Steps on the road to fiscal federalism

Eurfyl ap Gwilym argues that without at least some fiscal powers the Welsh Government is still a long way from being a real government

The outcome of the elections to the Scottish Parliament will have major repercussions not only in Scotland but for Wales and the rest of the UK. The Scotland Bill currently passing through the UK Parliament contains a range of fiscal measures including the right of the Scottish Executive cumulatively to borrow up to £2.2 billion for capital expenditure over ten years and the obligation for it to levy income tax.

Hitherto, in common with the Welsh Government the Scottish Government had no borrowing powers other than short term facilities. The current position with respect to income tax is that while the Scottish Executive has the right to vary the standard rate of income tax by up to 3p it was never used in practice. However the Calman Commission recommendations that the block grant be reduced and a commensurate reduction be made in the rates of income tax levied by the UK Government on Scottish taxpayers will oblige the Scottish Executive to set additional Scottish rates of income tax to make up the shortfall in funding. The Scotland Bill provides for each of the three UK rates of income tax to be cut by 10 percentage points in the case of Scottish taxpayers. Any rate of income tax set by the Scottish Executive must be applied (added or subtracted) to all three rates.

As the Scotland Bill is considered by the House of Lords, Joel Barnett, the author of the eponymous funding formula, is planning to introduce an amendment to change the basis of funding of devolved services in Scotland. Despite the authoritative report of the House of Lords Select Committee on the Barnett Formula that called for its replacement by a needs-based formula, a key question is whether or not, even if successful in the House of Lords,  such an amendment will be passed by the Conservative-LibDem majority in the House of Commons.

It is probable that moving to a needs-based formula would lead to a reduction in the Scottish block grant which while possibly being ‘fair’ would certainly antagonise the Scots and be grist to the mill of the SNP. The stance taken by the UK government will be driven as ever by political rather than fiscal considerations. Over many decades (certainly since the introduction of the Goschen formula in 1888 and some suggest since the Act of Union in 1707) Scotland has enjoyed relatively generous funding from the UK Government. Given the result of the Scottish election will this continue or will the UK government decide that it is time to change the basis of funding Scotland?

In the aftermath of the SNP’s victory Alex Salmond has called for greater financial powers including increased borrowing powers over and above the proposed £2.2 billion limit and the right to set the rate of corporation tax. To put this borrowing limit in perspective the capital budget for Scotland this year is £2.5 billion. Given that the £2.2 billion is the cumulative limit over ten years if a higher ceiling were conceded, it would not have a material impact on the UK’s total public debt, currently heading north of £900 billion.

The UK government is currently exploring the possibility of varying corporation tax in Northern Ireland (the Treasury published a consultation paper in March 2011). In the case of Northern Ireland even if the measure were agreed it is envisaged that implementation would take several years. It is unlikely that the UK Government will readily concede to Scotland the right independently to set the rate of corporation tax. However, if it does so in the case of Northern Ireland then not only will the implementation issues have been resolved but it will be difficult politically to deny Scotland similar powers.

What will be the financial repercussions of the Scottish election result on the rest of the UK? The UK Government has already proposed that following a Yes vote in the Welsh referendum it will, in the case of Wales, introduce a ‘Calman type’ review with the implication that the block grant and the rates of income tax be reduced, thus obliging the Welsh Government of the day to set rates of income tax to off-set the cut in the block grant. Given that such measures will have been applied to Scotland, the practical issues associated with such a change will have been resolved and applying such a measure to Wales will, from the viewpoint of the Treasury and HMRC, be straightforward.

In the run-up to the National Assembly elections the Labour party came out against having tax raising powers but it could well be that they will be introduced in any event. After all, it is not unreasonable for the UK government to argue that the current funding and spending arrangements for Wales are a case of ‘spending power without taxation responsibility’. Obliging the devolved administrations in Scotland and Wales to levy tax to fund, at least in part, their public expenditure would undoubtedly be a popular move in England where voters are increasingly convinced that they are being short changed.

Another advantage of such a move is that it would represent an important step in the maturing of devolved government in Scotland and Wales. As has been pointed out by Gerald Holtham (Agenda Winter 2010) having legislative powers without tax powers “does not make for grown up discussion of policy and good governance”.

The National Assembly has now gained primary legislative powers, yet statements made during the referendum campaign that the National Assembly would then have ‘the tools to do the job’ were, at best, only partly true. Labour’s appeal during the National Assembly election campaign was that they would seek to protect Wales from the ‘worst effects of Tory cuts’. As the cuts progressively bite over the coming years the Labour government will come to recognise that it has very limited power to shield Wales. Without at least some fiscal powers the Welsh Government is still a long way from being a real government.

Another issue triggered by possible changes to the funding formula is the ‘West Lothian question’. Until now, because all public expenditure came from centralised taxation then all matters funded by UK taxation should be voted on by all MPs. Given that Scotland will now have to levy material taxes itself that over-arching principle is broken.

At present MPs from Scotland and Wales vote in Parliament on English matters specific to England which are devolved to Scotland and Wales. A justification for this is that key spending decisions made for England feed directly through the Barnett formula to the funding of the devolved administrations.  If the formula is replaced by a needs-based formula then this justification would disappear.

MPs from Scotland and Wales should continue to be able to vote on those matters which are UK wide such as macroeconomic policy, defence and international development but we would no longer be faced with the bizarre position of Scottish and Welsh MPs not only voting on England-only matters such as health and education, but of MPs from Scotland and Wales being ministers or shadow ministers for these England-only departments of state.

Constitutional change in the UK progresses at a painfully slow pace. Nonetheless, it is to be expected that the SNP victory in Scotland will be a catalyst for further change in the coming years. It is to be hoped that the Welsh government is sufficiently agile, confident and competent to take advantage of such changes.

Eurfyl ap Gwilym is Plaid Cymru’s economics adviser

8 thoughts on “Steps on the road to fiscal federalism

  1. ‘Agile, confident and competent’. Sadly, the Welsh Government announced this week has none of those attributes. We desperately need a government with a vision of what Wales could become and the courage and commitment to make it reality. It must have the tools to generate and retain revenues in Wales. But the new Welsh Government primarily serves the interests of the Labour Party not the Welsh people. So it will most likely work towards its re-election, resisting the changes taking place in Scotland to perpetuate its position.

  2. Eurfyl says “At present MPs from Scotland and Wales vote in Parliament on English matters specific to England which are devolved to Scotland and Wales. A justification for this is that key spending decisions made for England feed directly through the Barnett formula to the funding of the devolved administrations. If the formula is replaced by a needs-based formula then this justification would disappear.”
    That is not so. Recall we are discussing relative needs – that is needs relative to an English base. Expenditure in England on devolved matters is still what drives the size of block grants, even if these are adjusted for relative need. For example: if England reduced education spending and devoted all the money to defence, the Welsh block grant would fall, whatever the needs adjustment. That could only be avoided if we moved to a federal system of each retaining own revenues with a revenue adjustment mechanism. But Wales would be worse off under revenue equalisation than under expenditure equalisation.

  3. correction:I wrote
    “But Wales would be worse off under revenue equalisation than under expenditure equalisation.”
    I should have said “worse off in cash terms”. That is undeniable. However, Wales would have more freedom of action under a federal arrangement and it is a value judgement whether that compensates for being materially poorer. I do not express an opinion on that point.

  4. The problem with the issue of ‘need’ is that it is always looked at in the context of Wales v England. In fact there are many parts of Wales where need isn’t as great as in parts of England. I really cannot see anyone who represents a Labour constituency in parts of the North of England and that includes the Leader of the Party and the Shadow Chancellor agreeing to any change in any redistribution formula which does not take into account areas of England which are worse off than areas of particularly East Wales. I also cannot see any English based politician of whatever political persuasion agreeing to any movement until Welsh politicians realise that mature politics does actually mean that you have to have the courage to tax those you wish to represent. As K.O. Morgan rightly argued ‘there can be no representation without taxation’.

  5. I do not agree with Gerry’s comments. He hypothesises that ‘if England reduced education spending and devoted all the money to defence the Welsh block grant would fall….’. Under my model England could not do this. I make clear that macroeconomic policy which would include the overall public spending envelope would be a matter for all MPs. Furthermore any decisions on non-devolved matters such as defence spending and social, protection would also be a matter for all MPs as my note makes clear.

  6. Distribution formula in England apply to the average statistics for each region, (there are 9 English regions if memory serves) just as they would do in the case of Wales. There are affluent areas in the poorest regions so I do not think Jeff Jones’ point is germane.

    As to Eurfyl’s point, distribution of spending across budgets is not normally regarded as a macroeconomic matter, which normally refers to overall amount and balance of tax and spend. It is perfetly possible for English MPs to make decisions about spending in devolved areas that affect the size of the Welsh grant and budget because ‘consequentials’ differ across budgets. My point is that therefore Welsh MPs have a legitimate interest in those decisions.

  7. At the end of the day whether or not the Barnett formula is reformed or not is a political decision. The point that I was trying to make is that the debate has often been framed in terms of how unfair the present system is to Wales. For many English MPs from all parties the policy divergence of both the Welsh Assembly and the Scottish Parliament from Westminster suggests that the issue is rightly or wrongly one of unfairness to their constituents. Look at the reaction of the audience on Question Time when Peter Hain boasted about free prescriptiions In Wales. They rightly argued why hadn’t he argued for the same policy for England. In an age of public expenditure cuts no politician is going to support a policy change, no matter how logical it might seem to the objective observer, which might look to their constituents as being of more benefit to one part of the UK than the area in which they live in. There might be affluent areas in many parts of the North but to many people living there both Scotland and Wales seem to be getting a better deal at the moment.

  8. It is quite true that English perceptions are that all the devolved areas get better treatment that they do. That is unambiguously true of Northern Ireland. It is true of Scotland if consistent needs criteria are used but not of Wales. Wales gets less than the North relative to the needs criteria used in the North. If we switch to a federal approach and ask about net transfers per head, irrespective of “needs” then Wales does very well and Scotland not so evidently so. People obviously pick the criteria that suit them.

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