Spending on HS2 and its impact on Welsh funding

Eurfyl ap Gwilym says Wales has not had a fair deal on funding for high speed rail.

Eurfyl ap Gwilym is Plaid Cymru’s Economics Adviser

As a result of the most recent Spending Review there have been various claims and counterclaims regarding the impact of HS2 spending on the Welsh block grant. It is hardly surprising that there is a degree of confusion because the application of the Barnett formula is a good deal more arcane and opaque than many would imagine: the HS2 programme is an illustration of this. In an earlier posting I drew attention to the need for the Welsh Government to anticipate the treatment of HS2 in the next Spending Review and urged them to ensure that Wales got a fair deal. In the event this has not happened.

To understand what has happened is a little complicated but a careful reading of the account set out here may help but be warned it is not easy reading.

In his Autumn Statement the Chancellor of the Exchequer announced that ‘Construction of HS2 will begin during the Parliament, and the Spending Review confirms a funding envelope of £55.7bn in 2015 prices which will deliver HS2 from London to Birmingham by 2026, and to Leeds Manchester by 2033’ (paragraph 2.85).

At the same time as the Spending Review the Treasury released an updated Statement of Funding Policy which sets out the comparability factors to be employed in determining changes to the devolved administrations’ block grants using the Barnett formula. Comparability factors for the various spending programmes of the Department for Transport were set out. HS2 is included in the programmes for the first time and the comparability factor in the case of Scotland is 100 per cent and in the case of Wales 0 per cent (Table C.16) . A comparability factor of 100 per cent means that expenditure is fully devolved and as a result Scotland will receive a Barnett Consequential. In the case of Wales the comparability factor is 0 per cent and this implies that the expenditure is not devolved and Wales will not receive consequential funding.

However a complicating factor is that in applying the Barnett formula  the overall, weighted comparability factor for each spending department, in this case the Department for Transport, is used. In the case of Scotland this is 91.0 per cent. In the case of Wales it is 80.9 per cent with the principal reason for the difference being the treatment of HS2 expenditure. (If HS2 expenditure   had a comparability factor of 100 per cent for Wales as is the case for Scotland then the overall comparability factor for the Department for Transport in the case if Wales would rise to 88.7 per cent.) This means that Wales will receive its population share of 80.9 per cent of changes in the Department for Transport’s expenditure while Scotland will receive 91.0 per cent. The shortfall in the case of Wales arises principally from the differing treatment of HS2. If HS2 for Wales had a comparability factor of 100 per cent then Wales in 2019-20 would receive an additional £25 million.

When looking further ahead the funding loss could be much more serious than this.  At the next Spending Review the comparability factors will be recalibrated by the Treasury and while HS2 spending currently accounts for 7.8 per cent only of the Department for Transport total spending (£762 million out of a departmental total of £9.750bn) as and when the HS2 programme is in full flow the annual expenditure on HS2 will be approximately £3.7bn or more a year (the total cost of £55.7bn spread over 15 years in real terms). By 2019-20 the Department for Transport budget in cash terms is due to increase from the current £8.7bn to £13.2bn. When this factor is taken into account then at the next Spending Review the Wales comparability factor for the Department for Transport could fall to ~62 per cent while that for Scotland could rise to ~93 per cent (we do not know at present what will be the levels of spending on the other programmes of the Department and inevitably the costs of HS2 will almost certainly rise even before inflation is taken into account. It is also unclear at present as to whether or not private funding will be employed partly to fund HS2.). If such a decline in Wales’s comparability factor were to occur then Wales would lose very substantially by not receiving a full Barnett Consequential for the HS2 programme because Wales would only receive 62 per cent of any increases in the Department for Transport’s total budget including HS2. Paradoxically the greater the spending on HS2 the greater the fall in Wales’s Department for Transport comparability factor and the less funding Wales will receive. In the case of Scotland the opposite applies: the greater the spending on HS2 the higher the Department for Transport comparability factor and the more consequential funding it will receive.

Another irony is that according to a study undertaken by the consultants KPMG for HS2, Wales will lose comparative competitive advantage as a result of HS2 while Scotland will gain thanks to shorter journey times between Scotland and England.

The Barnett formula has many weaknesses not least the lack of transparency in its application and the absence of effective challenge. Why does HS2 have a comparability factor of zero in the case of Wales when Crossrail had established a precedent for rail investment and was assigned a comparability factor of 100 per cent? Expenditure for Network Rail had a comparability factor of zero for Wales because such funding is not devolved but is applied on an England and Wales basis with Wales receiving a share of the funding. Thus the argument that HS2 should be treated in the same way as Network Rail is highly questionable. When the Secretary of State for Transport was challenged on this matter in the House of Commons on 30 November 2015 avoided answering the question.

When preliminary expenditure on HS2 arose in October 2013 Wales received a full 100 per cent Barnett consequential corresponding to that expenditure. The Finance Minister of the Welsh Government was quick to express her satisfaction but ominously the Treasury, having initially denied that Wales had received such a consequential, then pointed out that the position would be reviewed at the next Spending Review. Having failed to ensure Wales continued to be allocated a comparability factor of 100 per cent for HS2 may be the reason that the Welsh Government is now claiming that Wales is receiving a Barnett consequential for HS2. But those who have stayed the course in reading this note will appreciate that the position is not nearly as clear cut or as satisfactory as that claim suggests.

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