put all of that together regarding a tax level of over £20 billion in Scotland, we see those variations moving around, which leads to quite a significant reconciliation. That is the first point.

The second point is that the issue is not so much about the movement of reconciliation as it is about how much flexibility we have to manage that uncertainty. We are just highlighting that there could be a real challenge for the Government in 2027-28, because its borrowing powers to offset reconciliations might not be sufficient to do so in full in that year.

But we will get a clearer picture as we move forward.

Yes. The position will change, and we will keep updating that number.

Thanks very much.

I want to go back to the issue of social security payments. Given Mr Davidson’s comments about the behavioural effects and the interaction of different factors I understand that the situation is complex. What information has the Scottish Government supplied to you on its policy design, including its understanding of the thresholds, their interaction and the behavioural effects? Why did it choose the method that it has as the best one for alleviating poverty?

We would not be party to any discussion about what motivated the Government’s approach. We take the policy that it wants to implement and model what we think its effects would be. In turn, that might influence the Government’s thinking about what it would do. However, we would not be there to design policy—for example, to say, “This is the optimal decision that the Government could take to tackle child poverty.” We were told that the policy was to mitigate the two-child limit, so we took that as the Government’s policy design and modelled it.

So, the Government does not supply you with any of its working on evaluating whether it should adopt a certain policy approach. I understand your point about motivation, but that is not really what my question is about. We can agree about the motivation behind a policy but move on to decide the most effective approach. From what Mr Davidson described, deep complexity surrounds the behavioural effects, the thresholds, the timing of when people exit, and how all those factors are combined. However, you say that you were not provided with any working on the assumptions that the Government had made in choosing its approach.

I do not know about the discussion with the policy officials. Again, to be clear, we would make our own judgment call about what we think that the behavioural effects and so on would be. It is entirely fine that Government would chat with our officials about that, but, ultimately, it is a judgment call, and we would say, “If you mitigate the two-child limit at that threshold, we will be the ones who then decide what the behavioural effects will be.” The officials would critique and challenge what we say, but that would not be policy, and it would not be appropriate for them to say, “This is what we think your view on the behavioural effects should be as a result of the policy that we have done”—we would not accept that.

I am glad that you do not take their homework as read.

On the information that we receive, we had to make a few more assumptions when we did the costing in January, but the forecast that we produced in May was based on, and consistent with, the consultation document that the Scottish Government published on how it would deliver the policy. There is quite a lot of detail in there on its preferred policy, means of delivery and things like that. Our May forecast was based on that document, but it was pretty consistent with the assumptions that we had made in January anyway.

With regard to your evaluating the fiscal impacts of the approach, you will understand that one of the committee’s interests concerns the effectiveness of the approach that is chosen. That side of it is interesting.

Let us move on to the economic performance gap. In 2022-23, it was £624 million; in December 2024, it was £838 million; and, in May 2025, it was £1.06 billion, so it is clear that it has been increasing significantly over the past two years.

In addition, to pick up on what colleagues said about the negative income tax reconciliation, that has grown by 20 per cent in the past six months. I understand some of the factors that are involved in that. Are you concerned about the fact that, as a result of all those different factors, the Scottish Government appears to have a growing gap across those different areas?

There are a couple of things to consider. First, in figure 4.4 we look at the net tax position. That is still positive, so the Government is still raising more revenue than otherwise would have been the case without tax devolution—it is the stated policy to do that.

The net tax position is interesting. I will explain the calculation that we do, because it is not an assessment of Scottish Government policy or performance. It is essentially about asking, “If you implemented these tax policies and had exactly the same earnings, growth and economic performance as the rest of the UK, how much would you potentially be raising?” That is then compared with how much is actually projected to be raised, and that is where the gap comes from.

The gap is, essentially, everything that is not explained by that policy. As we highlight in the report, it could be down to different policy decisions; it could be the result of a UK Government decision having an impact on Scotland relative to the UK; it could be a Scottish Government decision having an impact on Scotland relative to the UK; or it could just be down to general economic performance in Scotland lagging behind that of the UK, or performance in different sectors.

We have highlighted previously some of the challenges that we see in the decline in relative tax paid per head in the north-east. That area has naturally been a rich source of tax revenue for Scotland relative to other parts of the UK, and that was baked into our baseline when we got tax devolution. If there is a decline in oil and gas, that naturally becomes less positive over time. London is also a factor in the UK numbers. If the city has a really good year, that means that it will be harder for Scotland with regard to the net tax position.

If we take a step back, it is interesting: you want the economic performance gap to be as small as possible, and ideally positive, because that means that you are getting even more benefits coming through. The fact that it is negative and is becoming more negative, partly because we are seeing faster earnings growth and taxes at the UK level, means that there is money that is essentially not there that otherwise could have been.

I understand all of that—it is a useful explanation. One of my colleagues has doubts about some of the terminology, it is fair to say; we have come back to that on a few occasions. However, it feels like, overall, the update presents a picture of a worsening situation. There is a challenge for the Scottish Government across those different areas, whether it is in the area of economic performance and tax take that you have illustrated or in the scale of the gap in relation to the amount of money that we have on social security. Are you more or less concerned than you were 12 months ago?

The net tax position is less positive than it was in December, and the social security position is more negative than it was in December. As I said in my article in The Herald yesterday, the key reason for that is to do with what has been happening in the rest of the UK, rather than anything that has happened in Scotland. That is one of the risks with the framework—it is about not only how Scotland does, but how the rest of the UK does, and UK Government decisions come into that.

I also understand that—that is well recognised. However, that does not change the fact that we should be concerned about the figures that I mentioned. Are you more or less concerned than you were 12 months ago about the broad picture that you have painted in your update?

That partly depends on what comes through in the spending review. The Barnett formula is still the biggest element in that. However, if we look at the key components, we can see that the net tax position on income tax has got worse, and the social security gap is projected to get wider towards the end of the horizon.

There are still some areas in which we need to wait and see what happens. Obviously, announcements by the UK Government on social security might offset some of the decline that we have projected. If more money flows through for things such as winter fuel payments, that might have a small marginal impact. Ultimately, as Mr Mason said, the net tax position might move around again, but it has certainly become more negative than it was back in December.

You mentioned tomorrow’s UK spending review. What discussions have you had with the Government about a Scottish spending review?

I have not had any particular discussions about that. I note that the Cabinet Secretary for Finance and Local Government talked about setting out the detail around that when the MTFS is published. We will wait to see what that says. We will be ready to respond.

Do you think that there should be a Scottish spending review? Would it be prudent to have a Scottish spending review?

I have been very clear that spending reviews are really important for a variety of reasons. They stop Governments focusing on the day-to-day issues and make them take a step back and think about where they are heading on public policy overall. They are good, because they give Governments a chance to look at the outcomes that they are trying to achieve and whether those are all aligned and in a good place. They also let Governments think ahead over the next four to five years.

In principle, spending reviews are a really good thing to do. We have not had regular spending reviews in Scotland for a long time.

Do you think that it would be achievable for the Government to have a spending review within the next six to nine months, so that it could consider a zero-based budgeting approach, which has been advocated by members of the committee, and look through the spending lines with a view to resetting the budget as we move forward?

That is probably a question for the cabinet secretary.

I suppose that I am talking about whether it is possible on a technical level. Do you think that that is achievable, as opposed to desirable? I understand that there is a lot of politics in this, and I do not want to draw you on that, but, on a technical level, do you think that it would be possible to have a spending review?

Everything is achievable. The question is how much detail you go into and how rigorous the process is. The word “comprehensive” often comes before the phrase “spending review”. How comprehensive would the process be? It has taken the UK Government quite a bit of time to do a spending review—it has taken it nearly a year to undertake a root-and-branch review. There is an advantage to doing it after an election, because that makes it possible to set out the path for a long time.

The challenge in Scotland is that, if a spending review is delayed, the Government will be rubbing up against the fact that it will be moving into the middle period of a UK spending review, so it will be lagging behind.

In general, what the UK Government is trying to do by having a comprehensive spending review followed by regular updates is a much more effective way to do it than has been the case in the past.

If we get ourselves into a position in which we undertake a spending review after the election in 2026, we will, as you said, be approaching the midpoint of the UK Government’s spending review cycle. There has been a lot of discussion about the problems with an MTFS, because events come along and things change. In your view, should the Government simply get ahead and get it done? Would that be the best thing to do to address the strategic challenges that you have set out in your report?

Ultimately, it will be for the Government to decide the specific timing of a spending review and what it does as part of that review. However, I will make a general point, which relates to my earlier point about the timing of things: much of the time, we focus very much on the marginal piece.

You were quite right, convener, to mention that, in relation to pay, a 1 per cent increase in the budget is £300 million. That is entirely right. We are talking about a budget of £60 billion, with some huge challenges coming down the line on health, ageing and net zero. We must be able to have a conversation about the totality and the strategic direction of that and then say that there will be marginal changes around all of that. In principle, the sooner that you can do a spending review, the better, but it is up to the Government and the Parliament to decide when that would be.

10:30  

For my last question, I want to go back to the issue of productivity. You mentioned that capital investment is comparatively lower in Scotland. I attended an excellent conference on Friday, at which I chaired a session, but there was one thing that I found slightly puzzling, so I will ask the question that I did not get answered then. It relates to the availability of capital to firms in Scotland.

Prior to the Ukraine crisis, companies and firms would tell me that the availability of capital was not the problem, because capital was relatively cheap for a long period of time. Because of low interest rates, it was accessible. Interest rates have now increased and it is a bit more difficult for firms to access capital. However, access to capital is a long-term problem; it is not just a short-term problem, following the invasion of Ukraine. In a marketplace in which capital was cheap, Scottish firms were still underinvesting in capital and productivity. Can you say why that is a problem?

That is a great question. Why there has been such underinvestment is a puzzle. You mentioned Scotland, but, across the UK more generally, why companies have underinvested is a puzzle. Part of the explanation is to do with the fact that, especially after the financial crisis, companies were, in effect, hoarding cash to build up resilience for a potential future shock. Future shocks happened, but companies kept on hoarding cash, and that did not lead to an unlocking of investment.

The issue is not to do with the availability of capital through borrowing; it is to do with how we use the potential that has been built into the UK economy. There are huge sums in pension funds that are waiting to be invested. How do we unlock that? We have never done that well in comparison with other countries. We need to encourage a vision for investment so that companies with huge balance sheets that have not been able to take a long-term view are able to do that.

There has been a lot of funding, but the interesting policy question is whether that has been the right type of funding. That is being looked at, and some of the changes in the UK’s fiscal framework are intended to provide more flexibility. The British Business Bank is considering more innovative ways of funding that could unlock greater potential.

As I said, it is interesting to look at the explanation for why the UK has been lagging behind. About a third of that issue relates to low investment, but there are huge funds sitting there that could be invested.

The comparison that was drawn between the amount of capital that we retain in-country and the amount that other developed nations retain was a striking one. I was also struck by the situation with regard to the ability of firms to mobilise capital and the absorptive capacity of the economy to use that capital effectively. It strikes me that you are saying that the issue is partly to do with the behaviour of firms and whether they are risk averse in relation to investing here rather than elsewhere. Is there anything that we could do to address those issues, rather than simply addressing the question of capital flows?

The issue is partly to do with the strength of the underlying ecosystem in the business base. In other countries around the world, that ecosystem is much stronger when it comes to enabling the flow of capital and funds. For example, with the Mittelstand in Germany, there is a completely different model for how economic investment is unlocked.

The issue is also partly to do with the types of companies that are growing, the sectors that are being invested in, and the speed and agility with which additional capital for projects can be unlocked. The part of the conference that I thought was really interesting was the bit when questions were asked about how much of the funds that we have in the UK get invested abroad compared with how much of them get invested domestically. Compared with other countries, we tend to invest much more abroad than we do domestically. There is a question about how we can incentivise the investment of capital in domestic companies, or skew investment towards those companies, without picking winners or throwing money after poor projects, as we have done in the past.

Domenico Lombardi might have some reflections on that from an international perspective.

Following the Greek financial crisis, there was a stream of regulatory reforms across a number of countries, certainly in Europe, and in the UK and the United States, to name but a few. Lending standards have been tightened up, not just in this country but elsewhere. On the one hand, tighter lending standards and regulatory reforms foster a sound financial system, but, on the other hand, at the margins, it has become more difficult for small and medium-sized companies to access capital. There is a trade-off, and some countries might move forward in different ways, but that is the reality that a number of countries are confronting.

I will close on this point. Firms have said to me that, for them, the challenge of attracting investment is more to do with the availability of talent in Scotland and their ability to find people who can run the company at a level that increases output; it is more to do with the skills base and the ability to access the right skills than the availability of capital.

Therefore, is the issue not more complex than simply being a question of bulking up or putting in place capital controls or trying to find a more tax-efficient route by which to direct investment in Scotland? A combination of those things is required, including consideration of the human factors, rather than just action on the regulatory side.

Yes. As I said, the extent to which there is high-growth potential depends on the entire underlying ecosystem that sits around the sector.

Last week, I was at a conference at the Technical University of Munich. What they do there is unbelievable—it involves looking at the whole ecosystem, from students to start-ups to scale-ups, and the support from the public sector and the business community. There are 21 unicorn companies linked to that one university, either through graduates or through research that has been done. Every year, 100 start-ups come out of that.

You are right—there is a huge pot of capital sitting there waiting to be invested, but it is all crowding around young people coming through, who are ambitious to be entrepreneurial and set up their company with fantastic academic research and a pipeline of support, including training and managerial support to enable them to grow their business, all within a relatively small geographical area. That comes back to the point that it is not just about capital—those in Munich would say that it is down to the complex ecosystem that they have been able to build over 50 years.

I have to say, from my recall of economic history, that the issues that you talked about, such as concerns about the amount of investment from British companies going overseas, was an issue before the first world war—that is how long that has been an issue for the Scottish and UK economies.

Good morning, Professor Roy. One of the features of the fiscal framework is that it links Scottish and UK fiscal and tax policy to relative economic growth and performance, which has led to what you describe as an economic performance gap.

In our discussions with ministers, we have picked up a sense that that does not appear to be a particularly big concern for them, because it is a notional, academic, intangible figure—it is not real money. Will you clarify how important it is that the Government takes that issue seriously, because of the interaction with the fiscal framework?

The figure that matters, ultimately, is the net tax position—essentially, that is how much you raise. That is the figure that enters into the budget. I think that we are projecting it to be £600 million for 2025-26.

When we highlight the economic performance gap, we stress that the net tax position is made up of two elements: the tax policy decisions of the Government in Scotland relative to the rest of the UK, and how the tax base is doing. That is what matters in the fiscal framework, and we think that it is important to look at both those elements. You need to think about not only how much you might raise from your tax policies, but how your overall tax base is doing within all of that.

That is why it is helpful to take a hypothetical view and to think about what you would have if you had your tax policy and you matched economic performance in the rest of the UK.

As we have highlighted in the past, growing the economy—the relative performance of the Scottish economy—is fundamental to the framework. That is why it is important to highlight it and to be cognisant of what we are seeing in that regard.

That reminds me of a chief executive officer with whom I worked, who used to say to the sales teams, “Don’t tell me how much you did sell—tell me how much you didn’t sell and what you didn’t bring in.”

Let us look at what, in a sense, the Scottish Government has not brought in. You made a projection that said that the top rate of tax—the 48 per cent rate—should have brought in £53 million in 2024-25, but, in the end, the Scottish Government realised just £8 million. That was from one of your previous reports. The top rate applies to those who earn more than £124,000 or so. What would be the reason for such a significant difference between what you estimated would be brought in by a certain tax policy and the net result, which was significantly less?

We have related that to things such as behavioural change and how people might respond to different tax rates. Again, we use evidence, including the increasing evidence that HMRC is pulling together about what has been happening in Scotland, and—crucially—what the international evidence shows.

That evidence shows that people on higher rates of tax typically adjust their behaviour in response to changes in tax policy. People think that that is about people moving, but it is not—it is simply about people adjusting their tax affairs, taking more of their income in dividends, marginally changing their hours worked and so on. There does not need to be much of a change in people’s behaviour for there to be quite a significant change in the tax position overall.

Changes in tax policy, which give you a static effect, need to account for the fact that people will change their behaviour. That is why, for higher earners in particular, we assume quite a high tax elasticity, whereby changes in tax policy would lead to a relatively marginal overall increase in revenue, because people adjust their tax affairs and tax behaviours. That is why we saw such a change.

With regard to the levels of behavioural change, I presume that the greater the differential in tax between Scotland and the rest of the UK, the more exposed we will be to such behavioural changes taking effect.

We model tax elasticities. Clearly, if you have more of an increase, you will raise more revenue, but the actual scale of potential behavioural change would be bigger.

There are a couple of points to consider. Some people have talked about whether there are tipping points, for example, so you could potentially increase tax quite a bit and have relatively limited behavioural change, but, once you get above a certain level, you might potentially have more behavioural change.

A lot depends on the individual’s circumstances. People who have one job that is very highly paid might have very limited flexibility; if someone owns a company and is self-employed, they might have much greater flexibility around how much they actually take as a dividend, as a salary and the like. We have highlighted that as an area in which HMRC is starting to pull together longitudinal data sets that will enable us to test much more empirically whether we have seen behavioural change going on.

One caveat is that we are still seeing net inward migration of taxpayers into Scotland. Again, everything has to be taken in the round. We might be seeing people’s behaviour change, but people are settling here; there is no evidence that large numbers of people are leaving Scotland or not coming here because of the changes in taxation.

The Scottish Government quotes the overall figure, but has there been any assessment as to which tax bands those who come into the country as part of that net inward migration fall into? Do they tend to be in the lower middle tax bands, or are we seeing greater numbers at the lower end of the pay spectrum?

10:45  

I do not recall whether the HMRC study broke it down into different tax bands, but we can have a look at that and come back to you.

One of the issues that you described as an asymmetric and downside risk to the net tax position is your assessment of Scottish earnings growth relative to the OBR’s assessment. Why do the two organisations take a slightly different view? Why is your outlook slightly rosier than the OBR’s in respect of Scottish earnings growth?

Ask two economists a question and you will get three different answers.

They could be one-handed economists.

As an institution, we have always been slightly more optimistic than the OBR on the outlook for earnings. There is a chart on page 39—figure 3.3—in which you can see that our forecasts are slightly ahead of the OBR’s.

For the first few years of tax devolution, Scottish earnings lagged behind the rest of the UK’s. To come back to your point about performance, that led to the net tax position not growing as much as we might have thought that it would have, because Scottish earnings were not tracking UK earnings. That turned around for a couple of years, partly because of improvements in the energy sector in Aberdeen, but also, we think, because of the performance of financial services in Edinburgh relative to the performance of financial services in London. That led to Scottish earnings outperforming UK earnings for a couple of years.

We have recently seen a closing of that gap, and, in the most recent forecast, the OBR uplifted its forecast to be more aligned with ours. That is the key reason why the net tax position has come down this year.

If you look at the chart on page 39 and at the risk, you will see that we are more optimistic than the OBR is on earnings in 2026-27 and 2027-28. If the OBR aligns its forecast with ours or we align ours with the OBR’s, the improvement in the net tax position will deteriorate further.

You mentioned financial services but not oil and gas. Has the public sector pay settlement given you some encouragement? Recently, that has tended to be higher than settlements in the private sector, and we have more public sector workers in Scotland.

To go back to Mr Mason’s point, there is an element of recycling over time. If the pay awards in the public sector are higher, you get income tax coming through from that. Again, public sector pay awards have been higher in Scotland, which is another factor that led to that relative improvement in earnings.

The figures say that unemployment is 4.5 per cent. If we look at the levels of economic inactivity, which are running just shy of 25 per cent, we can see that we are getting close to one in three working-age Scots not being in employment. Mr Davidson referred to issues in the benefits system that might lead to behavioural changes such as people simply not taking up work. As we look forward, how concerned should we be that, in effect, we are in a position in which 28 to 30 per cent of working-age Scots are not in employment? How will that aid our future productivity?

Overall, the figures for Scotland are not that different from those for the rest of the UK when we take activity and unemployment into account. In particular, we are not that different from other regions of the UK in that regard.

I will say a couple of things about that. Inactivity is a bit of a catch-all term for a large number of people. There are “positive reasons”—if I can use inverted commas in that way—to be inactive. For example, someone who is a full-time student will be classified as inactive. We might have views about how active students are, but they would be classified in statistics as being inactive.

Obviously, we are not worried about those people, because they are going through the education system. People who retire early will be classified as being inactive. We are more concerned about those people who are inactive because they are discouraged from entering the labour market, and, crucially, those who are inactive because of ill health.

Recently, there has been a switching, whereby people who were inactive for some other reason are now inactive because of ill health. That is a concern not just in Scotland but in the UK, because it suggests that there might be more significant reasons for people not being in the labour force, which are linked to their health and wellbeing. It suggests that there is something going on upstream or a challenge in society that is affecting people’s ability to be active in the labour market.

I accept that there is probably a similarity with the rest of the UK, but am I right in thinking that there is not a similarity with other Western economies that are the same size as ours?

Yes. The levels of inactivity in the UK are relatively higher than they are in other places in Europe. We have lower unemployment, however. Unemployment is higher in places such as France, for example.

We have more people classified as inactive. The interesting thing is that the national figures for inactivity hide huge variations between different parts of the country. That is why the comparison between Scotland and the UK is perhaps not the right one. The comparison between Edinburgh and the affluent parts of England, or between Inverclyde and the post-industrial regions of the north of England, is where we get the most insight into what is driving inactivity in some key areas.

I am looking at the state of the Scottish Government’s budget this year and going forward. We are seeing quite big policy changes at the UK Government level that will have a material effect on the Scottish budget. For example, we are seeing a potential reversal of the winter fuel payment, which will give the Scottish Government more money, and possibly the scaling back of other welfare reforms at the UK level. The consequence of that could be further cuts at the UK level to health, education or areas in which we get Barnett consequential funding. How difficult will that make it for the Scottish Government, which, by common consensus, seems to be too last-minute in the way in which it approaches its budgetary considerations, to forecast for the next 24 to 36 months?

There are a couple of things to say about that. The UK Government has set out broad parameters for departmental spending. Tomorrow, we will get the detailed intricacies between different departments, which, at the margin, will lead to modest changes in the position of Barnett consequentials relative to that total.

There is a lot of information out there that the Scottish Government can use to plan. That was one of the key reasons why the Government said in February that it was going to publish the MTFS before the spending review, and it was relaxed about doing that, because the broad parameter of departmental spending was set. We will get a bit more detail tomorrow, but the Government has a lot of information to enable it to plan what will happen to its overall budget.

With the winter fuel payment, you are talking about the potential implications of a small number of hundreds of millions of pounds—if that—in a budget of nearly £60 billion.

The Government has a lot of information. It has the forecasts, the trajectory for social security and a broad outline of what the block grant will look like. A lot of things will change at the margin, but, overall, the Government has a pretty clear indication of where the overall public finances are trending and when the reconciliations will hit.

Good morning. I will keep my questions brief. This session has been invaluable. It has been interesting for me to listen to it.

We have had a number of conversations about the so-called economic performance gap and you have clearly illustrated the reality and why it is more complex than simply seeking top lines. I am quite intrigued by the percentage of our conversation this morning about getting further clarity on the operation of the fiscal framework, with the different events that influence data and information coming in from the UK Government and the Scottish Government.

I also feel that, every time that we have these sessions, we are descending in terms of transparency, which has to underpin the point of why we are doing this. Things seem to become ever more opaque, ironically, as we get more data and information, and that is clearly driven by a system that seems to encourage short-termism and more complexity, becoming ever more inefficient. That is just my observation from sitting and listening to this session, but I am interested in hearing your views, because your work rate must also be increasing.

As the economist here, far be it from me to be more optimistic than you. I think that you are right. The nature of the fiscal framework means that it has a lot of moving parts, and a lot of those moving parts change relatively regularly, whether that be the economic performance gap or the UK Government making an announcement on social security reform, which has an impact on the Scottish budget, or whether we get a spending review and we are waiting on Barnett consequentials. There are a lot of things moving around in all of that. My answer to you, and the point that I think it is also important for the Government to think about, is that if we take a step back, a lot of what we are talking about is marginal changes in the context of an overall large budget.

If I take the example of winter fuel payments—Michael Davidson might be able to quickly work out on an envelope the numbers that we are talking about—the last time, we were talking about a difference of up to about £80 million between Scottish Government and UK Government policy. Even the two-child limit is a difference of up to £190 million—we were talking about growth from £156 million to £190 million. It is really important to consider those issues, but we are talking about £30 million in a budget of £60,000 million. Sometimes, we focus on the minutiae when the really big public policy questions are how we spend the £60,000 million budget most effectively to support the priorities of reducing child poverty, economic development and tackling net zero. Sometimes, there is a tendency for us to dive into the detail, which is quite right, and to scrutinise the forecasts and those elements of it, but the big-picture trends are pretty stable.

That is very helpful. I will pick up on a comment that you made earlier about HMRC. Have you got any indication from HMRC as to whether it might start to make more data available? You were talking about self-employed people, and, with the making tax digital programme coming during the next tax year, there will be much more data available, even if it is not collected—and it could be during future phases. There must also be more data available with people making interim, mid-year payments, which came in a few years ago. The whole point is to make data more readily available to mitigate the problem of the self-employed figures.

All of that helps. HMRC has been really good about sharing the information and data that it gets, and that definitely helps with things such as RTI. It is now able to give us an indication of the figures that it is seeing that might be coming through self-assessment, and we can take that into consideration for the update in advance of the outturn that we will get in July.

I do not know whether anybody here does self-assessment, but the challenge with it is that most people do it in January, which means that they are doing it right at the end of the tax year. For the tax year 2023-24, for example, people were doing their self-assessment in January 2025. We do not know the figures until a couple of months afterwards, when HMRC gets them through. It can then tell us what those figures are, but it cannot tell us any earlier, because that is just the way that it is done. We need more of a structural change in how we do things such as self-assessment, and getting it done earlier would really help us. It is a concern, and that is the bit that is very volatile in Scotland and the UK.

My last wee question is about economic inactivity. I have previously asked about the extent to which you disaggregate data by sex, because that often gives interesting patterns. It makes me wonder to what extent we might see emerging patterns when we do that. Obviously, there will always be a big proportion of economic inactivity related to childcare. Have you got any sense of what patterns there are? Do you disaggregate data in that way? Have you got any further plans to derive more key insights?

On inactivity, we rely on what the Office for National Statistics produces on the labour market. Again, you will hear some frustrations from us about the quality of the data that the ONS is producing on the labour market and some concerns about the labour force survey. That data is disaggregated by sex, age and reason for inactivity. The challenge—this is why we need them to produce the robust data—is that, once you start to drill in on age, sex and reason for inactivity, you could start to get into relatively small samples, particularly in Scotland. We need that to be as representative and robust as possible—

Sorry to interrupt, but the scale of the ONS data set for Scotland has been an issue in recent years, has it not? Has that moved on at all?

It is still work in progress. The Scottish Government boosts the ONS data, so it is more representative, which helps, but there have been bigger challenges in the ONS and concerns about the labour force survey. The ONS view is that it is more confident with the LFS, but I note that the Bank of England and others still do not use it.

11:00  

The challenge, in trying to drill down into exactly the types of policy questions in which you are interested is that, if you do not have confidence in the data, you could end up with really poor policy judgments on the back of that.

I have just a couple of further points. The first relates to social security. I am curious about employability services. The wee footnote in your report says:

“The forecast of Employability Services is an indicative forecast and includes spending on Fair Start Scotland and elements of No One Left Behind.”

You have the figure increasing from £52 million to £60 million to £73 million in the current year, which is an increase of about 15 to 20 per cent per year, and then you have it projected to go from £73 million to £70 million and remain at that level for five years. Is there a reason for that?

Michael Davidson may want to come in and explain that.

I am asking just out of curiosity. That is the only static budget that I have seen in your whole report.

We produce what is—as we have said—an illustrative forecast, because we take the budget allocation from the Scottish Government and then estimate the proportion that falls within our remit, based on the existing use of that money. What falls within our remit is spending to assist disabled people or those receiving reserved benefits with barriers into long-term employment. We estimate that around 80 per cent of the employability budget falls within our remit, and that is according to our legislation, so we just apply that to the budget that we are given by the Government and roll that forward rather than uprating it.

Right. But why do you think that it is going to fall from £73 million this year to £70 million and remain there for five years in a row?

Sorry—the fall by £3 million, from £73 million to £70 million, is the fair start Scotland element. That scheme is being phased out and is being entirely subsumed into the no one left behind scheme, and we ran it flat from then onwards. This year, we have £70 million; in 2025-26, the £73 million is broken down by £3 million on fair start Scotland and then £70 million on the no one left behind scheme. When fair start Scotland fades away, we are just left with the £70 million.

And there is no inflationary component.

We do not currently apply anything to that figure, based on the discussions that we have had on that with the Government and the spending that we have seen in previous years.

Okay. Thank you.

I am curious about something else—it is in paragraph 3.11, on page 39, regarding your projection on public sector employment.

Since the pandemic, there has been an increase of 42,000 in the public sector workforce; 25,000 of those posts are in the NHS, which means that 17,000 are not. The public sector reform agenda will be looking at the size of the workforce, particularly with regard to digitisation, artificial intelligence and so on—you name it. However, despite that, you are predicting only a 0.1 per cent reduction in the current year and 0.3 per cent for 2026-27 onwards. Can you explain that?

What we do on that is, largely, take pay policy and the public sector employment data and then just slide that forward, based on what we think public sector pay will be within that. That is across the entire public sector in Scotland. We do not have any details from the Government on its specific targets for, say, changes in employment, so it is largely just a mechanical forecast to help us to make our tax forecast. It is not a judgment whereby the Government has told us that it plans to remove X number of jobs and we have incorporated that—it is going the other way.

Is that something that you might expect to see in the medium-term financial strategy, for example?

As we have spoken about quite a lot, it is okay to have pay policy but it would be nice to have a workforce policy that underpins that. We would expect to see that sort of thing in a medium-term strategy.

Would you or your team like to make any further points?

No—that is it really.

I thank you once again for your evidence—it is much appreciated. We will now take a short break of some five minutes before we move to the next session.

11:04 Meeting suspended.  

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