Select Committee on Constitution Second Report


CHAPTER 3: FINANCING DEVOLUTION

79. Finance is a vital element of intergovernmental relations. It is the basis for the capacity of the devolved bodies to act and develop their own approaches to policy. In addition, ensuring that adequate resources are available for them to discharge their functions is itself an important element of the relations between the four governments.

80. The key element of the devolution finance arrangements is the Barnett formula (see Box 4). Named after Lord Barnett, former Chief Secretary to the Treasury, this has become famous, even notorious, after devolution legislation was proposed in the late 1970s. We note, however, that this is the successor to various formulae originally dating to the late nineteenth century and named after Viscount Goschen. We also note that Lord Barnett himself now considers the formula outdated and in need of replacement, although the House of Lords debate on the issue showed much divergence of view, irrespective of party.[70]
Box 4

The Barnett Formula

The Barnett formula is a mechanism for allocating increases in funding to the devolved administrations in Scotland, Wales and Northern Ireland. It applies only to some types of expenditure: large expenditure areas, such as welfare payments, are outside the formula's jurisdiction. There are three elements to the formula:

(i) the change in planned spending in departments in England;

(ii) the extent to which the relevant English departmental programme is comparable with the services carried out by each devolved administration; and

(iii) the population proportion in each devolved region of the UK. In 2001, these proportions were:

Scotland   10.23%

Wales  5.89%

Northern Ireland   3.40%

The formula simply multiplies (i) x (ii) x (iii). The increase in funding payable to the devolved administration is therefore the increase for England, multiplied by the extent to which a programme is comparable, multiplied by the population of the devolved region as a proportion of the English population.

Sources:

HM Treasury, Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly: A Statement of Funding Policy (London: HM Treasury, July 2002), pp.10-11.

House of Commons Library, The Barnett Formula (Research Paper 01/108, 30 November 2001).

81. Detailed matters of public finance and economics are beyond the Committee's remit, and we do not consider them here. Our concerns with finance arise from its constitutional implications: the way it affects the position of the devolved administrations, the extent to which it is open and transparent, and the processes which might be followed if the system were to change.

HOW THE DEVOLVED BODIES ARE FINANCED

82. It is worthwhile noting, albeit briefly, how the system of devolution finance works.[71] With very limited exceptions (such as the ability of the Scottish Parliament to vary the income tax rate in Scotland by 3%) the devolved institutions have no capacity to raise their own finance. Collection of revenue remains the responsibility of UK bodies (the Inland Revenue and HM Customs & Excise) and it is allocated by the Treasury under authority of Parliament by means of the Appropriation Acts. The devolved administrations are financed by block grants paid to the Secretaries of State for Scotland, Wales and Northern Ireland. After deducting the costs of running their own offices, this is then transferred to the devolved administrations for them to spend in accordance with their own priorities. As a block grant, the devolved administrations may do what they wish with this money. There are no formal restraints or conditions imposed by the UK on how they use or allocate their funds. While public service agreements exist between the Treasury and most UK Government Departments, setting out how the Department will use its funds, there no such agreements with the devolved administrations. The administrations are free to allocate their funds as they see fit.

83. The bulk of the funds paid to the devolved administrations constitute the Departmental Expenditure Limit (DEL) of that administration. These are the funds that are calculated in accordance with the Barnett formula. In addition funds are allocated as Annually Managed Expenditure (AME), not calculated or varied according to changes in the Barnett formula. This covers various forms of funding passed directly to the devolved administrations, notably funding from the EU for agriculture under the Common Agriculture Policy. The Barnett formula also does not apply to various payments that simply by-pass it. One notable example is for claims on the UK Reserve. Another has been public-sector pay claims such as the pay settlement for nurses in 1988.[72]

84. The Barnett formula applies to changes made to public spending, whether from year to year or during the course of a financial year (where there is a change in the money made available for spending in England). It does not relate to the starting-point for public spending in Scotland, Wales or Northern Ireland. That is a historic level and appears never to have been re-assessed (at least, not in public); although a needs assessment was carried out in 1978 to determine the spending needs of the Scottish and Welsh devolved administrations proposed at that time, the assessment was never implemented. The present levels of spending are simply what has happened over time by taking the original base-line set and adding to it successive annual increases.

85. The formula works by identifying whether an area of spending of a devolved administration is a 'comparable sub-programme' in relation to spending by the UK Government on services in England. This varies widely, because of the different structures of the devolution settlements: criminal justice and policing are comparable matters for Scotland but not Wales or Northern Ireland; social security is a comparable matter for Northern Ireland but not Wales or Scotland, while the National Health Service is comparable in all three devolved areas. If the programme is comparable, the funding payable to the devolved administration will be increased by multiplying the increase for England by two percentages: one for the extent to which the programme is comparable and the other by the proportion of the English population that is accounted for by the population of that devolved area. Details of the calculation are set out in Annex B to HM Treasury's Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly: a Statement of Funding Policy, and details of the comparable sub-programmes are set out in Annex C. The population proportions are revised to reflect changing populations as part of the Comprehensive Spending Review.[73] The increases it makes in spending are therefore of the same nominal amount per capita in each area with comparable sub-programmes.

FINANCIAL AND CONSTITUTIONAL IMPLICATIONS OF THE BARNETT FORMULA

86. The Barnett formula has been the subject of considerable criticism in evidence put to us by academic observers.[74] However, it attracted almost unanimous support from witnesses from the devolved administrations, as well as the UK Government. We are conscious that the evidence we have taken does not encompass all views on the subject. Because of the focus of our inquiry, we did not take evidence on this point from politicians and other representatives of the English regions, although we are aware that there are considerable concerns among them too about the operation of the formula.

87. Part of the reason for governmental support is that finance is allocated according to a formula. The Scottish Minister for Finance described the formula as "simple, straightforward [and] objective". It means that negotiations with the UK Government about particular aspects of funding are avoided: finance is allocated according to an automatic and simple mechanism.[75] We can quite understand the advantages of a formula for the devolved administrations as well as the UK Government.

88. We note, however, that these would be advantages of any formula for determining annual changes to the finance available to the devolved administrations, and are not unique to the Barnett formula. Other formulae could supply such advantages as well. Evidence to us shows that, in fact, the Barnett formula has a number of curious mathematical consequences.

89. The first of these derives from the fact that increases in funding throughout the UK are calculated per capita, and are unrelated to the current baseline of spending in each of the parts of the United Kingdom. If public spending per capita in England is 100, and increases by 10, public spending has increased by 10%. In the devolved administrations, however, public spending is higher per capita, say, 120. The per capita increase of 10 would thus represent only an 8.33% increase in public spending. As a consequence, the rate of growth in the financial resources available to the devolved administrations has slowed and will continue to slow. This is known as the "Barnett squeeze".[76] This does not mean that the devolved administration's funding will be reduced, but that it will grow at a decreasing rate in comparison with the rate at which public spending for England grows. The result is that the financial room for the devolved administrations to develop distinctive policies requiring extra funding will reduce. We should note, however, that finance ministers from the devolved administrations were divided about the extent to which this affects their capacity to develop policy.[77]

90. A second is that it provides for public spending across the UK to converge on a single uniform level of spending over time, if public spending continues to increase. Scotland, Wales and Northern Ireland each starts from a different base level of spending, but because increases are related to the increase in spending for England eventually the same level of per capita spending will prevail throughout the UK. This takes no account of different needs in different parts of the UK, or of the different costs of providing public services in the different parts of the UK. The present rate of growth in public spending appears to make convergence likely to occur within a relatively short period of time. There has been no public debate about whether this is an appropriate criterion to use for allocating public spending across the UK; it will happen, but as a mathematical inevitability not a decision about policy.

91. Third, the Barnett formula does not take into account a number of factors which have serious effects on the finances of the devolved administrations. One example drawn to our attention is the lack of funding for Welsh-language provision and the development of bilingualism in Wales, for which there is no comparison elsewhere in the UK.[78] Another appears to be the running costs of the devolved institutions themselves. These have increased substantially since devolution, as staffing levels have grown to service larger numbers of elected politicians and Ministers, and for the devolved institutions to have the capacity to develop their own policies rather than implement UK policies with local variations.[79]

92. The working of the Barnett formula in practice presents further difficulties. Two key ones relate to information. First, there appears to be some question about the extent to which the devolved administrations are informed about provision of additional money by the Treasury where this attracts a consequential payment under the Barnett formula. A public announcement that extra money is being provided may not be straightforward; it may be a switching of funds from the AME category to the DEL, for example, or a claim on the Reserve which may or may not attract a consequential payment.[80] Second, the data available to the devolved administrations may not be adequate for them to assess whether what they receive is in fact their fair share of the funds allocated, because for example data in relation to spending in England are either not collected or not published.[81] The devolved administrations' finance ministers have disavowed that they have problems in practice with access to data, but their own resources to gather data are limited. These are matters that, in the present state of relations, do not cause a difficulty, but might cause problems if circumstances were to change.

93. We recommend that:

(a) information about changes to public spending for England should be made available in a manner that relates directly to the categories attracting consequential payments under the Barnett formula; and

(b) the statistics collected and made available by HM Treasury to the devolved administrations be reviewed so as to ensure that all the information needed by the devolved administrations is available to them.

94. When such review is completed, it may be appropriate to include the categories of statistics to be collected and made available in a revised version of the over-arching Concordat on Statistics annexed to the Memorandum of Understanding.

95. We are conscious of criticisms of the Barnett formula from various groups, including those in England concerned by the inequalities in public spending between parts of England on one hand and Scotland, Wales and Northern Ireland on the other. We also had written evidence from Plaid Cymru - the Party of Wales - and Professor Iain McLean raising questions about the continued workability of the formula.[82] We note that the effects of the formula across the United Kingdom as a whole, including the different regions of England, are unequal, and also that at present they appear to be unmeasurable. We consider that this will pose a problem with ensuring that devolution finance is equitable and sustainable in the longer term.

PAYMENTS OUTSIDE THE SCOPE OF THE BARNETT FORMULA

96. We have already noted that payments made as Annually Managed Expenditure (AME) fall outside the scope of the Barnett formula. This does not raise any matters for us to consider from a constitutional point of view. However, we are concerned about other payments made outside the scope of the formula.

97. Two of these particularly attract our attention. First are claims made by the devolved administration on the UK DEL Reserve. While the devolved administrations maintain their own reserves, these are small (both in comparison with the devolved administrations' budgets and with the size of the UK Reserve). In the event of a devolved administration suffering a major financial shock outside its control, it is unlikely that it would have adequate resources to cope with such costs itself and it would therefore need to make a claim on the UK Reserve. The Treasury's Statement of Funding Policy provides that such claims will be considered:

(a) where a UK Department is granted access to the Reserve to meet exceptional pressures on a spending programme, and the devolved administration has a similar programme and faces similar pressures; or

(b) where a devolved administration faces exceptional and unforeseen domestic costs which cannot reasonably be absorbed within existing budgets without a major dislocation of existing services.[83]

98. The important point about the determining whether to grant such claims or not is that it is entirely in the hands of the Treasury. Not only does the Treasury determine how such funds will be paid, but it retains control of the criteria by which it makes such decisions. Moreover, the Treasury does not publish these criteria.[84] A UK Government department therefore determines both whether a particular event occurring in relation to a devolved administration is a crisis and what the appropriate payment to make is. The present state of relations has been such that no serious dispute appears to have materialised as a result, and claims on the Reserve have been paid by the Treasury, for example, in relation to the consequential effects for tourism of Foot and Mouth Disease. Such claims were paid for Scotland and Wales on a similar basis to that for England. We received no satisfactory answer to the question of whether claims would have been paid by the Treasury had Foot and Mouth Disease been a Welsh and Scottish but not an English disease. It would have been entirely a matter for the Treasury to determine, however serious its financial implications for the devolved administrations.

99. A similar issue arises in relation to EU funding. Northern Ireland, Scotland and Wales are all in receipt of funding from the European Union under Objective One of the Structural Funds. Scotland still receives transitional funding for the Objective One programme for the Highlands and Islands. Northern Ireland receives Objective One funding under two headings: the PEACE TWO programme (a cross-border initiative administered by the North-South Ministerial Council in one of its sectoral forms) and a 'mainstream' package of funding. Wales receives Objective One funding for West Wales and the Valleys. There has been considerable debate about 'additionality' in relation to this money - meaning not whether the UK Government makes extra public spending available to match the EU funding, but whether the UK Government passes on the extra funding to the relevant administration at all. Historically, it often has not, employing what one witness called 'a consistent scam'.[85] The PEACE TWO funding for Northern Ireland has been one exception to this, however. The funding for Wales has been another. The circumstances in which this occurred - being withheld by the Treasury, leading to a vote of no confidence by the National Assembly in Mr Alun Michael as First Secretary, and later being made available after Mr Rhodri Morgan had become First Minister - are well known. We do not propose to consider whether the judgement to make the funding available was right.[86] We must however note that this was a matter of high political controversy in Wales, which had profoundly serious effects for politics within the National Assembly, and that the key decisions were all taken by HM Treasury.

100. In this context, we must note what the Statement of Funding Policy says about the resolution of financial matters in general. Disagreements between the Treasury and a devolved administration must be pursued with Treasury Ministers by the Secretary of State (a member of a different administration, and in the future possibly of a different party). While the matter can be raised at the Joint Ministerial Committee, the Statement of Funding Policy notes that the issue remains the responsibility of the UK Government and that the final decision will be taken by the UK Cabinet, if raised there by the Secretary of State.[87]

101. We have no objection to this way of dealing with financial matters in the first instance. However, we have concerns about this as a way of reaching a final resolution of disputes raising financial issues. This appears to us to be an appropriate way to deal with a department of the same government, but we do not think it is appropriate for dealing with a separate administration. The difficulties that might arise where the administrations are of different political complexions, or where the interests of the UK Government and devolved administration conflict, are immense.

102. We recommend that where discrete disputes arise, they should be referred to an independent body, such as a Devolution Finance Commission, with that body then making a recommendation to the Cabinet. To the extent that macro-economic management requires control by the Treasury of the aggregate amounts of funding involved, such amounts could be set as the total value of a settlement to be allocated by the same body without the Treasury being able to determine the way in which it is allocated.

REVIEWING THE BARNETT FORMULA?

103. It will be apparent from the above that there are serious difficulties presented by the long-term continuation of the Barnett formula. We do not think that it will be a sustainable basis for allocating funds to the devolved administrations in the long term. Many of those in Wales and Northern Ireland, as well as those in parts of England, consider that the formula is unfair in its allocation of funds to them in comparison to its allocation of funds to other areas, and does not provide them with the resources they need. Even if it does provide those resources, it does not do so in a manner that convincingly demonstrates that.[88] This is largely because so much control remains in the Treasury's hands.

104. This will inevitably become a major source of tension in the devolution settlement. It may only become a matter of open dispute when the parties in office in the devolved administrations have profound disagreements with the UK Government, but that is likely to happen sooner or later.

105. We do not have a neat ready-made alternative to Barnett to propose. We do not believe that full fiscal autonomy would be the answer, not least because it would threaten the economic and fiscal integrity of the United Kingdom. However ,we would envisage that any alternative would incorporate the following elements:

(a) an assessment of the needs of the devolved administrations, and the different regions of England, taking into account the nature of their responsibilities and the demographic characteristics of the relevant population;

(b) that needs assessment would not be repeated every year but only at periodic intervals. Adjustments to the funds available, whether annually or in-year, would be made by means of a formula;

(c) however calculated, funds made available to the devolved administrations would remain in the form of a block grant which the administration could allocate as it wished;

(d) funds for the devolved administrations should be payable solely to them. The present arrangement by which the offices of the Secretaries of State are 'top-sliced' from the devolved administration's block grant should be ended and payments for those offices made separately and directly by the Treasury; and

(e) the transition to a new arrangement should be phased over a number of years, to minimise the effects of it for those parts of the UK which lose out relatively in terms of funding.

106. We are conscious that the carrying out of that needs assessment would not be straightforward. We were told of the difficulties arising from the Standard Spending Assessment used for allocating funding to local government in Great Britain, which is highly complicated, highly contentious, and (however the formulae involved are adjusted) always produces substantially the same outcome.[89] It would inevitably involve considerable tensions between the devolved administrations. Concerns about the present over-provision of funding to Scotland, and the unequal distribution of funding across England, would also emerge if a needs assessment were carried out. The impartiality of those undertaking the review will be of prime importance. Our attention has been drawn to a number of models used in other countries, and we are struck by the relative success of the Australian Commonwealth Grants Commission compared with other such bodies.[90]

107. We recommend that, when the Barnett formula is reviewed or a needs assessment is carried out, it be done by an independent and impartial body. This body should include persons nominated by the devolved administrations and by the UK Government, and should include people who reflect the views of all parts of the United Kingdom, including the English regions.

108. More generally, we note that management of the United Kingdom's economy, on both the macro-economic and micro-economic levels, remains wholly in the hands of the UK Government. While we do not consider that this should be changed, such decisions can have a major impact on the devolved administrations. Conversely, the devolved administrations may well be able to help the UK Government achieve its macro-economic objectives more effectively. For the UK Government to persist in making such decisions unilaterally seems to us to be inconsistent with the spirit of devolution.

109. We recommend that there should be consultations with the devolved administrations about macro-economic and fiscal policy before decisions about such matters are taken by the UK Government.


70   HL Debates, 7 November 2001, cols 225-64 (L. Barnett's view is expressed at cols 225-29).  Back

71   Details are set out in HM Treasury Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly: A Statement of Funding Policy (second edition, July 2000; third edition, July 2002). Back

72   Referred to by Professor D. Heald in his Memorandum to us; paragraph 12. Evidence volume, p. 146.  Back

73   Following the 2000 review, the proportions were 10.34% for Scotland, 5.93% for Wales and 3.41% for Northern Ireland; following the 2002 review, they are respectively 10.23%, 5.89% and 3.40%.  Back

74   See Memorandum of Professor D. Heald; evidence volume, pp. 144-47; evidence of Professor D. Heald and Professor D. Bell, 16 May 2002, QQ 499-526; Memorandum of Professor I. McLean, evidence volume, pp. 422-27. Support for it was however expressed by Professor V. Bogdanor in his Memorandum, para. 4 (evidence volume, p. 1) and his evidence of 20 February 2002, QQ 10-12. See also the evidence of Professor R. Hazell, 10 July 2002, QQ 1419-22.  Back

75   Evidence of Mr A Kerr MSP, Minister for Finance, Scottish Executive, 16 May 2002, Q. 528; evidence of Mrs E. Hart AM, Minister for Finance, Local Government and Communities, National Assembly for Wales, 27 May 2002, Q. 873.  Back

76   Evidence of Professor D. Bell, 16 May 2002, Q. 499, QQ 511-12.  Back

77   Evidence of Mrs E. Hart AM, Minister for Finance, Local Government and Communities, National Assembly for Wales, 27 May 2002, Q. 875, Q. 902 and Q. 910; evidence of Mr A Kerr MSP, Minister for Finance, Scottish Executive, 16 May 2002, Q. 529.  Back

78   Evidence of Professor D. Heald, 16 May 2002, Q. 503.  Back

79   For example, in Scotland "the core of the office headquarters department has gone up by about one sixth, that is 600 on 3,600 over three years" (evidence of Sir Muir Russell KCB, 15 May 2002, Q. 465). Seventeen per cent of the National Assembly for Wales's staff are entirely new (evidence of the permanent secretary, Mr J. Shortridge, 28 May 2002, Q. 1038). Back

80   Evidence of Professor D. Heald, 16 May 2002, Q. 504.  Back

81   Memorandum of Professor D. Heald, para. 10, evidence volume p. 145; evidence of Professor D. Heald, 16 May 2002, Q. 499. Back

82   Memorandum by Plaid Cymru - the Party of Wales Group, National Assembly for Wales 'The Case for Replacing the Barnett formula', evidence volume 436-42; Memorandum by Professor I. McLean, evidence volume 422-27.  Back

83   Summarised from Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly, para. 9.2.  Back

84   Evidence of Ms R. Dunn and Mr M. Parkinson, 26 June 2002, QQ 1268-71.  Back

85   Evidence of Professor D. Heald, 16 May 2002, Q. 503.  Back

86   They have been investigated by the House of Commons Welsh Affairs Select Committee. Seeits Second Report for the Session 2001-02, Objective 1 European Funding for Wales, 22 May 2002. HC 520. Back

87   See Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly, para. 11.2.  Back

88   See for example the Memorandum by Plaid Cymru, evidence volume pp. 436-42, or the Memorandum by Professor I. McLean, evidence volume pp. 422-27.  Back

89   Evidence of Mr A. Kerr MSP, Minister for Finance, Scottish Executive, Q. 529; Memorandum by Professor I. McLean, evidence volume pp. 422-27.  Back

90   See the evidence of Professor D. Heald and Professor D. Bell, 16 May 2002, QQ 504-05 and Q. 522; evidence of Professor R. Hazell, 10 July 2002, Q. 1420; Memorandum by Professor I. McLean, evidence volume pp. 422-27.  Back


 
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