21 November 2008
The Barnett Formula, used to calculate funding for the devolved nations, has favoured Scotland to the detriment of Wales. John Osmond says there is a desire for change across the UK, but finding an alternative that is acceptable to the four nations will be a tough task
Hints from the prime minister on future funding options for the Scottish Parliament are rare and usually Delphic in their meaning. So close attention was paid to Gordon Brown's relatively unambiguous remarks on the theme in a speech delivered to a CBI Scotland dinner in Glasgow in early September. Although observing that, on the whole, devolution had worked pretty well, he said he did see one problem: fiscal accountability. As he put it: 'The Scottish Parliament is wholly accountable for the budget it spends but not for the size of its budget. And that budget is not linked to the success of the Scottish economy.
'That is why we asked the Calman Commission to look carefully at the financial accountability of the Scottish Parliament. And this is a critical part of Calman's remit.'
The commission, chaired by Glasgow University chancellor Sir Kenneth Calman, a former chief medical officer for Scotland, began work in April. Established by the opposition parties in the Scottish Parliament, it was their response to the minority Scottish National Party government's call, in July 2007, for a 'national conversation' on Scottish independence. Given its provenance, it is unsurprising that the Calman Commission's remit specifically rules out independence. However, it is reviewing whether more powers might be devolved and, in particular, matters that 'would improve the financial accountability of the Scottish Parliament'. It is due to produce an initial report by the end of the year and a final report some time during 2009.
This month, a commissioned report submitted to the commission by an expert group of economists advocated extending the Scottish Parliament's fiscal autonomy by giving it greater responsibility for raising taxation. However, it stopped short of 'full fiscal autonomy'. As one member of the group, Jeremy Peat, a former chief economist at the Royal Bank of Scotland and former economic adviser at the Treasury, put it: 'We are clearly drifting towards more fiscal devolution, if that can be fitted in with managing the macro-economy effectively.'
Gordon Brown's remarks have led seasoned devolution watchers to conclude that the UK government is now resigned to giving up decades of opposition to changing the Barnett Formula. Since 1979 this has determined the level of the block grant funding given by Whitehall to the devolved administrations in Scotland, Wales and Northern Ireland. Now, it seems, Westminster is contemplating an element of fiscal federalism, in which the devolved administrations will become responsible for raising through taxation a significant proportion of their expenditure.
Hitherto, despite pressure from Wales and some northern English regions, which believe they have been short-changed, successive Westminster administrations have refused to open up a debate on changing the Barnett Formula. This is largely because of pressure from Scotland, which is generally acknowledged to have been a beneficiary.
However, tensions have risen since the SNP took power in Edinburgh last year, with the nationalists introducing a series of 'giveaways', including the phasing out of prescription charges and freezing council tax. This has prompted accusations that the Barnett Formula means English taxpayers are 'subsidising' Scotland for services that are not available south of the border. So it is significant that even some leading Scottish figures are now calling for change. Scottish Conservatives want the Scottish Parliament to be made fiscally responsible in raising the money it spends. Calman himself has given the broadest of steers that his commission is considering altering or even scrapping the Barnett Formula. Asked if the formula was fair to British taxpayers, he said: 'It's pretty good for Scotland – it depends if you think that's fair or not. But I don't think it reflects needs.
'It depends where you live in England. It's quite important you don't think about England as a single place – you can break down the regions quite nicely. If you look at London, for example, you would see London does pretty well.'
That doesn't apply in Wales, which is why the Assembly Government, a coalition between Labour and Plaid Cymru, has established its own commission to investigate the Barnett Formula and come up with recommendations for change. It is a small expert group, chaired by Welshman Gerry Holtham, a hedge fund manager and former director of think-tank the Institute for Public Policy Research. It includes Professor David Miles, a managing director and chief UK economist at Morgan Stanley, and Paul Bernd Spahn, an emeritus professor at the Goethe University, Frankfurt am Main, who has advised the treasury of Bosnia and Herzegovina.
Announcing the commission in October, Wales First Minister Rhodri Morgan said: 'You would be astonished at the way the debate has already been framed strictly in terms of the relationship between the UK and Scotland. You can imagine what a dangerous scenario that is for Wales. We do not believe we are overfunded. We believe we are probably – [and it's a] gut feeling – underfunded, but we need an evidence base to demonstrate that.'
Although Northern Ireland is generally believed to have benefited from the formula (see table on page 21), even here there have been calls for a review. Last year the Northern Ireland Assembly's committee for finance and personnel called on the Executive to examine the implications of the formula and scenarios for reform.
The formula, named after Joel Barnett, who was chief secretary to the Treasury the year it was established in 1978, determines the increase (or decrease) to a baseline block grant for each of the devolved administrations at each Comprehensive Spending Review. The change is calculated by considering three elements: the changes in spending for England by UK departments; the 'comparability percentage', which essentially refers to the extent to which a programme or service is devolved; and size of population compared with England.
The result is known as the Barnett consequential, with the calculation being made for each UK government department. Put another way, the formula means that for every pound of extra spending in England each year on a service which is devolved, Scotland, Wales and Northern Ireland will get an increase in their block grant proportionate to their populations. Originally the proportions were set arbitrarily at 85:10:5 for England, Scotland and Wales. So, for every 85p of extra spending in England, Scotland would get 10p added to its block grant, and Wales 5p.
These population proportions were too generous to Scotland (and too mean to Wales) until altered by Michael Portillo, as chief secretary to the Treasury, in 1992, to the correct population proportions. In practice, the changes have been complex. So, for example, pre-1992 for Scotland, for programmes other than law and order, the proportion corresponded to an 11.76% increase. Following 1992, this was reduced to 10.66%. For Wales, pre-1992, there was a 5.88% increase in expenditure. Following Portillo's review this was upped to 6.02% to reflect Wales' relative increase in population. These small changes in percentages have significant consequences in terms of reductions and additions to the block grant, though it is fair to say that the Scottish Parliament's share has been persistently high in relation to the other devolved institutions.
Now they are rebased for the following two or three years after every Spending Review. The table gives the breakdown for spending per head for 2007/08 across the UK, together with the percentage deviation from the UK average. The formula is not based on any assessment of relative need, or of costs of services, which critics see as one of its main drawbacks. The table gives a snapshot of the relative inequities. Wales, for example, is especially aggrieved that Scotland and Northern Ireland received 21% above the UK mean in 2007/08 compared with its own 8%. It argues that the distribution would be markedly different if there was a greater emphasis on need, taking into account levels of economic performance (gross value added per head) and levels of poverty (households below 60% median income levels).
Both Scotland and Wales complain that the process by which the Treasury determines whether spending is subject to the Barnett Formula or not is at best unclear, and at worst arbitrary. They are certainly not underpinned by any published criteria. So, for example, there are currently disputes regarding the Olympics being classified as being of the benefit to the UK as a whole and therefore not subject to a Barnett consequential. Plaid Cymru's economics spokesman, Carmarthen East MP Adam Price, claimed that, as a result, Wales was being robbed of £437m. He said it was 'a disgrace that the poorest part of the UK is effectively funding a massive regeneration project in London, officially the richest city in Europe'.
For its part, the Scottish Government claims it is being financially penalised by the failure to attach a Barnett consequence to the £1.2bn increase in spending on prisons in England and Wales, in response to the Carter Review and pressure on prison places.
A further drawback to the Barnett Formula is that it institutionalises what the political scientist Anthony King called an 'infinite blame potential'. The devolved administrations have virtually no control over the size of the block grant that is available to them. When things go wrong, or there is a cutback in spending, they simply blame Westminster and Whitehall. It is not a recipe for accountability and responsibility in spending.
However, it is one thing to criticise the formula, quite another to come up with an acceptable alternative. There are broadly three options for change.The first is to implement a needs-based system for calculating the block grants of the devolved administrations. To ensure credibility, this task should be carried out by an independent body, such as the Australian Commonwealth Grants Commission, established in 1933 to assess claims made by the Australian states for financial support.
Secondly, fiscal autonomy could be given to the devolved administrations to raise their own revenue. They will meet their own expenditure, and at the same time make a contribution to the central government for functions such as defence, the welfare state and international aid. This is broadly the case in the Basque region's relationship with the Spanish government, probably the most extreme example of fiscal federalism. Finally, the government could adopt a hybrid approach, combining greater fiscal autonomy with the equity of a needs-based grant.
The likelihood is that the Calman Commission, together with the Holtham Commission in Wales, will opt for the third, hybrid solution. Certainly, this was the recommendation of the report Fair shares? Barnett and the politics of public expenditure produced by the Institute for Public Policy Research in July 2008.
However, this still leaves the hard question of what category of tax to allow the devolved institutions to deploy. The choice is assigning taxes, where the proceeds of certain taxes are attributed to the area where they are raised, or allowing the devolved administrations to vary certain taxes, whether income tax, corporation tax or VAT.
Possibilities explored by the expert group of economists that this week reported to the Calman Commission include letting Scottish ministers set income tax. Currently they are only able to vary the standard rate of income tax by up to three pence in the pound, an option that has never been used in a decade of devolution. Other possibilities include devolving VAT, introducing a US-style sales tax, and devolving National Insurance contributions.
None of these options is straightforward. Yet the balance now seems to have tipped in favour of moving away from the Barnett Formula towards a system that would combine an element of devolved taxation with a needs-based equalising block grant. Despite the political problems in opening this 'can of worms', the arguments for change are gathering momentum. It is noteworthy, for instance, that even the author of the formula himself, Lord Barnett, now a Labour peer, has pronounced that he is amazed it has lasted as long as it has. He says it should be scrapped and replaced with one that reflects needs rather than population.
John Osmond is director of the Institute of Welsh Affairs. Gerry Holtham is speaking at the CIPFA in Wales annual conference in Cardiff on November 27—28
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