Fraser of Allander Institute describes “fragile outlook” ahead of expected tax hikes

The expected tax hikes for Scotland’s higher earners, which are expected to be announced as part of the Scottish Government’s latest Budget this week, could go for naught and simply be used to fill a black hole in the nation’s finances, according to the Fraser of Allander Institute, Scotland’s leading economic think tank based at Strathclyde University.

The FAI said Scotland could be facing a shortfall in the devolved taxes likely to be raised next year which could “offset”, at least in part, any tax hike proposed by the Scottish Government

The analysis comes days after business leaders at the Scottish Chambers of Commerce and then the Federation of Small Businesses warned that tax rises could seriously damage Scotland’s economy and hamper investment.

The think tank said this week’s Budget comes at a crucial time for Scotland’s economy, with the Scottish Government needing to set out a clear plan for how it intends to support growth and productivity in Scotland.

In its latest Economic Commentary, published today, the independent research institute says that, whilst the outlook is set to improve next year, Brexit uncertainty and ongoing weak demand in the Scottish economy will act to dampen growth.

Scotland’s economy grew by just 0.5 per cent over the past year, one-third the rate in the UK as a whole. FAI analysts’ point out that whilst employment has held up well in Scotland, this has been at the cost of falling productivity, which has now declined for seven consecutive quarters.

Graeme Roy, Director of the FAI, said: “The Scottish economy remains stuck in a cycle of weak growth.

“Brexit uncertainty is clearly not helping, but in such times it is important that policymakers focus on the areas where government policy can help support the drivers of long-term growth, such as entrepreneurship, innovation, skills and connectivity.

“Whilst much of the political reaction will centre on the government’s proposals for taxation, the Budget provides a vital opportunity for Scottish Ministers to set out their plans to grow the economy and boost productivity.

John Macintosh, head of tax for Deloitte in Scotland, said: “Scotland continues to grow, but it’s doing so at a slower rate than the UK and is exacerbated by weak productivity.

“Combined, these factors highlight the current fragile state of the economy. While we’ve seen a number of positive initiatives announced this year, Thursday’s Budget is an opportunity for the Scottish Government to set out a balance of policies that will help to get the economy growing at a faster rate.

“Investment in technology, education, skills, and infrastructure could be the best way of unlocking Scotland’s latent potential and, while it may be years before the results can be seen, a long-term mindset will be crucial to our long-term success.”

Graeme Roy added: “With the Scottish budget now much more dependent upon the tax revenues generated in Scotland, boosting Scotland’s fragile economy will be crucial in helping to alleviate budget constraints over the long-term.

“The Scottish Government undoubtedly faces delivering a tight budget settlement on Thursday.

“The Scottish Government’s resource block grant is on track to decrease by over £200m in real terms next year. On top of this, it is likely that the Scottish Fiscal Commission will revise down their estimates of the outlook for devolved taxes.

“With major manifesto commitments to pay for in health, education, childcare and policing – not to mention a more generous pay settlement for public sector workers than those in England – ‘non-protected’ areas will be in line for an extremely tough settlement.

David Eiser, head of Fiscal Analysis at the FAI, said: “The government has been open about its aspirations to raise revenues through increasing income tax. However, it is likely to be cautious given the largely unknown impact this could have on business sentiment and behaviour.

“At the same time, even one of its ‘bolder’ options on income tax – e.g. one that adds a penny to all tax rates and either protects or reduces the tax burden on lower earners – is likely to only be just enough to offset the cut to the Westminster block grant next year.

“Despite the recognition from across the political spectrum of the need for a long-term approach to managing public service delivery, budget planning remains remarkably short-sighted.

“This means there is a lack of awareness both of recent trends in the distribution of government spending, and how best to address the long-term challenges that our public services face.

Overall, the FAI have revised down its forecasts for growth to 1.2 per cent for 2018 and 1.4 per cent in both 2019 and 2020.