Institute of Welsh Politics Annual Lecture 2011

Introduction
It’s always a pleasure to return to Aberystwyth, where I spent enjoyable years as an undergraduate.  I have many vivid memories of that period – and some less vivid!  – but like many an ex-student I think it’s probably best if I keep those to myself.

In my time the University was very much smaller than it is today…it’s been pleasing over the years to see how the University has developed and gone from strength to strength.  It has built on long years of tradition and established national and international reputations in a number of areas.  Earlier today I met April McMahon, the recently appointed Vice-Chancellor, and I’d like to wish her and all the staff and students here every success for the future.  The environment for universities is challenging in a number of ways but I’m confident that Aber is well-placed to build on past achievement and will continue to provide relevant, quality education for generations to come.

This university was established in the nineteenth century by money collected, in part, from ordinary Welsh citizens in order to provide an education and better prospects for their children.  That tradition continues.  Today the Welsh Government aims to do what it can to give young people in Wales – that’s who we’re responsible for – a helping hand with tuition fees in recognition of the importance of education to our economy, and to help young people starting their working lives without being burdened by onerous debts.

I’m grateful for the opportunity to give this year’s annual lecture at the Institute of Welsh Politics – and thank you for the invitation. The Institute is now in its 15th year, I believe, and has over that time developed an excellent reputation.  It is important that Welsh civic society is able to scrutinise and challenge the work of government from an informed, evidence-based perspective.  As Wales develops a more distinct political culture, the need for institutions such as this is sure to grow.

It’s worth noting that no less than 10 of the 60 members of the National Assembly for Wales graduated from Aber – a fact I only became properly aware of when the University organised a reception for us in Cardiff a few weeks back.  The Members are just the tip of the iceberg…many, many civil servants who advise and service the work of the National Assembly and the Welsh Government were also educated here at Aber – a fact which would surely have delighted the founding fathers and mothers of this college.

Success of Welsh devolution

It was famously said that devolution in Wales is a process not an event.  Since the people of Wales took their first hesitant steps towards managing our own affairs back in September 1997, the devolution settlement has moved steadily forwards.  Many – but not all – of the weaknesses in the original settlement were tackled in the second Government of Wales Act (2006) and, subsequently, through the referendum on additional law-making powers in March this year.  We now have a clearly defined set of powers and a recent Supreme Court decision in the AXA Insurance case helpfully makes clear that only in the most exceptional circumstances will the courts be willing to apply common law principles to question the validity of Assembly Acts.

Crucially, improvements to the devolution settlement have been achieved with the consent of the people of Wales.  They have not been imposed on a reluctant population by an elite group of constitutional ‘anoraks’ [and incidentally I’m delighted to see so many of you here today!].  That support has been apparent in opinion surveys, in elections and most recently in the referendum.  Devolution enjoys broad support across regions, parties and social groups.  To adapt that other cliché that was originally applied in the Scottish context, devolution is now the settled will of the Welsh people.

The financial settlement for Wales is a different story.  During the first 12 years of devolution the debate centred on constitutional issues: the separation of the executive and legislature, moving to full law-making powers, removing quangos and building democratic accountability.  This next phase in the devolution process is dominated by financial and fiscal issues.  The issues surrounding finance haven’t just crept quietly out of the woodwork.  They were always there but it was inevitable that the early years would be dominated by getting the devolved institutions themselves into the right shape and on track.  It’s also true that questions about fair finance for Wales were, at least partially, masked by the benign economic circumstances which characterised the first decade of devolution.  Since the downturn of 2008 there has been a more pressing focus on financial fairness, and I’ll be returning to this in greater detail.

Focus on delivery

For me, devolution is about delivering real and quantifiable benefits to the people of Wales.  Yes, it’s true that devolution speaks to our sense of political and cultural identity as a nation, and I of course share this view.  But we must never allow debate about the process of devolution to supplant debate about its purpose.  The main reason that devolution enjoys widespread support in Wales is because people expect it to deliver real improvements in their everyday lives.  As First Minister, I am clear that the chief responsibility of the Welsh Government is to deliver the public services so vital to the wellbeing of the people we serve. Schools, transport, universities, hospitals, support for farmers – these things really matter and that’s why the Welsh Government’s focus must be on delivery in all our areas of devolved responsibility.  At a time when the global economic outlook is so uncertain, the Welsh public – rightly – expect us to focus on what matters most to them. Constitutional change should support these priorities, not replace them.

Constitutional change

Nevertheless, it is clear that there may be further constitutional change.  We know this because the UK Government has set up a new Commission to review Welsh Devolution under the chairmanship of Paul Silk.  Let me say something about how I want to approach that.

First of all, I am clearly a natural devolutionist – I wouldn’t have devoted the last 12 years of my life to it if I wasn’t!  For me, devolution offers a form of government which can enable the needs of people in Wales to be most effectively addressed.

That emphasis implies several things.  First, it means that further devolution for its own sake is unappealing to me.  My question will always be, “Does this new devolution proposal offer a real prospect of improving the lives of people in Wales?”

Let me illustrate this approach with a practical example.  We have sought, so far unsuccessfully, devolution of energy consents for renewable energy projects.  There is no doubt that this is a contentious issue in parts of rural Wales, and I believe the Welsh Government would be able to develop a policy that is more in tune with the concerns of our communities than the current UK Government approach.  I therefore believe that devolution of responsibility for this matter could potentially be beneficial to the Welsh public; the first test is passed.

The costs of devolving this function would not be excessively large.  We would have to agree a budgetary transfer along with the transfer of policy responsibility, but in general, I believe that this new function could be accommodated within existing Welsh Government structures.  The second test is passed.

Finally, the impact of devolution on the wider UK would be limited. I therefore believe that there is a clear case for energy consents for large scale energy projects to be transferred to Cardiff Bay and I believe that the relevant tests are satisfied.  (As it happens, such a transfer would be entirely compatible with the UK Government’s localism agenda in England; it would give local people a far greater opportunity to have their say on developments with potentially enormous significance for their daily lives).

A further implication of my take on devolution is this.  Our institutions of government should enable the particular needs of people in Wales to be most effectively addressed.  That means that governmental developments elsewhere within the UK may be of only limited significance.  We need a constitutional settlement which reflects distinctive Welsh circumstances.

So I’m cautious of arguments based on the view “well, the Scots have got it, so should we”.  For example, if the Scots were to choose the so-called “devolution max” scheme as a way of redefining their relationship with the rest of the UK, that would be their right.  But such an arrangement, in my view, wouldn’t be right for Wales, at least not just now.  Each country must work out its own solutions in its own time and according to its circumstances.  We should learn from others – certainly – but never blindly follow.  The flexibility inherent in devolution, its potential for allowing the development of local solutions to local circumstances, should allow that to be done.

One final point on my general approach to devolution.  You will have noted, in my discussion of devolving the energy consents function, that it would have only limited impact on the UK.  This is an important consideration.  Devolution is concerned with the best structures of governance for the United Kingdom as a whole, compatible with the fundamental unity of the country.  I am committed to that.  So I will not support new proposals for devolution which have the potential for long-term damage to the UK.  Let me give an example.

Suggestions have been made for the devolution of corporation tax.  This tax would potentially be a powerful new tool to promote economic development, and so devolution might benefit people in Wales.  The first test is comfortably passed.

However, the benefits of devolution would only be apparent if we were to cut substantially the headline rate of corporation tax.  The costs to the Welsh budget of using this policy lever would therefore be large.  What’s more, there would be a significant administrative and regulatory overhead involved in operating multiple corporation tax regimes within the UK; for instance, additional work would have to be put into ensuring that companies did not simply put up ‘brass plaques’ in low tax regions to exploit rate differentials.

But it is on the third test – the UK-wide implications – where I have the greatest concern.  The risks to the integrity of the tax base of the UK as a whole could be significant. We could hardly expect that the UK Government would grant Wales alone the power to vary corporation tax rates, however attractive such a scenario might be.  Other devolved administrations would also be given similar powers, and the pressure from English regions for equal treatment would be immense – if I were an English regional representative I, too, would apply such pressure.  In such a world, we would risk a ‘race to the bottom’ in corporate tax rates as regions competed against one another to attract businesses.  The end result would be lower corporate tax receipts across the whole UK but with little net impact on the location of business activity.  Taken as a whole, the costs and risks of devolving corporation tax would not necessarily invalidate the benefits – we would have to see a fully worked up proposal to make a final judgement – but they should certainly be sufficient to make us proceed with great caution.

Financial reform

That takes me on to financial reform.  With the success of the referendum we now – more or less – have the law-making tools we need to do the job.  But it is striking that, while our legislative powers have been rethought and reformed, the financial side of the system remains almost entirely as it was before devolution began. Indeed, in most fundamental respects the financial settlement is unchanged since 1980, when the Barnett formula was first applied to Wales.

We have a lop-sided system of devolution.  Our legal powers reflect the Assembly’s status as a modern, responsible legislative body, of at least equivalent standing to sub-state legislatures throughout Europe.  In contrast, our financial powers give us far less flexibility than is granted to a Welsh local authority – or to a community council for that matter.  That cannot be the right way forward.  The challenge we face is to develop a financial settlement that supports rather than hinders the effective operation of devolved government: providing stability, flexibility and responsibility to Welsh Ministers and the devolved institutions, while operating securely within a UK-wide fiscal framework.

So what are the problems with the financial settlement?  Many here tonight will be familiar with the work of the Holtham Commission, which shone a harsh light on the failings of the current system that sets our block grant.  Gerry Holtham concluded:

• that the mechanism for calculating the block grant lacks any coherent rationale;
• that the funding we receive falls short of what is required to meet Wales’ relative needs by at least £300 million per year;
• and that if the system is left unaltered, our underfunding will persist and, over time, get worse.

That is a pretty damning list.  Put simply, it means that the status quo is unsustainable.  Over time it would lead to an ever-growing underfunding of Welsh public services.  That is why reform of the financial settlement is not an obscure piece of constitutional theorising – achieving financial reform is fundamental to our ability to do the job we were elected to do.

Clearly, reforming the current funding system is in the interests of Wales and the Welsh Government.  It is also, I believe, in the interests of the UK Government.  Despite our political differences, both Governments have a shared interest in developing a fair and stable devolution settlement whose broad parameters are accepted on both sides of Offa’s Dyke.  That is the best route to ensuring that devolution works in a way that supports, rather than undermines, the structures of the UK state.

I want to be constructive. We are talking to the UK Government about both fair funding and borrowing powers.  We are pressing for a funding ‘floor’ as proposed by the Holtham Commission to tackle the problem of underfunding, along with permission to borrow to finance capital investment projects.

Just as our call for block grant reform is grounded in practical realities, there is also a pressing need for Wales to access borrowing powers.  The Northern Ireland Executive can already borrow, while the Scotland Bill will provide similar powers to the Scottish Government. Indeed, the Scottish Government is being allowed to use a borrowing mechanism to begin paying for the replacement of the Forth Bridge – a key piece of Scottish economic infrastructure – in this financial year.  And of course the UK Government has very wide borrowing powers to fund public services in England.

Our capital budget is being cut by a massive 50% in real terms over five years, with severe implications for our plans to invest in infrastructure.  Borrowing powers would help us to manage and offset the worst of those cuts, and could also be used to finance major infrastructure projects that are currently unaffordable, such as relieving pressure on the M4.  So in our inter-governmental talks we are not seeking change for the sake of it, nor are we making unreasonable demands that would have harmful consequences elsewhere in the UK.  We simply seek a mechanism to finance infrastructure projects which can help transform the economic prosperity of our country.

Turning to the issue of tax devolution, subject to what I said previously about corporation tax, I am open-minded about the case for change.  Over the coming year, the Silk Commission will be considering the arguments for and against passing some tax-varying powers to Wales, and we will talk constructively with the Commission.

Holtham identified several taxes – stamp duty, landfill tax, air passenger duty and aggregates levy – where devolution might be both feasible and desirable.  If those taxes can provide us with additional policy levers in areas where there is already a substantial degree of devolved responsibility, then devolution should be given serious consideration.  I can see no constitutional barriers to such a move.  In these fields, tax devolution powers would result in a deepening, rather than a broadening, of the Assembly’s competence.

It has been argued, by Holtham and others that Wales should go further and move to a system where limited powers over income tax are devolved.  Under this scenario, a chunk of the block grant – let’s say £3 billion pounds or so – would be replaced by income tax receipts from Welsh residents.  In addition, it has been proposed that Welsh Ministers should be granted limited powers to vary income tax rates in Wales, while UK Ministers would retain responsibility for thresholds, allowances and collection.

One reason for such a policy would be to end the system of so-called ‘block grant dependency’, in which the Welsh Government’s budget is wholly determined by a grant from the UK Government.  It is undeniable that this arrangement is very unusual by international standards.  And I can see why people argue that establishing a direct link between income taxes paid by Welsh citizens and the budget of the Welsh Government could strengthen democratic engagement.

However, it is inevitable that income tax devolution would be a complicated and risky process – far more so in Wales than in Scotland.  Our border is much more porous, our economy is more tightly integrated with England and, historically at least, our tax base has been less robust.

In line with our manifesto commitment, we are not seeking devolution of powers to vary income tax rates.  Furthermore, the constitutional precedent in Scotland, and the wording of the preamble to the question in the referendum last March, surely mean that the endorsement of the people of Wales in a referendum would be required before devolution of income tax could take place.  How many people want another referendum in the next few years?

However, that does not mean that some form of linkage between Welsh income tax receipts and the Welsh budget should be ruled out in the longer term.  One option might be to move over time to a system of assigned income taxes, whereby part of the block grant is replaced by Welsh income tax receipts.  As an interim arrangement the rate-setting powers might remain at Westminster while a new system bedded in.  Wales would receive its own, substantial stream of revenue; this would strengthen democratic linkages and it could directly fund a well-developed borrowing programme.  Income tax varying powers might follow at a later stage, but only if this was approved in a referendum.

So I am content for the Silk Commission to look at income tax as part of its work and to consider whether the risks and practical barriers could be managed in a phased and sensible way.  To be clear and to avoid misunderstanding or ambiguity, I am not advocating income tax powers, but neither do I have a closed mind to debate about the best ways to finance Wales over the long term.  In any case, on matters as fundamental as income tax, it is the people of Wales who should always have the last word.

This is a complicated, multi-faceted set of issues.  That is why I am adamant that piecemeal reform will not work.  We need to develop a comprehensive solution that addresses fair funding, borrowing powers and fiscal devolution in order to secure a financial settlement that is robust over the longer term.

Drawing these strands together, what might a new financial settlement for Wales look like and when might it take shape?  We have repeatedly made clear – and I emphasise this point again tonight – that a sustainable and fair block grant is the essential prerequisite to wider reform.  Even if Holtham’s recommendations were implemented in their entirety, the block grant would still account for around [80]% of the Welsh Government’s budget.  It would be irresponsible in the extreme to implement tax devolution, with all the volatility and risk that could entail, without an agreement to put the block grant on a stable footing.  The Holtham floor is my preferred approach to achieving this in the near term, but if the UK Government has other proposals I will give them serious consideration.

The good news is that this type of block grant reform requires no legislative changes – it simply needs the agreement of the UK Government.  In my view, and based on the evidence of the Holtham Commission, a floor should already be in place.  The UK Government is adamant that that this will not happen during the current spending review period, but I see no reason at all why a floor or a similar mechanism should not come into force at the next spending review in 2015.  I am hopeful that an agreement on this fundamental point can be reached.

Further good news comes from the fact that the Welsh Government already possesses some borrowing powers in law, which we acquired following the absorption of the WDA into the Welsh Government several years ago.  The problem has been that, to date, were we to use those powers our block grant would be adjusted so as to leave us with no net additional resources.  So here also we do not need to wait for changes to the law – an administrative agreement with the UK Government would suffice.  I believe that we should be granted powers to begin borrowing for key projects, [perhaps initially with Treasury consent and on a case by case basis,] within the lifetime of this spending review. Certainly, the offer that’s been made to Scotland on the financing of the Forth Bridge should also be available for Welsh infrastructure projects.

A more fully developed and less restrictive set of borrowing powers should follow in the spending review period that starts in 2015.  I expect that the Silk Commission will have its own thoughts on how this might be done, and I look forward to seeing what it recommends.  Once the Commission has reported, I hope that the Welsh and UK Governments will be able to agree reasonably quickly on a framework for devolved borrowing over the medium term that provides us with additional flexibility while giving the Treasury the necessary assurances about the impact on the UK’s fiscal position.

Unlike block grant reform and borrowing, devolution of tax-varying powers would require legislation and could therefore only take place over a longer timescale.  Before any tax could be devolved, a great deal of work would be required to improve our knowledge of the Welsh tax base and to agree how tax receipts would interact with the block grant, along with a host of other technical details.  In Scotland, devolution of powers over some smaller taxes will begin in 2015; we are at least a couple of years behind that schedule. And clearly, any linkage between our budget and income tax receipts would be still further away.

The Silk Commission is due to report on the financial aspects of its remit in the autumn of 2012.  In the following months I would expect the UK Government to consult with us on the Commission’s recommendations and, building on the outcome of the intergovernmental talks that are running in parallel to the Commission, to introduce legislation in 2013 that would take forward a comprehensive set of proposals that enjoy broad support.

The second stage of the Silk Commission’s work will move beyond financial matters and consider the devolution settlement as a whole.  The Commission’s work could provide a useful opportunity to review the current settlement and to consider which functions are best undertaken at the Welsh level, and which should be retained at UK level.  For the avoidance of any possible doubt, I will not agree to any repatriation of powers away from the Assembly; that is not the function of the Commission and it’s not what Wales needs.  Not to be fair, is it what either the Prime Minister or the Deputy Prime Minister have suggested in my discussions with them.  Equally, as I have made clear, I do not believe in devolution for devolution’s sake.  Indeed I would go further – those of us who believe that a strong devolved Wales is best served by remaining a part of a strong United Kingdom should be unashamed to acknowledge that some functions are best kept at the UK level.

That observation in turn begs a fundamental question, the future of the UK.  A key underlying assumption underpinning the Silk Commission work must be that the United Kingdom will continue to exist very much as it does now; indeed, the Commission’s Terms of Reference invite it to provide advice on improving the Assembly’s financial accountability “consistent with the fiscal and constitutional framework of the United Kingdom”.  So the Commission is effectively required to assume the constitutional status quo, and reconsider Wales’ place within that structure.

But what happens if the Scots choose, perhaps in 2014 or 2015, either to leave the UK, or fundamentally to change Scotland’s relationship with the UK through adoption of a “devolution max” scheme?  The United Kingdom as we currently understand it would become a very different thing indeed, and Wales’ constitutional relationships within it would require a much more radical reconsideration.

As I said earlier, in my view “devolution max” offers no satisfactory constitutional settlement for Wales.  But if the Scots do decide to change the rules of the game, it might be that a more generous transfer of legislative competence to the Assembly (perhaps based on something equivalent to the Scotland Act 1998, and underpinned by creation of a separate legal jurisdiction for Wales), supported by a more equitable system of devolution finance, could provide the basis for a new constitutional settlement for Wales within a restructured United Kingdom.

However that may be, the Silk Commission clearly faces a difficult task.  It may need to make recommendations for Wales on the basis of alternative assumptions: either assuming maintenance of the UK constitutional status quo, or on the basis of a radically-changed UK following decisions by the Scots on their national future.

All that is for the future, but before finishing, I want to say something about two constitutional issues which will require our attention quite soon.  First, the Westminster Government has announced its intention to appoint a Commission to consider the so-called West Lothian Question.  This is sometimes expressed as a call for “English votes for English laws”; the suggestion is that Scottish, Welsh and Northern Irish MPs should be excluded from debating or voting on Parliamentary Bills which in their subject-matter are exclusively of interest to England.

How is a Bill, in the House of Commons, exclusively of interest to England to be identified?  Given the extent of our social and economic integration with England, I see real difficulties for Wales here.  Our border with England is long.  Many people move freely and unselfconsciously, in both directions, for work, commerce, and services.  It is mooted that one possible answer to the West Lothian Question would be to exclude Welsh MPs from contributing on matters of direct and immediate concern to their constituents.  Any Welsh devolutionist has to recognise the right of England to determine its future, and I do, but I am left feeling uneasy at the prospect of the UK Parliament, in effect, discriminating between its Members to solve “the English question”.  If there is an English Question, and if it needs answering, then I do not believe the UK Parliament is the place to answer it.

This, when taken with the forthcoming 25% reduction in the number of Welsh MPs, could only result in the weakening of the Welsh voice at Westminster.  For anyone committed to maintaining a strong UK, and Wales’ place within the UK, that must be a matter of concern.

So I sound a note of caution about the need for elected representatives to take care with the constitutional settlement.  We risk undermining the broad support that devolution enjoys if the ‘rules of the game’ are changed arbitrarily and without popular consent.  This is especially so if done in a way that may be perceived as being motivated by partisan political advantage.

This takes me to the second immediate challenge. We now have the possibility of a significant reform of the electoral system used to elect Assembly Members since the start of devolution in 1999. The current system – a hybrid of 40 first past the post constituencies and 20 list members – is not perfect.  I am well aware (painfully so!) that the system makes it very hard to achieve a working majority in the Assembly even when a party earns a comfortable majority of the votes.

No doubt some of you will say that’s a good thing, but that’s a debate for another day.  My point is that the voting system was a significant component of the original devolution settlement, and as such was endorsed by the Welsh people in the 1997 referendum. That does not mean that another referendum is needed to change the Assembly’s voting system, but it does mean that a degree of broad popular consent is necessary. At a minimum, proposals for change should be published in party manifestos and tested in the cut and thrust of an election campaign.  That did not happen in the General Election of 2010, and therefore I believe that no party can at the moment claim to have a mandate for changing the current system.

So, how to conclude in these very uncertain times? As I said at the outset, at a time when the global economic outlook is so uncertain, Welsh citizens expect us to be focused on what matters to them.  Our primary focus in the coming years must be to use our devolved powers to improve people’s everyday lives.  The current financial settlement undermines our ability to do that.  We are arguing with the UK Government, and with the Silk Commission, for a new, fair settlement that can provide financial stability for the longer term.  We will take a principled approach when it comes to amending the wider devolution settlement, seeking benefits for Wales within a framework of UK institutions.

The devolution project in Wales has been remarkably successful. After a close run thing in 1997, the devolved institutions have become a natural and accepted part of people’s lives.  Provided we take care to ensure that further changes are in line with the aspirations of the Welsh people, I believe the future of devolution is bright.