HOLYROOD’S budget could shrink sharply because of Westminster rules if the Scottish economy lags behind the rest of UK’s after the Covid crisis, the financial watchdog has warned.

Caroline Gardner, the outgoing Auditor General for Scotland, said ministers could face “really difficult choices” if tax revenues per person fail to keep pace with those in England.

The issue lies with the 2016 fiscal framework agreed between Holyrood and Westminster which defines the Scottish Government’s tax and borrowing powers. 

Under the framework, Scotland’s budget is badly hit if the growth in tax revenues per person lags behind those elsewhere in the UK.  

The target is already hard to hit because of the relevant dearth of higher and additional rate taxpayers in Scotland.

However it could be made even harder because Scotland’s economy is highly exposed to the tourism and hospitality sectors most affected by the lockdown. 

Mr Gardner told BBC Scotland’s Sunday Politics: "Over the last couple of years Scotland has taken on responsibility for raising much more of the money that we spend here in Scotland, from about 10 per cent four years ago to 40% now, and potentially rising further.

“In the short term the [Scottish] Government has got a challenge managing cash during the current year. Its got some limited revenue borrowing powers, but they were never designed ti take account of something as big and all-consuming as the coronavirus crisis.

“The real challenge though comes in the longer term. 

“If Scotland’s taxes are affected in the same way as those in England and Northern Wales, then actually our budget will be insulated from the effects of that, and what’s important is what decisions the UK Government takes about how it will repay the enormous borrowing its undertaken to respond to the crisis.

“But if our tax revenues take a bigger hit per capita than those in the rest of the UK then potentially our budget will start to decline quite fast, and that will mean some really difficult choices here in Scotland about taxation and about public spending.”

SNP Finance Secretary Kate Forbes last week formally requested the UK Government for the power to borrow and extra £500m for Covid spending this year, plus other temporary “flexibilities” to overcome the restrictions imposed by the framework.

Asked if the Scottish Government was sensible to sign up to the framework in the first place, Ms Gardner said she had a “fair mount of sympathy” with ministers’ decision to accept the new powers that were part and parcel of the framework.

She said: “That is very much what this government is committed to - increasing devolution to Scotland with an aim of moving towards independence. 

“The fiscal framework was a process of negotiation between the two governments. 

“The per capita basis on which our taxes and revenues are adjusted provides us with some protection there, and it’s always been intended that the fiscal framework will be reviewed in 2021.

“What nobody could have predicted was this coronavirus pandemic and the overwhelming impact it’s had on the UK economy as a whole

“I do think there’s a case for a bit of additional flexibility for the Scottish Government this year, but for me it really does highlight the importance of getting the fiscal framework right in future.

“We know much more about the Scottish taxbase than we did when the fiscal framework was agreed, and we can therefore come up with better forecasts of what might happen under different scenarios.  

“Secondly I think it’s really important that the [Scottish] Government does produce much more transparency in its own long-term financial planning.

“That transparency is really key with these powers and we’re not seeing it just now.”