Memorandum by Professor Iain McLean, Professor
of Politics, University of Oxford
SUMMARY
1. The UK has developed two sets of formulae,
one for the territories that now have devolved government, and
one for the regions of England. Their conjunction leads to what
Lord Barnett calls "terrible unfairness".
2. The Barnett Formula was designed as an
anti-rounding-up mechanism and as a convergence formula. The first
was needed because Scotland had done disproportionately well under
the former "Goschen" arrangements. The second should
have led to convergence in spending per head of population, but
has only just started to do so. It has punished the territory
which poses no credible threat to the Union, viz. Wales, while
causing justifiable anxiety in Scotland that her favourable spending
position is being eroded by a "Barnett squeeze".
3. The formula for transferring revenue
to local authorities in England may have rewarded inefficiency
and has been politically manipulated. Within England, territories
with no credible threat have done badly. The Government has announced
that it is scrapping the formula, but not what is to replace it.
4. In the light of the principles of devolution,
it is inappropriate that finance disputes should ultimately be
resolved in the United Kingdom Cabinet. I recommend a set of measures
to tackle the defects of both formulae at once. Unless they are
both tackled at once, Lord Barnett's "terrible unfairness"
many remain. The measures include:
— a territorial grants board making
allocations by unanimity rule;
— as a default should unanimity not
be achieved, a rule that incremental grant in the next time period
will be awarded by an "inverse GDP" formula.
1. Introduction
1.1 The following is evidence on topic 1(4)
of your Call for Evidence, namely Finance, fiscal matters, and
the Barnett formula. I have been researching these matters since
the 1970s and have published extensively on them. A list of my
relevant publications is available on request. I arrange my evidence
according to your subheadings.
1.2 This evidence is a summary of a much
longer document, The Fiscal Crisis of the UK, co-authored with
Alistair McMillan. The longer document contains full citations
and methodology for the claims made here. It will shortly be freely
available on the Web at www.nuff.ox.ac.uk/users/mclean and I will
notify the Committee when it is available.
2. How is funding allocated to the different
parts of the United Kingdom; and what consequences arise?
2.1 Formula funding is allocated to the
different parts of the UK according to two quite different formulae.
Allocation to the three non-English territories is by the Barnett
formula. Allocation to the Government Office Regions of England
follows the "York indices of health care needs" for
NHS funding and the Standard Spending Assessments (SSAs) for local
authority services. These funds are assigned to health authorities
and local authorities, not to regions, but when aggregated to
regional level, they comprise the formula funding to the nine
standard English regions.
2.2 The English formulae attempt to allocate
funding on a needs basis. The health formula is generally regarded
as a success, but SSA as a failure. Its sponsoring Secretary of
State announced in December 2001 that it would be scrapped, but
gave no clear signal as to what would replace it (Hansard,
Commons, 11 December 2001, cols 713-28).
2.3 The population-based Barnett formula
has operated since 1978. It was intended to correct an anomaly
in spending per head between Scotland and the rest of the UK,
and then to be replaced by a needs-based formula. Because the
Scotland and Wales Acts 1978 were never brought into operation,
neither was the needs-based successor to Barnett. Therefore, for
many years now, the Barnett formula has been inappropriate.
2.4 In 1978, the idea of a mechanical formula
for devolved spending was not new. Some Scottish spending (but
never all) had been governed for decades by the "Goschen
proportion", viz, that Scotland should be assigned 11/80
of the money assigned in England & Wales for the equivalent
programme.
2.5 Table 1, which gives the population
ratios between Scotland and England & Wales for Census years
1891-71 inclusive, shows that the Goschen proportion was too mean
to Scotland until 1901 and too generous thereafter.
2.6 Scottish departments negotiating with
the Treasury programme by programme could always claim at least
the Goschen proportion, and more if there were grounds for making
an additional claim for the programme in question. They could
appeal to Ministers if the Treasury resisted. As there was always
a Secretary (of State) for Scotland in the Cabinet, they had a
reasonable chance of success. Therefore, by 1977, Scottish spending
per head on the services which the Scotland and Wales Bill proposed
to devolve was between 20 per cent and 30 per cent above English
and Welsh spending per head.
2.7 This caused resentment especially in
the Northern Region of England, whose GDP per head was comparable
to Scotland's but whose public spending per head was less. This
resentment led to the defeat of the Scotland and Wales Bill in
a guillotine vote on 22 February 1977.
2.8 In response, the Treasury produced a
Needs Assessment and the Barnett formula.
2.9 The Needs Assessment was published in
1979 using data for 1976-77. It reported that actual spending
compared to that needed to provide devolved services to the same
standard throughout the UK was ahead of needs on Scotland and
Northern Ireland, but behind needs in Wales (Table 2). A likely
reason is that Scotland and Northern Ireland had had devolved
administrations since 1885 and 1921 respectively; Wales only since
1964, and many programmes were still financed on a unified England
and Wales basis.
2.10 The Barnett formula was both an anti-rounding-up
device and a convergence formula. By stipulating that the territories
should negotiate for a block, not service by service, it succeeded
in ending the rounding-up that had enabled Scotland to claim more
than the Goschen proportion of spending on "devolved"
services.
2.11 The convergence component was designed
to reduce this disparity gradually until spending was more closely
aligned with "needs", when it would be replaced by a
needs-based formula. But if the Needs Assessment was correct,
the convergence element of Barnett should never have been applied
to Wales, because Welsh spending per head was already below needs;
to force it to converge on English spending per head would therefore
worsen the situation there.
2.12 Originally, for the services which
the Scotland and Wales Acts 1978 proposed to devolve, each increment
in funding in England was to lead to a proportionate increment
in Scotland and Wales (Northern Ireland was added to the formula
soon afterwards). For every £85 increment in spending on
a "devolved" service in England, an additional £10
would be made available to the Scottish administration and an
additional £5 to the Welsh administration.
2.13 These population proportions were incorrect
for 1978, and they worsened over time. Scotland's population in
1978 was less than 10/85 of England's; Wales' was more than 5/85
of England's. Therefore the formula tended to give too much of
any increment to Scotland, and too little to Wales. The population
proportions were corrected in 1992 and annually since 1997.
2.14 For three administrative reasons, of
which this was one, there was no convergence until the current
Comprehensive Spending Review round. The other two are: (i) that
until the mid-1980s, the formula operated on increments in volume
(real increments) which were few or negative; only since then
has it operated on cash (nominal) increments; (ii) that Governments
could and sometimes did bypass the formula.
2.15 The political reason lying behind all
three administrative reasons is that Scotland and Northern Ireland
(but not Wales) pose credible nationalist threats to the Union.
Were Scotland to leave the Union, the interests of both the large
UK parties would suffer.
2.16 By 1999 therefore, the anomalies that
had led to the 1977 Government defeat were as wide as ever. In
a sense they were wider, as Scottish GDP per head is now almost
at the UK level, but North of England and Wales GDP per head are
still at 1978 proportions.
2.17 Table 3 compares GDP per head with
public spending per head on "devolved" services for
the 12 standard regions of the UK. "Devolved" services
means (as accurately as the source permits) those services which,
outside England, are devolved to the three territorial administrations.
2.18 The poorer a territory, the more a
government should be spending there for both efficiency and equity
reasons. Therefore there should be a strong inverse relationship
between GDP/head and public spending/head. In fact, however, the
correlation between GDP/head and spending/head is not even statistically
significant.
3. How satisfactory are these arrangements?
3.1 Both the Barnett and the SSA arrangements
are deeply unsatisfactory. Their conjunction is worse still.
3.2 Their conjunction is most painful between
the Northern Region of England and Scotland. According to the
Journal, (Newcastle-upon-Tyne), health spending per head,
in fiscal year 1998-99, was £692 in Northumberland and £945
in the Borders. The secondary school in Duns (Borders region)
had a pupil: teacher ratio of 13:1 and one computer per five students.
The secondary school in Alnwick (Northumberland) had a pupil:
teacher ratio of 18:1 and one computer per 13 students. And yet
GDP per head in Northern England is below that in Scotland.
3.3 This conjunction has led Lord Barnett
to say repeatedly, eg in a debate he initiated in the House of
Lords on the inadequacies of his formula (Hansard, Lords,
7 November 2001, col. 228), that the operation of his formula
has led to "terrible unfairness".
3.4 However, this outcome is not due to
Barnett alone, but to the operation of one formula in the Borders
(Barnett) and another in Northumberland (SSA and York indices).
3.5 As SSA is a needs-based formula, it
ought to have led to a vertical distribution in favour of poorer
regions within England.
3.6 As with Barnett, there are both technical
and political reasons for its failure to do this successfully.
The technical reasons, now conceded by DTLR, relate to defects
in its regression formulae. These are hard to explain in a non-mathematical
way. But, in brief, they have (i) produced incorrect coefficients
on the vector of services that go into SSA and (ii) conflated
true costs of providing a service with inefficiency costs, thus
tending to reward regions containing inefficient local authorities.
3.7 Academic analysts have also shown that
the weightings in SSA benefited two sets of clients: (i) local
authorities that were "flagships" for the Government
that set up SSA in 1990; (ii) regions containing a high proportion
of marginal constituencies. As it happens, the Northern Region
of England contains none of the first and few of the second.
3.8 The needs per head of each non-English
territory are above the UK average. Each of them has below average
GDP per head, and each can plausibly plead special factors (sparsity
in Scotland and Wales; the security situation in NI).
3.9 But if Barnett operates mechanically,
it will in due course lead to convergence on average public spending
per head. For the mathematical reasons why this is so, see the
evidence that I understand Professors David Bell and David Heald
will submit.
3.10 As explained at 2.11 above, this was
never the correct policy for Wales. At some point it will no longer
be the correct policy for the other territories either.
3.11 Thus Barnett should be replaced by
a needs formula, and SSA by a corrected needs formula. I offer
some suggestions on how to do this in section 5 of this evidence.
4. In particular, how, and in what circumstances,
is funding allocated outside the Barnett formula?
4.1 The official answer to this question
is to be found in HM Treasury's operations manual Funding the
Scottish Parliament, National Assembly for Wales and Northern
Ireland Assembly Second ed July 2000, available on the Web at
http://www.hmt.gov.uk/mediastore/otherfiles/85.pdf. Briefly, Annually
Managed Expenditure (AME) and a small amount of Non-Barnett determined
spending within the Departmental Expenditure Limit (DEL) is allocated
outside the Barnett formula. The significant items are all in
AME. They include CAP; social security; and NHS and teachers'
pensions. Any money to be raised from the Scottish Variable Rate
of Income Tax would normally also be outside the Barnett arrangements,
although the Treasury states in its manual (at 5.2) that it is
"open to the [UK] Government to take into account" the
resulting self-financed expenditure if it has grown so much faster
than equivalent spending in England that it "threaten[s]
targets set for the public finances as part of the management
of the United Kingdom economy".
4.2 However, the academic's answer is broader.
In the past, the formula was periodically bypassed because, as
stated above, both Scotland and Northern Ireland pose credible
threats to the Union, and hence to the two parties that have formed
the UK Government since Barnett began. Formula bypass in Scotland
and Northern Ireland seems much diminished in the current spending
round.
4.3 However, in July 2000 the Welsh executive
and the Secretary of State agreed to an allocation outside the
Barnett formula, to guarantee the match funding for Objective
One EU funding for West Wales and the Valleys. Wales had offered
a credible threat to the Union for the first time since the creation
of the Welsh Office. The previous failure to promise match funding
had led to the resignation of the leader of the Welsh executive
on a confidence vote. The new leader (Rhodri Morgan) had the backing
of a National Assembly and popular majority in Wales for the claim.
4.4 If the analysis above is correct, this
extra-Barnett allocation was acceptable on equity grounds because
the Barnett formula has always borne harshly on Wales.
5. In the light of the principles of devolution,
how appropriate is it that finance disputes would ultimately be
resolved in the United Kingdom Cabinet?
5.1 It is not appropriate. Finance disputes
are disputes between governments. They should be resolved by intergovernmental
bodies, not by a government that is one party to them. Although
it is appropriate that most assignment should be by formula, the
formula should not make the money available to the three non-English
territories a mechanical function of decisions by the UK government
on spending in England, as the Barnett Formula does. That is such
a violation of the principles of devolution that I am surprised
that any politicians in the devolved territories wish to retain
Barnett.
5.2 Below I outline a possible set of intergovernmental
arrangements. They could operate either on a 4-territory (4T)
or a 12-territory (12T) basis.
5.3 In either case there is a non-partisan
Territorial Grants Board. It would be an NDPB with an analogous
constitution to the Electoral Commission, and for the same reason:
that its operations must be totally immune from partisan politics.
Its Director and staff would be public servants, who could be
secondees from the Treasury, the Office for National Statistics,
the DTLR, or the devolved executives. The Board would evaluate
needs and resources in the territories, and annually propose a
multiplier for each territory. The UK Government would continue
to decide how much to make available each year from the UK Consolidated
Fund for spending on devolved services. But the Board's multiplier
would be applied to the average per-head value of this transfer
to derive the per-head transfer to each territory.
5.4 The basic model for this Board would
be the Commonwealth Grants Board of Australia, which has operated
such a mechanism successfully for many years. But it has to be
adapted in two respects: (i) because Australia is a federal state
and the UK is not; (ii) because in its early years it would have
to correct the misallocations arising out of the defects of Barnett
and SSA listed above.
5.5 The Board must report to a joint ministerial
council. In the 4T case, the council would comprise one representative
of each of the devolved governments and one representative of
the government of England (as distinct from the government of
the UK). In the 12T case, each devolved government and each English
Regional Assembly (or successor body) would send one representative.
Each territory would have one vote, and all decisions of the council
must be unanimous.
5.6 The unanimity rule is needed to reverse
the fundamental inequality that has led to Lord Barnett's "terrible
unfairness" and much else, namely that some territories can
exercise credible threats against the UK Government and some cannot.
5.7 However, a unanimity rule on its own
is insufficient. In any year, a territory that stood to lose from
the proposed set of multipliers could threaten to veto it. Therefore,
the unanimity rule needs to complement, and be complemented by,
a publicly known default arrangement. If the joint ministerial
council should fail to agree the allocation by a set deadline,
then grant for the next period would be assigned according to
the default arrangement.
5.8 In the event of failure to agree, I
propose that each territory should receive the same cash sum per
head as in the previous time period plus an increment comprising
the mean amount of new money available per head multiplied by
the default multiplier. I propose that this default multiplier
be 1/relGDPi, where relGDPi denotes (territory i
GDP/head)/(UK GDP/head). If the ONS regional price level data
are sufficiently robust, the multiplier should be converted to
its value at (inter-territory) purchasing power parity. This formula
is called "inverse GDP" below.
5.9 I recommend inverse GDP over other possible
defaults because:
5.9.1 GDP per head is a reasonable
surrogate for a territory's neediness. It is not the direct result
of government policy, although it is highly correlated with things
that governments must try to improve, such as human capital and
health status.
5.9.2 GDP per head is measured
by an independent non-partisan agency (ONS), not by any party
to the proposed negotiations.
5.9.3 There would not, as now,
be perverse incentives to become and remain "needy".
In 2000, Wales gained from being "needy", and it will
lose (at a marginal tax rate of at least 100 per cent) if and
when West Wales and the Valleys cease to be "needy".
By contrast, if a territory's government improves its GDP per
head, then income per head must rise by more than grant/head would
fall on an inverse GDP formula, as government spending is less
than 100 per cent of GDP. Therefore the marginal tax rate on success
would always be less than 100 per cent.
5.10 If there is a Pareto-superior allocation
to inverse GDP, the bargainers at the joint ministerial council
will find it. A Pareto superior allocation is one that nobody
likes less than the default and that at least one party prefers.
If none exists, the inverse GDP default satisfies both efficiency
and equity, and is cheap to calculate.
5.11 If the inverse GDP formula were used
over a number of years, it would bring about convergence. But,
unlike the Barnett formula, it would converge on needs, not on
population. Therefore, unlike Barnett, it would be just and efficient.
5.12 In the 12T model, the formula operated
by the Grants Board would supersede SSA and the York indices of
health care needs for allocation of grant around England. Of course,
the Grants Board would retain those parts of the present mechanism
that work. Most commentators believe that the York indices work.
Most, including the Secretary of State, believe that SSA does
not work.
5.13 In the 4T model, the government of
England would have to decide on its own allocation formula. It
would have an interest in aligning the formula to the UK-wide
formula, so that Lord Barnett's "terrible unfairness"
disappears.
5.14 The Government is committed to replacing
SSA, but has not yet said what will replace it. All commentators
agree that the Barnett formula is under severe pressure. The proposals
in this section are designed to tackle both of these problems
at once. Unless they are both tackled at once, the scope for "terrible
unfairness" will remain.
Table 1. Relative populations of England
& Wales and Scotland, Censuses 1881-1971
| Population, 000s
|
| Census | England and Wales
| Scotland | Scotland: England and Wales=80
| Value of Goschen grants per head in Scotland (England=100)
|
| 1881 | 25,974
| 3,736 | 11.51
| 95.59 |
| 1891 | 29,003
| 4,026 | 11.11
| 99.05 |
| 1901 | 32,528
| 4,472 | 11.00
| 100.01 |
| 1911 | 36,070
| 4,761 | 10.56
| 104.17 |
| 1921 | 37,887
| 4,882 | 10.31
| 106.71 |
| 1931 | 39,952
| 4,843 | 9.70
| 113.43 |
| 1939 | 41,460
| 5,007 | 9.66
| 113.86 |
| 1951 | 43,758
| 5,096 | 9.32
| 118.07 |
| 1961 | 46,105
| 5,179 | 8.99
| 122.41 |
| 1971 | 48,750
| 5,229 | 8.58
| 128.19 |
Source: British Historical Statistics, B R Mitchell (CUP
1988)
1939: mid year estimate
Table 2. HM Treasury Needs Assessment, 1979 (data for
1976-77)
| | England
| Scotland | Wales
| Northern Ireland |
| Relative needs assessment | 100
| 116 | 109
| 131 |
| Actual spending levels 1976-77 | 100
| 122 | 106
| 135 |
Source, HM Treasury Needs Assessment—Report (1979)
esp para 6.5.
Table 3. Public Spending and GDP per head, Regions
of the UK, 1999-00
| Region | Public exp/head on `devolved' services, £
| GDP per head, £
|
| South-east | 2,281
| 15,100 |
| East Anglia | 2,386
| 15,100 |
| Greater London | 3,367
| 16,900 |
| South West | 2,395
| 11,800 |
| West Midlands | 2,504
| 11,900 |
| East Midlands | 2,403
| 12,100 |
| Yorkshire and Humberside | 2,481
| 11,400 |
| North West | 2,701
| 11,300 |
| North | 2,783
| 10,000 |
| Wales | 3,069
| 10,400 |
| Scotland | 3,406
| 12,500 |
| Northern Ireland | 3,870
| 10,100 |
Source for column 1: HM Treasury, Public Spending Statistical
Analysis 2001, derived from Tables 8.6b and 8.12. Column 1 reports
(for the Barnett territories) "Identifiable total managed
expenditure per head 1999-2000, and (for the non-Barnett territories)
"Identifiable general government expenditure per head, by
region and function, 1999-2000". In each case Social Security,
which is a non-devolved function, is excluded.
Source for column 2: Office for National Statistics, Regional
GDP 1999, summary table.
| 
