Scottish Budget: Ministers face ‘eye-watering’ £1.5 billion financial black hole

First Minister Humza Yousaf is reportedly considering introducing a new income tax band to help plug the gap

First Minister Humza Yousaf

Ministers face an “eye-watering” £1.5 billion funding black hole as they grapple with one of the most challenging financial backdrops to a Budget in the history of Scottish devolution, economists have warned.

First Minister Humza Yousaf is reportedly poised to introduce a new income tax band for higher earners as he battles to plug the gap. However, the respected Fraser of Allander Institute (FAI) at Strathclyde University said “significant spending cuts” are also likely to be required.

It pointed to factors such as the impact of public sector pay deals, as well as Mr Yousaf’s pledge to fully-fund a council tax freeze, which the FAI said would likely cost more than £300 million.

Shona Robison, the deputy first minister and finance secretary, has warned of “very difficult” decisions as she prepares to publish the Scottish Budget on Tuesday.

Mairi Spowage, director of the FAI, said: “This large funding gap will mean difficult choices for the Scottish Government on what to prioritise. In a devolved context, this gap cannot be allowed to manifest in practice, so steps will need to be taken to address it.

“Of course, the DFM [deputy first minister] may choose to use powers over income tax to raise more revenue to plug this gap, but it is unlikely that this would be sufficient in isolation. Significant spending cuts are also likely to be required – the DFM has the unenviable task of choosing where the axe will fall.”

The FAI said introducing a new 44p tax rate for those earning between £75,000 and £125,140, which is thought to be along the lines of what Mr Yousaf is considering, would raise only around £41m once behavioural changes are taken into account.

Possible behavioural changes include higher earners working fewer hours or receiving their pay in dividends. However, it could also include people leaving Scotland or choosing not to move here in the first place.

João Sousa, deputy director of the FAI, said: “There has been a huge amount of speculation on whether new income tax bands will be introduced to help with the government’s funding position.

"In our report, we analyse many of the options that have been discussed. It is important – always – to remember how much these measures will raise when likely behavioural responses are taken into account. For example, a new 44p rate above £75,000 will raise around £40m – not insignificant of course, but nowhere near sufficient to balance the books.”

The £1.5bn funding gap is identified as being in the 2024/25 financial year, made up of roughly £800m in resource (day-to-day) spending and £700m in capital spending.

Ms Robison has said the Chancellor’s recent Autumn Statement was the “worst-case scenario” for Scotland and left her little room for manoeuvre. The increase in resource spending is largely down to public sector pay awards, which are significantly higher than was budgeted for.

Income tax revenues have performed better than expected and there has been further funding from the UK Government, but the FAI said this has been outweighed by the spending pressures.

Meanwhile, the Scottish Government has used a “significant” amount of its ability to borrow money, which may constrain the choices of future administrations.

Scottish Conservative finance spokeswoman Liz Smith said: “This eye-watering report only highlights the SNP’s astonishing mismanagement of Scotland’s finances. All the signs are pointing towards Humza Yousaf trying to tax his way out of an ever-growing financial black hole. That would be naïve in the extreme and as the Fraser of Allander point out, a new higher tax band would barely make a dent in that deficit.

“Coupled with savage cuts to frontline services that are already buckling on the SNP’s watch, this would represent a devastating blow to the prospects of growth in Scotland’s economy.

“The SNP’s Budget looks set to widen the tax gap further between Scotland and the rest of the United Kingdom while ministers simultaneously refuse to accept responsibility for their abject economic failings.”

The Scotsman previously revealed NatureScot, the public body responsible for Scotland's natural heritage, has been told to expect a 15 per cent funding cut next week.

Elsewhere, the First Minister was urged to save Scotland’s hospitality sector by matching the UK Government’s commitment on business rates relief in next week’s Budget. More than 400 businesses and workers have signed the Scottish Hospitality Group’s open letter to Mr Yousaf, declaring an “SOS” alert for the industry.

The Save Scottish Hospitality campaign warns the sector faces a “crisis”, with many venues likely to “disappear forever” without support.

Ahead of the Budget, the group said it wants to see an emergency 75 per cent business rates relief introduced to ease the pressure facing the sector. The UK Government recently extended its 75 per cent business rates discount for retail, hospitality and leisure firms in England until 2025.

The Scottish Hospitality Group has urged ministers to match the Westminster pledge for hospitality businesses in the new year and give the sector a “fairer deal”.

Its letter to Mr Yousaf said: “Scottish hospitality is fighting for survival. The hospitality sector was the hardest hit of any Scottish industry by the Covid-19 pandemic and our businesses still face the legacy of challenges created by the pandemic.

“We can’t go on like this. Scotland’s hospitality is now at a crossroads. We can either be supported to survive and flourish, or suffer further decline. Our venues, our livelihoods, and our jobs – which support the communities we serve – are on the line.”

Stephen Montgomery, director of the Scottish Hospitality Group, said: “This letter is an urgent plea from hospitality owners and workers from the length and breadth of Scotland. The First Minister must listen to those on the front line of our hospitality sector and deliver support to save our hospitality sector before many of the venues we love disappear forever.

“We need to back our hospitality industry to survive and thrive, and a fairer deal on business rates would be one step the Government can take in the Budget to give our hospitality industry a fighting chance. If it can be done for hospitality businesses in England, then it can be done for Scottish hospitality too.”

A Scottish Government spokesman said it was “acutely aware of the enormous pressures facing businesses across the country”. He said: “The Scottish Budget 2023/24 ensured the lowest poundage in the UK for the fifth year in a row and supports a package of reliefs worth an estimated £749m, including the small business bonus scheme (SBBS), which is estimated to take over 100,000 properties out of rates altogether.

“We further estimate around half of the properties in the retail, hospitality and leisure sectors to be eligible for 100 per cent SBBS relief in 2023/24. Decisions on non-domestic rates for 2024/25 will be made as part of this month’s Budget.”