The Scottish Government's Medium-Term Financial Strategy

Executive summary

This is the sixth edition of the Medium-Term Financial Strategy (MTFS). It sets out the economic and fiscal outlooks from the financial year 2023-24 to 2027-28, underpinned by independent forecasts from the Scottish Fiscal Commission (SFC). Detailed tax and spend plans for each financial year are set out in subsequent annual budgets, subject to Parliamentary approval in the spring proceeding each financial year.

A. Economic outlook

The economic outlook has improved slightly since the Scottish Budget was published in December 2022 with the Scottish economy now forecast to avoid entering a technical recession in 2023. The Scottish labour market has continued to remain robust with high levels of employment and near-record low levels of unemployment.

However, economic conditions are set to remain challenging as inflationary pressures continue on households, businesses and public services. Relatively subdued growth is forecast over 2023 and households are set to see record falls in living standards that are not anticipated to recover to pre-pandemic levels until 2026-27. The outlook for inflation and the indirect impact that this has on tax revenue growth and spending pressures over the medium term remains highly uncertain.

B. Fiscal outlook

The financial situation facing the Scottish Government is expected to remain similarly challenging over the medium-term. Overall resource funding is expected to grow by 6.8% in real terms from £45.26 billion in 2023-24 to £50.971 billion by 2027-28. This is due to increases in the Block Grant and significant growth in the forecast net tax position. However, increases vary significantly between years. Pressures on funding are expected to be most severe in 2024-25 when resource funding is forecast to grow by only 1.2% in real terms. The medium-term funding outlook is also subject to considerable volatility, with the two main components of funding – the Block Grant and Income Tax net position – being uncertain.

The funding outlook cannot be considered in isolation. High inflation experienced in 2023-24 is expected to have a long lasting impact on public spending in Scotland, yet funding has not kept pace with this. We have used our devolved powers and chosen to support public sector workers through increased pay awards, invest in health and social care, and ensure those who need it most are supported via our social security system. We have made these decisions in response to an economic environment which is affecting people across the UK, but have not seen the UK Government similarly adapt its approach to public finances. As a result, public spending in Scotland is currently projected to grow at a faster rate than our central forecasts of funding. Our modelling indicates that our resource spending requirements could exceed our central funding projections by 2% (£1 billion) in 2024-25 rising to 4% (£1.9 billion) in 2027-28.

On capital, the funding outlook has worsened since the last MTFS. Total capital funding (excluding Financial Transactions) is expected to fall by around 7% in real terms between 2023-24 and 2027-28. Exacerbated by higher costs, this means that the trajectory of capital spending is more than funding available, with around a 16% gap in 2025-26.

C. A strategic approach to managing the public finances

Within this difficult context, and with limited powers at its disposal, the Scottish Government must ensure it delivers against the fiscal rule set by the UK Government, and is also required under Scottish legislation^[3] – to balance the budget each year. Tough and decisive action must therefore be taken to ensure the sustainability of public finances and that future budgets can be balanced. Three pillars will underpin our strategic approach to managing the public finances.

Pillar 1: focusing spending decisions on achieving our three critical missions.

The Government will prioritise the programmes which have the greatest impact on delivery of the three missions set out in our policy prospectus. Within this, we will not back away from tough choices and targeting. We will underpin our spending decisions with the necessary reform to ensure that Scottish taxpayers get value for the taxes they pay. Recognising the current impact of inflationary pressures, particularly on pay deals for 2023-24, difficult choices may be required in this current financial year to ensure we reach a sustainable footing.

Adopting a multi-year outlook is key to achieving fiscal sustainability. We will publish refreshed multi-year spending envelopes for both resource and capital alongside the 2024-25 Budget, and extend the Capital Spending Review and Infrastructure Investment Plan period by one year, taking these to 2026-27. This will ensure spending is aligned to the three missions for this Parliament and that it takes account of the fiscal and economic reality at the time.

Recognising the changes since the publication of the Resource Spending Review (RSR), we will also deliver a refreshed set of actions against the four areas of reform prioritised in the RSR: Pay sustainability; Public Service Reform; Efficiency Levers and Raising Revenue and Innovation. These are set out in Annex B.

Pillar 2: supporting sustainable, inclusive economic growth and the generation of tax revenues

We recognise that economic growth is necessary to generate the tax revenues which support sustainable, high-quality public services, so – as we deliver our National Strategy for Economic Transformation – the Scottish Government will prioritise policies and actions with the greatest potential to grow Scotland's economy, expand and broaden the tax base to fund our vital public services, ensure we have good, well paid jobs, and invest in making people's lives better. That is at the very heart of our approach to the wellbeing economy.

Ahead of Budget 2024-25, the Scottish Government will explore areas such as seizing opportunities in areas where Scotland has a competitive advantage, such as the Green economy, and supporting entrepreneurs, start-ups and scale-ups; helping businesses to raise productivity; and further boost labour market participation including through an enhanced childcare offer.

Pillar 3: maintaining and developing our strategic approach to tax

The primary role of any tax system is to raise revenue to fund public services. However, within this, there are choices for the government around who and what to tax, and by how much. We have policy responsibilities for tax rates and bands for Scottish Income Tax, Non-Domestic Rates income, Land and Buildings Transaction Tax and Scottish Landfill Tax and will seek to continue to apply these to best effect.

We will work with Scottish citizens, businesses, academics, trade unions, the third sector and other key stakeholders to ensure their voice is heard when we look at the type of tax system we have and want, to ensure it is fit for the challenges of the 21st century. We will establish an external tax stakeholder group this summer, chaired by the Deputy First Minister, ahead of setting out the Scottish Budget 2024-25. This group will build on the Government's inclusive approach to tax policymaking and will consider how best to engage with the public and other stakeholders on the future direction of tax policy, including whether a "national conversation" on tax is required. The outcomes of this engagement will feed into the Budget 2024-25 and the development of the Government's longer-term tax strategy. The Scottish Government will publish updates of these alongside the MTFS in 2024.

We will also publish a broader set of ready reckoners for all devolved taxes for 2023-24 alongside the MTFS 2023, to aid understanding of the impact of tax policy choices on the Budget.

Finally, the Scottish Government carefully considers any possible behavioural changes as part of our tax policy decisions. Building on the policy evaluation of the 2018-19 Income Tax reforms, the Scottish Government and HMRC are developing new, and robust, data sources and evidence to help better understand potential behavioural responses, including taxpayer movements across the UK over time.