Scottish and UK governments on collision course over £740m threat to Holyrood's budget

Last week, MSPs unanimously gave their backing to the new Scotland Bill that will transfer extensive new tax and welfare powers to Holyrood over the next three years.

It followed months of negotiations between the two government to agree a "fiscal framework" for the transfer of powers.

The Scottish Government succeeded in securing a deal that will not leave it out of pocket as a direct result of the changes.

However, the arrangements are due to be reviewed after the 2021 Holyrood election when the Treasury is again expected to argue for an alternative mechanism it believes would be fairer to taxpayers in the rest of the UK.

If the Treasury succeeds, Scotland would find itself £380million worse off by 2026/27 and £740million worse off by 2030/31, compared with the present arrangements, the IFS study says.

It adds: "With significant sums at stake in the years after 2021/22, it seems that the stage is set for another round of difficult negotiations in a little over five years time."

The fiscal framework talks went to the wire, with the two governments deadlocked over how to reduce Scotland's annual block grant when Holyrood takes control of income tax and other levies.

In the end, they agreed to use a compromise mechanism proposed by the Treasury adjusted to produce the same result as the Scottish Government's method.

The IFS report confirms the Scottish Government's favoured "per capita indexation" system protects Holyrood's budget.

It says Scotland would have been £330million per year worse off under the UK Government's compromise system, known as the "tax comparability" method," by 2020/21.

The gulf would have grown to £1billion by 2031/32.

It also calculates that under the UK Government's initial plan, termed "levels deduction," Scotland would have been £900million per year worse off by 2020/21, growing to £2.8billion by 2032/32.

Economists David Bell and David Eiser, of Stirling University, and David Phillips, from the IFS, conclude the deal meets a key principle of the Smith Commission, whose recommendations formed the basis of the Scotland Bill, that Scotland should suffer "no detriment" as a result of the decision to devolve powers.

However, they say it fails to satisfy the commission's so-called "taxpayer fairness" principle.

The report found that by 2021/2 an extra £900million raised in the rest of the UK from taxes devolved to Scotland will be transferred to Holyrood to help fund higher levels of public spending north of the Border.

The cash would have been transferred had the new powers not been handed to Holyrood - but the Treasury argued such transfers should end when taxes were devolved.

David Phillips, one of the report's authors, said: "In the end, the Scottish Government’s preferred approach was chosen, which prioritises the ‘no detriment’ principle.

"During the negotiations, the UK government had claimed this approach was unfair because it violates the ‘taxpayer fairness’ principle.

"This begs the question of whether the UK government has changed its mind or merely conceded the point."

The report also confirmed that the Scottish Government stands to gain or lose out to the tune of billions of pounds depending on future tax revenues and demand for the benefits devolved to Holyrood.

Using different forecasts, the Scottish budget could easily be more than £500million bigger or small after five years and £2billion different after 15 years.

Deputy First Minister John Swinney said: "The fiscal framework agreement implements the principles of the Smith Commission and is fair to taxpayers in Scotland and across the UK.

"This analysis by the IFS demonstrates Scotland’s budget could have been cut by £300million a year by 2020/21 if the UK Government’s preferred model had been implemented."