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£6.3bn is quite a hole

PUBLICATION of the final report of the Holtham Commission has opened – or re-opened – debate about how devolved government in Wales is financed. The issue exciting a lot of politicians is the existence and size of a ‘funding gap’: the £300 million by which the commission found public services in Wales are ‘under-funded’ in comparison with England. For Plaid Cymru, in particular, this finding has been a big political win – it’s taken as proving a long-standing Plaid argument, and it’s now a convenient area of agreement with Labour as well. We can already see a ‘politics of underfunding’ emerging, with the funding gap being blamed for every area in which public services in Wales are seen as inadequate.

Blaming the funding gap for all Wales’s problems is rather beside the point, however. The gap is, in fact, pretty small. It’s about 2.1% of the Welsh Government’s overall spending. While it’s hard to argue that Wales is generously treated when it comes to the allocation of public resources, this doesn’t explain much of the problems in those services. Would public services in Wales be dramatically different if the gap were filled overnight? It’s highly unlikely. Filling the gap would not be a panacea for Welsh health services, schools, universities or roads. Doing so would remove a justifiable source of grievance, but problems in public services are much more to do with what government does and how it does it more than this particular gap.

And Plaid should be particularly cautious about how much emphasis they put on this funding gap. They could quite easily win this battle but lose the war. Given the scale of spending cuts that are looming in England, it would be quite easy to redress the relative imbalance in funding (which is what gives rise to the funding gap), while at the same time reducing the amount of Welsh Government’s block grant. Remember that most departments in Whitehall are looking at 25% cuts in their budgets, and even the effect of protecting spending on health and education in England is limited. Those account for about 75% of changes in the block grant; but cutting 25% of the remaining 25% would almost certainly eliminate it. Wales could find itself receiving the now-talismanic 115% of English spending on ‘comparable’ functions, without getting a single extra penny in public spending – indeed, conceivably by getting less. Arguments to increase the Welsh Government’s resources by talking about ‘fair funding’ would then have no weight at all. The UK Government has shown no eagerness to do this to date, but it may well do in the next few years.

The Holtham Commission’s report is more interesting than just the work on the ‘funding gap’. Among a feast of important points, two stand out. One is the size of Wales’s ‘fiscal deficit’. Holtham tells us that overall tax revenues in Wales are £17.1 billion (all these figures are for 2007-08). I’ve calculated that this means Wales’s fiscal deficit – the amount by which all identifiable public spending in Wales (not just devolved spending) exceeds revenues – is £6.3 billion. That’s a horrifying sum, and indicates the measure of how poorly Wales’s economy performs. It gets worse if we look at that as a proportion of national income: it’s 14.2% (using a GVA figure for 2007 from ONS data).

We get a better idea of what this means if we look at Scotland. The question of whether there is a Scottish ‘fiscal deficit’, and how large it is if there is one, is a complex and contentious one. Thanks to a Scottish Government publication called Government Expenditure and Revenues Scotland (GERS for short), we have some quite good data about it. The most recent edition is available here although, for the rest of this post, I’ve used data for 2007-8, as that’s what Holtham used. There is a problem because of the question of how one treats North Sea oil tax revenues. For Scotland, the GERS figures for 2007-08 give a fiscal deficit 9.8% when North Sea revenues were wholly left out of the picture, 9% of GDP when Scotland was allocated a per capita share of North Sea revenue, and 2.7% of GDP when allocated an estimated geographical share of North Sea revenue. And one mustn’t forget that Scottish public spending is both higher than the UK average (about 118% of the average), and almost certainly significantly higher than could be justified on the basis of relative needs (which are probably around 105% of average).

So Wales has a significantly larger fiscal deficit than Scotland, even without being treated on the same basis as England, given its relative needs. And that means Wales’s fiscal deficit would be worse if its funding were on a relative-needs basis. But Scotland’s would be much smaller (and might even disappear – I haven’t yet tried to calculate that). Improving Wales’s economic performance to increase tax revenue generated in Wales and so tackle that deficit is vital, the more so because all the efforts to do this up to now have produced little if any improvement.

The other important thing we learn from Holtham is about how Wales should be funded, whether a block grant is the right way to do that. The Holtham Commission – a small group of expert professional economists – had little difficulty embracing for Wales one of the key points in the much more politically-oriented Scottish Calman Commission’s report: that devolution of public service functions, unaccompanied by financial responsibilities, means that there is a deficit of accountability, which can only be cured by ensuring that there is at least a measure of fiscal responsibility as well. (Calman’s members were drawn from the unionist political parties and wider civil society, advised at arm’s length by a panel of economists and other experts.) What is intriguing – and has impressed Scottish commentators – is the careful way the Holtham Commission appraised the issues, and looked at the technical aspects of how a limited measure of fiscal responsibility would work. When such a careful analysis supports the idea that this would work in practice for a poor part of the UK like Wales, as well as a relatively prosperous part like Scotland, it has to be taken very seriously.

Key to making this work are the changes the Holtham Commission propose to the block grant. First, it needs putting on a needs-related basis, and second the right mechanism needs to be used to calculate the reduction in the grant as a result of devolved tax powers. Holtham devotes a whole chapter to discussing different ways of doing this and their effects, while Calman skates over it in a single sentence. There are reasons to question this way of going about it – the amount of restoration work that the fabric of the inherited block grant needs to work reasonably well is huge, and will result in a system that is easier to put in place, but much more complex to operate. There are strong arguments for a wholesale reconstruction of how a block grant works and is calculated, so that it’s more fit for purpose. But the key point is that Holtham shows that this approach is workable, even for Wales, and even in times of public austerity.

None of this is to say that Wales should get less money from the public purse. But it is to say two things. First, it’s just unsustainable in the long term to expect public services to be paid for from revenues that others generate. This is a clarion call for Wales seriously to up its game in its economic performance. Even if a fiscal deficit can’t be eliminated, it can be reduced. Second, it’s in everyone’s interest for Wales to do so – for the UK Government as much as devolved politicians in Wales. And the fact this is a pressing problem suggests that the tools Wales has are themselves simply not up to the task. Broadly similar economic development policies (to attract large-scale inward investment) have been followed for many years. There’s a limit to what they can attract in the modern world, where there’s plenty of cheap labour around the globe and plenty of governments willing to offer a range of incentives to attract it. But the policy options open to the Assembly Government are limited by the powers it, and the National Assembly, have to use. Fiscal policy may well have a part to play in developing a different approach to delivering policy, and also in the policy itself.

This ball is now in the UK Government’s court. There are strong reasons for devolving some tax powers to Wales – for the accountability reasons Holtham discusses at some length, and to tackle the fiscal deficit and economic performance that it skates over.

And that’s where this creates a big question for the UK Government. Its Programme for Government commits the coalition to ‘implementing Calman’ for Scotland (as well as a bizarre commitment for a review for Wales, similar to Calman, if Wales votes yes in a referendum on Part 4, which is beside the point, and also dependent on stabilisation of the public finances). But why not make that model at least available to Wales as well? That’s what the Holtham Commission suggests, and it’s a compelling argument.

These problems can’t just be left to carry on as if they don’t exist.

This article will also appear today on Alan Trench’s own blog Devolution Matters – which is worth following