The Outlook for Public Spending in Wales.

Summary.

Now that the dust is settling after the UK general election a key question that arises is what is the outlook for public spending in Wales?  An analysis by the Institute for Fiscal Studies of the commitments made by the Conservatives in their manifesto and during the election campaign makes it possible to estimate the likely impact of the new government’s policies on public expenditure in Wales over the coming years. In this analysis spending up to 2018-19 is estimated.  If the UK government keeps to its plans public spending will fall to a minimum in that year and then start to increase again in the final year (2019-20) of this parliament.

In summary:

• The block grant should not change materially in real terms over the coming four years. This compares with a real terms cut of ~8 per cent over the last five years. This estimate is predicated on the UK Government evenly phasing in  over the next four financial years its planned increase of £8bn by 2019-20 on NHS spending in England with a consequential increase in Welsh funding which will offset other cuts.

• Non-devolved departmental spending in Wales will fall by approximately £260 million by 2018-19: this is a reduction of 16 per cent in real terms.

• Spending on social protection in Wales by the UK Government will fall by approximately £550 million a year by 2018-19. Given that just under half of such spending is for pensioner related benefits which are protected by the ‘triple lock’ this means that other welfare spending targeted at those of working age will suffer a cut of ~10 per cent in real terms.

• Total identifiable public expenditure in Wales will be cut by £810 million in real terms by 2018-19: a reduction of some 2.6 per cent.

Introduction.

One of the characteristics of the election campaign was last minute goodies being offered by the contending parties and a lack of clarity on how spending and tax give-aways would be funded. The incoming Conservative government committed not to make rate changes to the principal sources of revenue: income tax; national insurance; and VAT which between them account for 62 per cent of total government revenue. This commitment does not of course preclude the government from moving thresholds and changing allowances but it could prove to be major constraint if unforeseen macroeconomic events, often outside the control of UK government, unfold over the coming years. Furthermore there is a commitment to raise both the standard rate and higher rate income tax thresholds by 2019-20. The UK government also hopes to raise an additional £5bn a year by clamping down on tax avoidance and has committed to increasing the funding of the NHS in England by £8bn by 2019-20. Unsurprisingly the independent Institute for Fiscal Studies (IFS) in its analysis of the election manifestos of the three London based parties and the SNP observed that it was extremely difficult to draw clear conclusions regarding their fiscal plans or to be confident that they can be fully implemented.

The new UK Government has announced that it will publish a new budget for the UK on July 8. In the meantime what is the outlook for public expenditure in Wales? Most attention is usually paid to the block grant that funds devolved services but the funding of non-devolved expenditure which has a direct impact in Wales also needs to be considered: such expenditure represents 40 per cent of total identifiable public expenditure in Wales. Given all the uncertainties it would be foolish to claim a definitive answer to these expenditure questions but there is enough information to make reasonable estimates.

Departmental spending.

Total departmental spending (DEL) across the UK is forecast to be £364bn this year. Departmental spending covers areas such as health; education; transport; defence; and international development: it excludes expenditure areas such as welfare and debt interest. Crucially the bulk of the block grant that is used to fund devolved services in Wales is a sub-set of departmental spending and changes to departmental spending by the UK government are the principal determinants, through application of the Barnett formula, to changes in the block grant. Of total departmental spending in England approximately £211bn corresponds to programmes which are devolved in the case of Wales. The more important of these programmes are health and education and spending changes made to these programmes in England have a major impact on changes to the Welsh block grant. Thus undertakings given by the Conservatives regarding spending on health and education in England will help give a strong steer on what is likely to happen to the funding available to the Welsh government. It should be noted that because funding is in the form of a block grant the Welsh government has freedom to spend the funds in accordance with its own priorities. During the last parliament although spending on health was increased by the Coalition in England, and Wales received a consequential increase in funding, the Welsh government chose to cut relative health spending.

According to the IFS analysis of Conservative plans, departmental spending will fall from £364bn this year to £340bn in 2018-19 before rising sharply to £354bn in 2019-20 (all figures are in real terms). Thus a cut in total departmental spending of £24bn (6.6 per cent in real terms) is forecast between now and 2018-19. What can we expect to happen to the Welsh block grant?

Devolved spending.

The good news is that the two principal determinants of changes to the block grant are planned changes to education and health spending in England. In the case of health spending the Conservatives have committed to increasing spending in England by £8bn by 2019-20. The picture is a little less clear in the case of education although it appears that spending will stay at the current level in real terms. (It may well be that this implies a reduction in funding per pupil in England given the growth in the school population.). Given what will happen to these two big departmental spending programmes it follows that the overall cut of £24bn will fall disproportionately on other programmes such as: transport; economic development; Home Office; and culture, media and sports. The IFS estimates that the ‘unprotected’ departments will have average real terms cuts of 16 per cent by 2018-19. Based on these forecasts and using the Barnett comparability factors last published by the Treasury in 2010 it appears the Wales DEL will increase by £340m in real terms by 2018-19 thanks to health and education changes in England – assuming that the build up of health spending in England will follow an even path – and be £6bn higher by 2018-19. However there will be a reduction of ~£290m due to cuts in other, ‘unprotected’ programmes.  Broadly speaking and subject to the uncertainties noted the block grant should not change materially in real terms over the coming four years.

This estimate needs to be treated with caution due both to lack of clarity regarding the UK government’s detailed plans and the lack of availability of up-to-date comparability factors which should be published later this year at the time of the Spending Review.  This conclusion does not mean that there will not be challenges for the Welsh government. Simon Stevens, the CEO of the NHS in England, has estimated that an additional £30bn will be needed by the English NHS by 2019-20 with £22bn coming from efficiency savings and £8bn from additional funding. This implies that efficiency savings are meant to deliver an improvement of ~19 per cent which many observers believe to be ambitious. Given the decline in relative per capita funding of the NHS in Wales over recent years (it was 106 per cent of the UK average in 2008-09 and 99 per cent by 2013-14) the challenge is likely to be even greater in Wales.

Non-devolved departmental spending in Wales.

The UK government continues to be directly responsible for elements of departmental spending in Wales including, for example, areas of transport (Network Rail), business, energy, the police and justice. Most of these programmes are due to experience major, real term cuts amounting on average, according to the IFS, to some 16 per cent over four years. Departmental spending that is not devolved but spent by the central UK government in Wales is approximately £1.6bn a year. A reduction of 16 per cent in this spending equates to a cut of ~£260 million a year by 2018-19.

Social Security Spending.

So far this analysis has concentrated on departmental spending but another major element of public spending is social protection which accounts for some 35 per cent of total identifiable public spending in Wales. Such spending is, in the main, disbursed directly by the central UK government to recipients across Britain (arrangements are different in Northern Ireland), is not subject to the Barnett formula and is not controlled by the Welsh government. The Conservatives have committed to cutting welfare spending over this new parliamentary term. The IFS analysis forecasts that total social security spending across the UK will fall from £217bn this year to £207bn by 2018-19, a reduction of 4.6 per cent. Given that such spending is proportionally higher in Wales than in other parts of the UK a reduction of roughly £550m a year by 2018-19 can be expected. In the March 2015 budget those welfare programmes that were ‘in scope’ and ‘out of scope’ were identified but we must  await the coming budget for more details to be revealed regarding precisely which programmes are to be cut. Given that pensioner benefits are protected by the ‘triple lock’ and account for approximately 45 per cent of total welfare spending the cuts in benefits paid to those of working age such as tax credits, housing benefits and incapacity benefits could be of the order of 10 per cent.

Conclusion.

Over the past five years the Departmental Spending Limit for Wales has fallen by over 8 per cent or £1,346 million in real terms. It appears that the DEL cuts in the coming four years will be far less: indeed there may be no reduction. However if the UK government sticks to its current plans there will be  a sharp drop in identifiable public spending in Wales due to two other factors. Firstly departmental spending which is not devolved can expect sharp reductions and these could be as much as £260 million in real terms by 2018-19. Secondly social security funding could be reduced by up to £550 million a year by 2018-19 with the cuts being concentrated on those of working age. As well as reducing the incomes of those in receipt of such welfare payments there will be a knock-on effect in local economies. It is to be hoped that the impact of cuts in social security payments for those of working age can be ameliorated by an increase in the proportion of the population in employment and an improvement in wages and salary levels – two factors which would reduce the demand for such payments. Creating the conditions to encourage increased employment rates is a responsibility shared by the UK and Welsh governments while a major way to improve wage and salary levels could be to move to a Living Wage over the coming five years: this is a policy which is not devolved and is a matter for the UK government.