Seòmar agus comataidhean

Thank you, convener, and good morning. I am pleased to have the opportunity to attend this meeting to discuss the recent fiscal framework review.

The agreement with the United Kingdom Government to publish an updated version of the Scottish fiscal framework on 2 August fulfilled a key commitment in the First Minister’s policy prospectus. Since the fiscal framework was agreed in early 2016, it has been thoroughly stress tested as Brexit, the pandemic and the cost of living crisis have unfolded. Therefore, it was right to review arrangements and consider improvements.

The new agreement with the UK Government includes a balanced set of changes that strengthen the financial management tools that are available to the Scottish Government and provide the Scottish Parliament and the Scottish Government with greater long-term funding certainty. That said, I want to be clear that the review was not as broad in scope as the Scottish Government would have liked it to be. That reflects the fact that the scope and process for the review and its outcome were subject to agreement with the UK Government. Nonetheless, under the circumstances, the revised agreement represents meaningful progress and a good outcome for Scotland.

The adoption of the indexed per capita block grant adjustment methodology on a permanent basis is a significant win for Scotland. The authors of the independent report estimated that the use of the indexed per capita methodology for calculating income tax block grant adjustments alone could be worth around £500 million a year by 2026-27 compared with the use of other methodologies that were considered in 2016.

The agreement also provides a substantial increase in the Scottish Government’s resource borrowing powers to manage tax and social security forecast errors—the amount has doubled from £300 million a year to up to £600 million a year of borrowing capacity. That greatly improves the Scottish Government’s ability to manage and smooth funding volatility driven by forecast error.

The removal of drawdown limits on the Scottish reserve is also an important development. It provides a significant increase in reserve flexibility and improves the Scottish Government’s ability to manage funding across financial years.

The agreement to uprate borrowing and reserve limits in line with inflation ensures that the effectiveness of those powers will be maintained in real terms, which makes Scotland’s financial management arrangements more sustainable.

Taken together, and within the context of the narrowly scoped review that was on offer, those are meaningful improvements to the framework and the financial management tools that are available to the Scottish Government.

That said, we should not lose sight of the scale of the fiscal challenge in the aftermath of the pandemic, the on-going cost of living crisis and the urgent need to tackle climate change. Although the changes to the framework are welcome, they are not of the magnitude required to offset that broader fiscal challenge. That requires action by the UK Government and I hope that the Chancellor of the Exchequer will heed calls from the Scottish Government to take action on public services, fuel poverty, net zero and the cost of living as part of tomorrow’s autumn statement.

I also understand the concerns that the committee expressed about the process surrounding the review and its timing. The Scottish Government’s preference had been for a process involving broad stakeholder involvement. However, when a window of opportunity emerged earlier this year to conclude an agreement with the UK Government on changes to the framework, I was mindful of the value of securing borrowing powers ahead of the 2024-25 budget and that we were dealing with a UK Government that is likely to go into election mode soon. In that context, I judged that it was appropriate and prudent to conclude a deal when it became possible to do so.

I hope that the committee recognises the improvements that have been secured through the revised agreement and I look forward to discussing the detailed arrangements.

Matthew Elsby, do you want to come in on that? I think that it is fair to say that risk is inherent in every decision. I guess that our starting point was to minimise that risk for the Scottish Government and what came out of the review does that.

As you can imagine, we pushed on a number of fronts to try to get the maximum benefit and best deal and were more successful in some areas than in others. Getting indexation was better than getting nothing on capital, but we would clearly have wanted that to go further.

The biggest challenge that we face comes from capital borrowing limits. As part of the budget, I will lay out the full implications of that for the Scottish budget and for infrastructure projects. It is a real challenge and links directly to the economy, economic growth and the ability to invest in Scotland’s infrastructure. Capital borrowing limits are crucial and will be a major impediment to growth. We got as much as we could achieve, but were just not able to expand the basket of measures that were being looked at.

We would definitely want to reflect on the process. My predecessors engaged with the committee and stakeholders in the early days of the review, and the independent report was jointly commissioned, which was important for its credibility and acceptance as part of the process. There was then the rapid opportunity to conclude matters. The CST made it very clear that he wanted that to happen in a confidential space. I would not have had any issues at all with having further engagement with the committee and stakeholders but, given the CST’s very clear position, that would have been very difficult. Sometimes in a confidential space, agreements can be reached that might otherwise be difficult. Those are balancing acts.

Going forward, our clear preference would be to have the engagement that preceded the reaching of the agreement, not just with the committee but with external stakeholders, and to have that in a more open and transparent way.

I do not think that the UK Government would want to do that, to be fair. I think that it understands the risks, and I do not see any appetite for a unilateral imposition of VAT assignment. In the light of all the evidence—from HMRC and major influential organisations, which all say the same thing—I do not see any Government wanting to impose something in the full knowledge of the harm and risk that it would cause.

What I was getting at earlier was that what we end up saying about VAT assignment post-review will be discussed at a future joint Exchequer committee. The point that I was making is that I foresee us reaching some kind of joint position on what we do with VAT assignment in future.

That goes back to what was said earlier, which is that we need a more general look at the fiscal powers. Even with further tweaks to levels, resource borrowing does not change some of the fundamental weaknesses in our ability to respond to an economic shock, whether that comes from a pandemic or for any other reason. We have very limited levers, so tweaks to some of the levels do not suffice.

Our ambition is to have the policy levers to be able to manage VAT. The problem with VAT assignment is that you are assigned the revenues but you have none of the levers to be able to deal with risk: you get the risk but none of the benefits. If VAT and all the controls over it were devolved, that would be a very different proposition, but that is not what was on the table.

Assignment brings all the risk but none of the benefit of being able to use VAT as a tax lever to raise revenue. As I explained earlier, the evidence on that is so compelling that both Governments need to reach a position on what we do with VAT assignment in future, but we continue to want full devolution of VAT, along with the policy levers, so that we can manage that.

Yes, but the question is whether any model could remove the risk of having the assignments but no levers to be able to manage the risk. Earlier, someone made the point that, in the current fiscal climate, that risk would be at its greatest, so if we had gone forward, the impact on the Scottish budget would have been profound. If a model that would de-risk that situation exists, it has not yet been found. Therefore, the model is theoretically part of the discussions but, so far, none of the wise heads that have been considering the matter has managed to find a way to de-risk it. I come back to the point that there needs to be a joint conclusion on what we do next.

Over the years, we have set out many of our asks around fiscal powers, including potential borrowing powers. You mentioned at the start of this evidence session the disconnect whereby local authorities have, in many respects, a more straightforward borrowing capacity than the Scottish Government has.

There have been some fundamental asks, and we can add to them the other financial levers that we have asked for. VAT devolution is one example. That is a much more expansive ask, and one that would require a different political environment and a willingness to look beyond the confines of what we have been looking at.

I do not know whether that will come or not, but we will continue to put forward the proposition that Scotland needs that basket of fiscal powers in order to be able to deliver on our ambitions on both capital and resource in a sustainable and affordable way, but also in a way that recognises the economic shocks that we have been dealing with, and are still dealing with, in the midst of a cost of living crisis. The levers that we have are very limited. I think, looking back, that this is a good point at which to say that we need a more fundamental review of the powers that we have.

You made the point that it takes two to tango: it absolutely does. That is why we would have to find a landing space that is acceptable to both Governments. The use of the United Kingdom Internal Market Act 2020 is not covered by the fiscal framework, so it was not part of the negotiations. However, it is a major issue because it creates the ability to bypass transparency about how public money is allocated in Scotland in areas for which this Parliament is responsible. That really cuts to the heart of devolution. Our ask—and, I am sure, the ask of the Welsh Government—is that that be recognised. I guess that a reset is required.

We are keen to take advantage of any new thinking on how we could get into a different space.

Such decisions happen on two levels. One is the Government-to-Government level, so we are preparing some of the groundwork for that. Some of the work will be done by the Scottish Government, and some of it—this relates to key asks and getting on the front foot with what the proposition will be—will be shared with the Welsh Government. Clearly, some of our priorities will be a bit different from those of the Welsh Government, but there are some shared aims, such as on resetting the respect agenda and on issues to do with the Sewel convention and the United Kingdom Internal Market Act 2020. The Welsh Government is in a different position in respect of its fiscal powers, but it wants enhanced fiscal powers and it wants enhanced social security powers. The devolved nations are pushing for more power and responsibility, and for more levers to be devolved.

The other level on which such things happen—political-party level—is a bit trickier, because communication happens through personal connections and is done more privately. Therefore, whenever there is an election and there is the potential that a new Government will come in, there is an opportunity to be seized.

However, the convener made the point that it takes two to tango. The work would require different and new thinking. Opportunities for Governments and the civil service to get together to talk about doing things differently and taking a different approach are led by political willingness to avoid business just continuing as usual. That applies in the Scotland Office, the Treasury and any other UK department, and what happens depends on how each department regards the Scottish Government.

Political steer and appetite will be important, but there is, without doubt, an opportunity that the Scottish Government is keen to seize, because otherwise we will not get the maximum benefit for Scotland's public services and its people.