David Bell: Swinney must dish out the pain fairly

Tomorrow, John Swinney will deliver the fourth and final budget of the third session of the Scottish Parliament. He has an unenviable task. Since it was re-established, the Scottish Parliament has delivered consistent growth in the real value of its public spending in Scotland. This will be thrown into reverse in 2011-12. John Swinney has to find a way to cut the cash budget by £1.2 billion - 6.8 per cent in real terms.

Large scale spending cuts have been trailed for nearly a year. In the December 2009 pre-budget report, Alistair Darling set out plans to cut the UK budget deficit by 72.4bn by 2014-15. George Osborne added a further 38bn to the fiscal adjustment, taking the total to an unprecedented 110bn by 2014-15. Of this adjustment, 27 per cent is to come from tax increases and 73 per cent from spending cuts. This means that UK public spending will fall by 80bn, equivalent to 6 per cent of UK GDP, over the next four financial years. This is the largest reduction in the size of the public sector ever attempted in peacetime.

The scale of the Scottish Government cuts was set out in last month's Comprehensive Spending Review (CSR2010). They result from the application of the Barnett formula to the cuts imposed on Westminster spending departments. The vagaries of this formula mean that Scotland faces smaller current spending cuts than many other departments, including Wales and Northern Ireland. Scotland will receive around 7.5 per cent of the money allocated by the Treasury to current spending during the next four years. But its share of UK capital spending will decline significantly over the spending review period: the cash budget for capital projects will fall from 3.4bn to 2.3bn by 2014-15 - just over 5 per cent of total UK public sector capital spending. This will make it more difficult to fund large infrastructure projects such as a new Forth Road Bridge for the foreseeable future. It also perhaps explains the rumours that the SNP government intend to switch funding from current to capital purposes.

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The CSR also signalled cuts that will be imposed in Scotland but are outside the Scottish Government's control. Reductions in the defence budget will have drastic effects on the Moray economy. And the proposed changes to the welfare system for working age adults will have an impact in most communities, but particularly in West Central Scotland where claimant rates are high.

The intention is to reduce the UK welfare bill by around 17.5bn by 2014-15.

If the Coalition Government succeeds in this aim, there will be reductions in welfare spending in Scotland of around 1.7bn.John Swinney has had only four weeks to respond to the CSR. He had already opted not to take Scotland's share of the 6.2bn of cuts that were imposed by the incoming Coalition Government in 2010-11. This saved 372 million in this year's budget, but will make 2011-12 even more painful.

The Scottish Parliament has had no shortage of advice on how to seek greater efficiency in the public sector. The Scottish Government set up an Independent Budget Review which reported in July 2010. This followed previous contributions from the Howatt Report in 2007 and many recommendations by the Auditor General over the years for improvements in public sector delivery. Yet through all the years of plenty, radical change in how the public sector operates has been less evident in Scotland than in England. The switch from feast to famine in public finance means that radical change is now inevitable. But we may not learn about that until after the May 2011 election. This is because the Scottish Government, even though its spending "envelope" for the next few years was set out in CSR 2010, is only going to produce a budget for 2011-12. It might be argued that John Swinney has had insufficient time to take a considered view of the next four years. And if the Calman Commission changes are implemented, the whole structure of public spending in Scotland will change. But many public sector managers will regret the lack of a long-term vision for their organisations. Some will note the similarity with the decision of the last Labour government to postpone CSR 2010 until after the May 2010 election.

So how can we judge John Swinney's budget? Almost all commentators seem to agree that it should be "fair", but definitions of fairness are as numerous as Scottish malts. My view is that we should try to think of it as broadly as possible, taking the whole of Scottish society into account. Then everyone has a stake in the outcome.

If we take the broader view, then it is not just voters that matter. Young Scots may not be able to vote but they do have an interest in the budget because it will affect their life chances - including opportunities for education and training. The older generation also have a stake in ensuring that the young prosper because the taxes paid by young Scots fund the public services on which the older generation depend.

The issue of fairness between generations seems to have been a low priority for the Coalition, which reserved its most draconian cuts for higher education.

For most individuals, the source of budget cuts does not matter. Whether it is Westminster or Holyrood, the main issue is its effect on their household budget and on their access to public services. Coming after CSR2010, the Scottish budget could offset some of the effects of the Coalition budget.But in respect of fairness between generations, this looks unlikely. The Scottish Government has already made commitments to maintain free bus passes and free personal care. This has positive aspects, but contributes to the feeling that the young will have to bear the brunt of the cuts.

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And a more important issue for generational balance is how far the health budget will be protected be the Scottish Government. The sums involved are much larger. For example, the NHS drugs budget alone for Scotland in 2008 was 1.2bn - more than the entire justice budget. Health spending per head is mainly focused on the old (see Table 1), again raising the issue of generational fairness

Such is its size, protection of the health budget will substantially increase the cuts required of other departments, including local government. The Independent Budget Review commented that "we could find no overwhelming rationale for protecting major blocks of expenditure". Its argument was that all spending areas should be subject to the same pressure to increase efficiency. But also in any assessment of fairness, it is clear that NHS spending is not neutral between generations.

There are also important issues of fairness between rich and poor. The Scottish Government has fewer policy levers on this balance. But the council tax freeze does raise some important questions since it benefits more affluent households and has no effect on the very poor whose council tax is anyway covered by council tax benefit.

One area where we already know that Mr Swinney will act is public sector pay. Pay is likely to be frozen for those earning more than 21,000 per annum. This proposal is intended to save around 300 million. Most public sector workers will be affected. The table shows median weekly pay for occupations where the public sector is the main employer in Scotland. For most of these occupations, median pay is well above the 21,000 pa limit (400 per week).

Most public sector employees have enjoyed regular growth in earnings. Between 2008 and 2009 most received increases between 2 and 3 per cent. A pay freeze means that real pay will fall because price inflation is currently over 3 per cent. Those who have not done well in recent settlements will feel particularly aggrieved. The proposed measure is not intended to halt pay increments. The Independent Budget Review calculated that it would be possible to save 900m if all pay was completely frozen. Instead it appears that the Scottish Government is following the UK option, which allows for pay progression. But the proposal will still mean difficulties in the relationship between employers and unions. Mr Swinney may not be directly involved but this does not make tomorrow's task any easier for him.

• David Bell is professor of economics at Stirling University