What we have to spend over the next four years

The question of what will happen to the Welsh Government’s budget from 2011-12 onwards has been the subject of a number of estimates in recent years. In late 2009 I estimated that from 2011-12 it would show a cumulative loss over three years of £2.8 billion in real terms, that is after taking account of inflation (Agenda, IWA, Winter 2009, based on Labour’s 2009 and 2010 UK budgets). On 16 March 2010 this estimate was confirmed by the Wales Audit Office when they published their own estimate that the cumulative loss in real terms would be £3 billion.

In a speech to Cardiff Business Club on 29 March 2010, First Minister Carwyn Jones stated that the Welsh Government was planning future expenditure on the assumption of cuts of 3 per cent per year in resource spending and 10 per cent per year in capital spending over the coming three years. In June the Finance Minister, Jane Hutt, reiterated these ‘planning assumptions’. At the time I prepared a paper which demonstrated that these forecast cuts were far in excess of estimates based on the UK Labour Government’s 2009 and 2010 budgets.

In June 2010 the London Coalition Government’s budget set out a set of forecasts for total UK spending for the five years from 2011-12 onwards (Budget 2010 HC 61 Chart 2.3). More recently, in July 2010, the Beveridge Committee, an independent committee of experts commissioned by the Scottish Government, published a report which estimated the changes to its budget for the coming four years. These estimates were based on the June 2010 UK budget. The Welsh Government appears not to have sponsored a comparable, independent study.

On 20 October 2010 the UK Government is due to publish the outcome of its spending review for the next four years and this will include a definitive budget line for Wales. In the meantime I have used the June 2010 budget to recalibrate estimates for the Welsh budget for the next Spending Review period from 2011-12 to 2014-15. The baseline for 2010-11 has been updated in accordance with Treasury estimates made in June 2010.

Subject to the qualifications contained in the box at the end of this article, Tables 1 and 2 set out the estimates for the Welsh Government’s budget for the coming four years in nominal and real terms,

respectively.

Table 1: Departmental Expenditure Limits: Wales (£ billion nominal) based on the June 2010 Budget

Plan**			Estimate			Cumulative Reduction	AAGR*
	2010-11	2011-12	2012-13	2013-14	2014-15
Current	13.90	13.92	13.85	13.84	13.70	-1.5%	-0.4%
Capital	1.70	1.45	1.39	1.29	1.36	-20.0%	-5.4%
Total (nominal)	15.60	15.37	15.24	15.13	15.06	-4.3%	-1.1%

Table 2: Departmental Expenditure Limits: Wales (£ billion real) based on the June 2010 Budget

Plan**			Estimate***			Cumulative Reduction	AAGR*
	2010-11	2011-12	2012-13	2013-14	2014-15
Current	13.90	13.66	13.10	12.94	12.47	-10.3%	-2.7%
Capital	1.70	1.42	1.52	1.21	1.24	-27.1%	-7.6%
Total (real)	15.60	15.08	14.62	14.15	13.71	-12.9%	-3.4%

*AAGR is annual average growth rate.

**Table C 13. HM Treasury. Budget June 2010.

*** GDP Deflator           1.9%        2.3%        2.6%       2.7%

Taking 2010-11 as the base the cumulative loss over next four years in nominal terms will be £1.6 billion. In real terms it will be £4.8 billion (or £3.0 billion over three years compared with Labour’s £2.8 billion for the same period). This is equivalent to an average annual reduction of 1.1 per cent in nominal terms and 3.4 per cent in real terms (taking account of inflation). In 2014-15 the Welsh budget will be 4.3 per cent lower in nominal terms and 12.9 per cent lower in real terms than in the current year.

As a ‘sanity check’ the corresponding cuts estimated by the Beveridge report in the case of Scotland (Table 2.1 of that report) are for cumulative cuts in real terms of 12.5 per cent (my estimate for Wales is 12.9 per cent) and an average annual reduction of 3.3 per cent (my estimate for Wales is 3.4 per cent). Given that a greater proportion of public expenditure in Scotland is devolved compared with Wales (69 per cent for Scotland; 62 per cent for Wales) the corresponding cuts in the respective budgets will not be the same but should not differ materially.

The implication of the First Minister’s speech was that cumulatively over three years spending would be cut in real terms by 16.5 per cent or an average of 5.8 per cent per year. These compare with my estimates based on the Office of Budget Responsibility forecast of 9.3 per cent and 3.2 per cent, respectively.

It is significant that the forecast cuts in the Welsh Government budget estimated here are much lower than those alluded to in the First Minister’s speech to the Cardiff Business Club in March 2010 and by the Finance Minister in June 2010. By 2013-14 the difference in that year alone is £1 billion.

It is difficult to reconcile the forecast cuts as set out both in Labour’s 2009 and 2010 UK budgets, and in the Conservative Liberal Democrat 2010 budget with the planning assumptions being employed by the Welsh Government. Perhaps it is being deliberately used either by the Treasury or the Welsh Government to ‘flush out’ much greater potential savings than those being sought in practice or to provide a larger contingency fund.

It should also be noted that because the largest area of expenditure in England is being ‘protected’, that is the £104 billion NHS spending, other programmes in England will have to bear much deeper cuts than the average real departmental reduction of 14 per cent. Thus the Treasury may have directed all spending departments, including Wales, to draw up plans for much deeper cuts than those expected for Wales. It will be a matter for the Welsh Government to decide which spending areas will be subject to which level of cuts.

This paper has concentrated on the cuts to be made to the funding of the Welsh Government. Approximately 40 per cent of identifiable public spending in Wales ‘by passes’ the Welsh Government and is direct expenditure by the UK Government. The great majority of this is on welfare spending including old age pensions; invalidity benefit; unemployment benefit, income support and tax credits. Although the UK Government has not finalised its plans, on 9 September 2010 the Chancellor of the Exchequer announced he would be seeking reductions of £15 billion in these welfare budgets.

Given that Welsh spending per head on these programmes is 115 per cent of the UK average, such a level of cuts would mean that people in Wales would lose approximately £830 million a year. Further, given that most of this money is spent in the local economy (few recipients of such payments are in a position to save) then this will have a wider knock-on effect.

Assumptions made in preparing the estimates in Tables 1 and 2 Changes to the Wales budget will be proportionally the same as those for the overall UK budget, but will be reduced due to the Barnett convergence effect. This will entail a small reduction due to the offsetting impact of the GDP deflator. The Barnett squeeze is a function of changes in nominal growth (before inflation), with real cuts being offset by a relatively small amount of inflation. The GDP deflator used to convert real to nominal changes is in the time series set out in the June 2010 UK Budget. The ring fencing of NHS expenditure in England will have the effect of ameliorating cuts in the Welsh budget. However, this will be offset to a significant degree by deeper cuts in other UK departmental programmes which are, in the case of Wales, devolved. Nevertheless the estimates included here are likely, due to this factor, to be a little worse than the expected forecasts to be published in the forthcoming Spending Review.