 Yn gweithio'r 2800 oedd y Cymru a'r ffaithiau cymdeithasol, ac rydyn sy'n quandu'r ffaithiau ac mae'n gweithio'r ffaithiau, ac mae'n i gael gwneud yn rhan o'r tyflion ar ein bod nhw. Rwy'n ôlbon ydw i ddod yn gweithio'r gwaith i'r ffrwng Alyzyn y Barnett, ac mae'n ddweud i gael o'r gwaith i'r Gilgrann Grym Rwy, rwy'n gael i gael i gael i weld i gael i'r gwaith i'r ffaithiau i ddod. The first item on the agenda is to take evidence on the office of budget responsibilities economic and fiscal outlook, and it's to devolve taxes forecasts, both which were published alongside the UK autumn statement in November. We are joined by the chairman of the OBR, Robert Trot, and I very much welcome Robert Trot to the meeting. I invite him, if he wish, to make a short opening statement. Thank you very much indeed convener. Good morning everybody, it's a great pleasure I'm conscious that I'm your first appearance in the new year for the second year running, which suggests a degree of masochism on your part, which is much to be commended. Just as I say, by way of introduction, since I last appeared before you, we've published two forecasts in March and November of last year and our next forecast is coming up with the UK now spring statement on March 13. Obviously, that will be the first time that we'll have a chance to take detailed account of the Scottish budget measures that you're considering at the moment, so any questions I answer for you on that will necessarily be somewhat vague and provisional until we've fully crunched those for that forecast. In terms of the process, I should just reiterate that we've once again had very useful interactions both with the Scottish Fiscal Commission and with officials of the Scottish Government. They've both been very generous with their time and expertise in providing input that's been useful in our forecast, so I hope that we've been able to help them in their preparations and deliberations now that the fiscal framework has moved forward to this stage of the commission being fully responsible for the forecasts. We are independent institutions and we have a shared lack of anxiety about coming up with different answers to the same question, but we feel a shared responsibility to explain to you as best we can why they're different, if they are different, and to be as transparent about that as we can. The commission's December document was a model of how to do that. In terms of the substance, if you go back to the forecast that we published in November, the backdrop to that was that economic growth had been somewhat weaker than anticipated over the first three quarters of 2017 than we had anticipated back in March of last year. The Brexit squeeze on consumer spending came one quarter earlier than we had anticipated previously, but there was no substantive difference there. What was more notable was a feature that has been consistent in our forecasts for years now, which is weaker than expected performance in productivity and stronger than expected performance in employment, within a given outcome for economic growth. The most substantive revisions that we made to our forecasts in November relative to the preceding march were to take a step back and look at the record of productivity growth over the period since the financial crisis was much weaker than it had been in the period running up to the financial crisis or a little bit before. It's not clear that's actually the point at which the pattern breaks. We noted also that this is a phenomenon that is by no means unique to the UK. In many industrial countries you have seen this weakness of unexpected weakness in productivity relative to preceding patterns. If you look at the revisions to underline productivity growth made by the Congressional Budget Office for the United States, they're very similar to the ones that we've made over the last five or six years responding to the same sets of issues. We assumed that there was a weaker period of trend productivity growth. There were some offsetting factors there. We assumed that unemployment can be sustained at a lower level than was previously. The case taking some different views on the average hours worked in the economy, participation rates, etc. The net effect was that the growth potential of the economy over the next five years we have judged to be less than we thought back in March by basically taking a view on productivity that is roughly in between the record of the last few years and the earlier much stronger period. Weaker potential GDP growth means weaker actual GDP growth and weaker growth in all the major tax bases and therefore that has implications for the public finances. In terms of the public finances, in November the recent news had actually been somewhat better than expected. The Office for National Statistics had revised down the budget deficit for 2016-17, the previous year, and things were proceeding relatively well in 2017-18. You started off with the public finances in slightly stronger shape than we had anticipated back in March but then with a weaker outlook for the economy, that initial unexpected good news is used up and by the end of the forecast period you have higher government borrowing than we had in the March forecast. The policy measures that the UK Government took in March added a bit to borrowing in the first couple of years, some extra spending, some tax reductions but with much less effect towards the end of the forecast period. So weaker outlook for the economy driven primarily by stepping back and looking at the historical performance of productivity and a weaker outlook in the medium term for the public finances. If you look at that in the context of what the Scottish Fiscal Commission produced in December, they clearly have a weaker outlook for Scottish GDP growth than we do for UK GDP growth. We have UK GDP growth averaging about 1.4 per cent a year over the next five years. The commission has Scottish GDP growth somewhat below 1 per cent. The major drivers of that difference are weaker assumptions about prospective population growth, that's the largest single factor. The commission has also taken a marginally more pessimistic view about productivity, underlying productivity growth than we have done and then much less important in quantitative terms is a difference in the view of the amount of spare capacity there is in the economy at the moment and different assumptions about net inward migration. In terms of the devolved taxes picture for income tax, I think if you look at the relevant comparison is between our November forecast and the Fiscal Commission's December forecast excluding the impact of the announced changes to income tax rates, which obviously we didn't include in the November forecast. If you look at that comparison, that like for like comparison, it's very similar. Differences of less than 2 per cent in each year of the forecast looking forward, actually slightly greater differences in the interpretation of what's happened over the last couple of years. As I say, we obviously haven't had a detailed look yet at trying to cost the income tax measures. I note that the commission has basically taken the taxable income elasticities, the estimates of how taxable income responds to changes in the marginal income tax rate and has basically adopted or rather has come up with something that is consistent with what we've used in the UK context for changes of this sort, but assuming that there's greater responsiveness for higher incomes. They reasonably point to the greater possibility of cross Scotland rest of UK border issues there. That's obviously something we'll have to reach judgment on. One other thing I think we'll take into consideration is whether the fact that the UK taxable income elasticities are estimated on a measure of income that includes dividends, whereas the Scottish tax base doesn't include dividends, whether that would lead us to reach any different conclusion. The other thing I think we'll need to look at is forestalling. The fiscal commission haven't made a specific adjustment for that. We'll need to decide whether we want to do that. Again, the fact that the tax base excludes dividends means that you're excluding the channel through which most forestalling activity tends to take place. I think that with both judgments, if we take a different view, I don't think that it's a dramatic difference of opinion and that it's going to be quantitatively terribly significant. On LBTT, the differences between the forecasts are slightly larger, as you would expect, for a much more volatile tax series, but our methodologies are now pretty close. We've moved in the direction of the approaches that the fiscal commission is using. We both keep that under review. On landfill, obviously, much smaller quantitative numbers are at stake. The percentage differences in the forecast are slightly greater. That's probably because the commission has had more recent information on the infrastructure for incineration than we have, so we'll be looking at that when we get to the March forecast. I hope that that covers most of the territory relatively briefly and I'm happy to take it out. It was a very helpful introduction and setting the ground. It was very helpful indeed. You picked up on the issue of spare capacity in the economy of self-Robert in terms of your opening statement. That was one of the issues that the Scottish Fiscal Commission raised with us in its report, which we discussed with him before Christmas, in that it was suggesting that, in Scotland, there will be a rover capacity. In your report, the largest change that you have made to your economic forecast is revised down the trend of potential productivity growth by an average of about 0.7 per cent a year. You also state that the economy is operating near potential and the output gap is small. Can you explain in a bit more detail what you mean by that? Why have you decided to revise down the growth because of that? The question that seems to beg to me is, in those circumstances, with the information from the Scottish Fiscal Commission, although not the same, but the same trajectory from yourself, where are we going to get the growth from? Well, conceptually, the way that we think about the path of actual GDP growth over the next five years combines a view of what is going to happen to potential GDP growth. Potential GDP growth is basically—or the potential output of the economy—the level of output of goods and services that is sustainable in the sense that you would not expect it to be putting consistent upward or downward pressure on inflation. In the UK context, if you assume that the Bank of England is pursuing an inflation target, implicitly is the idea that, once they have got inflation to the level they are happy with, they want to keep actual output in line with potential output so that you are not shoving inflation up or down from that sort of level. An anchoring assumption for our forecasters is that, towards the end, unless you are starting from a position with a very big or small output gap, you end up with actual output equal to potential output. In that case, the actual amount of GDP growth that you get over the next five years reflects that growth in potential plus anything that you add or subtract from how far away you are from potential to begin with. Our judgment at the moment is that the economy is fractionally below potential—less than the half a percentage point below—and the commission's view is that, in Scotland, it is about half a percent high. I would not above potential. I would not argue that those differences are significant in the context of the uncertainty that lies around any estimate of that number to begin with. Potential output in the economy is not something that you can directly measure by counting up the number of widgets that are produced. It is a concept of how many widgets you could produce consistent with inflation being stable. At the margin, if you start above potential, as the commission suggests, then actual GDP growth is going to be slightly weaker than potential GDP growth over the five years, and for us it will be slightly stronger. Much the more important determinant of how quickly the economy grows and how quickly tax receipts go, is that growth in potential not the starting point because the difference is not that great? Why have we revised down the growth in potential? It is primarily because of the judgment that we have made on potential GDP growth, which we have pulled down significantly between the March and November forecasts. One point to clear up is that that is not a judgment about whether we have taken a fresh detail look at the potential implications of Brexit. We did make an adjustment to potential GDP growth in an earlier forecast for that, but we have not revisited it. It is more a question of looking at this puzzle of why it is that productivity growth has been so much weaker over the past decade than it was over the three or four preceding decades, roughly 0.2 or 0.3 per cent a year since the financial crisis compared to 2 per cent a year or a little above beforehand. If you go back a few years to the forecast that we were producing in 2011-12-13, we would have been pointing to a number of potential explanations linked closely to the financial crisis. For example, the hoarding of labour as firms assumed that things were going to get better just around the corner or the problems in the financial system preventing capital being reallocated away from inefficient firms towards efficient ones. As this period of weakness has gone on and as it has been mirrored in other countries as well as in the UK, resting too much weight on those temporary explanations that say it is going to be difficult for a couple of years but then we are going to snap back to the historical average fairly quickly does not look as plausible. The judgment that we have had to make is to basically decide what weight to place on the weak performance of the last 10 years versus the stronger performance of the preceding 30-40 years in taking a view on the medium-term outlook. There is not a huge amount of science in this. We have roughly split the difference between the two because nobody has firm explanations for why this dramatic slowdown has happened. The Fiscal Commission, as I understand it or as I can read from their numbers, has similarly looked at roughly what would be halfway between recent performance and the earlier performance and they may have shaded it to the slightly more pessimistic side of that balance than we have, but I would not overstate the significance of that difference. For both of us and for anybody doing a medium term forecast for Scotland, for the UK economy, for any other large industrial country, this puzzle of what weight do you place on this remarkable difference that we have seen between the last 10 years and the previous 40 just stands out as the single most important and unfathomable challenge-facing economic forecasters? Okay. Thanks a lot, Bruce. Good morning, Robert. I'm just interested in picking up on the issue of weak growth and the way that you've essentially taken another look at the forecasts in terms of moving forward. In relation to output, one of the drivers towards that is average hours and the view that you've taken previously, and obviously there's evidence to back this up, since the financial crisis, is that the number of hours that has increased and the implication seems to be that that's because the wages that people are earning have not been matched by inflation, so they've had to either take on other jobs or work extra hours in order to make up that shortfall. What you're now saying is that you thought initially that that trend would eventually start to correct itself, but that's not happening. I'm just interested in the assumptions on that going forward in terms of that average hours, what's continuing to be at that kind of higher level and is that kind of implication of people having to continue to work increased hours, because they're kind of core wages, if you like, and are not keeping pace with inflation, is that trend that's going to continue? You've explained that very well indeed. A very long-standing trend is for average hours to decline over time, and we're talking here decades to centuries of evidence of this, and as you say, that ceased to be the case over the time of the financial crisis, and you saw average hours going up, and again has, rather with productivity, when you're confronted with an abrupt change to a relatively long-standing historical pattern of that sort, you have to decide whether, you know, this is just a temporary aberration, and you're going to get back to the long-standing downward trend or whether something more substantive and permanent has changed. The view that we had taken in most previous forecasts prior to the last one was that it was pretty temporary and that you were going to see a return to the downward trend, and that's very much linked up to this idea that I mentioned a moment ago about, you know, for what it's worth assuming that some of the explanations for weak productivity growth were temporary ones, perhaps related to the financial crisis, and therefore you get back to something more normal relatively quickly. The fact that that hasn't happened, and the fact that we have simultaneously made this judgment that now productivity growth is going to be weaker looking forward, and therefore earnings growth is also going to be weaker looking forward, it seems logically to go alongside the judgment that we've made on productivity growth and on earnings growth, that you don't assume that you snap back to the long-run decline as quickly as we had previously been assuming. Again, in deciding what to do alternatively, you don't want to overstate the sciences involved in this, we've essentially assumed that it looks flat going forward, but there is clearly a significant uncertainty on both sides. And, as I say, one of the uncertainties is just knowing whether this is people responding to a, the unexpected weakness of earnings growth and therefore wanting to protect their incomes from that by, as you say, working longer hours or having a second job or something like that, or whether in a world in which people get used to weaker earnings growth they'll just adjust their expectations of living standards and maybe want to go back to that downward trend. There are considerable uncertainties in both directions, but the broad judgment that we've made is that you don't see this snap back to the downward trend as quickly as you otherwise would do, and we assume, for the sake of argument and for the sake of the forecast, that it's flat from here on out. That is a slight offset in terms of potential GDP growth to the productivity adjustment, because if people are working more hours than they otherwise would have done, there's more income, more economic activity going on, but it's only a small partial offset to the larger, more significant adjustment on potential productivity growth. Okay, that's helpful. Just again, linked to that, certainly over the last year there's been an increased political profile around trying to address the issues around public sector pay and giving fair increases to public sector workers. Obviously, we'll need to await the round-the-wage settlements that are going to come up, but it's fair to say that there's a greater political impetus behind it. Is that something that you've taken into your account in terms of looking into the future forecasts? On the pay side, at the whole economy level, which is the way in which we tend to look at the payment, the fact that you have weaker productivity growth is implying weaker earnings growth, both in cash terms and weaker growth in real earnings than you would otherwise anticipate. In terms of the public sector, we obviously have not taken into account the announcements from the Scottish Government on public sector pay, and I'm not sure that the commission has either, because it came up relatively late in the draft budget process. They, I think, produce an earnings forecast and an income tax forecast on a more bottom-up basis than we do looking at the public and private sector and bringing those things together, which I think reflects the greater importance of public sector pay in the Scottish context. For the UK forecast, we had to address two issues. One is that the Westminster Government is placing less of a constraint on public sector pay. It's simplifying it somewhat. It's no longer constraining it to 1 per cent a year, but there's no alternative, this is what it should be, policy. Simultaneously, you've had Government departments being over the next couple of years, in particular, giving some more money to spend. The judgments that we have to make combine those two. We would assume that if the Government no longer instructs public sector employers to keep pay to 1 per cent, you would expect that to be higher. We assume that public sector pay will return to the whole economy average or to in line with private sector pay more quickly than we would have done previously, because that constraint has been lifted. How do public sector employers respond to that? Partly, they may respond to it by changing the balance of the way they allocate their budgets between pay and non-pay. If you're wanting to or under pressure to spend more on pay, you might try to spend less on procurement and put some more money in on that basis, but the other way, obviously, do it, even if you've managed to put some more money into the pot from that source, is by having higher pay growth in the public sector, but fewer jobs. If you provide in addition to that judgment more money for departments to spend, then they're going to spend some of that on pay and some of that on non-pay. Our overall judgment is that you will still see less growth in public or rather a smaller public sector employment than you otherwise would have done because of this relaxation of pressure on pay, but some of the pressure is soaked up, first of all, by a reallocation from non-pay to pay, and secondly, by the fact that the Government has provided some more money for departmental spending in particular in the next couple of years. Okay, thank you. Thank you. Wally, I think that you had some questions in this area, as well. Yes. Thank you very much, Ruth. Good morning again, Robert. I was going to ask you what's actually been happening in your view to reduce this productivity over the last 10 years, and you've kind of explained and you've offered some suggestions comparing to the previous 40, but what can Governments or industry or anybody do to provide some kind of stimulus to change this? It's as though we've got into a frame of mind where we don't want to change or industry doesn't want to change given the financial crisis, and we're not going to move until something else happens. What could reasonably be done to provide a stimulus to change this, to get this turning around the way we want? Well, the fact that this is a global phenomenon indicates how difficult this is. It's not something where you appoint to a particular deficiency in national policy in one or two countries that can be addressed to bring them into line with a better performance elsewhere. With the UK, productivity performance is weaker than most since the crisis, but there is this global element to it. In terms of what would you do to boost productivity, numerous reports have been produced on this, which tend to say, spend more on training, spend more on education, spend more on infrastructure, planning reform, etc. The list of long-term structural reforms doesn't tend to get any different. Obviously, those things can always be revisited, and have you ever pursued any of them as much as some people would say would be necessary? The thing with all of those policies is that turnaround implies a rapid response. Those sorts of productivity enhancing policies are of their nature slow-burn ones, and the great challenge then, of course, is knowing what effect they've had. If we see productivity growth improving or declining over the next five to ten years, to what extent is that the response to a particular set of policy developments, or is it that the underlying policy of the underlying productivity puzzle has resolved itself one way or another? There are those who would say that we're still too optimistic and that you should just assume that the last decade is the new normal. The most extreme technopessimist view of this has been put forward by an economist in the United States called Bob Gordon, who, simplifying it somewhat, his argument is basically that we've had three industrial revolutions and that's your lot, and therefore you're not going to see that sort of pick up again. I don't think that we have the evidence to be in that camp. We are assuming that you see productivity growth beginning to pick up, and there's a couple of reasons why I think that still looks reasonable to expect, one of which is that the labour market is tightening coming back to the point that we started with. There's not a great deal of spare capacity, and there's a lot of uncertainty about the amount of spare capacity, but unemployment has dropped a long way. It's not realistic to expect that it can't go on and on and on dropping, so as constraints in the labour market intensify, as firms find it harder to provide or to find additional skilled labour, that will provide an impetus for them to rearrange their processes in a more productive, more efficient way you hope. Similarly, albeit very slowly, we assume that monetary policy is going to start tightening, so one of the potential explanations for why productivity growth has been so weak is that interest rates have been so low, so firms have not been under pressure to improve their productivity because the servicing of their debt has been relatively straightforward. We have started to see interest rates going up, and if they go up further, that too could provide some stimulus. Those are the main explanations for why we've not chucked all our eggs into the last 10 years gloomy basket. However, in terms of the policy response, as I say, the list of things that were the reports on how to improve productivity growth doesn't really change very much over time. It's things like education, infrastructure, planning, etc. Those are all easier to stick in a report than they are to implement wherever you're trying to do it. We know that we're in an extended and a long period of austerity, and every year perhaps most of us look round and hope—maybe more hope than expectation—that that will change and that the spending cut trend will reverse. However, is it really seriously that the austerity period is the new norm, and this is just to continue forevermore into beyond the horizon that we can see? Is that what people can expect in the public sector and elsewhere, that austerity will just continue to roll on the way it has been? Well, in terms of cutting public expenditure as a share of GDP, if you look at the quantified fiscal targets that the Government has set itself for the size of the structural deficit, i.e. the deficit that would be left if the economy gets to a Goldilocks state that's neither too hot nor too cold, they're on course to achieve that target in 2021 with a little bit of room for manoeuvre. That on itself does not imply an automatic need for greater austerity or greater fiscal consolidation than is already planned. However, the Government has also stated a longer term broader goal of essentially getting the budget back into balance. The date that it put on that is broadly the sort of 2025-ish period. Our formal forecast don't go that far into the future, but it doesn't look on the basis of the forecast that we have going to a couple of years before that that they are yet on course to achieve that. The deficit is still above zero and not on a clear downward trajectory right at the end of the forecast period. As you go into the mid 2020s, this is the period at which the ageing population, if anything, would be putting upward pressure on public expenditure rather than downward pressure on public expenditure. The conclusion that some people would draw is that, if this or future Governments are serious about balancing the budget, there's more fiscal consolidation to come on top of what's in the pipeline already. There are others who say that history suggests that you end up being content or at least living with a relatively small period of borrowing that budget surpluses and balances are relatively rare. What you expect to come out of that depends on how, in part, committed you think the Government would be to getting down to a completely balanced budget. It's going to go out at least to 2025, though. Clearly, in the numbers that we have already, you're relying on some continued squeeze on public expenditure as a share of GDP to deliver the further improvements in the budget deficit that's in the book already. Before I get to Murdoe and the difference between Scotland and England in growth, Patrick, do you have a supplementary in this area? Thank you, convener. Good morning. I just wanted to explore with you what the implications are of this uncertainty that you've described about what's happening with productivity, whether the last 10 years are the new normal or there's going to be a return, the idea that people are just splitting the difference to cast their projections forward. Is this period of uncertainty about that puzzle resulting in any wider debate about what we measure when we talk about productivity? For the most part, we talk about it in relation to labour. That doesn't necessarily tell us anything about whether the people undertaking that labour actually get the economic benefit of that economic activity. We could be measuring productivity in relation, for example, to sustainable resource use or other environmental thresholds that most of the world has a broad consensus on wanting to achieve now. Is this period of uncertainty about what's happening with productivity leading to a wider debate about what it is and what we're measuring it for? I think that, as you've described, that debate has been around there for a while anyway. Since there are two issues, there's one more narrow issue about are there particular measurement problems, leaving aside your issue of whether GDP is the right thing to look at for a whole variety of reasons and obviously the answer to that is that it depends on the question that you're asking whether GDP is the answer to it. Even if you're asking a question to which GDP is the answer, one debate is looking in particular in a world of we're moving away from the production of physical goods to digital economy, etc. Is it that we are simply mismeasuring the output of the economy and actually productivity is doing better than expected because we're not fully measuring output? That's one aspect. A related flip side of that is were we overmeasuring productivity in the period prior to the financial crisis in particular, for example, in the financial sector? Maybe the difference is not as great as it looked because of the way in which the statisticians tried to capture value added in the financial sector. Both of those are issues around which there has been a reasonable amount of debate. The Bank of England has done analysis and my colleague at the OBR, Charlie Bean, has looked at that as well. The general consensus is that the mis-measurement may be part of this story but it's hard to imagine that it explains a large part of what is now a 20 per cent plus shortfall in the level of productivity relative to what you would have anticipated. The Scottish Government talks about growth that uses the term inclusive for sustainable growth rather than just plain vanilla GDP growth. We could debate how successful that attempt has been but the attempt is there. Would there be value in the Scottish Government trying to take a different approach or cut through this problem in it from a different angle and try to understand it differently by having a measure of productivity that relates to other factors? As I say, I think that the measure that you used depends in part on the question that you want to answer. As you say, typically people in addition to the narrow issue of forecasting the outputs of the market economy etc, well-being more broadly, bringing into account environmental issues, distributional issues as well, is important. This is not an area that the OBR goes into, it's not really part of our remit. When I was at the Institute for Fiscal Studies, I looked at it a bit more. I'm slightly wary of trying to say, well actually there's a perfect single index number which allows you to capture all of those things. GDP is not a very good index number but I've got a much better one which captures all of those things. I think the nature of the sorts of broader policy questions you're describing requires you to look at a number of different indicators rather than pretending you can boil them all down into one alternative one would be my guess, which is not to say that all of those policy questions aren't valuable but trying to have a single magic number against which you can say, well, overall well-being is up 0.3 per cent this year, taking into account all of those factors. I'm not sure how helpful that is. Good morning, Mr Chote. You were talking earlier about the forecast for GDP growth, both for Scotland and for the UK as a whole. You've obviously downgraded your forecast for the UK official commission and I've also downgraded their forecast for Scottish growth, which is now forecast to be substantially lower than UK growth. That's a continuation of a trend that we've seen for about the last three years, where Scottish GDP growth has lagged behind that of the UK. Also in terms of productivity, you've downgraded productivity forecast but in Scotland we see again productivity forecast to be growing below the rest of the UK rates. One of the interesting aspects of this is that the fiscal commission concluded, notwithstanding all of that, that income tax revenues per capita are expected to grow in Scotland at the same rate as the rest of the UK. I was wondering whether you agreed with the fiscal commission's conclusion there or if you had any comment to make around how they arrived at that conclusion. One issue that we wouldn't have had a chance to take into account and I don't know how much weight they would place on is whether the implications of the latest set of proposed income tax changes by making the system more progressive in the sense of having higher rates at the top end would lead you to expect greater fiscal drag over time. As you return hopefully to a situation in which earnings growth proceeds ahead of inflation, you end up pulling more income into higher tax bans and with those higher tax bans more revenue comes out as a result. It's striking that our November forecast and the fiscal commission's December pre-measures forecast are really quite close. There's a difference of one and a bit per cent at the end of both of our forecasts, which compares to a difference of about eight per cent if you were to compare our March forecast with the preceding forecast of the Scottish Government. Even eight per cent, I mean, reasonable people can differ over that and I wouldn't want to overstate the importance of that but you are, as you point out, at a rather closer level there. Now, obviously, we in part are taking different approaches to how you model these things. I think one thing which complicates the matters is knowing what Scottish receipts have been over the last two or three years, where actually the percentage differences for what the Scottish Fiscal Commission and we assume are larger than in any of the forecast years. We are at the moment in the absence of having outturned data based on HMRC flagging Scottish taxpayers as Scottish taxpayers. We're relying on the survey of personal incomes to do this. If you go back to the last set of survey of personal income data that we're both using as a baseline in 2014 at 15, the Scottish Fiscal Commission is essentially taking the estimate of the Scottish share or the Scottish receipts then and is looking at their model of what developments in the Scottish economy will be implying for the path of receipts since then and drawing the line accordingly in order to forecast where we are today, let alone to forecast where we're going to be in five years' time. We take a slightly different approach and because we have been slightly surprised by the fact that income tax receipts turned out to be stronger in 2016-17 than the original data suggested, presumably because financial sector bonuses came in more strongly, it would be part of the story, and that provides a stronger starting point. We are more optimistic about how much Scottish income tax receipts have been over the last couple of years in the commission. We're talking here of differences of 3 per cent compared to one and a bit per cent later on, but that slightly complicates the picture of what you're looking at going forward, but I think what I don't know yet is, as I say, what difference we will assume that the newly announced measures here will have on the growth of receipts in Scotland. I know that you have had a lengthy discussion with them about the difficulties of assessing the behavioural impact and, therefore, how much of the static increase in revenue you would have expected from the measures that you're currently considering is lost as a result of behavioural responses. Looking at the relative projected and historic growth of the Scottish economy compared to the UK economy, what do you think of the major factors, why the Scottish economy is now lagging behind the UK as a whole? On the basis of the commission's projections, population growth is the largest difference. There is a bigger difference in the projected growth of overall GDP than there is in GDP per capita. The weaker population growth in Scotland relative to the rest of the UK reflects differences in both natural growth and the population, so fertility rates— Is that a historic problem? Does that explain what's happened over the past three years, for example? I think that that's been a much longer standing issue, the population growth has been weaker in Scotland and it has been in the rest of the UK because of smaller, mature family sizes at the end weaker migration periods. That's accounting for a chunk of it. On the productivity side, I think that the Scottish Fiscal Commission is taking a weaker growth view, a somewhat weaker view of trend productivity growth over the next few years, which I presume is based on there. They've had to do the same exercise for the Scottish data as we have had to do for the UK data, which is essentially to try to judge how much weight to place on each of these two very different periods of performance. I think that it's right to say that if you were to look in 2016 on its own, productivity growth was weaker in Scotland than it is in the UK, but I think that we're in making the adjustments that we've made relative to our March forecast and that the Commission has made relative to the Scottish Government forecast that they inherited, effectively speaking. It's been much more a question of taking a step back, looking at this historical picture and saying, are we really in the right place here than it is placing too much weight on what's happened over the last few quarters. There have been occasions when we've been thinking about making these sorts of adjustments and the most recent data has shown things picking up quite nicely. Those dawns of a last date turned out to be false ones, and the improvement falls back. Maybe now that we've made the adjustment, this will be the point at which everything goes off to the races. Let's hope that that's the case here as in the rest of the UK. I want to touch on the population issue, but I want to come back and ask a couple of questions on the productivity puzzle as well beyond that on the back of earlier contributions. On the population issue specifically, we've just talked about the differential population growth, and I was interested in the word historical in that context. Of course, the differential population growth between Scotland and the UK has been a problem for 300 years, not just three years. Back at 300 years ago, Scotland's population was more than 20 per cent of the UK's, and now we're at about 8 per cent, so that's not a short term issue. Looking initially at what you've said about your projections for UK growth going forward, you're talking about a number of 180,000 net inward immigration into the UK that your previous forecast was based on, and your latest one is based on 165,000 net inward immigration. Clearly, that's got an impact on growth. I think the question that I'd like to ask is looking back to the pre-Brexit forecasts and the reality of a net inward population growth of about 300,000 plus. What is the difference in terms of the population growth between where we were pre-Brexit and where you're forecasted at the 165,000 number? In terms of where we don't do population projections ourselves, we effectively like the commission choose from the variety of variant population projections that are produced by the Office for National Statistics. When we made the first set of forecast adjustments after the referendum vote, we were using the principal population projection produced by the ONS. The ONS projections are not a sort of detailed assessment of the impact of particular policy settings. It's a more mechanical exercise that basically says in the near term that you assume that net inward migration is going to be like it has been in a relatively recent past, but go five years ahead it'll be more like a longer term average. There has been a tendency always for these projections to show a relatively high rate to start with, declining into the future. As you said, we had been seeing net inward migration numbers considerably higher than we had been assuming. In the absence of the Brexit vote, we would have moved from the principal projection to a higher one, another mechanistic one produced by the ONS. The judgment that we, in effect, took then was that rather than raise our inward migration, we'd leave it where it was, but at the time—this was the November 16 forecast, I don't have it here—we set out what difference that made to the growth and the public finances by as it were not making that change. The fact that it's dropped in the most recent forecast is because the ONS has updated the principal population projection and the latest numbers have moved it in that direction. I think it's fair to say that at the moment it looks as though actual developments in population appear to be moving more in line with the ONS's principal population projections than they had been doing previously. When we made the adjustment at the time of Brexit, it was partly on the view that we weren't going to try to predict the precise outcome of where the Brexit negotiations were going to end up, but it seemed more likely that the migration regime would be more restrictive rather than less restrictive, so that was one reason to assume less net inward immigration. This, I think, is what's happening at the moment, is that the pull factors, i.e., in the absence of any policy change, that there is a natural tendency for fewer people to be coming into the UK in the wake of the Brexit vote than was otherwise the case, and that can partly be down to the fall in the exchange rate and the value of somebody coming here, working here and then sending money home, for example. The immediate Brexit adjustment was to not move to a higher population projection, but to stick with the principal population projection. The change in the most recent forecast is that the ONS has revised the principal population projection down. The commission is using an alternative, while I'm assuming less EU migration as well, which is an interesting one. That's one of the ones that you can look at. My sense is that, quantitatively, that does not make an enormous difference. If you think about what has affected the commission's GDP growth forecasts over the next five years relative to the Scottish Government ones that they inherited, population and productivity are more important, and then migration and the different view on the amount of spare capacity that you're starting with are material, but much smaller than the first two. Just in terms of the pure numbers, the change that you've made going from 185,000 net immigration down to 165,000 net immigration has got an impact on your GDP growth number of what, at point? The judgment that we would have made on product. I think that it's at point two or point three, is it? Yes, I think that sounds right. That sounds like the right number. I think it's of that order. Yes, point two per cent by 2021-22. Having looked at the paragraph, another important reminder is not just the number but the age composition of the population looks less favourable to growth of net immigration, looks less favourable to growth than the previous version did, so it's not just the number that's lower but the proportion of those who are of working age that is lower as well. The forecast that the SFC is used, as you said, is to use a more conservative interpretation of the ONS's numbers, and that is one of the principal reasons why their growth forecast with the Scottish economy is lower going forward. I think that describing it as one of the principal reasons would overstate its importance, and I don't have the equivalent of the point two number for them, but I think that this would be by some way the third or fourth largest factor after the productivity and population. Population as a whole is clearly an important factor, specifically the difference between our net-inward migration and their net-inward migration would be a small part of it. Yes, but the key point is the difference between where we are and where we will be, where we are pre-Brexit and where we will be going forward. Yes, well, yes, how much their choice of regime is down to a specific view on where you end up with, where you end up with in terms of migration regime, etc. I don't know. From our point of view, we have been very clear across the forecasters a whole that we are not basing on a particular well-defined prediction of where all those negotiations are going to end up in terms of trade access and migration regime. It is a broad brush adjustment, but the direction is clear. I am going to talk about productivity, and I am not an economist, so you can help me through that, but based on the contributions that we have had before, I understand productivity, just leaving aside Patrick Harvie's valid points about whether it is the right thing to measure and whether GDP is the right thing to measure, but productivity is basically mathematical terms of calculation of GDP per hour worked. You are basing your assessment of where GDP potentially could be based on the fact that productivity growth is low, therefore the potential and the economy for GDP growth is constrained to some extent. If you dig into the maths of that, GDP is the consumption, its investment, its government spending, the difference between an important export. When you look at those factors, you are saying that the point of maker is that we tend to think of productivity as people working harder, but in reality when you dig into the maths of it, it is all about the GDP number, which is about how much people are spending, how much the government is spending and how much it has been invested. To some extent, is there an issue whereby the fact that we have been in an environment where real wage growth is low, therefore people are not spending as much, therefore the consumption number is down, the government has not been spending as much because of austerity, therefore the government spending number is down, those are at a drag-on GDP. To some extent, it is not the fact that GDP is constrained by the productivity growth that is the other way around. Is there something in that? You can have the direction of causality that can go in both directions. You are right that you can think about the underlying potential of the economy, i.e. the level of activity that you would get to if you assume the Bank of England is getting demand in the economy to the point that is consistent with keeping inflation stable, so to getting to the Goldilocks point, as it were, and of course in terms of demand, you are talking about exactly the things that you described there, it is the mixture of different types of spending, consumer spending, business investment, net exports, et cetera, stock-willing, et cetera. I think that when you have to bear in mind that in terms of the, I would be wary of the argument that really the dominant direction is from weak demand has driven the weak productivity growth. The one way of restating the productivity puzzle is why is it that firms have felt the need to hire so many more people to produce not very much more stuff and that if demand was greater, would that have made that, i.e. the amount of spending power in the economy was greater, would that puzzle have gone away? As I say, the fact is that for the given amount of economic activity that there has been, you have just had an awful lot more of it showing up in falling unemployment, rising employment and less of it in output per, either output per worker or output per hour worked. Clearly there is an interesting debate in terms of its broader social consequences of which is better, would you rather have a productivity puzzle or would you rather have a much larger rise in unemployment for a given increase in economic activity? Certainly some people would say that if you go back to the more 1980s model, which is where you have more of the pain of a weak economic activity being focused on a relatively small number of people who are either unemployed or on the margins of being so and fearful of being unemployed, or what we have had instead, which is actually not having a huge rise in unemployment but having weak wage growth in both the public and the private sectors. There is an interest, as I say, and there is a value interest that is not one for us as to which of those is better. In terms of the long-term implications for living standards, you do worry about the productivity growth and it seems sensible to have that as your constraint overall. As I say, the puzzle is why is it that if you think that demand has been weak in economic activity, why have we employed so many more people? I think that it is a completely unrelated question. Moving into a different area of the Scottish Government's proposed budget, one of the most eye-catching features of its proposed budget is the restructuring of income tax. I wanted to ask you about the structure of income tax in the UK and in Scotland. In the UK, we have had three bands of income tax for quite a long time, and those bands have been set at thresholds, which are quite far apart from one another. The rates are very significantly different. You move straight from 20p to 40p. The Scottish Government's proposal is that we will replace those three bands of income tax with five bands of income tax, three of which will be very close together—1920 and 21p. Is that likely to have any—I mean, never mind where we set each rate—restructuring of income tax? Is that likely to have any consequence, positive or negative, on the Scottish economy? Is there a reason in terms of economic management? Why, for 30 or 40 years now, have we had a much smaller number of income tax bands spread quite far apart? Is there such a thing in the thinking of professional economists about an optimum number or distribution of bands? Are there any issues here that we need to be worried about, just in terms of the structure and the proposed restructuring of income tax? As you say, the mainstream economic view, when you've got those rates are very similar, one percentage point apart in the bottom three, 19, 20, 21. As you say, the differences between the rates at that level are not large enough, you would think, to have an enormous amount of implication for the shape and structure of economic activity. There is clearly an issue, which I presume the Scottish Government has thought about. The desire to have more bands at the bottom is presumably a reflection of a desire. They have particular distributional objectives and maybe particular work incentive objectives that they think are helped by that. They may also have the view that they are close together now, but maybe you want the flexibility to have them further apart in the future. Laying the groundwork for that, I don't know whether that's an issue that's arisen at all. Clearly, the creation of new bands is something that is likely to impose some sort of administrative cost, both in terms of HMRC and businesses who have to adapt their payroll in order to do this. I suspect that creating a new band involves a greater administrative cost than simply changing the rate in one that already exists, but I have no idea what the quantitative significance of that in terms of cost is. I don't know whether any regulatory impact assessment or equivalent has been done for the implications of that. Clearly, it will require some work for firms with workers in that band of salaries and wages to adapt their payroll in order to be able to cope with that, but whether that is a significant burden or not is not something that I am expert on, but you need tax practitioners to answer that question. Who should we expect to do that regulatory impact? Is it something that falls within the OBRs or the SFCs brief, or is it something that we can expect? It's not something that we would do for an equivalent UK change. If we thought that you were doing something that was likely to change business behaviour at a macro level, we might think about that, but it's more the sort of thing that, in the UK context, changes of this sort are generally accompanied by a regulatory impact assessment or some assessment of the costs imposed on businesses and consumers. I don't know whether what the arrangements are here for that, whether it's done or not, to be honest. The officer indicated that he wanted to ask any more questions, so Robert, thank you. During your opening, you stated that it's the second year in a row that you'd been our first witness in the year. I think that that's probably been to our significant advantage, because you're able to deal with such detailed and complex issues in such a simple manner. Gets you off to a cheerful staff. It's also the realism that you bring to it, which is very refreshing, so thank you for that, and we may do the same to you again next year. Well thank you very much, it's my pleasure. Thank you for giving us your time, thank you very much. I just suspend this meeting to allow you to change your witnesses. Welcome back, colleagues. The second item on today's agenda is the evidence on the Scottish Government's draft budget for 2018-19 from Derek Mackay, the Cabinet Secretary for Finance and Constitution. As part of today's proceedings we'll be predominantly and primarily concentrating on revenue issues, and obviously, when we get to Aberdeen on Monday, we'll turn more to the issues about the constitution. Sorry, the expenditure, not the constitution. I've been obsessed with the constitution and clause 11 and the EU bill for too long. Mr Mackay is joined today by Scottish Government officials Aidan Griswyd, who's the Deputy Director of the Fiscal Responsibility Division, Simon Fuller, the Deputy Director of the Economic Analysis Office of the Chief Economic Advisor, and Andrew Chapman, who's the team leader for the fiscal delivery and constitutional change. It was your fault, Andrew. I put it in a constitutional line, obviously. Cabinet Secretary, this is an interesting time when you have obviously proposed new... Sorry, you want to make an open statement. That might be a good place to start. That would be helpful, I think, convener, and then it can open up to committee. I wish all of the committee and officials a happy new year. This is indeed an interesting and exciting time in terms of the use of our devolved function and devolved powers. Undoubtedly, quite an uncertain and what has been internationally, globally, an uncertain and turbulent time. Through the course of composing the draft budget, I've tried to deliver stability and stimulus and sustainability for our public services as well. I'm in very challenging circumstances. The draft proposals reflect our determination to use those powers to grow our economy, build a fairer country and build a Scotland that we want to invest in, live in, work in and support our public services. Supporting our businesses to develop and thrive is a key part of that. Taxation proposals are, of course, central to all of that, raising the necessary revenues to be able to invest in our society and our public services. The budget outlines the spending plans and the revenue plans. I also hope that some of the recommendations from the budget review group and this committee have been taken into account in terms of presentation and responding to that as well. Key features of the draft budget this year—of course, underpinning the budget—is the new role of the Scottish Fiscal Commission in producing their independent forecasts for the economy. Whatever any of us may think about any element of the fiscal commission's forecast, the fact of the matter is that they underpin the budget. Therefore, we are relying on those forecasts in tax revenues and social security spending. I very much thank them for their work and engagement over the period. The committee, of course, has taken much evidence from members of the commission and others, and the chief executive, looking at both forecasts and methodologies during their inquiries. As I have said, it is not just a matter of their opinion. Their forecasts, of course, relate to the block grant adjustment and the OBR forecasts, which underpin our budget numbers. Most substantial income leaver is around income tax, which now accounts for £12 billion. HM Treasury releases the funding on the basis of those forecasts and revenues. The second major innovation in the budget this year is around how we propose to use those income tax powers. It was very helpful that we had engagement with Civic Scotland and others when we published the discussion paper on the role of income tax in Scotland's budget. It was good practice to have engaged in that fashion and set out the principles that the Scottish Government supports on how we would deploy those income tax powers around protecting lower income earners, supporting public services, protecting the economy and using the tax system in a progressive way. Whatever the difference of opinion is on the outcome of that discussion paper, I think that we can take great heart from the confidence and competence around the paper and the impartial analysis of political parties' propositions. It was that consultative approach with Civic Scotland that ensures that we are prepared to implement our income tax powers in any changes competently and, effectively, in giving as much notice as possible. Members of the committee will be familiar with the budget's draft proposals, but just to re-emphasise some of the key proposals in setting out income tax proposals, it will mean that 55 per cent of taxpayers earning up to £26,000 a year will pay less tax than they would elsewhere in the UK, making Scotland the lowest tax part of the UK for the majority of taxpayers. I would argue that the fairest taxed part of the UK with the best deal in terms of expenditure and entitlements also. Hathling carefully considered all available evidence on market performance and forecast. I propose to keep the rates and bans for land and build and transaction tax as they are at present, and I have, however, proposed the introduction of a first-time buyer's relief, which would have the effect of raising the zero-rate threshold for first-time buyers to £175,000. I have also set out proposals for Scottish landfill tax rates. They will rise in line with inflation and continue to match rates in the rest of the UK. On business rates, they will provide the most competitive relief package in the UK, worth a record £720 million up from £660 million in 2017-18, which includes several measures unique to Scotland to stimulate and support business growth in Scotland, such as the growth accelerator and proposals to delay rates' reliability until occupation for new buildings, as well as supporting small business bonus, which should lift over 100,000 properties out of rates altogether. Of course, the number one ask of business was to move to CPI from RPI for business rates poundage uplift. As committee would expect, those proposals have been considered in great detail and in conjunction with the Adam Smith principles around efficiency and certainty and proportionality and progressivity. I am happy to take questions on the revenue aspects of the budget. I thank you, cabinet secretary. As you say, it is an interesting time and you have proposed new rates and bans for Scottish income tax. It means that your budget now is much more dependent on the performance of the Scottish economy relative to the UK economy. Therefore, could you give the committee some insight into how you have changed the way the Scottish Government may approach the budget this year and the draft budget and your plans for future years? It is fair to say that all politicians in Scotland should always have been mindful of economic growth, sustainable economic growth and what can be done to stimulate the economy. It draws a closer focus on what needs to be done to support economic growth. That includes tax decisions in creating the right environment for economic growth. Absolutely part of that is in delivering quality public services and creating the kind of society that we want to live in and having a fairer society. However, to deliver economic growth, yes, arguably we have all had to look that bit closer at what we can do to support economic growth. I think that the Scottish Government and Ministers will always, of all administrations, look to the best way to grow the economy. However, now there is an added reason to do it because it affects the resources that we will have to spend on public services in Scotland. In terms of looking at it, yes, there has been an even stronger focus on economic spending, economic industrial interventions, a tax environment that takes a balanced approach to grow the economy in a stable way. The process of undertaking is to ensure that we approach how we spend resources and how we raise resources that are very mindful of economic growth. I am sure that, because there has been much commentary, there will be questions around forecasts for Scotland. Arguably, you could say that that has led to an even stronger emphasis on economic interventions, business support. However, something arguably even more substantial than that is working-age population and migration, absolutely a critical factor in the economic success that Scotland will enjoy and, for that reason, it relates back to the constitution after all, but that is clearly a determinant in the economic forecasts that have been set out by the SFC and others. However, in the thinking of ministers, it is absolutely front and centre, because if we do not make the right decisions on the economy, we will have less resources to spend on our public services naturally. There has also been some commentary on the budget settlement from the UK Government and claims that it has been increased with counter claims that the resource spending has been cut in real terms. For the record, it would be useful for the Scottish Government to put on your position on the record for the purposes of the committee about what you understand the situation to be. I think that this becomes the annual ritual between Mr Fraser and myself and the others to play in terms of interpretation of resources. It is a feature of the budget, why change it. You play in real terms increases, the difference between resource and capital, financial transactions. Fundamentally, my point would be that, over the 10-year period from spending review about 2010, over the 10-year period, overall resources are down in real terms by about 8 per cent, and that is a £2.6 billion reduction. I suppose that people are most interested in that, going into financial year 1819. It is the case, and I welcomed the resources on capital. I welcomed the resources on financial transactions, but I made the point that for resources from 2017-18 and 2018-19, it is a £211 million reduction and then a £1.5 billion reduction over two years for resource. That is the fiscal resource that we have available to fund our front-line services, be it the health service or other front-line services. That is the key point. That is what has been most severely affected by the UK Government's spending decisions. Of course, you can go beyond that and talk about the Barnett consequentials. Again, they are over a four-year period. That is a £2 billion figure, but it is largely financial transactions. I welcome financial transactions. We will use them to grow our economy, but I can't use them to invest in front-line public services such as school education, delivery or hospitals, of that £2 billion figure. Over half of that was financial transactions. Budget is complex, but there has been a real-terms reduction going on to 2018-19. That is why the Government is proposing to turn a resource reduction into a positive real-terms increase by using our tax powers in the fashion that we have described. Willie Coffey, I hope that you have a question and I hope that you have a picture on the issues that the cabinet secretary has mentioned around four key tests. Okay. Thank you very much, Bruce. Good morning, Derek. In the discussion paper, the tax discussion paper, you set out four key tests that you proposed at the time. One, to mitigate UK Government spending cuts. Two, to make the system more progressive and free, to protect low-earners and four, to support economic growth. Could you outline to us how you have managed to achieve those four aims within your proposals and perhaps illustrate in each of those categories what you have done? I believe that we have held true to those four tests. I recognise that the Government is in a Parliament of minorities and a compromise will have to be found on income tax. Approaching the issue, we wanted to create quite a transparent, engaging debate in advance of decisions being taken on income tax, recognising that there were options in changing the number of bans and the thresholds and rates. It was right to take that consultative, collaborative approach with stakeholders in advance. When setting out the test, we tried to give a degree of certainty as to what we were trying to achieve. One of the tests is to ensure that our decisions don't adversely affect the economy. I was very struck a few weeks before presenting the draft budget that we convened at an inclusive growth conference in Glasgow, attended by key figures from the world of academia, economists, finance, ministers past and present. It was really important to set out progressive taxation but to do it in a way that doesn't adversely affect the economy. I was struck that the IMF has said that progressive taxation doesn't necessarily affect economic growth. How do we believe that we have achieved all four? First of all, in protecting our public services. We have gone from real-terms decline in that resource expenditure into real-terms growth. Investing more by raising extra resources to invest in our public services is what we are trying to achieve for our public services. In protecting lower income earners, we believe that we have done that by introducing the starter rate and the figures that I have given about those who will be paying less tax. I am not going to say that it is a massive reduction. I don't want to overplay that but it is structural change and it is structural change that does benefit a majority of people and, as it happens, it is those that were lower earners primarily. I believe that we have protected those earning less. I believe that the tax system that we have proposed is more progressive because it asks for a bit more from those who have more. That is the essence of progressivity and it takes less from those who have less because of the introduction of the starter rate. Of course, the personal allowance issue is part of that as well that can be taken into account. Restructuring the system to have the five bans and not three. I think that structural improvement also assists with tackling inequality and progressivity. Then it takes me to the final test of supporting the economy. You have seen the SFC report, which has said that they do not believe that our tax decisions taken into account with the spending decisions will have a negative effect on the economy. They, of course, are forecasting and modelling. The tax decisions then raise resources for investment in our public services but also for business and innovation as well. When we come to spending, I suppose that I will talk more about the uplift in the economy portfolio or talk more about the industrial interventions or the aim skills interventions, i.e. support for higher further education, international hubs and so on and so forth. I am saying that it is a balanced approach but I believe that it has delivered those four tests in the way that I have described. Good morning, cabinet secretary. Given the answer that you gave to the convener's second question, you would be disappointed if I did not pursue the issue of the size of the Scottish Government's budget. I am not going to ask you about the overall size of the budget. I just want to ask you about your discretionary spend, which I believe is your preferred measure. Looking at the block grant, is your discretionary spend either up or down in terms of next year's budget compared to the current year? I have pointed out that overall you include capital and financial transactions. It is up, but I have deliberately focused on resource because of the reasons that I have given. You would accept when the Fraser of Allen Institute said in its economic commentary in December that the Scottish Government's total block grant, resource and capital, but excluding financial transactions, is on track to increase by around 1 per cent between 2016-17 and 2019-20. You would accept that. That is correct. I am not objecting to that. I have said so far as true and this is the exchange that we normally have, but I have focused. I think that there are good reasons specifically on resource for the reasons that invest in front-line services. I have welcomed the capital and financial transactions. I have also taken a 10-year review of why that timescale is because that is the timescales of the spending review periods. You said that you welcomed the financial transactions. I remember when they were announced that you described them as a con. If I had a choice between £2 billion to spend on our front-line resource spending over financial transactions, I would take the resource spending. Why? Because I could spend it on health, education and other areas. In terms of financial transactions, they are loans and they have to be paid back to treasury. We can use them and we will use them wisely, but I am afraid that they are not. They substitute for enhanced discretionary resource spending, which, as Murdo Fraser knows, could be well spent by many parliamentarians, including Tories who would quite like to spend it in that fashion as well. I think that we have accepted that financial transaction money is not a con, so perhaps we can agree on that point. On the question of discretionary spend, you quoted a figure of 8 per cent decline in discretionary spend since 2010. Fraser Valander, according to his briefing, states that he believes that discretionary spend declines 3.8 per cent since 2010—not 8 per cent, but 3.8 per cent. Perhaps more significantly, they go on to say that it is debatable whether or not comparisons just with 2010-11 are appropriate. 2010-11 marked the year when the Scottish Government's resource del budget was at its historic peak following years of significant growth. The 2017-18 resource del budget, in real terms, is around that in 2007-08. If we take the 10-year period of the Scottish Government—the S&P Government—the 10 years that you have been in office, the amount of money that you have to spend today in terms of the block grant is roughly equivalent to what it was in real terms 10 years ago when you came to power. So, over that 10-year period, according to Fraser Valander, there has been no real terms cut. Do you accept that? No, I would refer Murdo Fraser to page 7 of the budget document that goes through the treasury limits and the real-terms change that we have outlined using the figures that shows a real-terms reduction from 2010-11 over to the period 1920. I suppose that it is worth pointing out as Murdo Fraser has covered the timescale issue again. That is the period of successive spending reviews, so I think that it is an appropriate timescale. Murdo Fraser has also pointed out that some of the choices in terms of growth that could have otherwise happened are a choice. It is a choice about austerity, a choice about controlling public expenditure and a choice that the UK Government has made. It remains to be the case that, if we had the same resources in real terms that was achieved in 2010-11, you can make a view at that point in time. At that point in the term, we would be better off to the tune of £2.6 billion now, ffiscally, financially, and think of the difference that that would make in our public services. As we move forward so that we can keep arguing about the past, that is fine. I am able to focus on that, but if we are looking forward, I welcome the capital and the financial transactions, but because of the resource reduction in real terms that requires difficult choices, yes, and it has also required us to use our tax powers in a fair and balanced way, and that is what I have proposed to make up for the decisions of the UK Government. Before we even get into other financial disputes, whether it is real funding, whether it is the consequentials that we could have had, if Scotland got a similar deal to Northern Ireland in terms of buying off the DUP or how other Barnett resources arguably have been bypassed. Fundamentally, the trajectory under the Tory Government has not been year-on-year real terms increases. According to Fraser Vallander, over the 10-year period of the SNP Government, there have been no real terms cut in your resource budget. Are they correct? No, I am pointing out once again— You are saying that Fraser Vallander has got this wrong. I am happy to rely on our officials, our stats. When it comes to economists, she can have many different views, but I have shown repeatedly to Mr Fraser that, when it comes to resource spending, there has been a real-terms reduction to Scotland's budget and Fraser Vallander Institute has said so as well. Not since 2007-08. The different baseline that we are talking about. I have tried to outline why the 2010-11 baseline is important. Interesting thing, though. It is our annual start of new year. It would not be the same without it. Thank you, convener, and thank you, cabinet secretary, for coming along this morning. What I am interested in is just exploring a bit further what work is on-going and what the budget is focused on in terms of supporting business and supporting growth in the economy. Maybe you could take the opportunity to outline a bit more detail about what the budget does to support business. I am focused. I am happy to go into expenditure, convener, but I can tell I would test your patience if I did too much of the spending side. Just on taxation and revenue, how that relates to business, I believe that the income tax policies are balanced. It raises additional resources for public services, industrial and commercial intervention, but the tax environment in itself, despite what some people would gleefully argue, undermines Scotland. Scotland is now, in terms of personal taxation for a majority of taxpayers, the lowest tax part of the UK. I think that it offers the best deal. That should attract people to Scotland because of the deal and the quid pro quo that it offers for what people pay. In terms of attracting businesses and growing businesses, I think that the business rates policies are very significant around taxation. Barclay Reviews said that he would have recommended moving from RPI to CPI on the business rates poundage if he thought it was affordable. I noted a revenue-neutral remit, but the considerations and evidence that he was able and the panel was able to give me allowed me to develop that thinking further. I would argue that having the best package of business rates relief anywhere in the UK, supporting particularly small businesses, was significant. More support for hydro and the particular interventions around growth accelerator, no rates liability and toll occupation are unprecedented anywhere in the UK. Why is that important? I believe that it is genuine. It is not just a tax cut for its own sake. I believe that it is stimulants for businesses to make decisions to improve, expand and enhance property. I will give you an example. If a business wanted to make its property more environmentally friendly, less emissions, it would probably end up paying more. Business rates and non-domestic rates are a consequence immediately. The growth accelerator even supports interventions like that, because it gives a period of grace for non-domestic properties to benefit from enhancement improvement or indeed a new build, or speculative new build as well. All of that puts it at an advantage, frankly, which is very helpful in making Scotland even more competitive. Despite some politically charged commentary, most of the responses that I have seen to the budget have welcomed it as a balanced approach, and that includes for business as well. Patrick, you have got a supplementary to this. It is a very brief supplementary on non-domestic rates. As long as it is brief, because I know that you have got to question what that is. Thank you. Good morning. Just on non-domestic rates, you mentioned the fact that the Barclay review had been given a remit to be cost-neutral. I might criticise that decision, that narrow remit, rather than a comprehensive review of local taxation. The briefing that we have got now refers to the cost-neutral remit that it was given, but then says that the policy reforms largely flowing from the review will cost £96 million in 2018-19. It is not, in fact, cost-neutral. We have had evidence from others who suggest that the reductions in revenue from non-domestic rates roughly take up the majority of the extra revenue that you are raising from income tax, which you say is for public services. Is that accurate? Does the majority of what you are raising from income tax get given away as non-domestic rate cuts? The figures that have been cited are correct. It is approximately £96 million as a consequence of the Barclay recommendations and how I have gone further than the Barclay recommendations. Of course, the other side of Barclay non-domestic rates is the recommendation in Ken Barclay's report on how to raise revenue in Parliament does not have the appetite to see them through. For example, allios. Of course, I concur with that view, but I make the point that Parliament is largely supportive of the interventions to support business growth and enhance reliefs and so on, notwithstanding the position of the Greens and maybe the Labour Party too. Overall, there was a lot of support for a lot of the growth interventions in Barclay non-domestic rates interventions and not so much growth when it came to the revenue-raising element of it. Maybe more support around some of the smaller revenue-raising elements of it, such as independent mainstream schools, not having a rate relief going forward. I think that that is why there is a difference in what Barclay recommended and then what has come out in the financial outturn. That said, I think that the measures around non-domestic rates are necessary. There is an argument about the Laffer Curve debate in the past. Certainly not from Patrick Harvie, and I am not even sure whether Murdo Fraser would use Laffer Curve analysis any more, having seen some recent commentary. However, my point is that each tax has to be taken in a case-by-case basis. You are disputing what we have been told by others that the non-domestic rate tax cuts take up the majority of the extra revenue that is being generated from income tax changes. No, overall policy decisions on income tax plus the element of methodology change as well leads to an increase of £366 million in income tax. Only part of that is the current year's budget proposals, but that is the total amount that is derived from Government decisions on income tax. However, this year, it is, say, £164 million is a consequence of our policy decisions. I am just saying again that each tax has to be taken on a case-by-case basis. Yes, Parliament has a choice. Yes, Parliament can say don't spend £96 million on non-domestic rates relief or make different choices, but it is my position that some of those very specific and substantial interventions, the growth accelerator and no rates liability until occupation will, I believe, lead to a stimulus in economic activity, particularly in property, because it is an advantage that Scotland has. I simply make the point that those interventions should lead to further economic growth. Each tax should be taken on a case-by-case basis. Parliament can make choices, but I believe that that is the right balance in personal taxation to raise revenue and on non-domestic rates interventions to support growth for economy and respond to the Barclay report in a balanced way. However, it is true to say that the elements that would have made up revenue to help fund the expenditure elements of Barclay would not have the support of Parliament. I want to ask you a number of quite detailed questions about the implications of your proposals with regard to income tax. You said a few moments ago that you are using the Scottish Parliament's tax powers in a fair and balanced way, those were your words. According to the SPICE analysis of the proposals, cabinet secretary, those earning between £33,000 and £43,000 will pay more tax next year than this year, but those earning more than £43,000 up to £58,000 will pay less tax next year than this year. How is that fair and balanced? What kind of behaviour are you trying to incentivise or disincentivise by giving those tax cuts and those tax rises to those different brackets of salary? There are some elements of a policy where you may not set out to have that intended consequence and what that relates to is the decision last year to freeze the higher rate threshold. We are not proposing to do that in those proposals this year, we are proposing to increase it in line with inflation. It creates what I have admitted is an anomalous situation, but in resetting the tax structure in the way that we have done, it creates that anomaly. I am not saying out to say that there must be a bracket that is treated differently, but it is stemming from the structural resetting of the whole system that introduces a new starter rate and has the intermediate rate and has the thresholds in terms of the higher rate that is raised in line with inflation. It creates that unintended consequence for a particular bracket. Of course, if you take it over the two years in terms of you could argue that people in that bracket were not the beneficiaries last year because the higher rate was frozen, it benefited this year because I am proposing to increase the higher rate and you take it over the two year period. That is the reason for that outcome. It is anomalous, but that is what happens when you have structural resetting and increase the higher rate threshold. That is the technical explanation as to why that has come about. So it is an unintended consequence? I did not say out of a particular bracket that is affected in that way. It is an unintended consequence of resetting the whole system and proposing to increase the higher rate threshold. I wonder what other unintended consequences there are looking in those tax plans. You said in your opening statement, cabinet secretary, that you were proud of the engagement with civic Scotland that the Scottish Government had had during the course of the autumn. What kind of engagement have you had with the Treasury and with HMRC to ensure that there are not other unintended consequences of your tax plans, with regard to, for example, the married couples allowance? As Adam Tomkins would expect, I engage regularly with ministers. I am assuming that it is the same ministers in the UK Government that I am dealing with. I have not checked the latest status of the UK Government Cabinet kerfuffle or reshuffle. I engage regularly with UK Government ministers and I certainly saw as much early advance notice of their tax proposals as possible. We are all familiar with this committee on the issues around timescales and notice. The chancellor stands up and gives his budget, and I have the three weeks to propose the Scottish budget. Officials work constructively and engage positively. HMRC has advised me through officials that they are satisfied that the changes that we propose to make to policy can be delivered administratively and effectively. Of course, what they would like is as much advance notice as possible if there are to be changes. Timing certainly helps them, but there is constructive engagement, as a matter of course, on the practicality of the Scottish Parliament using its devolved functions competently. I was going to come back to your other question that I was interested in. I think that it is fundamental to know that officials do work together. I am going to say harmoniously that might not be totally true, but it is certainly constructively to make sure that it works. In terms of those specific examples, there are again a couple of areas that are not on our gift to resolve. They are functions reserved to Westminster administered by HMRC that are unintended consequences of any divergence of policy. Not a reason not to diverge in tax policy, of course, I would argue, and anyone who believes in devolution would say so. Where there are any anomalies, we would expect the UK Government and HMRC to support that. Specifically, officials have engaged with HMRC on that. If it requires any change, then I would encourage the UK Government to do that to ensure that there are no unintended consequences. Essentially, we are not at a settled position yet because HMRC continues to work on the issues, but they are now familiar with our policies and should, hopefully, address any unintended consequences where they have arisen. It may be helpful for officials to see more of the technical detail behind a marriage allowance, if that is of assistance. Just on specifics of the discussion paper, it is helpful in early engagement with HMRC on potential scenarios to give them a heads up on where we are going without necessarily having the precise policy that we could share with them, which would not be appropriate to share in advance of the budget itself. On marriage allowance, specifically, we have already engaged with HMRC on that post-budget. As the cabinet secretary said, that is a reserved matter. There is an intention to make sure that that is resolved and that there are any unintended consequences. I do not know what needs to be resolved. Can you explain what the issue is so that we know what is trying to be resolved? At present, a basic rate of payers who are married are entitled to a £260 entitlement—that is the maximum relief entitlement—for £18.19. There is a consequence of structural changes. There is a question about the intermediate rate that is being set—the 21p rate. The fact that the higher rate threshold is lower than the UK equivalent is a question of marriage allowance. Do you stick to the letter around the basic rate, which means that those people on the intermediate rate lose that entitlement, or do you take a pragmatic approach that avoids that eventuality? We are working closely with the UK Government. We understand that there is a minor legislative change that could be put in place that could be corrected for this. That, again, is the UK Government's gift to take that forward. As we say, it is early engagement post decisions that have been made, but there are potential solutions to avoid that outcome. What is the policy intent? Is the policy intent for people in Scotland on the new intermediate rate to lose their entitlement to the married couples allowance or not? The policy intent is that we can express a view—it is a policy that we do not control. We can express a view. My view is that Scottish taxpayers continue to have that entitlement. It is then back to the Westminster Government to make that change or not. It would not lose out by making the change, because for it it would be continuity. I make the point that it is one of the anomalies that is not a reason not to diverge an income tax policy. At maximum, it is £260 per couple relief for those affected and could be resolved in advance of the new financial year with a minor technical change if the UK Government wishes to do it. If you foresaw this problem before you presented your budget proposals to Parliament last month, why did you not seek to resolve it with HMRC before coming to Parliament? No, I think that Mr Greaves said that we do engage with HMRC the actual tax policy that I propose. Parliament hears it first, apart from the SFC for obvious reasons. There are scenarios, discussions, engagement on potential anomalies in advance, engagement with civic society. Helpfully, in civic society, some of the tax experts, whether it is the Chartered Institute of Taxation or the Institute of Chartered Accountants in Scotland, will volunteer issues that they foresee with us. We take that on board, work on it, engage with relevant agencies. My point is that even the budget is now out for consultation, and that is the purpose of this committee appearance when we engage further with HMRC. It is for them to then ignore the issue, ignore the anomaly or resolve it. A question that I put back is would Mr Tomkins say that in itself is a reason not to use or devolve powers, not to have divergence because some intended consequences are the outcome? In looking at them, we hope that HMRC will resolve them. I do not see any reason that they will not. It then is back to Westminster politicians to respect the fact that we have devolved functions and should be free to use them. My view would be that devolved powers should be used in such a way that you have done your homework first and have thought about the consequences so that they are intended and not unintended. That is not a fair characterisation. I made the point that this was not a surprise to us that we do engage on such matters, so there is no suggestion that we have not prepared for such anomalies. My point back is that those issues are not within our gift to resolve, they are within Westminster's gift to resolve, and they should respect the fact that the Scottish Parliament is using its devolved functions in the spirit of Scottish democracy. It is then for Parliament to decide whether we use those powers or not. On the substance of the married couples allowance, you cannot give us an assurance that people on the intermediate rate will not lose that allowance. Can we move from that to that? I cannot give you the assurance that Westminster will see sense and ensure that the devolved powers in Scotland are exercised fairly, but I have found in many other matters in relation to the budget that they have been willing to take a constructive approach on a number of matters, and I hope that they will take a constructive approach on that as well. What about pensions? With respect, there are tax release available, so how will that work, given the restructuring of income tax that you are proposing in this budget? In terms of tax relief, I make the same point that this will be a matter for HMRC in terms of those reliefs. I want to make an overall point about pensions, because I have seen it referred to elsewhere. Again, there are relief anomalies for HMRC to address, knowing what our tax policy is and where our intended policy outcome is. When it comes to tax relief, specifically on the issue of pensioners' lump sums—I suspect that Mr Tomkins was probably going there next—I would argue that our progressive tax policy benefits most pensioners as well, because if they are working, they will be paying the progressive tax regime. If they are drawing down a lump sum, that would also be more progressive than most people. The evidence and information that I have seen is that most people drawing down a lump sum are at the lower end of the sums that they are drawing down, and therefore should benefit from a more progressive rates as proposed and the income tax policy as well. That makes the point on some of those anomalies. The lump sum is a significant issue, but the majority actually benefit from a more progressive tax regime. However, it makes the point of the inadequacy of the current devolution settlement that we do not control every element of it, we do not control the relief, we do not control national insurance contributions, so where are the anomalies? It is not to say that the Scottish Parliament should not exercise its power and income tax. I would argue that it suggests that we should have all the powers around income tax, national insurance contribution and others, so that the system absolutely can be far more harmonious. I welcome the fact that we have the substantial income tax power, but any of the anomalies that arise from not having control of the other powers suggest that we should. I want to pick up on a couple of the points that have already been raised. You made the point when you were talking about the principles around the taxation changes that one of the principles was to offset austerity. Patrick Harvie questioned you about the overall amounts raised in relation to income tax. You will be aware of the Fraser of Allander institute analysis, and they clearly demonstrate in their analysis that you raised, as you have stated, £164 million through tax, but when you take into account the business rate offset, the LBTT change and support for carers allowance, there is only £28 million available in terms of meeting the challenges of offsetting austerity, not to mention funding your public sector pay policy. The analysis shows that what you have produced is a weak set of tax proposals in order to meet the challenges that you have set yourself. I think that what I have tried to do, as I have described, is deliver a balanced budget, one that supports the economy, one that protects our public services and invests in them, lifts the public sector pay cap. If I ask the question, is this budget pro-business, yes, as well as being pro-public service, as well as being pro-sustainable economic growth, as well as being pro-NHS, a higher than inflation increase than the national health service, yes, I do also believe that it is pro-business as well. I think that it is the right thing to do to grow our economy for the reasons that we gave at the start of this evidence session, but a balance in tax using our tax powers in a fair and progressive way to raise extra resources. The decisions that the Government has taken last year and this year around income tax specifically result in an extra £366 million for expenditure on our public services, so we have done it in a balanced way. Again, whatever we think of the fiscal commission forecast, they underpin our budget. In taking the tax decisions, I have tried to ensure that we meet the four tests that I have described to Mr Coffey. It is a balanced budget, one that protects our public services, invests in a fairer society, protects the country from the welfare reforms as best we can from the UK Government and invests in the future, and that includes investment in infrastructure as well, so I would not accept the charge that Mr Kelly has made. How can you say that it is a pro-public service budget when the evidence clearly shows that, when you work through the tax changes, there are only £28 million available to offset the impact of austerity and cuts? It is through the number of decisions that the Government has taken. We are investing more than inflation for the national health service. We are lifting the public sector pay cap. I believe that we are protecting local government in terms of resource and capital. There is record investment in housing to meet our affordable housing target. There are new interventions for a broadband as well. There is the mitigation of welfare reform too, so all of that is achieved by this budget. That is how I say that it is a pro-public service, because it achieves all those things and more. I would certainly submit that it is highly questionable that it can be a pro-public service when the amount of money raised that can be allocated to offset the public service cuts is only £28 million. On to the issue that Adam Tomkins raised, around those earning between £43,525 and £58,500 paying less tax, is that something that you are aware of when you publish your budget? Yes. In the press briefing, we were upfront about it, so I am aware of it. I have explained its anomaly, but it is not something that I set out to say. Here is a band of taxpayers that I want to be treated differently. It is a consequence of the structural change. The proposal to lift the higher rate threshold is part of that structural resetting. If you take it over the two-year period, those people who were not the beneficiaries last year are the beneficiaries this year of that outcome. It is not a big secret, Mr Kelly. People understandably will be looking at this year's budget. Do you not think that people will view it as inconsistent to say the least? If you take somebody earning £42,000, they will pay £90 more. Somebody earning £55,000 will pay £35 less in tax. Is that not a really inconsistent approach against some of the principles that you outlined at the start? I would like to think that, by definition, an anomaly is not normally consistent. I make the point that this is resetting the tax system. This is structural change. This is delivering a fairer system overall. This is addressing the fact that it is normal to increase thresholds in line with inflation, but it is a choice. From all of that, I believe that we have delivered a system. Of course, we have to abide by the SFC forecast, but a system that raises and policy choices that raise £164 million that is fairer, more progressive and does not adversely affect the economy that ensures for the majority of taxpayers that is the lowest tax part of the UK and for 70 per cent of taxpayers, they pay less, not more. Those who are paying more have more, and that contributes to a better and fairer society. In delivering that structural change, there is an anomaly within it, but that is the outcome of overall restructuring of the tax system in which we are introducing two new bands. Is it not the case that, rather than being a progressive set of tax changes that are weak and incoherent—weak in the sense that they only raise a minimal amount of money to offset public service cuts and incoherent in that you have got inconsistency in the tax rates and changes that have been brought forward? I think that tax, to be fair—and I am sure that Mr Kelly wants to be fair—tax is a very complex area. I think that we have covered some of that this morning. To make such a substantial change in resetting the system, I say that there will be some complexities within it. I do not know of any commentator, frankly, who has said that this is anything other than progressive. I do not know of any economist or commentator who has said that it is anything other than progressive. A politician, we argue, does not go as far as they want, but there is consensus, it is competent, it has been constructive, it has been engaging. It has been a good way to do policy by engaging in advance to make sure that we can iron out any issues and hear from people what they think about, whether it is trade unions, whether it is a business community, whether it is a taxation expert or others. Everyone has agreed that it is progressive. How far you wish to go, that is a matter for others. However, I would argue that it is a major step in delivering a fairer structure and the rates and thresholds within that, I would argue, are fairer as well, and certainly better than the previous structure that we had, although at the same time raising extra resource for Scotland's public services. Of course, it is a discretion of the Parliament as to how it spends those resources, but, as I said, taking together last year and this year's decisions, it has amounted to an increase in the resources that we will have to spend. An interesting, of course, fiscal commission on current forecasts suggests that income tax forecasts will continue to arise in Scotland, even if that is not the same for GDP. Wage growth and will match the UK income tax. Receipts for Scotland should be in a strong position. Good morning, everybody. I am interested in the structural changes that you are describing and how it will benefit people. In the first three tax bans, I see that, like many of the employees in the first three tax bans, 89 per cent of nurses are women, most healthcare support workers are women, and most people in the caring community are women. The draft budget directly reflects what the Scottish Government has as far as the equality agenda, but can you describe the benefits of the first three tax bans? Was that a conscious decision to include women? There is equality thinking when we are composing the budget both in revenues and expenditure. It is fair to say that Emma Harper has done that, in delivering a more progressive system, it does benefit women, as well as at the expenditure site will, too, when we come to that, whether it is childcare or education or other entitlements specifically. Because of the composition of the workforce, and this includes within pay policy as well, beneficiaries of that, in terms of the lower paid, will be women, too. In making sure that our pay policy and our tax policies are aligned, as well as overall expenditure equality, there has been a forefront in our mind. No, I am quite happy with the benefits because of the feedback that I am getting from people. I am picking up on this anomaly that a couple of other members have asked about. The way that you have described it almost sounds as though it is an unfortunate but inevitable consequence of what you are doing. It is not inevitable, is it? You have described it as a great restructuring, and I very much welcome that. I have argued for a restructuring of income tax bans for some years now. However, if we are restructuring income tax, that seems to me an ideal opportunity to set the bans and the thresholds, as we think they ought to be, rather than to base them on an inflation calculation deriving from the old abandoned structure. Why do that? I think that I have tried to cover those points. At no point I have said that it is not a choice. I have said that it is a choice to the Parliament as to where we set the thresholds. It is just normal that thresholds increase with inflation, but it is a choice. It is also true to say that, in restructuring it, we can set, within our competencies, the bans and rates as thresholds where we want them to be. I am just saying to take a two-year view that those who did not benefit last year are beneficiaries this year of that structural change. Yes, Parliament can choose otherwise in terms of that. I have tried to describe how we have arrived at the structure. I can say more, but it is increasing the higher-rate threshold that we did not do last year, as Patrick Harvie well knows. That was necessary for the budget to be supported. That is just a fact of the engagement last year. If it is normal to increase thresholds by inflation, let me ask a question that you did not properly answer last year. Why do you not want to increase the top-rate threshold by inflation? We have looked at the structure and at the tax base. We have engaged with, as they say, a number of stakeholders and what the tax system should look like. The structure right now is where we think it should be. From memory, that would be in the top-rate tax about 19,000 people in that particular ban. Forgive me. You have consulted and asked people about this, but all the approaches outlined in your discussion paper on the role of tax in the Scottish budget were based on a higher-rate threshold, which is an inflation-based increase from where it currently is, and a top-rate threshold, which is precisely where it currently is. You have not consulted or asked people about what the options might be. Every single option that you have put forward was based on that assumption that you would increase the higher-rate threshold by inflation. I can assure Mr Harvie that inviting political parties to put submissions to the tax and discussion paper could send me any submission in any composition that they liked. I did specifically my request for submissions. I asked for views around thresholds and inflationary assumptions as well. The approaches in the discussion paper were not from other parties, but they were your approaches. I was about to come to that as well. I am just making the point that I have been responding to political parties in what their submission was to that exercise. In the subsequent engagement that I had, people were perfectly free to make suggestions beyond our illustrative modelling—perfectly free to make alternative suggestions. I have to say of all the engagement that I had, I did not get a lot of push or questions around the thresholds for the top-rate of tax—an additional rate, frankly. There were more questions around whether it was the rates or maybe assumptions that people had made, but I did have an open mind to people engaging on other matters. I think that the balance was struck as the right one, though, in terms of the composition of the tax base, understanding as best we can the behavioural effects and then arriving at a system that will generate the right amount of income and revenue. In terms of top-rate, there is a very specific argument around that, but trying to ensure that we raise the optimum amount of money for next year? To be clear, just as with last year, I was not suggesting that we should increase the threshold for the top-rate. I am suggesting that there is an anomaly, and the fact that you are not doing so really challenges your claim that it is normal to increase thresholds. What you have done is produce a set of proposals that are based on an assumption that higher rates taxpayers ought to get the benefit of a threshold increase. What other alternative variations have you considered, either in the development of that discussion paper or subsequent to the discussion paper in the development of your draft budget? What other options did you examine, cost out and then rule out of consideration for publication alongside the draft budget? Just to go back to the top-rate tax specifically, of course, we have not increased the threshold for the top-rate tax. There is another argument that you can move it about, but that has remained static. I was making the point more about other rates, just to be absolutely clear on that point. Over the course of the discussion paper, the role of income tax in Scotland's budget, leading to the draft budget, clearly I would look at different scenarios, what I thought, what different numbers would mean, what would the outcome be, and the reason for that is following on from the chancellor's budget, I have a different set of numbers to work with. I am working on different budget figures. It was still a fluid position and it was still yet to be determined. I looked at different modelling, different tax policies, and in real time the civil service was trying to get a better understanding of the fiscal commission's modelling as well, so that the civil service could get as close to SFC modelling as possible to understand what we propose, whether that be the outcome that SFCs say it will be, because that is what I have to put in the budget. That was a pretty intense period of exploring the numbers, fluidity of the numbers to arrive at the final proposition that I gave to the SFC that they put in the document, which then informs the draft budget. It was pretty fluid during that period. I have been asked about two specifics, and I will ask whether they were considered. The proposal in the draft budget is closest to the approaches in the discussion paper. It is closest to approach 4, which is the only one that has a 1920 and 21 rate. The main difference is the absence of an additional band between £75,000 and £150,000, so the top end of that higher rate range. You have not included that in your proposals, so I would ask whether that was considered and why it was ruled out. Secondly, whether you considered a different threshold for the intermediate rate, it would be possible, for example, to set a higher threshold for that, but leviate at a higher rate, thereby protecting people on middle incomes and even on slightly above the middle income, but having a more progressive approach overall. Did you consider those two specific alternatives and, if so, why did you rule them out? I think that I would want to revisit my working notes at the time. I have tried to describe fairly to Mr Harvie that it is a pretty fluid situation, so it was not just driven by what looks like the perfect structure. It was also driven by what are the needs around public sector investment, what are the factors, what is the methodology from the SFC. I think that there was a range of factors going on at the time and the position that we arrived at. That was an intense period, post-UK budget, getting the settlement numbers, understanding how the SFC was arriving at its modelling, assessing what the expenditure demands were going to be, so all of that was fluid at the same time as trying to ensure that the system and the structure and the thresholds were where we wanted them to be. There was a variety of submissions that we had received naturally from other political parties and considerations to take into account. It is true to say that the outcome is a hybrid of the illustrative approaches that were set out in document in terms of suggesting the introduction of a starter rate as well as increasing the number of bans overall. As I say again, it was perfectly fluid. I applied the four tests and we looked at the numbers and understood the modelling. The outcome is what I have proposed in the draft budget. I wanted to come on to reconciliation as well. Later on, okay, thank you. Ash, you wanted to cover the issues around pay policy. Thank you. Recently obviously there has been a change in the public sector pay policy, the lifting of the 1 per cent pay cap, so if that goes ahead and pay rises across the public sector, what are the implications of that policy in terms of the revenue raising? I believe that the SFC built the pay policy figures into its forecasts, which generated a sum of about £55 million for income taxes as a consequence of pay policy as proposed. Okay, Neil, on the issues to do with local government council tax. Yeah, in relation to council tax. Earlier today he said that Scotland is not just the fairest tax part of the UK, but for the majority of tax payers the lowest tax part of the UK, and your budget statement also said that you are safeguarding those on low incomes. Can I ask, have you taken into account the impact of a 3 per cent rising council tax across the board when making those statements, particularly on those on low incomes? Yes. At the moment it remains the case that in terms of council tax it is still lower on average than it is south of the border, and that is even with the changes to the higher value properties last year. Yes, I am convinced that if a council chooses to use its power to raise council tax by up to 3 per cent it should not have a disproportionate effect on household budgets. I think that council tax freeze was necessary at the time, but now I also believe that it should be the case that local authorities should have that discretion to increase council tax. I do not know if we are now turning to settlement issues, but just in terms of that, yes, I feel that the 3 per cent is proportionate, and many, including Neil Bibby, have argued in the past that council should have that discretion to increase the council tax, since it is now for them to determine whether they use it or not. Of course, as part of council tax, is council tax benefit, which safeguards people, including low income earners, single people, pensioners and others as well? Do you not accept that if people on those low incomes whose tax liabilities may only reduce by £10 or £20 excluding the changes to personal allowance, this could be more than wiped out by a 3 per cent increase in council tax, and the end result could be, as a result of your decisions, that those on the low incomes actually pay more tax when you include council tax as a result of your decisions that you make? The council tax is not the decisions of the Scottish Government, it is a decision of local authorities. I would argue, of course, as Mr Bibby would expect, that local governments have a fair settlement from the Scottish Government, but whether or not they choose to increase council tax is up to them in dialogue with their local communities. I understand that it is a decision for the councils to make, but I think that we need to look at the overall tax take on people on low incomes in the round and include those. I would encourage you to look at the impact. That is a very fair question. Of course, I should look at taxation around and arriving at my decisions, and I think that income tax is a substantial engagement and a substantial shift this year to make it fairer, more progressive and restructure it. I am looking forward to seeing the Labour Party's position on income tax, which I am told is imminent. It would have been helpful if it came before the discussion paper, after the discussion paper, during the course of the parliamentary discourse, every other party seemed to want to engage in it. Even after the Labour Party found a new leader, I still did not get a tax position, but I am delighted to hear that I know the income tax policy of the Labour Party. It may be that the Labour Party should take into account the Labour Party's position on income tax when it drives a position on council tax as well. Thank you for that, cabinet secretary. You have said that if councils raise council tax by 3 per cent, it will give £77 million extra revenue for councils to spend. We will have a debate next week about the impact of that on spending, but why have you not provided that £77 million extra through income tax? Is it not more progressive to raise that £77 million through income tax, your own income tax, progressive proposals and through council tax? I think that it is fair to say that the income tax policies that I am proposing are more progressive. By the nature, income tax was progressive. However, I think that it makes it more progressive in changing it as we have proposed. If we go back to the debate on council tax, what Parliament voted on and what Parliament agreed to say was that we should continue engagement on reforming council tax. I am happy to do that, but we need to go beyond just providing a critique of the Scottish Government and into what alternatives it might look like. I think that the responsibility is on the opposition to do that. Do I happen to think that the income tax is more progressive than council tax? Yes, I do. By nature, the fact that it more accurately assesses income. Council tax is a property tax, not an income tax. Therefore, it is assessing the value of property, and there are other safeguards and checks in that as well. However, to be fair, substantial change to income tax to deliver a fairer society, we need a degree of stability right now. If we make any changes to the council tax system, we should engage constructively in that. That is the plea that I have put out to all opposition parties on that. I think that I have adequately supported local government. I have set that out at the budget. I have engaged with local government. I have met a number of leaders with COSLA, and I know, as a matter of fact, that the settlement that is proposed is far better than they were anticipating. It also delivers a very small cash increase in their settlement, and if they use their council tax powers up to 3 per cent, it delivers a real-terms increase. However, that said, it is a matter of discretion for local government. I may not get into party politics, but it is strange that Labour members ask me about council tax increases when it was eight Labour authorities that did not increase the council tax and at the same time say that those local authorities did not have enough money. It is a strange argument to say that a council does not have enough money, and therefore it proposes to raise less. It is a slightly different issue to what we have been discussing already, but it is about budget adjustments and so on, but for the longer term it is still Patrick. This is a longer-term question about the way in which the forecast of revenue raise would be reconciled in the longer term. It is not specifically a question about just this year's budget but about how we do budgets generally under this new arrangement. I prefis this with my usual apology for my share of culpability for the Smith commission and what it did. The income tax revenues, if the forecast is wrong, it is unlikely to be absolutely spot on, but to the extent that it is wrong, the forecast of income tax revenue will be reconciled in time for the 2021-22 budget. Is that correct? One of the briefings that we have had suggests that it is not implausible that that could be in the order of hundreds of millions of pounds. Is that a realistic prospect that the difference that is adjusted at that point might be in the order of hundreds of millions of pounds in any one year? I do not want to cause alarm. It is plausible that that might be correct, but not necessarily likely but possible for the very reasons that Patrick Harvie has given, that they are only forecasts. You are right that this is a product of the agreement, the system and the fiscal framework. It is based on forecasts, block grant adjustment and, at the point of reconciliation, it may well be hundreds of millions pounds or it may not be and it might be either way more relaxed. Would you like Simon Fuller to say more as the economist charged with forecasting such matters? No, the only other point that I would add to that is that you are right that the Scottish income tax forecast may be wrong and it will need to be reconciled, but what is really important for our budget is the difference in that error compares to the error that OBR is likely to make in forecasting block grant adjustment, so it is a net effect of those two numbers that should be really key. You would expect that that net effect to be slightly smaller perhaps than any of the two individual effects, but, as you say, it does vary and the forecast will certainly be different. Given that that kind of variance is possible, I am not suggesting that it is likely, given that it is possible, there does need to be some willingness to work with that possibility and take account of it. Doesn't it slightly undermine the argument that some have made that the purpose of tax devolution was to make a Scottish Government accountable for the tax decisions that it makes? If the consequences of the tax decisions that it makes are only really felt toward the end of a parliamentary term when decisions were made at the start of it. It is interesting that Patrick Harvie, of course, is asking me, not a member of the Smith commission at the time, but a beneficiary of its agreement in administering it as best I can as finance. I ask self-questions about this all the time. I simply ask—obviously—if support the devolution settlements, support the fiscal framework, support the fact that we have more powers. I think that we can only agree that it is a pretty complex way to determine a budget, and the fact that the budget is underpinned by forecasts that are reconciled in a future year does bring those risks. That is a fair point, a fair analysis. What behaviours does it generate? I think that it would encourage us to ensure that we have future flexibility. Of course, there are mechanisms in place if there is a forecast error, such as the borrowing capacity and facility if that is required, if it occurs because of forecast errors. Arguably, many of us have said that maybe the SFC's projections are a wee bit cautious. Maybe that is a good thing in that regard. It could be argued, but it will be down to the reconciliation compared to OBR. What I would say is that I think that it encourages us to have, although we have that flexibility, borrow and powers in the event of a major discrepancy. I think that it should encourage any finance secretary to have some medium-term financial planning, and that is something that the committee has encouraged. I am keen to do even more than has been done in the past, just as the functions of the Parliament have progressed and matured. Of course, we need to prepare for such scenarios, but the current projections, of course, are good, but the point is a fair one. If you were to design the system based not on forecast, it carries risk. I was just going to finish that up by asking what level of flexibility currently exists. The committee, as well as the budget review group, has talked about the lack of transparency that there has sometimes been around mechanisms that give the Government flexibility year to year. Will you be arguing for any changes or additional forms of flexibility in order to mitigate against that kind of potential risk, whether in your own term in office or for the much longer term? It does relate back to the answer that I gave to Mr Tomkins about what is essentially a maximalist position on fiscal autonomy, that the more control we have, the better, but addresses anomalies would also give us more flexibility and more room for manoeuvre in the event of such a scenario, as Mr Harvey described. It is a matter of public record what the resource borrowing facility looks like, what it could be, and then within that, if you look at budget transparency enhancement in the budget document, this is partly because of the budget review group. I am not just set out what was traditionally set out, but on page 184, I set out other contributing factors to the budget as well. That is the kind of new approach that I have tried to take to be more transparent about beyond just tax and spend, what other elements are a feature such as budget exchange, as well as what I have tried to be. This is sometimes reported on out-turn, and I am setting it out at the start of the part of the budget process in that table 1. I think that I have tried to improve transparency. I am trying to show that we are thinking ahead in terms of that modelling. The system is so complex that it carries risk. You are talking about a few million pounds in some of the block grant adjustment for some of those taxes, and those are just the forecasts. I think that you have already been fully briefed by both the SFC and the OBR, and I am sure that you enjoyed the sessions on methodology and the factors that build up their forecasts. Of course, I asked to economists for a view. You are going to get a range of different answers. I make the point that there is uncertainty. It is the best estimate that each agency has provided, but the SFC is different from EY, and it is different from Eason Fraser of Ander Institute as well. However, there is a risk carried in how we conduct the budget process, arriving from the fiscal framework. Fundamentally, the Parliament exercising its new devolved functions is one that I think has been well received. It has been the right thing to do. It makes us more accountable and engaged as a nation and hopefully can make the right policy interventions as well in any risks that can be mitigated. The final point that I will make is this. Reconciliation should not be a massive shift, because the forecasts and assessments in the year and the work of HMRC in actual outturn should be more stable and certain than is currently envisaged because we are using baseline data that is not yet concluded, because it is from 16 to 17 if people have not completed it. It is terribly complex. I appreciate the point, which is the best thing to do to explain that. I will relieve Patrick from torturing himself from his time in the Smith commission. The impact that has happened is obviously on him since. Thank the cabinet secretary for coming along and giving us evidence today. We look forward to meeting you again on Aberdeen on Monday to discuss the expenditure side of the budget. I will now close this session in the finance committee.