Inflation and pay deals Create £1.5 Billion Budget Challenge for Scottish Ministers.

Photograph: Jane Barlow/PA

   Scottish ministers are confronting a £1.5 billion shortfall ahead of next week's draft budget, as a combination of surging inflation and costly public sector pay agreements intensifies pressure on government spending.

The independent Fraser of Allander Institute characterizes the situation facing Finance Minister Shona Robison as "one of the most challenging fiscal backdrops in the history of Scottish devolution" in its annual budget report.

However, the institute, affiliated with the University of Strathclyde, cautions that proposals to introduce a new higher band of income tax fall "nowhere near enough" to balance the budget.

With substantial cuts expected across the public sector to safeguard frontline areas like health and social security, Robison has already cautioned that staffing for public services will inevitably need to be reduced.

Police Scotland has initiated a voluntary redundancy scheme, and 29 stations, including the former police headquarters at Fettes in Edinburgh, are identified as at risk of closure as part of efforts to address the budget shortfall.

The UK chancellor's autumn statement added further pressure on Finance Minister Shona Robison, who described it as the "worst-case scenario for the Scottish budget."

Amid increasing speculation about the introduction of an additional 44p rate on incomes between £75,000 and £125,000, the Fraser of Allander report has revised its estimate of potential revenue from £56 million to around £41 million. This figure falls well below the £92 million suggested by the Scottish Trades Union Congress.

The proposal reportedly sparked internal disputes within the cabinet, with some ministers expressing concerns about alienating middle-income and aspirational voters. Nevertheless, the proposal was ultimately accepted, and the Scottish Fiscal Commission was informed of the decision last week.

It's worth noting that individuals earning more than £28,000 already pay higher taxes in Scotland.

Amidst the challenges faced by the cabinet, a coalition of business networks cautioned that the proposed tax increase could hinder recruitment from other parts of the UK. Former finance secretary and Scottish National Party leadership candidate Kate Forbes acknowledged on ITV Border that it was "very difficult to protect against behavioral change."

The move to potentially introduce an additional tax rate might aim to appease Scotland's third sector. This follows a backlash against Humza Yousaf's pledge at the October party conference to freeze council tax, a policy reminiscent of the Alex Salmond era. Yousaf had assured that it would be fully funded by Holyrood, adding pressure to the budgets.

As negotiations continue and an emergency cabinet meeting takes place to navigate these challenging decisions, Green party ministers may find themselves overseeing environmental cuts despite advocating ambitious plans to address climate and nature crises. Conservation groups have been informed that NatureScot, the official conservation agency, faces a 15% budget reduction next year, exacerbated by increased wages from recent public sector pay deals.

Scotland's largest environmental groups had previously warned that NatureScot's core funding had declined by 40% in real terms over the past decade, casting doubt on its ability to meet ambitious climate and nature restoration targets.

Bruce Cartwright, the chief executive of the Institute of Chartered Accountants of Scotland, expressed concern that adding an extra tax band would result in six income tax bands for Scotland, further complicating an already intricate tax system. He emphasized the need for tax simplification to enhance understanding for taxpayers and cautioned against continually relying on taxpayer contributions to address shortfalls, deeming it a limited and unsustainable approach.