The wrong questions about devolution finance in Wales

The latest issue, no. 15, of the Bevan Foundation Review, is now out.  Alongside an array of articles about justice-related issues, I’ve got one on the implications of Wales’s ‘fiscal gap’ and economic performance for the constitutional options now available there.  The content is unlikely to surprise regular readers of this blog, but this is what I’ve said there.

It’s been fascinating to watch Welsh politicians as they respond to the Holtham Commission’s final report on funding and finance. Clearly they’ve found it useful to receive confirmation for the argument – long advanced by Plaid, now embraced by Labour – that Wales receives less than its fair share of funding through the block grant. Other aspects of the report, notably its proposal to include a limited measure of fiscal autonomy in financing devolved government in Wales, have drawn much less support. Of course, the Coalition Government  has already muddied these waters by promising a  ‘Calman-style review’ of finance for Wales, to take place after a ‘yes’ vote in a referendum on primary  legislative powers and only to be implemented after the public finances have recovered. This isn’t so much an offer of jam tomorrow as a conditional offer of a modest amount of low-fruit spread in several years’ time, and it ignores the fact that Calman was – for all its flaws – an initiative that started in Scotland, not London.

The key part about Holtham’s fiscal recommendations is the logic underlying the argument for a limited degree of fiscal autonomy, centred on income tax, to be introduced after ensuring that the block grant adequately reflects relative needs.  As was the case for the Calman Commission in Scotland, Holtham reached this conclusion because of arguments about accountability. 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. (If it did, devolution would be pointless.) That only changes if a devolved government also raises a substantial part of its own revenue. Then, it 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 very 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. None of this about what powers the Assembly and Assembly Government might acquire in future (one reason why the Coalition’s proposal is so odd). It relates entirely to the existing nature of devolved government, not its possible future form. That view is clearly controversial in Wales, and has been rejected by Rhodri Morgan, for example. 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. Technically speaking, Holtham did a terrific job in showing how these two goals could be brought together, doing a lot of heavy intellectual lifting that the Calman Commission ducked.

Both sets of political responses so far conflate issues that properly should be regarded as distinct. Some, like Carwyn Jones, are determined to press for ‘fair funding’ before, and regardless of, a referendum. Others, like Cheryl Gillan, are keen to defer financial issues and link them to the nature of Wales’s constitutional powers. Gerry Holtham has been keen to emphasise that the amount of funding for Welsh public services relates to place, not to the constitutional form of government – and he’s right. If Wales is under-funded, there is no good reason to make fixing that conditional on a referendum. But because the sort of fiscal autonomy he recommends relates not to any extended form of devolution but to the present one, there’s no reason to link that to a referendum vote either. It’s understandable to want to see the Assembly put on a proper footing both constitutionally and financially at the same time, and an Assembly with legislative powers but hamstrung financially is clearly undesirable. But these are different debates about different issues.

In any case, the big question is not who’s right or wrong, but where this debate goes now. The problem is that it’s hard to avoid concluding that the politicians, so far, are talking about the wrong issues. The ‘funding gap’ has attracted much interest, and no wonder. It’s a great political cause, and ‘winning’ an extra £300 million for Wales would be a fine prize for whoever won it, but it’s probably going to be a lost one. For one thing, the gap is, in fact, pretty small. It’s about 2.1 per cent of the Assembly Government’s overall spending. While it’s hard to argue that Wales is generously treated when it comes to the allocation of public resources, the funding gap doesn’t explain the shortcomings in any of those services. Would public services in Wales be dramatically different if the gap were remedied overnight? It’s highly unlikely. Filling the gap would not be a panacea for problems in Welsh health services, schools, universities or roads. Doing so would remove a justifiable source of grievance, but problems in public services are much more to do with what government does and how it does it than this particular gap.

For another, it will be very easy to win this battle but lose the war. It’s essential to remember that the funding gap is a relative gap, not an absolute one. Wales gets 112 per cent of spending on comparable functions in England. Holtham argues that it should receive 115 per cent to take account of its relative needs, and to be able to provide the same level of public services as people in England enjoy. Given the scale of spending cuts that are looming in England, it would be quite easy to redress that relative imbalance while at the same time reducing the total amount of Assembly Government’s block grant. Remember that most departments in Whitehall are looking at 25 per cuts in their budgets. Health and education are being protected, and together account for about 75 per cent of changes in the Assembly Government’s block grant; but cutting 25 per cent of the remaining 25 per cent would almost certainly eliminate the gap. Even if London does nothing, Wales could find itself receiving the now-talismanic 115 per cent of English spending on ‘comparable’ functions, without getting a single extra penny in the block grant – indeed, conceivably by getting less. Arguments to increase the Assembly Government’s resources by talking about ‘fair funding’ would then have no weight at all. If the aim is to increase the Assembly Government’s resources or improve public services in Wales, you need to start looking elsewhere.

Second, Holtham enables us to work out how bad Wales’s fiscal deficit is. Holtham was able to formulate accurate figures for the tax revenues from Wales: £17.1 billion in 2007-08 (see table 4.1 of the full version of the report). That means that for the first time since 1997 we can see how much higher public spending is in Wales than are the tax revenues generated there. Total identifiable spending in Wales was (according to Public Expenditure Spending Analyses 2009) was £25.309 billion and local taxation generated £1.921 billion, so Wales’s fiscal deficit is £6.3 billion. That is a huge sum; it accounts for a shade less than a quarter of total identifiable spending in Wales. It gets worse if we look at it as a proportion of national income: it’s 14.2 per cent (income calculated using a GVA figure for 2007 from the Office for National Statistics). Compare that with Scotland, which with significantly higher levels of funding for ‘comparable functions’ had a fiscal deficit of 9.8 per cent when North Sea oil tax revenues were wholly left out of the picture, 9.0 per cent of GDP when a per capita share of North Sea revenue was allocated, and 2.7 per cent of GDP when allocated an estimated geographical share of North Sea revenue (Scottish figures from Government Expenditure and Revenues Scotland 2009). So Scotland, ‘over-funded’ as it’s said to be, is much closer to being in fiscal balance than ‘underfunded’ Wales. Eliminate the ‘over-funding’ in Scotland, and it would be pretty much in fiscal balance even on the least favourable treatment of North Sea oil revenues. Fix the ‘funding gap’, and Wales’s fiscal deficit will be worse than it already is.

The point of this is not that Wales is in poor economic shape, but that its poor economic shape affects a huge range of constitutional issues as well. A system of financing devolution that has to cope with such huge, entrenched disparities is going to come under very serious strain. It’s no accident that the most comprehensive system of redressing disparities in a federal country – that used in Australia, and run by the Commonwealth Grants Commission there – operates in a country that for the most part has pretty limited economic differences between the states, and the pattern of ‘winning’ and ‘losing’ states is constantly in flux. The Northern Territory excepted (which has a tiny population, so the amounts of funding involved are small even if the proportions are huge), pretty much every part of mainland Australia will at some point run a fiscal deficit, and at others be in ‘fiscal credit’. An egalitarian system of fiscal federalism can work pretty well in a homogeneous country like that. The UK is quite different; the differences in prosperity and economic performance are much wider, and pretty deeply entrenched. Now we know the extent of that, it’s necessary to put the issue of Wales’s long-standing weak economic performance at the forefront of devolution finance debates as well as economic development ones.

The answers to those economic development problems are far from straightforward, and I’m not a specialist in them. But two points are striking. One is that the strategy followed for some time, of concentrating on attracting inward investment, hasn’t yielded sufficient dividends, for all that it consumes a large (and increasing) proportion of the Assembly Government’s budget. Maybe the new strategy recently unveiled by Ieuan Wyn Jones will herald a sea-change; but a new approach is clearly needed. The other is that tax-raising powers are one important lever to spur economic growth. Being able to offer a more attractive set of tax rates is a key element of securing economic development – just look, for example, at how Sweden was able to build its welfare state on a combination of low corporate tax rates combined with high personal and consumption ones. The pursuit of fiscal autonomy in Scotland (particularly ‘full fiscal autonomy’, as espoused by the SNP government) is rooted in a similar desire to shape Scotland’s economy in Edinburgh, to fit Scottish needs.

How Wales’s political parties respond to these challenges is up to them. But if they want a Wales that can sustain a generous, social-democratic welfare state, simply trying to screw more money out of the UK Government isn’t the way to do it – especially when that’s a Conservative-dominated government intent on cutting public spending, if not taxes. They need to ensure Wales is able to fund much more of its services than it can at present, and is less dependent on transfers from elsewhere. And a measure of tax autonomy may provide them with the economic and fiscal means to do that.

The Bevan Foundation’s own website is here, and their blog This is My Truth is here.

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5 Comments

Filed under Comparisons from abroad, Devolution finance, Publications and projects, Wales

5 responses to “The wrong questions about devolution finance in Wales

  1. DSKS

    I thoroughly agree that some level of fiscal independence is critical.

    Regarding this statement,
    “An egalitarian system of fiscal federalism can work pretty well in a homogeneous country like that. The UK is quite different; the differences in prosperity and economic performance are much wider, and pretty deeply entrenched.”

    It seems to me that a lack of fiscal federalism is in large part responsible for sustaining the current differences in prosperity by, as you later describe, preventing regions from competing with a certain south eastern region for business presence. It’s simply too difficult to modernise under those circumstances. Interestingly, the US, which has done a plum job of getting federal fiscal policy wrong for several decades, is actually starting to get it right in terms of investing in, rather than simply propping up, the American equivalents of the Wales’ and Scotlands. This investment can only work here though because the states already have sufficient fiscal autonomy to take the logical next step and use this initial investment to secure further private investment that, in time, will ween them off the central government’s teet (or at least, make them less reliant on it than California, NYC, Texas and everybody else).

  2. Jeff Jones

    Another excellent contribution to the much needed debate which is sadly being ignored by most politicians in Wales. The £300 million and full lawmaking powers are now seen by too many in my opinion as the talisman which will solve all ills.No one has even bothered to work out what an extra £300 million would get you in improved services. That of course is also assuming that the extra money will be used wisely which past performance in a number of areas suggests might not be the case.

    Unfortunately, most Assembly politicians would run a mile at the thought of obtaining some fiscal powers. It is far easier to blame the Westminster government as Plaid has done since 1999 and both Labour and Plaid will now do in the future.The lat thing anyone would want is for people to look at their pay packets and see possible deductions caused by decisions in Cardiff Bay. Between 1981 and 1996 I was a Counnty Councillor responsible for the decisions that affected the bulk of the rates and then the council tax bills. I didn’t receive one complaint. One of the reasons for this was that the billing authority was the small district council. All of this changed in 1996 with the creation of unitary authorities which fundamentally changed the relationship between elected members and the electorate because of the large increases in council tax to pay for services. For the first time there was no confusion in terms of who was responsible for the tax rises. I’m afraid that no one is going to agree to any tax raising powers unless they are forced to by a UK government that wants to rightly increase the accountability of the devolved administrations. As you rightly point out in your article what we now have is an ‘elected spending agency.’ I’m afraid that even if there is a ‘yes’ vote next March many people are going to be disappointed with the legislation which might then be enacted. Particularly if the legislation requires extra public expenditure in an age of public sector cuts. Throw in the proposed reduction in the number of Welsh MPs and there is a real fear as one Welsh MP expressed to me this weekend of Wales ending up in a political cul de sac. Responsible for large areas of public expenditure but totally reliant for finance on another political institution where its politicians have very little influence.

  3. Jeff Jones

    Alan. Another stat to put the £300 million into context.The figure is less than the cost of the media centre for the London Olympics which press reports suggest will have to be abolished if no buyer can be found after the Games.

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