The Scottish Government is facing a stark choice between “axing, taxing and hoping” for more money and powers from London, a leading economic thinktank has warned.

The Institute for Fiscal Studies (IFS) said expensive spending policies, underwhelming tax revenues and inflationary pressures had left Nicola Sturgeon’s administration in a financial bind.

The SNP-Green Government projected last year its spending would outstrip its income to leave a funding gap of £3.5billion by 2026/27, equivalent to 8 per cent of its budget.

Equivalent to £640 for every person in Scotland, bridging it in one move could add 6 to 7p to all rates of income tax.

SNP finance secretary Kate Forbes is due to publish the Scottish Government’s Medium Term Financial Strategy and Resource Spending Review on Tuesday setting out day-to-day spending plans for the next four years.

The Scottish Fiscal Commission, the independent oversight body for Holyroood’s budget, will publish its five-year economic and fiscal forecasts for Scotland the same day.

In a briefing paper looking ahead to next week, the IFS said the Scottish Government would “have to either take the axe to certain areas of spending, plan for higher levels of taxation - or ignore the issue for now, hoping instead for extra funding or borrowing powers from the UK government to ease the fiscal situation”. 

It added: “Some very tough decisions will therefore need to be communicated next week, unless the Scottish Government instead decides to pin its hopes on the UK government topping up UK-wide spending by around £40 billion - a scenario which seems unlikely.”

The Scottish Tories said Scottish Government incompetence was responsible for a “huge black hole” in the public finances.

The IFS said bridging the gap would be tricky in the best of times, given Holyrood’s limited borrowing and saving powers under its Fiscal Framework arrangement with the Treasury.

However the next four year “will be far from the best of times”, making it even harder.

The thinktank said some of the issues were of the Scottish Government’s own-making, including its decision to increase social security spending, while others were largely outside its control, such as slower economic growth relative to the UK, the pandemic and soaring inflation.

The latter meant its plans for public sector pay rises of 3 to 4% may not be enough, as they would leave workers facing real-terms cuts.

Its observation paper said: “Because it is not in general allowed to borrow to fund day-to-day spending, it will have to choose some combination of axing, taxing, and hoping for the UK government to top [up] its spending plans.”

But banking on the UK plugging the Scottish Government’s spending gap was “risky”, as the Treasury would need to increase its spending by more than £40bn to generate an extra £3.5bn for Holyrood.

The thinktank suggested Ms Sturgeon’s most likely course would be to delay tax rises or cuts for political convenience, with the independence campaign a factor.

It concluded: “Difficult choices on Scottish tax and spending over the next few years will eventually have to be faced. Political considerations - including those related to the Scottish Government’s desire for another independence referendum - will undoubtedly play a role in whether those choices are made clear next week or not. 

“Announcing them could be delayed, but they can’t be avoided for long.”

Co-author David Phillips, an associate director at the IFS, said:  “A series of expensive spending commitments on top of underlying spending pressures mean that the Scottish Government faces a multi-billion budget shortfall over the next four years under current forecasts. 

“Because it cannot borrow to fund day-to-day spending except in some limited circumstances, next week’s Scottish Spending Review could see the announcement of pretty hefty tax rises or cuts to spending on lower priority services, and even the abandoning of some policy commitments, to bring the budget into balance.       

“Alternatively, and perhaps most likely, the Scottish Government could pin its hopes on further UK government funding being forthcoming. 

“That is effectively the gamble made in the SNP’s 2021 election manifesto, and indeed a significant boost to funding was subsequently announced. But repeating the gamble might well not be as successful this time. 

“While further funding top-ups could be on the way it seems unlikely that the UK government will top up its plans by anything like enough to allow the Scottish Government to pay for all of its policy priorities without some hard choices on tax and/or other areas of spending.’

Tory MSP Liz Smith said: “These forecasts are a damning indictment of the SNP Government’s economic mismanagement and will be deeply concerning to both Scottish taxpayers and to the wider public.

 “There is already a huge black hole in the Scottish Government’s budget and now economists are telling us that it has just got a whole lot bigger thanks to the profligacy of Nicola Sturgeon. The financial shortfall is the product of incompetence from an SNP Government which has squandered taxpayers’ money on a whole range of failed public sector projects, of which the ferries fiasco is top of the long list.

“The writing has been on the wall for many months now. The Scottish economy is not performing as well as it should be, mainly because the SNP has failed to address long-term productivity problems and imbalances in the labour market. These are having detrimental effects on both tax revenue and investment, and the blame for this lies firmly at Nicol Sturgeon’s door.”

Labour MSP Daniel Johnson said: "The IFS paper lays bare the price of SNP economic failure. 

"Fifteen years ago, Scottish salaries were growing more quickly than the UK average - now they lag behind. 

"It is clear that the spending review, due next week, will spell out the heavy cost all Scots will have to pay for nationalists prioritising constitution over the economy.

"This will be counted in lost jobs, cuts to public services and few will be able to forgive the SNP them for it."

Scottish Liberal Democrat fiinance spokesperson John Ferry added: "Scotland gets a good deal as part of the United Kingdom's pooling and sharing arrangements and Nicola Sturgeon is only too happy to cash the cheques.

“Unfortunately the SNP's management of the Scottish economy has left a gaping hole at the heart of our public finances. The fact is Scots are faced with paying more and getting less under the SNP.

"Almost every economic intervention the SNP have attempted has blown up in their faces and Scottish ministers are becoming a byword for managerial incompetence.

"It’s time to replace this SNP/Green government with one that has a clear plan for driving up productivity, encouraging investment and creating highly skilled, well-paid jobs. That’s how to close the gap.”

A spokesperson for Ms Forbes said: “The IFS are right to highlight the challenges caused by rising inflation and by uncertain UK government funding decisions, which can dramatically reduce Scotland’s budget at the drop of a hat.

“While the chancellor offered some support to households, he has done nothing to support the public sector and public sector workers, who have helped the country through the pandemic, in the face of rising costs. 

"Our budget is already worth less this year as a result of inflation and – without the borrowing levers available to other governments – the Scottish Government faces challenging spending decisions.

“The Spending Review is not a budget, but it will set out how, within those limited means and powers, we will focus our resources to help with the cost of living crisis, to tackle child poverty – which is only being exacerbated by the actions of the UK Government – to grow our economy and to support our public sector.”