James Foreman-Peck, Cardiff Business School:
Yesterday saw the creation of an Assembly Government Commission to recommend how Wales’ Government should be funded. The Commission needs to address three essential points. The first is the block grant from UK central government that currently pays for devolved services, together with the Barnett formula, which determines changes in the block grant and has been at the forefront of the Welsh debate so far about funding. Second there is the issue of tax devolution. Finally, the possibility and extent of Assembly borrowing must be considered.
The Barnett formula was a quick and temporary fix devised before devolution, at the end of the 1970s. It is designed to equalise in the long run resources allocated to the (now devolved) nations and England. This goal, for areas with very different Gross Value Added (GVA) per head must generally be wrong, even granted the shortcomings of average GVA as a welfare indicator. The Barnett formula has lasted so long because of the expansion of general state spending in England. Consequently the pressure in Wales has been small. This is now changed. A needs-based formula would have more legitimacy and would be feasible – for this is the way local authority block grants have been allocated for decades. Even a GVA-based formula would make more sense.
Comparing Wales under Barnett and the North East of England without the formula, the North East (with a comparable GVA per head to Wales) receives more government spending. A political drawback to reconsidering Barnett could be that, whereas, given GVA per head, convergence has been achieved by Wales, it has not for Scotland or Northern Ireland (when I last looked). Consequently these influential polities would probably not favour a change that would benefit Wales.
A needs-based block grant could also be more predictable than Barnett but in any case revenue is likely to vary less in a downturn than under complete tax devolution. In effect the central government absorbs the ‘business cycle’ risk with a block grant.
More radical than block grant reform is tax devolution that could render a block grant obsolete. I myself favour a lower corporation tax for Wales in an attempt to mimic Ireland’s precocious economic growth. But both European pressure for tax harmonisation and HM Treasury’s determination not to give up any control of revenue are likely to defeat such a policy.
Standard economic theory indicates that for small, open economies like Wales, taxes should be placed on the least mobile goods and factors. Otherwise the value of taxable assets, investments and incomes – the tax base – is likely to contract with migration. Indeed it is the responsiveness of the tax base to policy that is one of the stronger economic arguments for tax devolution. There is an incentive for the devolved government to pursue sound economic policies that expand rather than reduce the sources of taxation.
A sales tax would be an example of taxing immobility. I favour a special alcohol tax to correct, or partly compensate, for the impacts of alcohol consumption, on the health service for instance. However, it would not be a major revenue earner. Also, there would be a ‘booze cruise’ problem near boundaries, so any differential tax would need to remain small.
A completely devolved tax system would probably require revenue equalisation, which is, in effect, another name for a block grant. So there does not seem much advantage in this extreme solution. But small taxes, like one on plastic bags for instance, might be useful in this case for an environmentally sensitive Assembly Government, if the administrative costs could be covered.
There is evidence that the public capital stock in Wales has not benefited from needed investment over the last decade to the extent that England has. This is ironic since the Treasury made much of the reversal of disincentives for public sector investment since 1997 (e.g. in the 2002 Spending Review). At least a portion of the shortfall can be attributed to the unwillingness of Assembly Government to adopt Public Private Partnership/Private Finance Initiative schemes with the enthusiasm of the English. Greater borrowing powers could provide an offset. Alternatively or additionally they could impose a greater long term burden of debt service presumably from the block grant, and squeeze current expenditure.
Devolving borrowing powers will be resisted by the Treasury on the grounds that there is an implicit Treasury guarantee to such borrowing although they cannot control the amount. The UK central government would be obliged to pick up the tab if the Welsh Assembly Government defaulted. But are we not seeing something like this for our big commercial banks at the moment? Anyway the Treasury’s point will need addressing in any recommendation for greater powers.