Ed Poole and Guto Ifan outline the findings of their Government and Expenditure Review for Wales.
Each March, the publication of Government Expenditure and Revenue Scotland triggers a major political and public debate as government and opposition wrangle over the latest annual assessment of Scotland’s fiscal health. As an official statistical publication quantifying the nation’s public spending, revenues and net fiscal balance, GERS played a starring role in the independence referendum campaign and in the intense negotiations over tax devolution that followed the narrow “No” vote in September 2014.
Although a similar publication for Wales also started life in the 1990s, unlike GERS, the Welsh series was discontinued by the incoming UK government in 1997 and therefore did not have the opportunity to undergo the gradual revisions to methodology that have significantly improved the Scottish report over its 25 year history. As a result, since devolution, serious discussion of the state of Wales’ public finances has been constantly hampered by the paucity of disaggregated public spending, taxation and other basic economic data. The absence of such data is increasingly serious given that fiscal devolution constitutes the next major phase of Welsh devolution.
A landmark new report by Cardiff University’s Wales Governance Centre, Government Expenditure and Revenue Wales 2016, attempts to address this need to enhance awareness of Wales’ relative financial position and how Wales’ finances might fare under a system of greater fiscal autonomy. The report presents a multi-year analysis of Wales’ public spending, revenues and the nation’s overall fiscal balance, utilising similar methodologies used by the Scottish Government and Northern Ireland Executive for their annual surveys of expenditure and revenue.
Among the many fiscal aggregates for Wales presented in the report, GERW’s key headline finding is that total expenditure for Wales exceeded public sector revenues by £14.7 billion in 2014-15, meaning Wales’ net fiscal deficit is equivalent to around 23.9% of estimated GDP. This figure compares with a deficit of 4.9% of GDP for the UK as a whole and £14.9 billion (9.7% of GDP) for Scotland.
Total public sector revenue in Wales is estimated at £23.3 billion in 2014-15, around 3.6% of total UK revenues of £648.8 billion. Revenues per head in Wales were around £7,500, significantly less than the average UK figure of £10,000.
The composition of revenues in Wales is markedly different from the UK as a whole. Large direct taxes (e.g. Income Tax and Corporation Tax) constitute a smaller share of Welsh revenues, while a greater share is raised through indirect taxes (e.g. VAT and excise duties). This difference reflects a Welsh tax base that is significantly different from that of the UK.
Over the past five years, Welsh revenues have grown by £2.6 billion, or 12.3%, slightly behind UK growth during the same period (13.0%). The main components of this growth were the increase in VAT and council tax revenues. In contrast, Income Tax revenues in Wales actually fell during the period, and were 2.6% below their 2010-11 level in 2014-15. These trends reflect population divergences between Wales and England and the effects of UK government policy, particularly the rapid increases in the Income Tax personal allowance over the past five years.
Compared with non-devolved taxes such as VAT which have shown robust growth in recent years, revenues from soon-to-be devolved taxes have been relatively stagnant, primarily because of the fall in the estimated revenues from the Welsh rates of Income Tax.
Total expenditure for Wales was £38.0 billion in 2014-15, around 5.2% of total UK expenditure of £737.1 billion. Expenditure per person was approximately £12,300, around £900 (or 7.7%) above the UK level. Total expenditure for Wales was equivalent to 61.8% of estimated GDP in 2014-15, compared with 40.2% across the UK.
Social protection (including social security payments, pensions and devolved social services) is by far the largest expenditure programme for Wales, accounting for 37.4% of total spending, followed by health (17.0%) and education (10.8%). Social protection as a share of total expenditure for Wales increased from around £4,100 per person in 2010-11 to £4,600 in 2014-15.
Health expenditure for Wales also grew during this time period, by £278 million, or 4.5%, in nominal terms. This however was a substantially lower rate of increase than the corresponding growth across the UK of 11.9%, reflecting decisions taken by the Welsh Government not to ring-fence health spending and to moderate the impact of cuts across other areas of spending. The flipside of this decision was that there was a greater increase in social services expenditure and a smaller reduction in education expenditure than across the UK.
Net Fiscal Balance
Figure 1 shows Wales’ net fiscal balance, or the difference between total expenditure and revenues, over time. Because total expenditure for Wales grew much more slowly than revenues over the same period, Wales’ net fiscal balance has improved from the deficit of £15.8 billion (or 29.2% of estimated GDP) recorded in 2010-11 to £14.7 billion (or 23.9% of estimated GDP) in 2014-15.
Going further back in time*, the estimated net fiscal balance for Wales in 1999-00 was a deficit of £5.1 billion, or 14.5% of estimated GDP. Rapid growth in expenditure meant this deficit grew to £8.0 billion (20.1% of GDP) by 2002-03, but remained relatively constant as a share of GDP until 2007-08. As was the case across the UK as a whole, the financial crisis in 2007-08 severely worsened Wales’ fiscal aggregates. Declining revenues, increasing expenditure (particularly on social protection) and contracting GDP meant that the net fiscal deficit reached a peak of £15.9 billion in 2009-10, more than 30% of estimated GDP.
Net fiscal balance does not constitute a direct measure of regional transfer from other parts of the UK because the UK as a whole was also in deficit, and therefore borrowing funded some of the overall UK expenditure. Furthermore, transfers between richer and poorer territories within a state are also not unusual internationally.
That said, at around 24% of estimated GDP, Wales’ £14.7 billion net fiscal deficit is a very substantial gap between the revenues raised in Wales and public spending for Wales, and there is no evidence that the gap between Wales and the rest of the UK is being bridged.
Wales’ current fiscal framework means that the level of public expenditure by the Welsh and local government in Wales is mostly unconnected to the amount of revenues collected in Wales. In future however, fiscal devolution will mean that several revenue sources will contribute directly to devolved expenditure. The net effect of tax devolution will ultimately be determined by how the block grant from HM Treasury will be adjusted after devolution.
The risks and opportunities that the Welsh budget is facing for the first time as a result of fiscal devolution represent a major course change in Wales’ devolution journey.
*Difficulties in compiling consistent data (especially for government expenditures) before 2010-11 mean that these data should be treated with particular caution.