10

Written evidence submitted by the Scotland Office, UK Government (FSG0003)

 

Introduction

  1. The Barnett Formula has been used since the late 1970s to calculate the changes to the block grant for the Scottish Government. The formula does not determine the total size of the block grant but is used to calculate consequentials, which are changes to the Scottish Government’s budget as a result of UK Government spending in devolved areas.
  2. The Barnett formula is a mechanism that aims to give Scotland the same pounds-per-person change in funding in devolved areas by taking into account Scotland's relative population, and the extent to which the public services are devolved.
  3. Since the passage of the Scotland Act 1998, which established the Scottish devolved institutions and devolution settlement, further powers have been devolved to both the Scottish Parliament and Scottish Government through the 2012 and 2016 Scotland Acts.
  4. The Smith Commission was convened in September 2014 and charged with reaching cross-party agreement on the devolution of further powers to the Scottish Parliament. It was agreed that the Barnett formula remained in place to calculate changes to the block grant, and made recommendations on further devolution of fiscal powers to the Scottish Parliament.
  5. The Scotland Act 2016 delivers on the recommendations made by the Smith Commission - in particular it devolved further income tax powers, including the power to set rates and bands on earned income. This built upon commitments made in the Scotland Act 2012, which included devolving the ability of the Scottish Parliament to set a Scottish Rate of Income Tax.
  6. Alongside the devolution of additional tax powers, the UK Government and Scottish Government agreed to a Fiscal Framework in 2016, to establish a set of rules and methodologies to manage funding flows to and from Scotland.
  7. The Scottish block grant is adjusted to reflect the devolution of tax and welfare powers to the Scottish Parliament in the manner set out in the 2016 Fiscal Framework agreement between the UK Government and the Scottish Government. The UK and Scottish Government always intended to review the Fiscal Framework after a Parliament’s worth of experience of operating it.
  8. The review of Scotland’s Fiscal Framework was informed by an independent report that set the basis of the updated Fiscal Framework, which was jointly agreed by the UK Government and Scottish Government in July 2023.
  9. The review resulted in some changes to Scotland’s borrowing limits and additional flexibility for the Scottish Government’s Reserve. The Scottish Government’s borrowing limits and the Scotland Reserve are now fixed in real terms in 2023-24 prices and indexed each year in line with the OBR’s GDP deflator forecast. The annual capital borrowing limit is £450 million, and the cumulative maximum is £3 billion. The annual resource borrowing limit, which can be used by the Scottish Government for in-year cash management or forecast error, is £600 million and the cumulative maximum is £1.75 billion. The Scotland Reserve can hold up to £700 million with no annual limits for payments into or drawdowns from funding held in the Reserve by the Scottish Government.
  10. Through the Fiscal Framework, the Scottish Government is able to exercise its fiscal powers fully and flexibly, while operating within a framework that is sustainable for the whole of the UK.
  11. As a recent example, Autumn Budget 2024 confirmed that the Scottish Government will be provided with a £47.7 billion settlement in 2025/26 – the largest in real terms in the history of devolution. This includes a £3.4 billion top-up through the Barnett formula, with £2.8 billion for day-to-day spending and £610 million for capital investment. That additional funding can be deployed by the Scottish Government to boost frontline services, to bring down NHS waiting lists, or lift attainment in schools.
  12. The most recent August 2024 Scottish Government publication of the Government Expenditure and Revenue (GERS) figures re-confirmed that being part of the UK means higher public spending for Scotland. GERS figures showed that people in Scotland benefit from £2,417 more per head of additional spending compared to the UK average, as a result of the redistribution of wealth throughout the UK - enabled through the Barnett formula.


Evidence

Q1. How effective is the Barnett formula in calculating the amount of money made available to Scotland for providing essential public services?

 

- What was the original design intention behind the Barnett Formula, and to what extent has it fulfilled this purpose?

 

- What potential reforms to the Barnett formula could improve its effectiveness?

 

- How transparent is the UK Government’s decision making regarding the application of the Barnett Formula?

 

- What impact could putting the Barnett formula on a statutory footing, or otherwise formalising it, have on its effectiveness?

 

  1. The Barnett formula is used to calculate the change in the block grant given to each devolved government from year to year, and ensures that changes to the block grant are proportionate to the populations of each nation served by each devolved government. It was first used for Scotland in 1978. The formula is simple and efficient and has stood the test of time. It is a key part of the arrangements for pooling and sharing risks and resources across the UK.
  2. Under the Barnett Formula, the Scottish Government receives a population share of changes in UK government funding on areas that are devolved to the Scottish Parliament. That is added to their existing baseline funding and forms the majority of their block grant (another part of the block grant is non-Barnett funding provided by the UK Government to the Scottish Government for a specific purpose, for example the delivery of City and Growth Deals in Scotland).
  3. Pooling and sharing ensures that all parts of the UK receive a secure and stable level of funding for public services. It also means that a downturn in one area can be supported by other areas, rather than being dependent on local economic conditions – and a windfall can be shared with other areas.
  4. As part of this system, the Barnett formula provides the devolved governments with broadly the same change in funding per person across the whole of the UK when the UK Government allocates new funding in a devolved area. These changes are added to the devolved governments’ existing baseline funding, which is much higher per person than equivalent UK Government spending. The Scottish Government currently receives more than 20% per person than equivalent UK Government funding in the rest of the UK.
  5. The Fiscal Framework, which confirmed the continued use of the Barnett formula, was reviewed and subject to an independent report, which then informed an updated version of the framework. This was then jointly agreed by the Scottish and UK Governments in 2023.
  6. The application of the Barnett formula is set out publicly in the annual Block Grant Transparency, published by HM Treasury. This publication provides a detailed breakdown of the devolved governments’ block grant funding and is intended to increase transparency of the block grant calculation process.
  7. The Block Grant Transparency publication shows the calculations underlying the application of the Barnett formula in detail, including change in UK Government spending, the ‘comparability factor’ (to what extent the change in spending is in a devolved area), and the relevant population proportion.
  8. As such, decision making regarding the Scottish Government’s block grant is transparent and open to scrutiny. This is underpinned by the constructive relationship between the Scottish and UK Governments. UK Government ministers, including the Secretary of State for Scotland and HM Treasury ministers, meet regularly with their Scottish Government counterparts to discuss a range of issues including the financing of the Scottish Government. There are also well-established relationships at official level.
  9. Furthermore, the Statement of Funding Policy is currently in its 10th edition, and whilst HM Treasury is keeping the Statement under review, it is also open to the Scottish Government to propose changes to the Statement.

 

 

Q2. Following its review in 2023, to what extent does the current Fiscal Framework effectively govern the mechanisms for Block Grant Adjustments and fiscal flexibilities of the Scottish Government?

 

- To what extent could changes to Scottish Government borrowing powers enable more effective fiscal management, and mitigate against the impact of inflation and economic shocks in Scotland?

 

- Does the current methodology for calculating Block Grant Adjustments effectively reflect the associated transfer of tax revenues or welfare spending?

 

 

  1. The updated Fiscal Framework agreed with the Scottish Government includes substantial borrowing powers for the Scottish Government. From 2023-24, the statutory limit on capital borrowing was increased to £3 billion and the annual limit was increased to £450 million.
  2. These limits will be maintained in real terms going forward, with both limits to be uprated each using the OBR’s DGP deflator forecast at the time of the Scottish Government draft Budget; and as a result, accounting for inflation.
  3. These capital borrowing powers are in addition to the share of UK Government borrowing they receive through the Barnett formula.
  4. The updated Fiscal Framework also increased the Scottish Government’s resource borrowing limit to £600 million each year within a statutory overall limit for resource borrowing of £1.75 billion.
  5. These enhanced borrowing powers will be maintained in real terms going forward, with both limits to be uprated each using the OBR’s GDP deflator forecast at the time of the Scottish Government draft Budget.
  6. The Scotland Reserve will be capped in aggregate at £700 million in 2023-24 prices (using the OBR’s GDP deflator forecast at the time of the Scottish Government draft Budget), and therefore uprated annually.
  7. The Governments have agreed that annual drawdowns from the reserve will be unlimited. There are also no annual limits for payments into the Scotland Reserve.
  8. Block Grant Adjustments (BGAs) were designed as a way of upholding the principles of the Smith Commission, including:
    1. There should be ‘no detriment’ to the devolved budget from ‘the decision to devolve’.
    2. The UK Government should continue to manage economic shocks and budgetary risks that affect the whole UK, given that the Scottish Government does not have major borrowing powers or other tools to manage major cyclical tax revenue risks.
    3. But nonetheless that the devolved budget should ‘benefit in full’ from policy decisions by the Scottish Government that increase revenues (and conversely bear the costs in full of policy decisions that reduce revenues or increase expenditures).
  9. Under the updated Fiscal Framework agreement, the indexation mechanism for tax and welfare remains the Indexed Per Capita (IPC), thereby delivering the same outcome as the 2016 agreement. The BGAs calculated by the IPC method were always the ones used for determining Scotland’s funding following tax and welfare devolution to the Scottish Parliament. The alternative Comparable Model was initially used to calculate a separate BGA but was never used to determine Scotland’s funding. Overall, this ensures that the Scottish Government’s overall level of funding will be unaffected if Scotland’s population grows differently from the rest of the UK.
  10. The UK Government adjusts the Scottish Government block grant funding to account for tax devolution. The block grant adjustment for tax devolution reduces Scottish Government block grant funding to account for UK Government tax revenue foregone due to devolution. The Scottish Governments then retain devolved tax revenues generated in their respective nations.
  11. For the Scottish Government, there is also a welfare block grant adjustment which increases Scottish Government block grant funding to account for UK Government expenditure in Scotland which is no longer required as the Scottish Government now funds devolved welfare policy.
  12. Reconciliations to the block grant adjustments are a normal part of operating the Fiscal Framework and ensures the Scottish Governments funding is based on actual revenues and expenditures, rather than forecasts.
  13. The Fiscal Framework has a review point after a further parliament worth of experience following the Review in 2023.

 

 

Q3. Within the existing devolution settlement, what steps could the UK Government take to offer Scotland more financial certainty?

 

- Is there an appropriate level of coordination between the UK and Scottish Governments regarding in-year fiscal changes?

 

- To what extent can HM Treasury’s decisions regarding the block grant be challenged by the Scottish Government?

 

  1. This UK Government has been clear about the importance of clarity and stability in the Scottish Government’s funding arrangements, and has taken decisions to deliver this.
  2. At the Autumn Budget the Chancellor announced that Spending Reviews will be held every two years, setting plans for at least three years to ensure public services are always planned and improve value for money.
  3. Furthermore, there will be one major fiscal event per year which will give certainty on tax and spending changes.
  4. The UK Government has been clear around its commitment to improve transparency and consistency of information shared with the OBR.
  5. The Chancellor has confirmed to the House of Commons that the OBR has been commissioned for an Economic and Fiscal Forecast which will be published on 26 March 2025.
  6. This is in line with the Budget Responsibility and National Audit Act 2011 which requires the OBR to produce two forecasts each financial year. This will be accompanied by a statement to Parliament from the Chancellor.
  7. The Scottish Government have agreed borrowing powers as well as flexibilities to move funding between years through the Scotland Reserve.
  8. In addition to this, the Scotland Reserve, resource and capital borrowing limits are maintained in real terms at 2023-24 prices and is uprated each year using the OBR’s GDP deflator forecast.
  9. When the Scottish budget is published, it has to be based on forecasts of revenues raised from devolved and assigned taxes, and social security spending. As well as based on forecasts of the block grant adjustments agreed between HM Treasury and the Scottish Government. However, there is a close working relationship to ensure that once outturn data on tax and spending is available, adjustments are made to the Scottish budget to reflect differences between the forecasts and realised data.
  10. There are both ministerial and official relationships in regards to matters of finance and funding. The Finance Interministerial Standing Committee (F:ISC) is led by the relevant finance ministers from the UK Government and devolved governments, with meetings typically taking place each quarter. Any disputes about the application of the Statement of Funding Policy can be pursued through the F:ISC and the Intergovernmental Relations (IGR) Secretariat.
  11. In exceptional circumstances, the Scottish Government have access to the UK Reserve, in line with the criteria set out in the Consolidated Budgeting Guidance and the Statement of Funding Policy. HM Treasury is therefore able to provide certainty to the Scottish Government in exceptional circumstances, including during the pandemic -a UK-wide external economic shock- when HMT provided a funding guarantee to ensure the Scottish Government was able to provide immediate financial support in devolved areas without being  restricted by the budgetary cycle.

 

 

Q4. Are there any comparative perspectives that should be considered when assessing the effectiveness of fiscal devolution in Scotland?

 

- What learnings can be drawn from Wales and Northern Ireland’s funding settlement arrangements?

 

- Are there any learnings from international perspectives that should be considered?

 

 

  1. As set out above, the Fiscal Framework is working well and has been agreed to by both the Scottish and UK Governments. All allocation systems have strengths and weaknesses, and the fiscal frameworks continue to evolve as can be seen with the updated Fiscal Framework, which increased the capital and resource borrowing limits for the Scottish Government.

 

  1. The Statement of Funding Policy is in its tenth edition since 1999 and reflects the necessary flexibility to account for new developments that both the UK and Scottish Government agree on that need to be formalised.
  2. There are differences in fiscal frameworks for Scotland, Wales and Northern Ireland, partly as a result of the different socio-economic contexts of each region and the different agreements reached between the UK Government and each devolved government. The UK Government’s approach to fiscal devolution involves the consideration of a range of evidence, drawing on both domestic and international examples.

January 2025