Written evidence submitted by Stuart McIntyre, Professor of Economics, University of Strathclyde; James Mitchell, Professor of Public Policy, University of Edinburgh; and Graeme Roy, Professor of Economics/Assistant Vice Principal, University of Glasgow, and Chair of the Scottish Fiscal Commission* (FSG0008)

 

The authors are academics with research expertise on Scottish public policy, devolved fiscal policy and Scotland’s constitution. Several recent (and forthcoming) academic papers are referenced in this submission. They touch on many of the questions raised in the submission for evidence. Please note that the views expressed in this submission are those of the authors and not of the Scottish Fiscal Commission

 

Question 1. What was the original design intention behind the Barnett formula, and to what extent has it fulfilled this purpose?

The Scottish Office’s share of public expenditure over the course of the twentieth century was largely the result of expediency rather than principles.  While the ‘Goschen formula’ is frequently referenced as the basis of early expenditure for Scotland, this formula did not apply to all public spending under the Scottish Office.  The Scottish Office – officials and Ministers – proved adept in making the case for special treatment, due to claimed additional costs of providing services (in remote parts of Scotland for example) or particular needs (housing conditions for example). While ‘needs’ were frequently invoked, there was little systematic treatment of relative needs.  In essence, Scotland gained disproportionately in public spending terms largely due to the existence of the Scottish Office, which operated as an authoritative voice at the centre of UK central government.  Prior to devolution, the Scottish Office would engage in bilateral negotiations with the Treasury but officials and Ministers would also attend meetings of English and English/Welsh spending departments that corresponded with Scottish Office responsibilities.  The accretion of Scottish Office responsibilities, and related public spending, occurred piecemeal.  Richard Rose estimated that by 1982, the Scottish Office had the equivalent of eleven English functional departments.  This created complexity in the allocation of public spending.

The ‘Barnett formula’ was designed by Treasury officials, though given a name by Professor David Heald in a seminal paper in 1980, Territorial Equity and Public Finances: Concepts and Confusion (Strathclyde University Studies in Public Policy no. 75, 1980).  Professor’s Heald’s comment was prescient, ‘All formulae need a name. In the apparent absence of an official one, I now name this the “Barnett formula”, after Joel Barnett MP, the then Chief Secretary of the Treasury with responsibility for public expenditure. Perhaps, some day, this will make Joel Barnett as famous as Lord Goschen!’  But it would take time before the formula became politically contentious.  Indeed, references to the formula in Parliament after it was first given a name were rare until the lead up to devolution.  Even Joel Barnett was unaware that the formula had been named after him as late as 1985 (correspondence with one of the authors of this submission, 8 February 1985).

Mentions of ‘Barnett Formula’ in Hansard:

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There has been a tendency to conflate two developments in the understanding of the formula’s origins.  The financing of proposed scheme of devolution required attention with detailed deliberations on tax powers and central government grant taking up considerable time and attention in Whitehall.  By the time of the 1979 devolution referendum, the details of how the grant to the proposed Scottish Assembly would be determined was still under development but there was an understanding that a formula-based system would be a ‘means of avoiding too frequent and acrimonious financial discussions between the Government and Scottish administration’, as noted by David Andren, a senior official on secondment at Glasgow University in a report prepared at the time of the referendum.  He also suggested that the ‘most promising approach in the early years of devolution would be to relate total public expenditure on devolved services to its English equivalent’.  The formula he suggested (taken from the report):

A key question was the base year to be used. This had been a contentious issue when the Goschen formula was introduced and applied to changes in educational expenditure after the first world war.  The prospect of devolution meant that a formal analysis of needs was instituted for the first time. 

The other key development in the mid/late 1970s was a ‘decade of intractable economic problems combined with high electoral turbulence’, as Hood and Himaz note in their study of the period (A Century of Fiscal Squeeze Politics: 100 Years of Austerity, Politics, and Bureaucracy in Britain, OUP, p.122).  Reflecting on his period as Chief Secretary to the Treasury (1974-79), Joel Barnett later explained in evidence to a House of Lords enquiry in 2009 that he ‘just wanted to get through every day without too much trouble’ (28 January 2009).  The introduction of a formula-based at least partially would limit the process of spending decisions, especially fraught during this period.  As Brian Unwin, senior Treasury official who would be charged with considering these matters in the 1980s, noted in his memoirs, ‘At the time [the Barnett formula] was introduced it was primarily a convenience to spare the Treasury the need to haggle with the territorial departments every year over each item within their spending allocations, and also, by favouring Scotland, hopefully to take some heat off growing devolutionary pressures.’  The logic of introducing a formula at a fiscally challenging time was similar to the reason referred to by Andren above.

However, as has been well documented, the formula was applied inconsistently with the continuation of effective lobbying.  Efforts in the 1980s to address disparities in spending across the UK met with strong reaction from the Scottish Office.  Prime Minister Margaret Thatcher asked Brian Unwin to consider Scotland’s share of public spending following the conclusions to a spending round in 1985, requiring ‘corrective action’.  The possibility of a new needs assessment was mooted the following year to ‘service as the basis for the allocation of public service provision as between England, Scotland, Wales and Northern Ireland’, as the official noted in his report. 

In his 1980 paper, Professor Heald noted that it was an ‘indication of the extent of official secrecy that this [formula] was never placed upon the public record until the Select Committee on Scottish Affairs elicited this information’.  Further, when Prime Minister Thatcher instructed Brian Unwin to study the pattern of public spending in the components of the UK this was to be done in ‘strict secrecy’, as Unwin noted.  Controversies have surrounded mechanisms for funding Scottish public expenditure but lack of transparency have not helped.  But transparency alone would not be enough.  Transparency would contribute towards more informed understanding of the mechanisms but the complexity in the current devolved fiscal arrangement lends itself to political blame games.  The challenges of explaining a complex system and dangers that it is misunderstood, even misrepresented, is a problem that is difficult to overcome. Our forthcoming paper in British Politics “Two cheers for Holyrood: Devolution and Dimensions of Fiscal Accountability” discusses a range of accountability challenges that extend beyond issues of transparency.

The case for placing the funding arrangements on a statutory or formalised basis is that this can help embed the system but embedding arrangements will need to be periodically reviewed and reformed.  A balance needs to be struck between allowing for greater transparency, predictability and flexibility in the funding mechanism.  Circumstances and priorities change.  In addition, while there may be symbolic value in a statutory footing, the issue of how much detail and whether the mechanisms would be justiciable arise.  Would the arrangements take the form of a convention of the constitution, as with the Sewel Convention in the Scotland Act 2016?

Rather than pursuing a formalisation of the funding system itself, which would bring with it the challenges identified, formalisation of a cross-parliamentary body to provide scrutiny and accountability around the operation of the funding arrangement, and to make recommendations for its improvement as well as better means of operating it, would be a more valuable focus of attention in our view. This builds on a long-forgotten recommendation in the Calman Commission on ‘strengthening cooperation’ between the UK and Scottish parliaments.

 

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Question 2. 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?

The current fiscal framework sets out a range of mechanisms for Block Grant Adjustments and the flexibilities available to the Scottish Government to manage its budgets. These mechanisms have been updated following the 2023 review of the fiscal framework.

Several points are worth noting:

Firstly, the Scottish Government’s borrowing and reserve limits were initially fixed in cash terms. Following agreement between the two governments, they now increase in line with inflation each year. For resource borrowing, what is most important is not the level of borrowing per se but the relationship between any gap and the range of possible forecast error (and reconciliation) it may need to address. The most recent report from the Scottish Fiscal Commission in December 2024 suggests that large reconciliations may be likely in the next few years.

Secondly, the Scotland Reserve has become a more flexible tool, with annual drawdown limits abolished. However, what matters is not just the overall size of the reserve but its relative size vis-à-vis the overall budget. If budgets grow faster than inflation in the years ahead, year-on-year underspends will likely use a significant amount of the reserve’s capacity each year.

Thirdly, additional flexibilities have occasionally been provided to help manage day-to-day budget challenges beyond the formal rules and processes set out in the Fiscal Framework. For example, during the COVID-19 pandemic, the UK Government provided a guaranteed minimum level of funding for the Scottish Government.

Fourthly, the provision for additional funding for a Scottish-specific ‘economic shock’ no longer exists within the framework. Since 2023, the extended flexibilities that were once available under the scenario of a ‘Scotland-specific economic shock’ now apply in all circumstances. It should also be noted that there was never a stated intention within the fiscal framework that borrowing powers should exist to ‘mitigate against the impact of inflation.’

Finally, it is important to remember that even with tax devolution, the block grant remains – by far – the most important element within the Scottish Budget. This is because, under Scotland’s Fiscal Framework, what matters is not the total value of devolved tax revenues but their relative interaction vis-à-vis the Block Grant Adjustments. For example, in 2022/23, total outturn Scottish income tax revenues were £15.2 billion. However, the ‘net income tax position’ – that is, the financial impact upon the Scottish Budget after adjusting for the relevant BGA – was just £257 million. Unlike many other countries, the Scottish Government is free to spend its block grant as it sees fit, with no ring-fencing.

With regard to Block Grant Adjustments (BGAs), these are designed to support the transfer of devolved tax powers and social security spending. As we set out in our 2022 paper, “Careful What you Wish for? Risk and Reward with Scottish Tax Devolution”, the broad intention of these BGAs was to make the Scottish Budget no better or no worse off following the transfer of fiscal powers. From that initial point of transfer, the (net) impact upon the Scottish Budget would depend upon policy choices (both in Holyrood and Westminster) in the respective areas of taxation and social security, the relative performance of the tax base, and the relative change in social security caseloads.

On tax, the experience thus far has seen the Scottish Government seek to increase revenues beyond the devolved BGAs with the aim of raising additional funds for public spending. The Scottish Fiscal Commission reports that in 2025/26, the total net tax position is projected to be £1.2 billion (Figure 4.4, page 87 of Scotland’s Economic and Fiscal Forecasts, December 2024). However, it is interesting to note that for the main devolved tax – income tax – the net position has been lower than might be expected based on policy differences alone. This is due to what the Scottish Fiscal Commission has termed an ‘economic performance gap.’ In 2022/23, for example, this gap was estimated to be around £624 million.

On social security, the Scottish Government has sought to set a different policy agenda compared to the rest of the UK. This has included the creation of new payments (e.g., the Scottish Child Payment), more expansive coverage in some areas (e.g., Pension Age Winter Heating Payment), and a different form of delivery. In 2023/24, social security spending in devolved areas was £0.9 billion higher than the corresponding funding provided by the UK Government. For 2025/26, social security spending is forecast to be £1.3 billion higher than such funding. This gap is a result of the Scottish Government’s approach to social security, but it comes with an opportunity cost in other areas of devolved public spending.

 

 

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

It is important to note that the Scottish Government has a relative degree of financial certainty embedded in the fiscal framework, given that block grant arrangements focus upon marginal ‘changes’ year-on-year rather than the full block grant. There are also detailed forecasts from the Scottish Fiscal Commission, which highlight risks and uncertainties beyond the current financial year to both devolved fiscal powers and UK Government funding.

The nature of the framework, however – including the operation of a mix of block grant funding, devolved taxation and social security, and a series of block grant adjustments – means that there will always be a degree of financial uncertainty and risk at the heart of the Scottish Budget process. Budgets may evolve due to a series of complex interactions, including the relative performance of the Scottish and UK economies, differing assessments from the Scottish Fiscal Commission and the Office for Budget Responsibility, and the series of ‘reconciliations’ that adjust budgets into the future to account for forecast errors.

As we argued in our 2022 paper, “Careful What you Wish for? Risk and Reward with Scottish Tax Devolution”, fiscal devolution was designed to meet demands to ‘do things differently’. But this needs to be balanced alongside “what is an acceptable level of fiscal risk to transfer, the tools to manage such risk, and who should ultimately bear the burden of that risk”.

We offer a series of suggestions of areas policymakers may wish to consider with regard to greater financial certainty. We make no judgment on whether one particular option is more favourable than others:

While these changes would require UK Government action, we also note the conclusions of the 2017 Scottish Parliament Budget Process Review Group, which recommended several steps within the devolved context to help provide greater financial certainty. This included a shift in Scotland to multi-year spending reviews, medium-term financial planning, and improvements in the quality of data and information provided in Scottish Government Budget documents.

 

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

In the past, there have been numerous studies examining the experience of other countries in delivering fiscal devolution. This includes the work of the expert group chaired by Sir Anton Muscatelli to support the recommendations of the Calman Commission. Professor David Bell and Dr David Eiser provided a useful summary of international comparisons in the context of the Smith Commission (Scotland's Fiscal Future in the UK, Stirling Economics Department Research Papers, Oct 2014). The OECD has, over the years, developed a network of researchers and institutions focussed upon understanding fiscal devolution and sharing insights from different countries.

A challenge with comparative perspectives is that each experience is unique, reflecting country-specific federal and devolved government structures, different political histories, and evolving regional economic structures, all influenced by local factors.

It does not make sense, therefore, to point to another country as an ‘exemplar’ for Scotland to follow. Instead, particular lessons might be drawn from individual case studies – for example, the nature of block grant funding, the tax powers devolved, and the nature of borrowing powers – and applied to the Scottish case. However, there is no guarantee that the effects would be replicated.

Similarly, it is problematic to generalize from international experiences. Assertions like “fiscal devolution improves accountability or economic growth” or “fiscal devolution increases volatility or costs” are overly simplistic and unsupported by available evidence. Instead of relying on such generalizations, the priority should be to better understand the strengths and weaknesses of Scotland’s existing fiscal devolution arrangements.

For example, in our 2023 paper, “Fiscal Devolution and the Accountability Gap: Budget Scrutiny following Tax Devolution to Scotland”, we concluded that while the Smith Commission reforms were designed, in part, to improve scrutiny of budget decisions, progress has been limited. Interviews with senior MSPs, parliamentary officials, and public servants identified barriers such as complexity, political dynamics, procedural constraints, and capacity limitations. These factors collectively hinder the effectiveness of fiscal devolution.

Ultimately, debates over the effectiveness of fiscal devolution should move beyond the question of what powers to devolve and focus equally on the processes and frameworks that underpin the transfer of those powers. A more nuanced and pragmatic approach is needed to ensure fiscal devolution delivers its intended benefits.

January 2025

 

 

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