The Barnett Formula - Select Committee on the Barnett Formula Contents

Memorandum by Economic Research Institute of Northern Ireland

INTRODUCTION

1.  The Barnett Formula is named after Joel Barnett (now Lord Barnett) who was Chief Secretary to the Treasury when it was introduced in 1978.[5] The use of a formula for allocating at least some expenditure among the territories (now called countries) of the UK goes back to 1888 when Chancellor George Goschen in preparation for Irish Home Rule introduced a set of proportions for allocating resources between England and Wales, Scotland and Ireland in the ratio of 80:11:9. This formula persisted in Scotland well into the 1950s whereas arrangements for Ireland went a different way with partition and devolved government in the North.

2.  This short paper sets out the formalities of the Barnett Formula as they currently apply, with particular reference to Northern Ireland. It also gives some insight to how the formula has worked in practice. The detailed questions posed in the call for evidence are addressed in an annex.

THE BARNETT FORMULA BASICS

3.  The most common misconception about the Barnett Formula is that it determines the total allocation of public expenditure to Scotland, Wales and Northern Ireland. This is not the case. The formula is a mechanism that adjusts the public expenditure allocations at the margins. Moreover, it applies only to parts of public expenditure. It does not, for instance, apply to demand-led expenditure such as social security benefits which are funded on a need or claimant basis.

4.  The three key elements of the Formula are:

(a) changes in expenditure on services in England, England and Wales or Great Britain, depending on the coverage of the expenditure considered;

(b) the degree to which the English et al services have counterparts in the devolved administrations. This is called the "comparability proportions"; and

(c) each country's population as a proportion of the population of England, England and Wales or Great Britain depending on the coverage of the expenditure being considered.

The outcome of the formula is the product of (a), (b) and (c) and is know as the "consequential". This is the amount of additional spending made available to the devolved administrations.

EXAMPLE: Suppose expenditure on an English service increases by £100 million. The service is 100 per cent comparable in Northern Ireland and Northern Ireland's population relative to England is 3.4 per cent. Then Northern Ireland's consequential is £100m x 1.0 x 0.034 = £3.4 million.

As a rough rule of thumb a 1 per cent increase in a comparable service in England would provide enough extra resources to fund a ¾ per cent increase in Northern Ireland.

POPULATION PROPORTIONS

5.  Population proportions are one of the more objective elements of the formula. There has been an erratic history of updating these percentages. Up until 1992 the mid-1976 population levels were used. In 1992 there was a one-off adjustment but from 1997 onwards the latest mid-year population estimates have been used. The failure to use up-to-date estimates was an advantage to Scotland where in the relevant period population proportion was actually declining. In the 2007 Spending Review the population proportions for Northern Ireland were 3.43 per cent relative to England, 3.24 per cent relative to England and Wales and 2.96 per cent relative to Great Britain.

COMPARABILITIES

6.  Comparabilities are a key element of the formula and in some instances are open to considerable interpretation. Comparabilities are calculated as a weighted average of expenditures by the relevant Whitehall department. Up to CSR 2007 the basis of expenditures were the sub-programmes operated by the department. In CSR 2007 these were replaced by "programme objects". Comparability proportions for each devolved administration are estimated for each of these programme objectives and then a weighted average is constructed for the entire department using the baseline expenditures for each programmes objective in the year immediately preceding the CSR.

7.  Two problems arise with this approach. First, a weighted average of a Whitehall department's expenditure may not be a good guide to actual expenditures in a devolved administration. Sometimes the latter will gain and sometimes lose from this procedure. This is known as "taking the rough with the smooth".

8.  Second, where administrative arrangements for delivering services differ substantially, estimating a consequential can be problematic. The classic example is local authority delivery of services in England that are delivered by central government in Northern Ireland. In England these services are part financed by central government grants and part by the Council Tax and the authority's share of the uniform business rate. Calculating a consequential on the total spend would give Northern Ireland an advantage by relieving local ratepayers of having to make a contribution. On the other hand a consequential based on aggregate external finance (mainstream grants to local authorities in England) may fall well short of actual expenditure in Northern Ireland.

9.  A further problem is "departmental unallocated provisions" or in simple terms the reserves UK departments are encouraged to create against unexpected expenditure demands. The convention is that consequentials for these provisions are calculated on the assumption that they mirror the weighted average comparability of the department. In principle this is fine so long as when these resources actually are spent they follow this pattern. Otherwise the reserve may or may not end up in areas where comparability is significantly higher or lower than the average.

THE "BARNETT SQUEEZE"

10.  A mathematical feature of the Barnett Formula is that it should, other things being equal, tend over time to converge per capita spending on comparable services in the devolved administration towards the English per capita figure. This is known as the "Barnett Squeeze". The phenomenon arises because the formula gives Scotland, Wales and Northern Ireland additions equal in per capita terms to those in England (this is another way of saying these administrations get their population proportion relative to England of any increase). But it is generally the case that existing per capita expenditure on such services is greater than these marginal additions so that the average per capita spends will converge.

11.  Theoretically the convergence phenomenon should be faster:

(a) the greater the initial per capita lead in the devolved administration; and

(b) the greater the increase in expenditure on comparable services in England.

Since the formula is entirely symmetric falls in English comparable expenditures should widen the per capital expenditure gap.

12.  Empirical evidence for the "Barnett Squeeze" is limited partly for data reasons and partly because the convergence is likely to be slow, so that other changes to expenditure not dependent on the formula can cloud the issue. The usual data source used is "identifiable public expenditure" which is published in the annual Public Expenditure Statistical Analysis (PESA) which accompanies the Budget. Identifiable public expenditure is expenditure identified from administrative records as being in or on behalf of the devolved territory (country). Settling just what is identifiable expenditure in practice is an issue that at the margins provokes considerable debate, particularly in Scotland.[6] The current identifiable expenditure ratios for the devolved administration relative to the UK set at 100 are:

 2002-03 2007-08 England 96 97 Scotland 117 118 Wales 114 110 Northern Ireland 130 126

So over this period at least Northern Ireland and Wales appear to have been squeezed slightly but Scotland has extended its lead. However, not too much weight should be put on small movements over a short run of years particularly when classification changes and amendments to methodology are taking place.

BYPASSES

13.  One reason why theoretical Barnett Squeezes do not materialise is that additional allocations are made to the devolved administration outside the working of the formula. These are commonly referred to as "bypasses".

14.  Since the Treasury has invested heavily in the Barnett Formula they are generally resistant to bypassing it and significant departures are usually associated with either technically unavoidable changes or highly political issues. All the devolved administrations have benefited from bypasses at one time or another. Wales, for example, got over £200 million additional cover for Objective 1 EU Structure Funds programmes in the 1990s while Northern Ireland was given additional funding to support the privatisation of aircraft production and shipbuilding in the regions. Northern Ireland also secured additional funding to cover the series of Peace and Reconciliation Programmes launched by the EU in the mid 1990s and some costs associated with implementing the Good Friday Agreement.

15.  In recent years the Treasury has tried hard to keep the devolved administration on a strict Barnett Formula diet and has largely succeeded. Despite announcements of new packages of support for devolution these usually turn out, on closer inspection, to be rescheduling of expenditure or movements in non-cash items in budgets.

BARNETT AND THE FUNDING RULES

16.  The Barnett Formula is the centre piece of the rules governing the funding of devolved administrations.[7] However, it is the interplay of the formula with these rules that gives the process texture and allows interesting possibilities to emerge.

17.  Of particular interest is the rule that says "if the UK Government makes a general cut to the budgets of UK departments it is entitled to impose the same adjustments to the budgets of the devolved administrations".

18.  Alternatively the reductions in UK departments could be fed through the Barnett Formula to give negative consequentials (reductions) to the devolved administrations.

19.  An interesting combination is to apply across the board cuts to baselines including those in the devolved administrations and then give Barnett consequentials on any allocations restored to UK departments. Since the latter are based on population proportions while baseline proportions are usually higher this is an indirect way of cutting budgets for devolved administrations within the rules.

SETTING BASELINES: NEEDS ASSESSMENT

20.  Baselines do not enter into the Barnett Formula except as weights in the calculation of the departmental weighted average for comparabilities. However, baselines are very important. As baselines stand at the moment they are historical constructs reflecting a myriad of past changes, including changes from previous applications of the Barnett Formula. A systematic revision of baselines requires some form of Needs Assessment.

21.  The basic idea of a Needs Analysis is to start with a benchmark for expenditure in some policy area which in the UK is usually expenditure in England. This expenditure is then associated with a number of "objective factors" such as total population or population structure for those receiving the services and this gives an idea of the unit cost of the service "Objective" in this sense means factors that cannot readily be adjusted by policymakers. The pattern of objective factors in the devolved authorities is then compared to the same factors in England to give an idea of how much more or less it would take to deliver the same service as in England in the circumstances of the devolved administrations. Comparing this to actual expenditure shows whether the devolved administration is over or under provided for that service.

22.  This is the barest outline of the technique and in practice Need Assessments are data heavy exercises fraught with difficulty in matching expenditure data and properly identify relevant factors. They work best where services are clearly linked to population such as in education or health programmes but are much less successful in areas such as economic programmes.[8]

23.  The only official Needs Assessment in the UK was carried out in 1976 in preparation for devolution to Scotland. Only a summary report was published in 1979. Since devolution did not occur at that time this work faded from view, although there were periodic updates carried out internally by the Treasury. In 2001 the Northern Ireland Executive initiated a unilateral update of Needs Assessment but that work was abandoned when Direct Rule returned.

24.  Needs Assessment is often presented as an alternative to the Barnett Formula but that can not be the case. The exercise is too resource-intensive to be repeated annually and there are concerns that as time goes on fundamental changes in the character of services in one area of the UK as opposed to another progressively render the needs assessment technique invalid.

25.  Some commentators have argued that the approach adopted by the Commonwealth Grant Commission in Australia for allocating monies to the States could be adopted in the UK even though the constitutional situation is rather different. However, this again is an elaborate exercise and certainly not immune from political influence.

CONCLUSIONS

26.  The Barnett Formula has been operating in its basic form for 30 years and has been incorporated into a comprehensive set of funding rules for the devolved administrations. It is a uniquely British approach to devolved financing with nothing similar elsewhere in the world.

27.  Critics of the formula generally focus on two issues. The first is a fear that repeated use of the formula as the main means of adjusting devolved budgets will lead to steady convergence to English per capita expenditure on services. The other, which is basically the same point, is that using a formula that only takes account of population proportions is a poor way of capturing relative need.

28.  One approach would be to replace the formula by one which was the reciprocal of the relative outputs of the devolved administration and the UK (or England). In Northern Ireland's case the relative output (GVA) ratio is 80 per cent so this formula would give Northern Ireland approximately 125 per cent of comparable spending the in the UK. Since regional productivity figures are notoriously unreliable this would not seem much of an advance.

29.  Combining other factors with population in the formula raises the question of what these should be and what relative weight they should have. This in turn can lead down the path to what statisticians call an index number problem.

30.  Convergence is an inherent characteristic of the formula but in practice has not been a critical issue. When devolution began some commentators feared that the new administrations would quickly run out of money as the formula took its toll. In fact the reverse could be argued, that the devolved administrations, at least initially, had rather too much money and made some unfortunate spending decisions as a result.

31.  Another aspect of the formula is not its impact on the devolved administration but on England or at least the perception among some English commentators that it gives the devolved administrations too much. This, of course, is a misconception arising from confusing the baseline expenditure in the devolved administrations with changes in these baselines. Whether the devolved administrations have too much of a share of public expenditure or too little is not a question the Barnett Formula can answer.

32.  Should the formula be abandoned or replaced with some other funding mechanism? That is essentially a political rather than a technical question but some points that need to be kept in mind are:

— The Barnett Formula does remove the need for detailed negotiations with the Treasury on the minutiae of budgets in Spending Reviews—a very big plus;

— It offers some protection to any existing expenditure advantage enjoyed by a devolved administration; and

— Its workings alongside the other funding rules are reasonably well understood so it offers a degree of stability that a replacement might take a long time to deliver.

5   The formula was devised by Sir Leo Pliatsky and has always officially been known as the funding formula. The term "Barnett Formula" is attributable to Professor David Heald, a long time student of devolved finance in the UK. Back

8   See http://www.scotlandoffice.gov.uk/freedom-of-information/document.php?release=78&doc=179 ,for a description of the technique used for an update of the 1979 study for Scotland. Back