Wales must choose Northern Irish or Scottish devolution routes

Big decisions lie ahead for the nations of the United Kingdom. The extent and direction of devolution and the shape of the United Kingdom itself are likely to be determined for a long time in the next few years. In Wales, the Silk Commission has been set up to consider these matters – financial devolution first and constitutional matters next. It faces a bigger task than the Coalition government imagined when they promised to create it, as the ground moves under our feet.

I am sometimes asked how the first part of its mandate differs from the work of the Independent Commission on Funding and Finance for Wales that I chaired and which reported last year. The most obvious difference is that Silk is reporting to the British government and is a representative political body. My Commission, as the name implies was an independent group of specialists reporting to the Welsh Government. We could examine the technical arguments, set out alternatives and make some proposals but then it was up to the politicians to act or not as they saw fit. There was complete consensus in Wales on a number of our proposals: replacing of Barnett with a succinct formula based on relative needs and limited borrowing powers for Wales. There was some agreement but certainly less than complete consensus on our findings about tax devolution.

The things on which Welsh politicians agree – reform of Barnett and borrowing –are being pursued separately in inter-governmental talks, and Barnett reform has been explicitly excluded from Silk’s terms of reference. The first objective for the Silk Commission must therefore be to reach as full a consensus as possible among the Welsh parties and the UK government about tax devolution. That will not be straightforward.  While Plaid Cymru and the Lib Dems will presumably favour as much tax devolution as can be obtained, Labour in Wales is intensely suspicious of government motives and inclined to rule out substantial tax devolution unless there is an ironclad agreement to reform Barnett first.

The Conservatives’ position is the most opaque at present. The Secretary of State has been talking about accountability, suggesting she is in favour of the Welsh Assembly having responsibility for setting some taxes rather than being funded entirely by a block grant. The accountability argument was the one that the Calman Commission used in Scotland to justify more tax-varying powers there and our Welsh Commission also found the argument convincing. It is a general argument – a body spending public money should be responsible for raising at least some of it  – and if that applies in Scotland it applies in Wales as well.

If accountability requires a government to raise a reasonable proportion of its revenue, the options in Wales are limited. Only three taxes raise really big revenues: VAT, national insurance and income tax. VAT cannot easily be devolved. It would lead to cross-border smuggling and, anyway, it is contrary to EU law to have different VAT rates within a single country.

National insurance is seen as part of the welfare system, what people pay in to earn benefits. The benefit system is not devolved so it seems coherent to leave NI un-devolved too. That only leaves income tax as a big revenue source although there are other smaller taxes that could be devolved to give the Welsh government some more policy levers. It is quite likely that Conservative AMs would be content to back the Secretary of State and call for income tax devolution but they will surely be cautious since the policy will not be attractive to many of their rank and file supporters.

So last year it looked as if the Silk Commission would have the essentially political task of hammering out a deal among those various points of view, helped, we hope, by the analysis in the earlier Commission’s report. However, it now it begins to look as if some bigger issues will have to be addressed. The political situation has changed radically and is throwing up some wider questions.

Both the Calman report in Scotland and our Commission’s report in Wales were expressly unionist documents. They asked what fiscal arrangements made sense in a union state. In our report we were quite explicit:

“As an apolitical Commission independent from the Welsh Government, it would be inappropriate for us to make recommendations for the funding model for Wales that are grounded in our political preferences. Instead, we take the current constitutional position of Wales as given. Our recommendations are intended to be appropriate for devolution as it currently operates in Wales… For that reason we have not attempted to trace what a consistent scheme for fiscal federalism would look like in Wales.”

The Calman Commission approach was not very different and it represented a consensus among the UK government and the three unionist parties in Scotland which controlled the Scottish Parliament at the time. That, in the words of the poet Yeats, has now “changed, changed utterly”.  The current Scottish Parliament has a large SNP majority that rejects the Calman report and is demanding changes to the Scotland Bill, currently before the Westminster Parliament, that was based on its findings. If it cannot have independence, the SNP wants something called ‘devo-max’. Essentially that means full fiscal autonomy for Scotland, which would levy its own taxes and keep all the revenue. That would, indeed, be a form of fiscal federalism.

Alex Salmond’s plan is to hold a referendum offering three choices to the Scots: status quo, independence or devo-max. At present, the betting is the electorate will opt for devo-max. That raises the question: what then would the fiscal framework be for the other devolved territories and what, in particular, would become of the Barnett formula?

In considering this it might be helpful to consider the difference between a union arrangement and a federal arrangement. In a union state nearly all taxes are centralised and raised by a single government agency. Once an allocation has been made to different departments, the geographical distribution of that spending within departments is decided by formulae, usually based on estimates of relative need. No one asks where the revenue comes from and, indeed, those data are not collated. Needs, not revenue-raising, determines relative expenditure.

Devolution modified that but did not change its essence. Westminster asked which departments or functions were devolved and allocated a block grant to the territories based on English expenditure on those departments. To be sure the block grant was anomalous because it was set historically to grow by the same per capita amount each year as expenditure in England. That meant as functions were devolved, their allocation ceased to be determined by relative need. This anomaly is at the heart of the case for Barnett reform.

Note that tax devolution, too, need make only a moderate change to this system and our report, like Calman, worked out how to devolve taxes keeping upheaval to a minimum. Some taxes are devolved and the revenues, assuming a standard UK rate is levied, are deducted from the block grant. Assuming the standard rate is important, that fixes the deduction which does not change then if the devolved authority varies tax rates. Therefore any change in tax rates has an effect on the total revenues at the disposal of the devolved government – an absolutely necessary condition; otherwise the tax devolution would not be ‘real’.

The system still means that if taxes are kept at the standard UK level, a territory has similar expenditure possibilities to the rest of the UK, irrespective of its own tax-raising capacity. If the grant were on a proper needs basis each area would have potentially the same public services as the rest of the UK.  Devolution means they could opt to have more or less of public services but only by raising or lowering taxes.

On the other hand, in a federal system people are not blind to the geographical origin of taxes. A record is kept of tax collected in each region and that region keeps its own revenue to spend. Since most federations have some areas more prosperous than others there are usually some compensating transfers for poorer regions. However, these are usually modest, doing no more than equalise revenue per head.

Consider what that would mean for Wales. We currently have public expenditure in Wales at about 112 per cent of the English average. A needs-based formula based on those in use within England would give us about 115 or 116 per cent, an increase of some £400 million a year. But if we just had revenue equalisation, that could mean we would have the same spending per head as England, a drop of some 12 per cent from the current level, or about £1.6 billion a year. In principle, a federation could have more generous transfers, but it is unusual. Only Australia attempts equalisation based on expenditure needs rather than revenue and that involves a substantial public body independent of government to carry it out. There is no British precedent for such a body and you can bet your last penny the Treasury would fight it to the death.

Why, then, do the Scots want devo-max? And if it’s good enough for them, should we want it too?

In union terms Scotland gets a very good deal from the Barnett formula. We calculated that a needs-based formula would give them expenditure of around £105 a head for every £100 spent in England. Barnett gives them £120 a head, a 15 per cent premium of about £4 billion a year. No English government wants to tackle that excess allocation, fearing that to do so would increase support for the SNP.

Nonetheless, the grumbling in England and Wales is getting louder and that is uncomfortable for the Scots. Get well-informed Scots in private and you don’t need to ply them with too many whiskies before they admit that they are doing relatively very well. They justify it by saying, “you get what you negotiate”, but they know there is no principled basis for their position. With devo-max they would be able to justify matters on a principled basis though, to be sure, a different principle from “to each according to his need”.

Yet would they really be no worse off? The SNP believe that the mere fact of getting so much autonomy would enable them to release new energies in Scotland that would drive the economy and make current calculations irrelevant.

Let’s assume Scotland gets its geographical share of North Sea oil. According to the Government Expenditure and Revenue in Scotland statistics, in 2009-10 the country had a net fiscal deficit of nearly £14 billion, 10.6 per cent of its GDP. However, that reflects the economic downturn and the fact that the UK as a whole had a similar deficit. So look instead at 2007-8, the last year before recession when revenues were at a peak.  In that year the statistics show a deficit of  £3.7 billion (2.6 per cent of GDP). So in a good year, with high oil prices, Scotland would be in much the same boat as it would under the present system if Barnett was reformed and it lost £4 billion.

However, revenue per head in Scotland is a little below that for the UK as a whole. In 2007-8 its revenue was a shade over £52 billion. The UK’s revenue was £549 billion. So if Scotland’s population is about 10 per cent of the UK and it got a revenue equalisation grant, it might get another £2-3 billion. That would mean its position was little different from the current one or only slightly worse – and no one would be moaning about it.

In practice, if recession is prolonged and the oil price goes down, Scotland could be very much worse off. Its balanced budget could go the same way as Alex Salmond’s notorious “arc of prosperity”. But then if you believe that more autonomy would confer extra policy levers and enable the Scots to stimulate growth, you might be prepared to run that risk. At the moment many Scots seem ready to do so.

What of Wales? The situation here is more obscure because we do not have the data we need for careful assessment. Comprehensive figures for Wales do not exist and what follows are estimates.  In the same pre-recession year, my Commission estimated that total identifiable expenditure in Wales was about £25 billion, exceeding Welsh tax receipts by £6 billion. This was a fiscal deficit above 10 per cent of Welsh GDP.  On the face of it a revenue equalisation grant would boost Welsh revenues to some 5 per cent of the UK, some £27.5 billion for the year in question, which would have more than made up the gap.  But Wales would presumably have to pay extra contributions towards UK-wide expenditures, on defence, foreign policy and debt service. And the comparison between 112 and 100 per cent of English expenditure per head suggests Wales could lose out compared with the current situation.

So if Scotland gets devo-max, what should Wales do? Should it ask for the same arrangement, with revenue equalisation or insist on remaining within a union system with a block grant? With Scotland federated and not receiving a Barnett-based grant, there could be even less resistance to replacing Barnett with a needs-based formula. It is possible Wales would thereby benefit from Scotland getting devo-max. However, I would not bet on it. The Treasury will still resist and Welsh bargaining power would still be pitifully small.

In my opinion, the Silk Commission should liaise with the Scottish government and other interested parties to try and understand exactly how they think devo-max would operate. Then it should demand some detailed work on the Welsh expenditure and revenue accounts.  That would allow an informed comparison to be made among the different possibilities.

Some people are worried that Wales will not get a choice. If English politicians see it as a way to save money, could they not insist that Wales has the same federal arrangement as Scotland and look to reduce the scale of subsidies from the centre? I do not think that is a risk for one reason – Northern Ireland. The Irish unionists will fiercely resist anything that makes it look as if the ties with Great Britain are being weakened.  English politicians will not disturb the fragile equilibrium in Northern Ireland. If they do not push the Irish into federalism it would surely be impossible to push the Welsh.  We can be in a federation, like Scotland, or a union, like Northern Ireland. Our future is surely in our own hands.

The probability that Wales would indeed be initially worse off under its own version of devo-max, plus the innate conservatism of Welsh politicians and the electorate will presumably mean Wales opts to stick with union arrangements.

Nonetheless, the situation remains open-ended and is not easily predictable, as with constitutional developments in the UK more widely. We live in an interesting period. The Silk Commission will no doubt strive to rise to what Nye Bevan called “the imperious needs of the times”.