Making sense of the Holtham Commission’s report

The Holtham Commission’s report, published on Tuesday (and available here if you’ve not looked at it yet), is a fascinating document.  It illustrates, vividly, an intriguing maxim of devolution in Wales (and the UK more generally): the conservatism of its radicalism.  For the third time now in recent Welsh history, an independent expert commission has looked at important aspects of how Welsh devolution works, and concluded that simply in order to make the underlying principles of the status quo work properly, there need to be very substantial changes.  In two of those cases – the Richard Commission in 2004, and the Holtham Commission now – politicians have initially reacted with great caution, even scepticism.  In the case of the All Wales Convention, which largely restated the conclusions of the Richard Commission 4 1/2 years earlier, it was embraced much more enthusiastically.  The first reactions to Holtham may not be the wisest – and the present silence of the Assembly Government is a prudent response.

Holtham end up with many similar conclusions to the Calman Commission for Scotland.  Devolved government should be funded by a combination of a block grant, calculated on the basis of relative need, and own-source tax revenues.  The main tax to provide those would be personal income tax, accompanied by some smaller taxes like stamp duty land tax or landfill tax.  Like Calman, the report recommends that UK income tax in Wales should be reduced by 10 points, and a commensurate reduction made in the amount of the block grant.  Like Calman, it calls for a borrowing power to finance capital expenditure, at the discretion of the Assembly Government, and the power for the National Assembly to introduce new taxes, with Westminster’s consent.

In some ways, Holtham is more radical than Calman.  It is willing to countenance the devolution of corporation tax, though it acknowledges the legal and practical problems this presents and emphasises the need for further thinking and debate about it.  (I think this is more problematic than the Commission do, but that’s an issue for another time.)  And Holtham treats it as axiomatic that the income of Welsh rates of tax should depend on actual revenues, not estimates even for a transitional period.  The use of estimates was a problem with the Calman recommendations; even more so with the version of them adopted by the Labour UK Government in its white paper Scotland’s Place in the United Kingdom last November. It’s also explicit about the need for full End Year Flexibility over the block grant, a rather technical issue that can provide an important degree of flexibility in managing devolved finances.

One thing that’s particularly impressive about the Holtham report is the thorough and careful way it analyses the effects of its recommendations – whether it would be the impact on tax revenues of the changes in tax rates that it contemplates, or how to calculate a reduction in the size of the block grant.  Most impressive is its work (mostly in its first report, not this one) on how to calculate the block grant – a simple ‘top-down’ grant that could capture most elements of need in a relatively simple calculation.  While Calman called for a needs-based block grant, it said nothing about how that might be done, let alone when it might be introduced.

The report also provides a lot of important data about taxation in Wales.  Table 4.1 gives the first up-to-date figure for total tax revenues from Wales (£17.1 billion in 2007-08), for example.  As total identifiable spending in Wales was (according to PESA 2009) was £25.309 billion and local taxation generated £1.921 billion, we now know the scale of Wales’s fiscal deficit: £6.3 billion.  That is not only a huge sum, but accounts for not much less than a quarter of total identifiable spending in Wales.   This puts the issue of Wales’s long-standing weak economic performance at the forefront of devolution finance debates as well as economic development ones.

There are some interesting departures from Calman, though.  First, Holtham suggests that the Assembly Government should have power to make different changes to the rate of Welsh tax across the various tax bands, while Calman said that the Scottish rate would have to be the same across all the tax bands.  That would leave the UK Government in control of the progressivity of the tax system.  Holtham thinks that Wales should control progressivity as far as the Welsh rate of tax is concerned, so it could introduce greater change in standard rate tax than higher rate, or vice versa.  (I’ve made a similar argument for Scotland, in my recent piece for the Scotsman.)

Second, it suggests a formal constraint on how much Welsh tax rates could diverge from UK ones.  While Wales would get 10 income tax points (with UK income tax being reduced by 10 points – so standard rate tax in Wales would be 10 per cent, not 20), it could only vary from the UK rate by 3 points, up or down. So, while UK standard rate tax remains 20 per cent, standard rate income tax in Wales could be no less than 17 per cent and no higher than 23 per cent.  Economically, it is not really necessary – as the report points out, the economic consequences of a wide degree of divergence are a powerful restraint.  And constitutionally it is undesirable as well.  However, it makes much more sense politically, as a way of comforting Welsh tax payers that they will not be subject to wildly different levels of tax than ones on the other side of Offa’s Dyke if the Assembly were to put taxes up, and of comforting HM Treasury that the UK would not be subject to a high degree of tax competition from Wales if the Assembly were to reduce taxes.

But what’s most telling is the logic underlying the report’s overall argument.  As was the case for Calman, it finds the accountability argument compelling.  A government that spends money but has no responsibility for raising it doesn’t make its voters bear the full burden of its decisions.  Such a government can simply blame its funder whenever it wishes; and the funder has no control over the services provided by the devolved government.  That only changes if a devolved government also raises a substantial part of its own revenue, and both has to make more balanced judgements about its policies, and accept the verdict of the voters for those judgements.  In the Holtham Commission’s view – the view of three experienced economists, not politicians, lawyers or other pundits – the present arrangements simply do not work.  A devolved government needs to be more than just an elected spending agency, if it is to be properly accountable.

That view is already proving controversial in Wales – Rhodri Morgan, for example, has rejected the idea.  But the logic is a powerful one, especially if it can be combined with a redistributive UK-level grant to help ensure equity in public services.   The Holtham report makes a considerable effort to ensure that this would be the case, by the work it has done (in its first report, and working paper on needs assessment) on revising the block grant.  It was initially pretty controversial in Scotland as well; the immediate response to the Calman report was pretty lukewarm from unionist parties, as well as attracting fairly predictable criticism from the SNP.  But within a matter of months support for fiscal devolution in Scotland has grown hugely, to the point where Calman is now seen as a very modest move, not a radical one.

The big question now will be what the UK Government does.  We’re promised a further white paper, and a bill, implementing Calman in the autumn.  The expectation has been that that would just relate to Scotland.  Indeed, the Coalition’s Programme for Government not only covers that, but prejudges the Holtham report by promising a ‘Calman Commission for Wales’ at some future date, when the public finances are restored to order.  The Holtham report puts the UK Government under a lot of pressure to rethink that.  It has done much of the heavy lifting to work out how limited fiscal autonomy and a needs-based block grant would each work, and interact with each other. This is work that the UK Government appears never to have done at all (it has never published it if it did it).  And as the Holtham report argues strongly that this approach can be made to work for Wales as well as Scotland, it creates a basis for a more consistent way of funding devolution across Britain, in contrast to the set of disjointed and ad hoc approach that has been taken up to now.

(This is a slightly revised version of a post that appears under the heading ‘Conservative Radicalism in Wales’ on the blog of Public Finance, the magazine of the Chartered Institute of Public Finance and Accountancy, available HERE.  The figures for the size of Wales’s fiscal deficit in the fifth paragraph have been corrected since its first publication, in response to the comment by Syniadau below.)

For another discussion of Holtham from a Scottish perspective, see James Mitchell’s piece from today’s Herald here.