(This is a guest post by Gerald Holtham, who chaired the Welsh Government’s Independent Commission on Funding and Finance in Wales, and whose previous accomplishments include being a former director of IPPR as well as an academic and City economist. It shouldn’t need saying, but for the avoidance of doubt these are his ideas, not mine.)
When the Barnett formula was inaugurated in 1976 it was not expected to last. Because it has done so, a particular problem has arisen that at the inception was no more than a remote possibility.
The formula has always taken existing block grants and arranged to add to them each year a sum equal to the population of the devolved territory times the change in expenditure per head in England on comparable devolved activities. At the outset, expenditure per head in the devolved territories was above average expenditure per head in England. This in a rough sense reflected relative need. Within England, expenditures in the different regions and localities on health, education, local authority revenue support and other items are determined by a series of needs-based formulae. As items of expenditure were devolved and bundled into a block grant, the link with needs-based formulae was broken.
Because Barnett gives territories the same nominal increase in expenditure per head as England but they start from a higher baseline, the arithmetic of the formula means that the funding it allocates converges on the English level as spending rises. Consider a territory starting with expenditure of £110 per head when England on average has £100 per head. An increase of £10 a head in England would be a 10 per cent increase but the same increase in the territory would be only nine per cent (10/110). Slowly therefore, other things being equal, the Barnett formula pushes the territories to the same expenditure per head as the English average.
Why is that anomalous? Because different parts of the UK have different needs; and English regions have widely varying expenditures per head, reflecting their different needs for public spending as calibrated by the various formulae employed. Unless needs converge there is no mechanism to drive convergence of spending in English regions, but there’s exactly that for Scotland, Wales and Northern Ireland.
What is supposed to happen if the convergence process entailed by Barnett drives a devolved territory to a level of expenditure per head below what it would get if part of England, that is below the expenditure level dictated by its needs according to the formulae in use by the Treasury in England? It was simply assumed that Barnett would have been reformed or replaced before such a point was reached or, when it was reached, the relevant Secretary of State would protest so as to obtain a solution.
The evidence now is that one of the devolved territories – Wales – has arrived at that point where it receives a lower block grant than it should get on English needs formulae. It is in effect being penalised for being devolved. Scotland has not reached that point, largely because of demographics and the lag in the way these are incorporated into the numbers underpinning the operation of Barnett. So far, so bad but the real problem is that when nominal growth of public expenditure resumes the squeeze will continue and the relative underfunding will grow and become acute.
The time for a fix has therefore arrived. The UK Government has said that it cannot reform Barnett until it has dealt with the current large budget deficit. What is required therefore is a minor change to present arrangements that is self-financing. Fortunately that is possible.
Because only Wales is below the ‘floor’ implied by what it would receive on English distribution formulae, a needs-based safety net can be constructed for the three devolved territories that requires no new Treasury funds.
The Barnett allocation can proceed as before with one addition. The UK Government applies its distribution formulae to the devolved authorities to assess where they lie in relation to the floor implied by those formulae. That procedure could be cumbersome and an alternative is to use a single simplified formula distilled from the various detailed ones. Research for the commission I chaired has shown such a simplified formula can reproduce the results of the complicated ones with at least 95 per cent accuracy.
When one of the territories is below the floor, its Barnett allocation is adjusted to ensure no further squeeze takes place. Note this does not entail restoring the grant to the floor level, it simply prevents any further cumulative divergence – surely a minimal requirement for fairness. The cost of that adjustment is subtracted from the allocation of the other two devolved territories in proportion to their upside deviation from their own floor. As long as the sum of divergences across the three territories is positive this procedure will always be self financing. That condition is currently met and likely to be so for the foreseeable future.
Consider a numerical example. Suppose one territory has a floor of 115 per cent of the English average and has fallen below that to 112, roughly the Welsh case now. If relevant nominal public expenditure grows at three per cent in England; Barnett would give a growth of 3/112 = about 2.68 per cent in the devolved territory. The adjustment would add back 0.32 per cent. Suppose the territory’s annual budget were £15 billion, the adjustment would add back some £50 million. That would come from the allocation of the other two territories which have a combined budget of £35 billion, a reduction of just 0.143 per cent. That means unfairness is limited, at no overall cost to the Exchequer and minimal cost even to those providing the compensatory payment. If one of the two territories exceeded its floor by 15 per cent, while the other were three per cent above the floor, the £50 million would come from them in the ratio 5:1. One would contribute some £42 million while the other contributed some £8 million.
That solves the UK Government’s problems. It prevents any extra spending on the devolved territories above what the Barnett formula would imply, and it largely protects the position of those treated favourably by Barnett and avoids making the grants as a whole needs-based (and preserves its arbitrary nature, which appears to be a design criterion for the Treasury). It limits, however, the egregious and extreme unfairness where one territory is in effect penalised for being devolved, and is made unable to maintain public services at the same level as the rest of the UK.
Circumstances change, and the Union could mutate or even fail. Even within the Barnett framework, over the decades a current beneficiary of the arrangement could become a contributor. This proposal would provide a co-operative safety net among the devolved territories, pending a further- reaching review. It’s a sticking plaster solution, but one that delivers what the UK Government says it wants.