Weekend 4

Scotland’s Finances: Explanation of

Terms and useful background materials

Introduction

In Weekend 4, the Assembly is invited to consider Scotland’s finances, including where funding comes from and how decisions about tax and spending are taken. For further information, please see Weekend 4 Introductory note.

The Secretariat have prepared this introductory factsheet which includes:

- Section 1: Explanation of some of the key terms that will come up in evidence (split into ‘Part 1: Budgets and Finance’ and ‘Part 2: Tax’) - Section 2: A list of links to useful background material - It is not essential to read all of this material in advance since the presentations at the weekend will cover the relevant issues. However, we know that Members can find it helpful to familiarise themselves with what will be discussed and we hope you find this material a useful resource in the lead up to Weekend 4.

As the list of background material is quite extensive, we have highlighted a few online resources, that you may find interesting:

- Scottish Government: Scotland's finances 2019-2020: key facts and figures, a guide setting out key information about how the system of public finances in Scotland stands in 2019 to 2020 and how this system is changing https://www.gov.scot/publications/scotlands-finances-2019-2020-key-facts-figures/

- Scottish Parliament: Where does Scotland get its money from?, a video prepared by the Scottish Parliament’s Financial Scrutiny Unit in 2016, which explains how the Scottish budget is funded. It looks at the block grant, how the Barnett formula is calculated and the impact of new tax powers. https://www.youtube.com/watch?v=oNw-1516a08

- Audit Scotland: Overview of the journey of financial devolution in Scotland. https://www.audit-scotland.gov.uk/reports/e-hubs/financial-devolution-in-scotland-the-journey- so-far

- - Citizens Assembly factsheet, prepared by Professor Nicola McEwen: What Powers does the Scottish Parliament have?, which covers how tax powers have changed https://www.citizensassembly.scot/sites/default/files/inline-files/SCA_Factsheet_1-1_0.pdf

- Scottish Government: Draft Budget 2020-2021 (Published by the Government and presented to Parliament on 6 February) https://www.gov.scot/budget/

SECTION 1 - EXPLANATION OF KEY TERMS

PART ONE: BUDGETS AND FINANCES

Barnett formula (or Barnett-determined Block Grant) The devolved administrations in Scotland, Wales and Northern Ireland all receive a transfer, the so called ‘block grant’ from the UK Government that funds a substantial proportion of their spending. A system known as the Barnett funding formula calculates the annual increase or decrease in the block grant given to each country. Budget consequentials is where the UK Government increase spending in a policy area which is devolved (e.g. health) and a share of this increased spending is passed on to the Scottish Government.

Base Rate (or bank rate) The bank rate is sometimes referred to in the news as the ‘Bank of England base rate’ or ‘BOEBR’ or ‘the interest rate’. The bank rate determines the interest rate the Bank pays to commercial banks that hold money with them which then influences the rates those banks charge people to borrow money, or pay on their savings. The bank rate in the UK is currently 0.75%.

Block Grant Adjustment The Scottish Government’s Block Grant is now adjusted to reflect that some of the Scottish budget is now funded by Scottish tax revenues that were previously retained by the UK Government. There are also additions for social security benefits that have been devolved to Scotland. The Fiscal Framework sets out how this Block Grant Adjustment (BGA) mechanism works but put simply, if tax revenues per head grow faster in Scotland than the rest of the UK then the Scottish Budget has extra resources available and vice versa.

Business Rates (see Non-Domestic Rates)

Borrowing Government borrowing is the money any government borrows to make up the difference between what they earn (revenue, mostly from tax) and what they spend (expenditure).

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Capital spending Government spending or expenditure includes all government consumption, investment, and transfer payments. Capital spending involves spending on assets that have a durable life of over a year and the spending does not have to be renewed each year. Examples of capital spending include investing in schools, roads or hospitals.

Current Budget Balance This is the difference between government’s current revenue (the money it makes) and current expenditure (what it spends on day to day public services). It excludes capital investment in infrastructure, for example. It measures the degree to which taxpayers meet the costs of paying for day to day public services, excluding capital investment.

Current Expenditure Current expenditure refers to the short term spending on goods and services within a financial period.

Current Revenue All revenue raised by the public sector from tax and non-tax revenues except the sale of assets or interest received.

Disposable income Total personal or household income once direct personal taxes have been taken off.

Economy An economy is the system according to which the money, industry, and trade of a country or region are organised. A country's economy is the wealth that it gets from business, industry and other services.

Expenditure Government expenditure, or spending, is a term used to describe money that a government spends on goods and services such as education, health care and defence.

Financial year basis In financial forecasts and documents this is commonly the 12 month period running from April in one year to March in the next year. Some companies, institutions, individuals and governments may use a different definition of a financial year.

Fiscal This relates to government revenue especially taxes.

Fiscal position (also see GERS) A government’s net fiscal balance, or fiscal position, measures the difference between total public sector expenditure, including capital investment, and total public sector revenue. If

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expenditure exceeds revenue, the Government runs a net fiscal deficit, and vice versa. Scotland’s fiscal position can be considered through a National Statistics publication: Government Expenditure and Revenue (GERS).

Fiscal forecasts A fiscal forecast is a fiscal management tool that presents estimated information based on past, current, and projected financial conditions.

Fiscal Framework The 2016 Agreement between the Scottish and UK governments that sets the fiscal rules, funding and borrowing powers available to the Scottish Government. This followed on from the Scotland Act 2016 new powers

GERS (Government Expenditure and Revenue in Scotland) GERS is a National Statistics publication which outlines Scotland’s fiscal position within the UK. It estimates the contribution of revenue raised in Scotland toward goods and services that benefit the residents of Scotland. GERS addresses three questions about Scotland's public sector finances under the current constitutional arrangements:  What revenues were raised in Scotland?  How much did the country pay for the public services that were consumed?  To what extent did the revenues raised cover the costs of these public services?

GERS provides an account of Scotland’s:  Total Public Sector Revenue (so what was money was generated, including a share of North Sea revenue)  Total Public Sector Expenditure (so what was spent)  Net fiscal balance (difference between total revenue and total public sector expenditure including capital investment) – which can be a deficit or surplus  Current Budget Balance (difference between total revenue and current expenditure excluding capital investment)

GDP (Gross domestic product) GDP is the total value of all the finished goods and services which have been produced by a country in a specific time period. It includes what consumers and the government spends as well as what is exported, but it does not include what we import. GDP is the most popular way of measuring the output of an economy (what it has produced) and it is therefore seen as a way of showing how big an economy is and how much it is growing by.

Growth (economic) Economic growth is the rate at which Gross Domestic Product (GDP – see GDP) - the size of the economy- is increasing.

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Inflation Inflation is the rate of increase in prices for goods and services in a particular country. The higher inflation is, the more you have to pay for goods and services. There are a number of different ways of measuring inflation such as through the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). The UK inflation rate was 1.8% in January 2019, following an average of 2.55% from 1989 to 2019.

Interest rates Interest is what you pay for borrowing money, and what banks pay you for saving money with them. Interest rates are shown as a percentage of the amount you borrow or save over a year.

Macroeconomic forecast This is a general term which refers to what may happen to a range of economic variables such as GDP, inflation or employment.

National Accounts National accounts are a statistical system that represents the economic activity and transactions between sectors in a national economy.

Onshore GDP Onshore Gross Domestic Product describes Scotland’s GDP not including the value of oil, gas and other hydrocarbons produced in the Scottish sector of the UK continental shelf.

Outturn data From a forecasting perspective, the outturn data is the amount of taxes which have been collected, or the amount of expenditure which has been undertaken in a given period rather than what was expected or forecast.

Potential Output Potential output is the maximum amount of goods and services an economy can sustainably produce without creating excessive price pressures.

Projection A projection is a simple estimate of the future value of a particular element of say tax. By developing a projection it can be possible to then create a more elaborate forecast of what might happen to an area of spending or tax.

Public Sector Finances Public sector finances show how the relationship between public sector monthly income and expenditure leads to changes in deficit and debt. For example, public sector finance statistics measure net borrowing, government receipts, spending and central government net debt.

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Public sector spending Public sector spending is also referred to as government spending or public expenditure. It is the money that government spends including on central and local government, public sector pensions and welfare.

Resource spending Spending on the day-to-day running costs of government programmes and administration.

Revenue Government revenue is the money a government receives from taxes and non-tax sources. It is the income available to fund the activities and spending of a government. Government revenue and spending are components of the government budget and are important tools of the overall government's fiscal policy.

Scottish Budget The Scottish Budget is an annual Act of the Scottish Parliament, which gives statutory (legal) authority to the Scottish Government for its proposed revenues and spending for a financial year. The Scottish Government's Budget sets out their planned spending for the upcoming financial year. For the financial year 2019/20 the budget was approximately £42.6 Billion. The 2020-21 The Budget Bill was laid in Parliament on 6 February (where the Budget was around £49 Billion) and will now be scrutinised by the Parliament. The Scottish Budget was moved from its earlier scheduled date in December due to the UK General Election and the postponement of the UK Government budget, which is now expected on Wednesday, 11 March.

Scottish Consolidated Fund The Scottish Consolidated Fund is the main fund operated by the Scottish Parliament and from which public expenditure is made. The Fund is made up of the block grant plus the operational receipts of the Scottish Government e.g. from Scottish devolved taxes.

Underspends An underspend is when the amount actually spent is below the amount that was allocated to spend that year. The Scottish Government is permitted to save underspends (up to a limit) in the Scotland Reserve which it can then spend in future years.

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PART TWO: TAX

There are a wide range of taxes applicable to Scotland, controlled and collected at different levels of government. The diagram below, published by the Scottish Government, describes the main taxes and responsibility for their collection across the UK and Scottish governments and local government:

Source: Scottish Government (2019)

Aggregates Levy This is a tax on the commercial exploitation of rock, sand and gravel. The Scottish Parliament has the power to devolve Aggregates Levy under the Scotland Act 2016 but has not yet been implemented.

Air departure Tax The Scotland Act 2016 allows the Scottish Parliament to devolve the UK tax - Air Passenger Duty (APD) - which is a UK tax on all eligible passengers leaving UK airports. Air Departure Tax (ADT) is Scotland's planned replacement for Air Passenger Duty but has not yet been implemented. 7

Business Rates See Non-Domestic Rates.

Council Tax Council tax is a system of local taxation that is determined and collected by local authorities (or councils). It is a tax on domestic property. Some property is exempt from council tax either because no-one lives in it or because of the condition it is in or because the people who live in it are exempt from paying council tax. Some people do not have to pay any council tax. Some people are liable to pay it but get a discount. The money collected from council tax payments helps to pay for local services.

The Scottish Government provides a block grant to local authorities that makes up around 85% of their expenditure, with the remainder coming mostly from local taxation, including council tax.

Devolved taxes Devolved taxes are those which control has been transferred from the UK Government to the Scottish Parliament. These are:  Income tax - some aspects of which are the responsibility of the Scottish Parliament, others the UK Parliament  Council Tax  Non-domestic rates (or ‘business rates’)  Land and Buildings Transaction Tax  Scottish Landfill Tax  Air Departure Tax (yet to be introduced)  Aggregates Levy (yet to be introduced)

Gross (and net) Gross refers to the total amount of business profits or say your salary, before anything is taken off. Net refers to the amount which is left after deductions such as tax and national insurance. Gross is before taxes and net is after taxes and deductions.

Income Tax Income Tax is charged on most types of income, such as wages and salary from jobs, your profits from businesses (only from self-employed individuals if not incorporated), pensions, rents received by landlords, and interest and dividends from savings and investments. Aspects of income tax are devolved (see below).

The Scotland Act 2016 provided the Scottish Parliament with the power to set the rates and bands applying to all non-savings non-dividend (NSND) income tax paid by Scottish taxpayers from April 2017 (primarily income tax from employment and pensions, and excludes income from savings and dividends). The Scottish Parliament can therefore:

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 Vary tax rates  Change the thresholds between tax bands  Change the total number of bands

The personal allowance, the amount of income after which you start paying income tax, remains reserved to the UK Government (currently set at earnings up to £12,500). Income tax continues to be administered by HMRC.

The basic rate tax is the rate of income tax that most taxpayers will pay. In the UK, the basic rate of income tax is 20% (which means you pay 20p in tax for every £1 you earn). In Scotland, five rates (depending on your income) are in place to make the tax system more progressive. The rates and bands for 2019 to 2020 are as follows:

Bands Band name Rate

Over £12,500-£14,549 Starter Rate 19%

Over £14,549-£24,944 Scottish Basic Rate 20%

Over £24,944-£43,430 Intermediate Rate 21%

Over £43,430-£150,000 Higher Rate 41%

Above £150,000 Top Rate 46%

Source: Scottish Government (2019)

Landfill Tax Scottish Landfill Tax is a devolved tax, introduced in 2015 to help reduce the amount of waste being sent to landfill sites by encouraging other ways of disposing of waste, such as recycling. Operators of landfill sites are charged on the weight of their waste using two rates: a standard rate; and a lower rate for less polluting materials. Landfill operators then normally reflect the costs of the tax in their charges to the local authorities and businesses who dispose of waste at these landfill sites.

Land and Buildings Transaction Tax The Land and Buildings Transaction Tax (LBTT) is a tax payable when someone buys land or property in Scotland. Prior to being devolved, it was previously known as ‘stamp duty’. It applies to both residential and commercial buildings and land. If you buy a residential property over £145,000, you now have to pay LBTT. Tax is payable at different rates on each portion of the purchase price within specified tax bands.

Non-Domestic Rates Non-domestic rates are also referred to as business rates. These taxes are paid on non- domestic properties such as shops and offices and are used to help pay for local council

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services. The Scottish Government is responsible for the policy and legislative framework and decides what rate non-domestic taxes are set at. However, individual councils administer and collect the tax. The rate at which the tax is set is based on the value of a property which is decided on by the independent Scottish Assessors.

Personal Allowance The level of income that can be earned by a taxpayer that is not subject to tax (currently earnings up to £12,500).

Progressive tax A progressive tax system is one where the tax rate increases as the taxable amount increases. Using The Land and Buildings Transaction Tax LBTT as an example, if you buy a house for £280,000 you will pay:

0% on the first £145,000 £0 2% on the next £105,000 £2,100 5% on the final £30,000 £1,500 The total LBTT will be £3,600 Source: Revenue Scotland

Reserved taxes Taxes that apply to Scotland but where the control of those taxes is reserved to the UK Government. Those taxes include: Fuel duty, Oil and gas receipts, Income Tax (some powers are devolved), National Insurance, Corporation Tax, VAT, Tax on alcohol and cigarettes, Inheritance Tax and Capital Gains Tax.

Revenue Scotland Revenue Scotland is responsible for the collection and management of the taxes fully devolved to Scotland – currently The Land and Buildings Transaction Tax and Scottish Landfill Tax. As a Non-Ministerial Department, Revenue Scotland is part of the Scottish Administration and is directly accountable to the Scottish Parliament to ensure the administration of tax is independent, fair and impartial.

Tax Bands, Tax Brackets and Tax Rate The tax rate is the percentage or ratio at which an individual or business is taxed. A tax band is the amount of income which will be taxed at a particular tax rate. The bracket refers to the successive sections or bands into which a tax regime is divided.

VAT (Value Added Tax) VAT is an indirect tax which is applied to the purchase of many goods and services. VAT is currently either charged at 20% (standard rate), 5% (reduced rate) or 0% (zero rated).

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The Scotland Act 2016 states that receipts from the first 10p of standard rate of VAT and the first 2.5p of reduced rate of VAT in Scotland will be assigned to the Scottish Government’s budget. VAT will be the second largest source of tax revenue for the Scottish Government, after income tax. Because VAT is assigned rather than devolved this means the Scottish Government will not have any direct policy control over it. VAT will continue to be collected by HMRC at a UK level.

Wealth tax A wealth tax is a tax on the total value of a person’s assets. Assets include the money they have in the bank, any property they own, assets they have in insurance and pension plans, ownership of businesses, financial securities, and personal trusts.

Scottish Fiscal Commission Scotland’s official, independent economic and fiscal forecaster. It produces five year forecasts twice a year to support Scotland’s budget cycle.

Office of Budget Responsibility Produces UK forecasts for the economy and public finances. The OBR’s forecasts determine the Block Grant Adjustment.

Tax reconciliations Tax reconciliations are reflections of the fact that Scottish budgets are initially set on the basis of forecasts. Once tax data is known there is then an adjustment – or reconciliation – according to whether or not these forecasts turned out to be higher or lower than forecast.

Tax hypothecation A name for a ring-fenced tax intended specifically to fund one project or government department.

Sources for explanation of terms include the links of background materials listed below.

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SECTION 2 – USEFUL BACKGROUND MATERIAL

Audit Scotland Audit Scotland is responsible for providing independent assurance that public money is spent properly, efficiently and effectively. It audits 222 public bodies, including central government and government bodies, NHS bodies, local government, public joint boards and committees, further education colleges and the European Agricultural Fund. This link is to an overview of the journey of financial devolution in Scotland. https://www.audit-scotland.gov.uk/reports/e- hubs/financial-devolution-in-scotland-the-journey-so-far

Chartered Institute of Tax (CIOT) The CIOT is the leading professional body in the UK for advisers dealing with taxation. It is a not-for-profit organisation with a primary purpose to promote education in taxation and a key aim of achieving a more efficient and less complex tax system for all. This link is to a 2019 news release reporting on research on public understanding of devolved taxes. https://www.tax.org.uk/media-centre/press-releases/press-release-poll-scots-still-failing- understand-devolved-taxes-support

Convention of Local Authorities (COSLA) COSLA is the representative body for Scottish local government. This link is to a report, Invest in Essential Services, which argues for funding for local government. It highlights the risks to funding for local government, wider challenges and threats including Brexit and argues for the need for fiscal empowerment for local government. https://www.cosla.gov.uk/system/files/private/cosla-investinessentialservices.pdf

Fraser of Allander Institute, University of Strathclyde The Fraser of Allander Institute is a leading Scottish commentator on matters relating to Scotland’s economy, including public finances. This link is to a publication Scotland’s Budget Report 2019, which provides an overview of the state of the economy, the outlook for Scotland's block grant and tax revenues and policy options. https://www.strath.ac.uk/business/economics/fraserofallanderinstitute/publications/scotlands -budget-report/

Institute for Fiscal Studies The IFS is a leading UK think-tank which provides independent advice and commentary on a range of financial and budgetary matters. This link is to two videos, Jargon Busting the Budget and Where does the Government get money from?, which provide an overview of the UK Budget and Tax system. https://www.ifs.org.uk/budget-2020

Scottish Fiscal Commission (SFC) The SFC is Scotland’s official, independent economic and fiscal forecaster. It produces five year forecasts twice a year to support Scotland’s budget cycle. The explainers below are short factsheets on:

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Scotland’s Fiscal Framework: Explainer on Fiscal Framework, https://www.fiscalcommission.scot/explainers/fiscal-framework/ The tax powers that are devolved to Scotland: Explainer on Tax https://www.fiscalcommission.scot/explainers/tax/

Scottish Government The Scottish Government is responsible for devolved public expenditure in Scotland, including the use of devolved tax powers and negotiations with the UK Government on fiscal matters. The links below are to a range of useful resources:

Scottish Budget 2020-2021 - Resources about the draft budget published by the Government and presented to Parliament on 6 February 2020 https://www.gov.scot/budget/

The role of income tax in Scotland's budget, a 2017 discussion paper prepared to inform the debate on use of the income tax powers devolved to the Scottish Parliament. https://www.gov.scot/publications/role-income-tax-scotlands-budget/pages/1/

Scotland's finances 2019-2020: key facts and figures, a guide setting out key information about how the system of public finances in Scotland stands in 2019 to 2020 and how this system is changing https://www.gov.scot/publications/scotlands-finances-2019-2020-key-facts-figures/

Government Expenditure and Revenue Scotland (GERS) which addresses three questions about Scotland's public sector finances under the current constitutional arrangements - What revenues were raised in Scotland? How much did the country pay for the public services that were consumed? To what extent did the revenues raised cover the costs of these public services? https://www.gov.scot/publications/government-expenditure-revenue- scotland-gers/

Scottish Parliament information Centre (SPICE) The Scottish Parliament is responsible for agreeing Scotland’s budget each year in the Budget Act. SPICE provides information and analysis to support this process and for wider public information. The links below are to a range of useful resources:

Where does Scotland get its money from? a video prepared by the Scottish Parliament’s Financial Scrutiny Unit in 2016, which explains how the Scottish budget is funded. It looks at the block grant, how the Barnett formula is calculated and the impact of new tax powers. https://www.youtube.com/watch?v=oNw-1516a08

Guide to the new Scottish budget process, a report from 2018 summarising recent changes, including on the make-up of the Scottish budget as a result of new devolved taxation and welfare powers https://sp-bpr-en-prod-cdnep.azureedge.net/published/2018/5/10/Guide-to- the-new-Scottish-budget-process/SB%2018-35.pdf

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