1st report – The financing of the Scottish Government

We note the Scottish Government’s call for full fiscal autonomy, but do not consider that this currently appears to be a realistic prospect. Fundamental questions remain about how full fiscal autonomy would work in practice, and whether it would be operable within the constraints of the UK’s current devolution settlement. Practicality aside, we do not believe that a compelling case has been made that such a change would automatically result in Scotland receiving a higher level of funding. Given that the Scottish Government did not accept the invitation to come before us to explain its proposal and respond to these fundamental questions, we do not see how we can consider this a serious proposition, and we remain to be convinced that this proposal is desirable in principle, let alone workable in practice. (Conclusion, Paragraph 20)

Whilst the Barnett formula is an imperfect method of calculating Scotland’s funding, we have heard no convincing evidence of a workable alternative. We therefore consider the formula to be fit for purpose and are not convinced there is clear need to reform it significantly. (Conclusion, Paragraph 33)

In particular, we are not convinced there is a need to introduce a needs- based factor into the Barnett formula at this time. Scotland currently may be receiving more than it would if a needs-based factor, like the floors introduced in Northern Ireland and Wales, were to be introduced. However, whilst such a factor is not appropriate at this time, the need of one should be kept under review. (Conclusion, Paragraph 34) Transparency

The operation of the Barnett formula is not as transparent as it could or should be. In particular, there is a lack of transparency around how comparability percentages are calculated. Comparability percentages are a fundamental feature of the Barnett formula and the only multiplier which cannot be effectively scrutinised by the public. We have heard no 43 good reason for this opacity, which limits the ability of the public and UK and Scottish Parliaments to hold their respective Governments to account. (Conclusion, Paragraph 41)

In all future Statements of Funding Policy, the UK Government should include details of how the comparability percentage of each department has been calculated, including a programme-by-programme breakdown of what has and has not been included in the calculation. (Recommendation, Paragraph 42)

We recognise the importance of the Block Grant Transparency document, as well as the value in it being published in a timely manner. We welcome the Secretary of State’s commitment to publishing an updated document after the 2025 Spending Review and hope the Government will continue this practice in future years. We see no reason why HM Treasury cannot provide an updated Block Grant Transparency document alongside each major fiscal event in the same way in which it provides a raft of other relevant documents to accompany such events. (Conclusion, Paragraph 46)

The UK Government should publish an updated Block Grant Transparency document alongside each fiscal event which will result in changes to Scotland’s funding. (Recommendation, Paragraph 47) Dispute resolution and formalisation

HM Treasury, and therefore the UK Government, is the “ultimate arbiter” of the Barnett formula. As the formula is non-statutory, there is no legal recourse for the Scottish Government to challenge the UK Government’s application of it. There is also currently no formal, objective dispute resolution process relating to the application of the formula, although there are existing intergovernmental structures through which such matters can be raised. An imbalance persists however, with HM Treasury’s position enduring when agreement between parties cannot be reached, as reflects the UK Government’s constitutional position within the UK’s devolution arrangement. (Conclusion, Paragraph 68)

We are not convinced that putting the Barnett formula on a statutory footing, or otherwise formalising it, would significantly improve its effectiveness. The use of the Barnett formula is already a well-established practice, not unlike other features of the UK’s uncodified constitution. Although new routes to legal challenge may be opened though legislation, such a change would restrict the flexibility of the operation of the formula, with little evidence there would be practical benefits for either Government. We also cannot see how a new dispute resolution process 44 specifically for the Barnett formula would not unduly overlap with or duplicate the existing intergovernmental dispute resolution process. (Recommendation, Paragraph 69) Budget stability

The Committee notes that the Block Grant is the single largest source of Scottish Government funding, and that tight rules on borrowing and fiscal reserves mean that significant changes to the block grant will almost always require significant, urgent changes to the Scottish Government’s spending plans. (Conclusion, Paragraph 80)

The timing of supplementary estimates and UK Government fiscal events can cause clear challenges for the Scottish Government in terms of financial planning, with the Scottish Government’s final funding position not confirmed until close to the end of the financial year. This uncertainty is compounded by in-year changes to UK Government spending plans, and the possibility of multiple fiscal events per year. We welcome the UK Government’s commitment to “one major fiscal event” every year and the stated commitment to informing the Scottish Government of relevant funding changes as early as possible. While noting the regular official- level communication regarding spending, we remain concerned about the significant impact UK Government spending decisions can have on the Scottish Government’s budget, often at very short notice and without warning. (Conclusion, Paragraph 92)

The importance of regular communication between the UK and Scottish Governments, in respect of UK spending decisions which could impact Scotland’s budget, cannot be overstated. The UK Government must ensure that the impact of UK budgetary changes on the block grant is assessed and considered while decisions are being made. The details of such impact assessments must be released alongside or very quickly following any spending decisions. While we recognise the need for due process, the Scottish Government should be informed of major changes which impact its funding as early as possible. (Recommendation, Paragraph 93) Flexibility

Given the challenges the Scottish Government faces, we recognise its need for fiscal flexibility. The Scotland Reserve is a key tool that enables the Scottish Government to carry funds from one year to another, and there seems little benefit in capping the amount of money that can be stored in it. 45 The danger of the Scottish Government having to surrender funds, due to a late addition which pushes the Reserve over the limit, whilst hypothetical, remains of concern to us. (Conclusion, Paragraph 99)

We note also that the jeopardy for returning funds to the UK Treasury at the end of the financial year incentivises poor behaviour in departmental spending, relative to value for money to the taxpayer. The removal of the Reserve, which is simply a treasury rule, would allow the Scottish Government to plan more strategically both within and across financial years. A political decision could remove the Scotland Reserve in advance of the next Fiscal Framework event in 2027 to the immediate benefit of the Scottish Government’s budget setting. (Conclusion, Paragraph 100)

At the next Fiscal Framework review, the UK Government should consider removing the cap on the Scotland Reserve, to ensure the Scottish Government’s fiscal flexibility is not unduly limited and to avoid the undesirable possibility of it having to return funds. (Recommendation, Paragraph 101)

At present, the Scottish Government’s limited borrowing powers constrain its ability to manage fiscal shocks, as it is only able to borrow for resource purposes to cover forecast errors. Capital borrowing limits are currently linked to and grow in line with inflation, which may not necessarily be the highest metric of growth. (Conclusion, Paragraph 113)

We recognise the arguments presented calling for reform to the Scottish Government’s current borrowing arrangements. We maintain that such borrowing should continue to be subject to interest payments, the same as it is for any other government when it borrows to cover for its own forecast errors. However, we agree with the Secretary of State that borrowing limits should be linked to the measure which offers the Scottish Government the highest level of flexibility but, crucially, we note that which metric delivers this remains undetermined. The UK Government should therefore publish a transparent analysis of what borrowing limits would look like based on the different metrics advised in the evidence for this inquiry. At the next Fiscal Framework review, we encourage the UK Government to consider reforming the Scottish Government’s capital borrowing powers, by automatically coupling borrowing to the metric which offers the highest limit. (Recommendation, Paragraph 114)

It seems highly unlikely to us that the assignment of VAT revenues will ever come into force. It is clear that implementing the assignment poses a significant challenge, and given the amount of time that has passed since the change was due to come into force, it is far from clear whether it is realistic or possible. (Conclusion, Paragraph 120) 46

We call on the UK Government, in its response to this report, to explain why it thinks the assignment of VAT revenues is still possible, despite robust views to the contrary, and whether the Scottish Government shares this position. We also call on the UK Government, by the summer of 2026, to write to us with an update on the progress made to date on implementing VAT assignment. (Recommendation, Paragraph 121) 47