Tax devolution and the block grant: a solution for Scotland that doesn’t work anywhere else?

This is a guest post by Gerald Holtham, who chaired the Welsh Government’s Independent Commission on Funding and Finance in Wales and is adviser on finance to the Welsh Government. The question he addresses – of how to manage a reduction in the block grant to allow for tax devolution while maintaining the Barnett formula – is a highly timely one, given the ongoing discussions about the ‘fiscal framework’ for Scotland (for which this is the key issue) as well as corporation tax devolution for Northern Ireland and moves on income tax devolution for Wales announced in the Spending Review.  (My own comment on this post can be found here.)

In all the discussions about tax devolution for all parts of the UK, a key issue has not been clarified. That issue is how to reduce block grants when a tax is devolved. Indeed there still appears to be no general agreement between the devolved governments and the UK Government about how to proceed. It is a particularly knotty question in discussions about income tax but also VAT and it has the capacity to delay devolution to Scotland and to stall it altogether for Wales.

There is little problem in the first year of devolution. An estimate can be made of the revenue foregone by the Westminster government, given prevailing tax rates, and that can be deducted from the block grant. Subsequently the deduction can be revised when actual revenues differ from the estimate. The difficulty comes for subsequent years when the deduction must be expected to grow with the economy and its tax base but must not be affected by changes in tax rates by the devolved administration – otherwise devolution of tax powers is not real.

Gerry Holtham guest post: ‘Providing a self-financing floor to Barnett’

(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

Canada’s spending cuts in the 1990s: lessons for the UK?

A guest post by Russell Mellett

The 1995 Canadian federal government budget announced cuts of over 10 per cent in total programme spending phased in over the 1995/96 and 1996/97 budgetary years. Additional restraint measures were introduced in subsequent years. At that time, and more so today, federal government spending was heavily tilted toward transfers to persons (such as old age pensions) and transfers to provinces.  Another important piece of context is that the provincial order of government, including territories and local government, was (and remains) responsible for delivering publicly funded health care and education. Provinces also funded and continue to fund the vast majority of these services through own tax revenues. Taken together, the provincial order of government has for decades accounted for a larger share of total government expenditures and revenues than the federal government.

Back to the cuts: The federal government cut its own programmes, including national defence, customs and immigration, and reduced the size of its civil service (with the Department of Finance, the Canadian equivalent of the Treasury, leading by example). Transfers to provinces that funded health, post secondary education and social services were also cut – but transfers to persons were largely spared, although some, notably unemployment insurance benefits, were restrained in subsequent years. Equalization transfers to the provincial governments were also left intact.  These exist to promote reasonably comparable levels of provincial public services at reasonably comparable levels of provincial taxation, and so ensure  ’fiscal equity’ for all Canadians.. In short, federal transfers to needy persons and the elderly and equalization transfers to poorer Canadian provinces were largely spared, with cuts applied (with varying degrees of severity meted out through a Cabinet-level ‘Star Chamber’ process) to virtually everything else.

Overall federal government cash transfers to provinces were hit hard.  The federal government claimed at the time not to have cut  transfers to provinces more than they cut direct federal programmes’. That claim was fiercely contested at the time, and still is. Most commentators would now agree with the provinces’ claim that the three federal budgetary transfers to them for health, for higher education and for social services were cut by about a third.  To make these cuts easier to swallow, the three transfers were subsequently rolled into one and made