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I will answer that question in parts. On the size of the budget, you are right that the Scottish Fiscal Commission’s figure is the one to prioritise because, ultimately, I cannot spend a penny more than the SFC has forecast. That really matters in terms of the overall size of the budget.

Her Majesty’s Treasury’s figures are useful too, because, as is indicated in its publication “Block Grant Transparency”, the block grant is less than the current aggregate for 2021-22 in every year of the spending review. For resource, that will mean a £2.6 billion real-terms reduction for next year, and for capital it will mean a £0.5 billion real-terms reduction in 2022-23.

The convener referenced the forecast deficits. One of the key points to make is that we will use the forthcoming resource spending review to plan future years. On social security in particular, but also on income tax, we know that the Scottish Government needs to manage those within its budget and that our choices have a direct impact on the level of funding that is available.

There is an argument to be made—I have made it in the past and will continue to do so—about income tax and the methodologies that are used for bulk grant adjustments. You will know about the forthcoming review of the fiscal framework; I hope that the matter will feature in the review. However, to put it bluntly, I say that, when it comes to social security, the uncertainty—it is a demand-led budget—needs to be managed within a fixed budget. That is where multiyear spending plans are essential.

This is the first time for a number of years that we have been able to make multiyear plans. Inevitably, that will require that we make some very difficult decisions. However, at the end the day, that will allow us to plot out and plan how best to allocate the available funding to meet our evolving priorities over subsequent years.

Thank you for the way that you have asked that question, because it allows us to bring more light than heat to the issues. I am happy to go through the figures, one by one, to explain. Just for the record, I have no issue with Audit Scotland’s very important report, because Audit Scotland plays a hugely important role.

Regarding the figures on page 104, £580 million is the figure that has been identified not from Covid consequentials but from the total Scottish budget. That is against an overall budget of about £50.7 billion, so it is about 1 per cent of the total.

If we divide that further, £207 million of that is underspend on capital projects. That is primarily because of the impact of the last quarter when, as you will recall, we were in lockdown. A lot of initiatives were not able to proceed and could not draw down that capital. There was an appeal from community groups, local government and others to try to manage that slippage into this year. All of that funding has been allocated on an on-going basis to capital needs, including for infrastructure. One of the key lines, where there was an underspend of £321 million, was in transport infrastructure and connectivity.

On the issue of resource, I draw your attention to the fact that it is the health line that is seeing a significant underspend. You might wonder why on earth that is the case with health spending during a pandemic. You will recall that, in the last month of 2020 and the first few months of 2021, there were considerable late consequentials, particularly for things like vaccination programmes.

I recall the conversations that I had with health colleagues at that time. If I had obliged them to spend all that money in the run-up to the end of the financial year, that would not have made for a smooth spending pattern into this financial year. So, we agreed with health that we would try to manage some of their budget through the reserve, to meet the challenges prior to the end of the financial year and immediately after the beginning of the new financial year. In other words, that prevented any strange behaviour if they had desperately tried to draw down that money before the end of the financial year. Instead, they could manage the Covid response over that bridge of 31 March.

I realise that I am going on. I want to answer your question about where the money has gone.

The autumn budget revision was passed just a few months ago. It has formally allocated £560 million of that original £580 million. All the lines that show where it has been allocated are in the autumn budget revision, which gives a full account of how the money has been spent. You will see that health is drawing down a lot of that funding.

With capital, there is almost an opposite risk in that it has to be managed over a longer time period because of the risks of Covid. That is where we get into the territory of trying to figure out how we carry forward funding from year to year. Last year, the situation was acute, given that—as I said—we had a lockdown in the last quarter. We then had to figure out how not to breach the limits of the reserve drawdown, and how to ensure that all that funding would still be available to us in subsequent years. Technically, local government can carry forward more funding than we can. The risk, therefore, is in ensuring that money can still be managed and drawn down.

As you can imagine, that is part of the reason for the length of the dispute. I believe that the Scottish Government should be properly compensated as per the methodology and the agreement with the UK Government.

The key is that the funding assumption that we have made in the budget should not prejudge the outcome of the dispute resolution process, and we will continue to engage with the UK Government in good faith as we progress that process.

I have not compensated the NHS for national insurance contributions. It has chosen to use part of its budget for national insurance contributions. That obviously has an inflationary impact. There is not a line in the budget that we received that is for national insurance contributions. I have taken the overall budget and allocated it, and all public bodies are being expected to absorb the national insurance contributions.

Thank you very much, convener. I thank the committee for allowing me to come and give evidence so soon after publication of the budget. Events over the past two weeks have almost overtaken the budget that was published, so this scrutiny session is hugely important.

This is another challenging budget; it is probably the most fiscally challenging budget that I have been involved in over the past few years. It is now, I hope, beyond debate that our overall funding for next year from the UK Government is falling. On the other hand, I recognise that our funding is greater than its pre-Covid levels. We can get into some of the numbers and the data during our scrutiny session.

I am keen to provide as much transparency as possible on the budget, given the extreme levels of volatility and uncertainty that exist right now, particularly in our fiscal outlook. I have set out clearly where we have had to make assumptions about our funding and I have set out some of the difficult choices. Even before omicron hit, it was clear that public services’ responses to Covid would continue beyond the end of this financial year.

Over and above the impact of Covid, it is important, as part of our recovery, that we push ourselves to be as ambitious as possible within our fiscal constraints. It is very much a budget of choices and it is a transitional budget, as it continues to address the immediate pressures in the NHS and supports the recovery effort. It should be seen as a step on the road to our resources spending review for the longer term. The choices that we have made are all informed by the priority themes of tackling inequality, supporting economic recovery and fulfilling our net zero obligations.

I know that the committee has been busy this morning. I know also that predecessor committees have been interested not only in where budgets are spent but in how they operate, so I commend the report on budgets that I saw this morning from David Bell, David Eiser and David Phillips, which underlines the need for fiscal flexibilities and guarantees at a time of volatility such as we are in just now. I hope that that is in line with many of the committee’s previous discussions.

I look forward to the committee’s questions.

On your first question about the UK Government spending review, I think that I answered that when I pointed out that our budget will fall in every year of the spending review period. That is a challenging outlook for Scotland that underlines the challenging choices that we have had to make.

The other element is the opportunity for investment in, for example, infrastructure or the transition to net zero. From a capital perspective, the UK Government can do that through borrowing; ultimately, I am constrained by what is allocated to us in the spending review.

As for the overall budgets, I can take you through the detail of the net zero, energy and transport and finance and the economy budgets, but I have to make it clear that this has not been an easy budget. For me, the bottom line is that although, on one hand, we have headlines about record funding for Scotland, on the other there are hard choices to be made in determining where the funding is to be spent. In the net zero, energy and transport portfolio, we have absolutely prioritised investment in the transition to net zero; you can see in the budget the significant investment that is being made in climate change initiatives and the huge investment in energy. We are ramping up delivery of the heat in buildings programme, doubling Home Energy Scotland’s budget to deal with energy efficiency and investing in hydrogen and carbon capture and storage via the emerging energy technologies fund. Significant investments are being made.

I will go back to the point that I started with. This is a budget of choices, and one of the three key themes that we have chosen is investment in the transition to net zero. You can see that in the infrastructure portfolio.

With regard to the finance and the economy portfolio, I have chosen to prioritise our enterprise agencies—Scottish Enterprise, Highlands and Islands Enterprise and South of Scotland Enterprise—and the Scottish National Investment Bank, as key levers and agents of economic growth. There will be views and opinions on how they can do their jobs better, so I am engaging with them. From a budget perspective, that is what I have prioritised.

The report highlights that business investment as a share of gross domestic product has increased in the past decade, but it is still low by the standards of the Organisation for Economic Co-operation and Development, and it has fallen in the two consecutive years since 2018.

What are we doing already? Our global capital investment plan, which was published earlier this year, does what it says on the tin—it tries to attract additional investment. The inward investment plan was published in 2020.

Those are both key to improving Scotland’s business investment performance. We have seen good data tracking against that, but these are not things that can be delivered within a matter of months. We have already set ourselves a business investment target.

If I heard correctly, the second part of your question was about innovation and the fact that the share of innovation-active businesses in Scotland was about 32.2 per cent, which was a decrease from about 50 per cent in 2015. That area is one of the key elements of the national strategy, which looks at how we develop actions to improve Scotland’s performance. Among the five objectives of the strategy, one is on productivity and another is on entrepreneurship, and they are closely aligned to innovation. It is about us incentivising businesses to do what they want to do, rather than us making substantial investment. A few sectors that are doing exciting things, from manufacturing through to the green economy, which is leading the way on innovation.

I do not think that it will be deployed differently, because that would just create a big hole somewhere else. If I move that money, all it does is give me a headache elsewhere. It is not new money.

There was a lot in that question. I will ask Lucy O’Carroll to comment, but we need to get beyond the headlines of what this means and what it does not mean. We might automatically think that it means that earnings are not growing in Scotland, but earnings grew in every year between tax devolution and the pandemic. There is clearly a challenge around the fiscal framework, but let us park that, because I have already talked about it, and it has been made clear that, where we see stronger earnings growth elsewhere, it still means that our budget is being reduced.

You mentioned the north-east of England. Of course, it does not have tax devolution. There will be an impact on its position and, more generally, we know that there are some inequalities there, but we also know that particular sectors in Scotland have been hit hard by Covid. I talked about the oil and gas sector, which contains some of the highest earners in Scotland. It has been through a tumultuous time and we have seen big challenges there, so I think that we need to understand that more.

I will move on to the solutions. You talked about labour participation, and I will bring in Lucy to comment on that. One of the keys here is to understand precisely where the challenges in the Scottish economy are and are not. There are some difficulties in relation to economic activity, and we are looking at how we can get more people into work. There are good reasons why many people are classified as economically inactive. For example, they may be carers, stay-at-home parents or students. However, there is another cohort who are economically inactive due to long-term sickness or for other reasons. We have invested intensively in things such as the no one left behind approach in order to bring those people closer to the labour market, although it is an incredibly expensive process, because the individuals need a lot of wraparound help and care.

I will stop at this point, if you do not mind, and invite Lucy to comment, because she is the expert on all things tax related, and particularly the aspects that get to the nub of the problem that we are discussing.