After weeks of leaks and speculation, yesterday Rachel Reeves finally unveiled her Budget setting out the UK Government's tax and spending plans for the coming years.

In preparing the Budget the Chancellor faced a daunting set of challenges. Economic growth has stalled through the second half of 2025, and a weaker productivity forecast from the Office for Budget Responsibility (OBR) further constrained revenue forecasts. Even before any new policies were announced, this left a multibillion-pound hole in the public finances that needed to be filled if the Government was to meet its own self-imposed fiscal rules and retain any meaningful headroom.

Compounding this, a series of manifesto commitments had already ruled out changes to the largest revenue-raising taxes – income tax, national insurance, and VAT. As a result, the Chancellor was forced to choose between breaking election promises or trying to plug a widening fiscal gap with one hand tied behind her back.

While the Scottish Government’s Budget is not due to take place until January, the decisions outlined in the UK Budget affect Scotland in several ways. Reserved policies apply in Scotland directly, while changes in devolved areas flow through to the Scottish Budget via the Block Grant and its adjustments. In some cases, UK decisions can also interact with specific Scottish Government commitments, creating additional knock-on effects.

In this blog, we explore the implications of the UK Budget on Scotland’s public finances, assessing the likely impact of the most significant policy announcements. 

Perhaps the biggest announcement was the freeing of income tax thresholds until April 2030, despite the chancellor previously committing to uprating them with inflation from April 2028. This ‘fiscal drag’ measure will raise £8 billion in 2029/30 for the UK Government by pushing more taxpayers into higher bands as nominal earnings rise – even when those earnings only keep pace with inflation.

Although income tax is devolved to the Scottish Government, this decision will reduce the grant that Scottish ministers receive from the UK Treasury – even though income tax policy in Scotland remains unchanged (for now). This in turn will put pressure on the Scottish Government to follow suit and raise additional revenue from income tax to avoid cuts. To understand why, we need to look at how the devolved Fiscal Framework operates.

Most of the Scottish Government’s budget comes from the UK Government’s Block Grant, which in turn is determined through the Barnett formula. Because income tax used to be administered by the UK Government, the Block Grant is now adjusted to reflect the fact that Scotland raises this revenue itself. Specifically, the Block Grant is reduced by an estimate of what the UK Government would have collected from Scottish taxpayers had income tax not been devolved. This Block Grant Adjustment (BGA) produces the net Block Grant, which is then topped up by the actual income tax revenue collected in Scotland.

The Scottish Government’s net income tax position – the difference between what it raises and what is deducted through the BGA – depends on how income tax receipts per capita grow in Scotland relative to the rest of the UK. This means UK income tax decisions directly affect growth in rUK receipts, the size of the BGA, and therefore Scotland’s net position – even when Scottish income tax policy is unchanged.

The logic behind this is straightforward: the Block Grant is tied to UK Government spending, and UK spending is shaped by UK tax decisions. If the UK Government raises income tax to fund stronger public services, Scotland should not benefit from higher Block Grant funding while keeping its own taxes lower. Equally, if rUK reduced income tax, it would be unfair for Scotland’s Block Grant to fall without an offsetting adjustment.

In practice, this means that when the UK Government raises income tax – either directly by raising tax rates or indirectly by freezing thresholds – the Scottish Budget takes a hit. According to the OBR, the UK Government’s decision to freeze thresholds will reduce Scotland’s budget by £51m in 2029/30 through an increased BGA. While relatively small in the context of the overall Scottish Budget, this still adds to the already difficult medium-term outlook for resource spending.

The UK government also announced two percentage point increases to income tax rates charged on savings, dividends, and property. This was unexpected and also has implications for Scotland.

Taxation on income from savings and dividends is reserved to the UK, which means Scottish taxpayers will face the higher rates, but the Scottish budget will be unaffected. Income from renting out property however falls within devolved tax powers. Therefore, bar any policy changes at the next Scottish budget, Scottish landlords will continue to face Scottish income tax rates, but the additional revenue the UK government raises from the reform will lead to a larger Block Grant Adjustment and impact the Scottish budget negatively.

How large could the impact on the Scottish budget be? The UK government estimates the policy could raise £435m in 2029/30. We estimate that the negative impact on the Scottish budget through a larger BGA impact could be just below £30m. 

As such, the Scottish Government must now decide whether it wants to follow the UK in creating differentiated tax rates for property income, or retain the status quo and absorb the loss from the BGA adjustment. As the Scottish Government has made income tax more progressive in recent years, Scottish taxpayers are already paying different, and in many cases higher, tax rates on their income from property compared to the rUK. As the chart below shows, only landlords earning less the £43,662 in combined employment, self-employment, pension and property income will pay a lower income tax rate in Scotland on their property income.  Those earning above this are already paying higher income tax rates than those across the rest of the UK, even accounting for Rachel Reeves's new increase. 

While the Scottish Government could mirror the UK policy move and tax Starter, Basic, and Intermediate rate taxpayers at 22% for their property income, this would probably only impact a small fraction of landlords – most of whom are are likely to be concentrated in higher income brackets. Alternatively, it could decide to increase income tax on property income by 2% across all tax bands, as the UK has done – raising more revenue but widening the gap in tax rates between Scotland and rUK.

Another major announcement was the scrapping of the two-child benefit cap, formally known as the Two-Child Limit (2CL). This restricts the child element of Universal Credit to the first two children in households with children born after April 2017. This is a long-overdue and welcome move that will support the shared UK and Scottish Government goal of reducing child poverty.

Analysis from the Resolution Foundation estimates that abolishing the limit will lift 330,000 children out of poverty across the UK. Previous Scottish Government analysis estimated that around 10,000 children in Scotland would be lifted out of poverty by the measure.

The decision also has important budget implications for Scotland. The Scottish Government had planned to mitigate the 2CL from 2026/27 onwards – a commitment the Scottish Fiscal Commission (SFC) estimated would cost £156m in 2026/27, rising to £209m by 2030/31 as more households were affected. With the UK Government now scrapping the limit at source, this mitigation will no longer be required.

However, the savings will be slightly smaller than the SFC’s original forecast. The Fraser of Allander Institute estimates net savings of around £120m in 2026/27 once indirect costs are taken into account. For example, removing the 2CL will make more families eligible for Universal Credit – the key qualifying benefit for the Scottish Child – which will increase caseloads and costs for the Scottish Government. It may also push more families up against the UC Benefit Cap, which the Scottish Government partially mitigates through Discretionary Housing Payments.

Even with these offsets, the Scottish Government will still see a significant net saving – and it has committed to redirecting the freed-up funding towards other measures aimed at eradicating child poverty.

A new ‘mansion tax’

One of the more headline-grabbing budget announcements was the introduction of a new ‘mansion tax’, designed as a surcharge over Council Tax on houses worth over £2m pounds.

This tax will only be levied on houses in England, so Scottish households will be unaffected. The potential impact on the Scottish budget is currently unclear. The chancellor said the revenue from the surcharge would go to the UK government. If this revenue is used to direct more funding to local authorities, this additional spend – funded by an England-only tax – could yield Barnett consequentials for Scotland and Wales. Alternatively the UK Government could factor the ‘mansion tax’ into the Block Grant Adjustment calculations for another tax like Stamp Duty. 

How the policy will interact with devolved financial frameworks has not been clearly set out. However, the policy points towards a shift in attitudes towards the taxation of wealth that should spur action this side of the border too. We have long argued that the existing council tax system in Scotland needs to be fundamentally overhauled, and tinkering with the council tax band multiplier does not address the regressiveness and unfairness inherent in the system. Instead of simply mirroring the new UK surcharge on high value properties, the Scottish Government should instead undertake more fundamental reform – replacing council tax with a proportional or progressive property tax. We will be publishing more work on this over the coming months.

In addition to tax changes, the UK Budget also resulted in increased government spending, which will boost funding for Scotland through the Barnett formula. In practice, it will deliver around £0.5 billion more resource funding for Scotland spread over four years, and £0.3 billion more capital funding over five years. The pattern of these additions is uneven, with a short-term uplift that quickly tails off and even turns into a small cut in day-to-day spending by 2028-29. 

This reflects changes in UK Government spending on devolved areas rather than any deliberate decision about Scotland’s budget – it is simply the automatic result of how the Barnett Formula distributes funding. While by no means game-changing, this modest funding boost is welcome – and the Scottish Government must decide how this is most effectively allocated given the broader challenges facing the public finances.

Although Rachel Reeves ultimately opted not to raise income tax rates, the recent speculation around this exposed quirks in the devolved fiscal framework that could have serious implications for Scotland’s public finances in the future. 

In the run-up to the Budget, there were strong signals that the UK Government was preparing to raise the basic rate of income tax by two percentage points, to 22%. As discussed above, any such change would have automatically increased Scotland’s income tax BGA and cut the funding available to the Scottish Government – even if Scottish income tax policy remained unchanged. 

Using a similar methodology as the Fraser of Allander Institute, we estimate a 2% rise in the basic rate would have reduced the Scottish Budget by around £810m in 2026/27 and £951m by 2028/29, forcing significant tax rises or spending cuts. While the UK Government backed away from the change, the episode illustrates how vulnerable Scotland’s finances are to rUK decisions.

Any major change to rUK income tax rates leaves  Scottish ministers facing a stark choice: maintain the existing income tax structure and absorb the BGA hit through spending cuts, or mirror rUK policy to protect services. In practice, devolved tax autonomy is sharply constrained.

The episode also exposes a more uncomfortable truth about Scotland’s current income tax position. Because tax-base growth in Scotland has been slower than in the rest of the UK, Scotland has captured only a fraction of the benefit of introducing a more progressive income tax system. The SFC estimated that in 2025/26 the Scottish Government’s policy income tax position – how much extra it raised compared to a UK-norm baseline – was £1.7bn, equivalent to income tax being 8.9% higher than under UK policy. But once Block Grant Adjustments were applied, the actual net benefit to the Scottish Budget was only £616m, roughly a third of the value of the policy gains. In other words: the Scottish Government’s income tax reforms are raising only a third of what would be expected. 

Had the UK Government raised the basic rate by 2%, this would have almost wiped out Scotland’s net income tax advantage, reducing it from a projected £1.1bn in 2026/27 to around £260m. In effect, Scottish taxpayers would have paid significantly more tax than their rUK counterparts while Scotland’s budget would have seen almost none of the benefit. This stark result is driven mainly by slower growth in income tax receipts per head in Scotland and by the way this feeds into BGA calculations – an issue already highlighted by Audit Scotland.

Underlying this are structural factors largely outside devolved control. Scotland has fewer high-earning taxpayers, who are disproportionately concentrated in London and the South East, and it is more exposed to sectors that have contracted, such as oil and gas, rather than fast-growing sectors like financial services. These long-running structural differences depress Scottish income tax receipts relative to rUK. Although the fiscal framework is intended to reflect Scottish choices and economic performance, in practice it penalises Scotland for features of its economy that it cannot meaningfully influence.

As such, we recommend that the UK and Scottish Governments begin discussions on revising the devolved fiscal framework to account for these differences and ensure Scotland is not penalised for factors largely outside its control.