The official papers covering the discussions before the budget reveal how senior figures believed that Scotland’s was over-provided for by £900 million, around 15 per cent of its £6 billion budget.
The senior figures involved in the talks included chief treasury secretary Peter Rees, Mrs Thatcher’s chief policy adviser, later Welsh secretary John Redwood and the prime minister’s private secretary, later head of the civil service Andrew Turnbull.
The papers have been released at a politically sensitive time when the future of the Barnett Formula, which decides how much money is allocated to Scotland, has become a major issue in the run-up to next year’s independence referendum.
The Scottish Government claims that there are plans to slash Scotland’s budget by £4bn in the event of a No vote.
According to the papers, Mr Redwood suggested that the block grant for Scotland should be slashed by £500m, but fears over the political consequences of cuts led Mrs Thatcher to overrule them and instead favour a strategy of “chipping away” at the grant eventually proposed by the then Scottish secretary George Younger.
Mr Turnbull said she felt “it would be better to trim Scottish programmes as and when opportunities arose rather than through a very conspicuous exercise”.
The prime minister also warned of the “real political dangers” of handing support to the Scottish Nationalists should a strategy of overt cuts be pursued.
In a note, Mr Turnbull said that “great care” should be taken because of the extent of industrial closures in Scotland at the time.
He went on: “There should be no attempt to publicise the figures. Instead, the aim should be to pare them down.”
And in evidence that the Scottish secretary was being kept in the dark about the discussions, he added: “I would be grateful if this letter were shown only to those who need to know of its content.”
Once he was brought into the behind-the-scenes discussions, Mr Younger was pressurised into making cuts and offered £5m in both 1985-86 and 1986-87 and then £20m in 1987-88.
The Scottish Office also wrote a document on how to keep cuts “invisible”, but warned that the Scottish affairs committee would receive advice from Professor David Heald which showed how spending in Scotland should equate to that in England when it was scrutinising the budget.
Mr Younger resisted a review of the funding formula, saying it would have political consequences, and rejected a proposal by Mr Rees to remove Scotland from it and decide its needs on a year-by-year basis.
However, this was not enough for the Treasury and a series of angry notes between Mr Rees and Mr Younger revealed that the then chief secretary to the Treasury wanted the Scotland Office to cut much deeper.
In November 1984 the Scottish Office was told it needed to find an extra £36m in cuts for 1985-86.
The SNP yesterday said that the papers underlined that Westminster does not have Scotland’s interests at heart.
A spokesman for First Minister Alex Salmond said, “These are astonishing revelations.
“Not only did Mrs Thatcher conspire to cut Scotland’s grant, she made sure the plan was kept secret from Scottish voters.”