Finance & Public Expenditure - A case study

Finance and Public Expenditure in Scotland Since Devolution

Scottish Politics Assessment 2

Introduction

Devolution is a constitutional change that allows the organisation of independent government in regions where they consider themselves to have a national identity in the absence of transferring legal sovereignty. In the case of the United Kingdom, the establishment of the Scottish Parliament as well as the National Assembly in Wales has lead to the creation of English identity at the expense of the British identity. (Condor, 2006) In the process, the English and British citizenship were established in order to identify the social inclusion of each society.

As an after effect of the constitutional change in the UK, the distribution of revenue throughout the regional and territorial government in relation to its corresponding public expenditure was greatly affected. (McLean, 2003) In order to minimise and prevent an unfair distribution of UK revenue among the English and British territories such as the Northern Ireland, Scotland and Wales, the need to examine the Barnett and the traditional Goschen formula used in the allocation of money to its corresponding territories arises.

In line with the increasing concern over the use of Barnett and Goschen formulae in the UK, the researcher will first conduct an in-depth analytical study on the budgetary, financial arrangements, and public expenditure of Scotland including the impact of devolution over its finances. In the process, the researcher will discuss a brief history behind Scotland’s financial arrangements prior to devolution in 1999, including the application of the Goschen formula. The researcher will also provide an analytical description of the Barnett formula since its inception in 1978 and subsequent revival in 1992. The researcher will also examine the strengths and weaknesses of using the Barnett formula versus the Goschen formula.

The Budgetary, Financial Arrangements and Public Expenditure of Scotland

As stated in the third edition of the Statement of Funding Policy that was published by the Treasury in July 2002, the financial arrangement between the UK and the Administration in Scotland follows the conventions for Scotland before the devolution settlement. (Scotland Office, online.)

Using the public expenditure framework controlled by the UK Government, the HM Treasury allocates budget for the public expenditure of the UK, Scottish Executive, and Northern Ireland. The devolved Scotland administration normally receives a block grant. There are legally two components under a block grant known as the: (a) redistributed national non-domestic rates (NNDR); and (b) the Revenue Support Grant (Adam, Emmerson & Kenley, 2007) which will be spent on: health and personal social services; education; and law, order and protective services which are three of the major services in Scotland (McLean, 2003).

Even though the UK Government normally announces the priorities on public expenditures, it does not fully exercise any tight control over the spending in Scotland. Based on the budget allocated for the Scottish Executive, the UK Government departments in Scotland are made fully responsible with the budgetary decisions for the actual ‘Scottish Assigned Budget’ or the overall public expenditures. The public funding is usually based on the spending reviews and in accordance to the policies set by the UK government aside from the non-domestic rates and the Scottish Variable Rate of Income Tax as well as the total borrowings of Scotland’s local authorities. (HM Treasury, 2007: p.1 ) Eventually, the Scottish Assigned Budget will be subjected to the Scottish Parliament’s final approval so as to ensure that they stick with closely with the UK Government priorities.

Since 1980, the UK Treasury has been using the Barnett formula when allocating the funds throughout the devolved territories including Scotland. In line with the use of the Barnett formula, the ‘population-based proportion’ has been applied to Scotland, Wales and Northern Ireland accordingly based on the total public spending in the UK. (HM Treasury, 2007: p. 1) Basically, the Barnett formula determines the additional changes needed in the public expenditures of Scotland and Wales.

Considering the past decisions made in the allocation of funds for the public expenditures, the Barnett formula is used in the computation of the block grants in such a way that the computation for the public expenditure in the UK is equally proportionate to the amount of funding the three devolved territories will receive. (Edmonds, 2001)

With regard to the Scottish redistribution of grant funds, the local Department for Education, the Home Office for police services, as well as the healthcare division under the supervision of the NHS Executive and the Department of Health has practised a vertical redistribution of grants since 1990. (McLean, 2003)

A Brief History behind Scotland’s Financial Arrangements prior to Devolution

Prior to devolution, the financial arrangement behind Scotland followed the Gladstone’s Irish Home Rule Bill of 1886 and 1893 which failed because Joseph Chamberlain decided not to follow its financial clauses. (Powell, 1977) In order to solve the public expenditure problems in Scotland, George Goschen – the Chancellor of the Exchequer, introduced the use of the Goschen formula in 1888. (McLean, 2003)

The guidelines set for using the Goschen formula clearly states that the allocation of funds should be “in proportion with the general contribution of each country to the Exchequer.” (Hansard, 1888) In line with the allocation of funds using the Goschen formula, the UK Government decided to allocate the Local Taxation accounts for England & Wales, Scotland and Ireland using the proportional ratio of 80:11:9 respectively.

Right from the start, the main purpose of using the Goschen formula was not to solve the fund redistribution problem in Scotland but in Northern Ireland. Eventually, the use of the Goschen formula and Scotland’s entitlement for 11/80ths of the funds became one of the major concerns of the Scottish Office and the Scottish Education Department who decided to get together to study the use of the Goschen formula. (Schelling, 1984)

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Despite the Scottish politicians and the civil servants’ agreement that the 11/80 fund allocation will be sufficient for Scotland’s public expenditures, both parties were alarmed when the 11/80 allocation of funds turned out to be insufficient for the entire Scotland’s public spending. Even though there was a decrease in Scotland’s population, the public expenditure in Scotland remained high. (Schelling, 1984)

Between the years 1888 to 1900, the use of the Goschen formula did not provide Scotland with sufficient allocation of funds for its public expenditures. It was only in 1901 that Scotland experienced a better good deal when it comes to the allocation of funds. (McLean, 2003)

The Impact of Devolution Over Scotland’s Finances

The problem with regard to the inequalities in the allocation of funds for England & Wales, Scotland and Northern Ireland required the 1974 – 1979 Government to submit the Scotland and Wales Bill to grant devolution.

In the 1970s, a serious imbalance was noted with regard to Scotland and Northern Ireland’s public spending. On the whole, the spending per person in Scotland was 19% more than the average spending per person in England & Wales. (Mair, and McLeod, 1999) In line with the significant increase in the spending per person in Scotland, the budget allocation using the 11/80 ratio became inadequate to support the financial needs of Scotland.

During the mid-1970s, the gross domestic product (GDP) per person in Scotland was 84% of the average GDP in the UK. However, the mean spending in Scotland, particularly on its three major services has reached 117% of the Great Britain’s average per person. (Guthrie and McLean, 1978)

In esssence, the devolution in UK gave rise to a huge controversy over the UK and devolved territory’s spending matters as well as the best way to allocate the government funds. For example: Issues related to the level of Council Tax rebates in the form of Scottish block fund allocation versus the total amount of taxes paid by Scotland was the usual topic of debate. (HM Treasury, 1999) Since there were great disparities with regard to the distribution of government funding, the quality of Scotland’s public service particularly in the field of education as well as the housing and economic development, was also negatively affected. (Bennet, Fairley, and McAteer, 2002)

The Impact of using Goschen Formula Prior to Devolution and the Barnett Formula since the Devolution over the Financial Arrangements in Scotland

Aiming to solve the problem with regard to the imbalance in the financial arrangements in the UK, the Barnett formula, which is based on a population-based formula at a ratio of 85:10:5 to England, Scotland, Wales respectively, was developed in the UK in 1978 by Joel Barnett the then Chief Secretary to the Treasury. (McLean, 2003) After assessment the use of the Barnett formula was introduced to the public two years later. (Heald, 1980) Even though the use of the Barnett formula has been subjected to a lot of criticism (HM Treasury, 2004; Edmonds, 2001; Bell, 2001; Bell and Christie, 2001), the formula stayed in use even up until the post-1997 devolution settlement in the UK and is still in use up to the present day.

With regard to the use of the Barnett formula, the implementation of an equal ependiture per capita all over the UK is not a good solution since it does not recognise the specific needs of each region when it comes to the costs of each public service, aside from the fact that the cost of goods and services in each territory varies. (Bell and Christie, 2001) Despite the limitations of the Barnett formula in providing a fair financial arrangement in the UK’s devolved territories, the UK Treasury published on its website the application of Barnett formula to each of the devolved administrations hoping that it could prevent and minimise any miscommunication with regard to the use of the formula. (Heald, 2001)

The main reason for choosing the Barnett formula is because it is an “anti-rounding up device” combined with a “convergence formula”. The Treasury prefers to use an anti-rounding up device because of its negative experience with the bias Goschen proportion with the Scottish departments (Mitchell, 2006).

Prior to the devolution, the Goschen formula was used as a benchmark when negotiating for the funds allocation. For example: Scotland could debate on receiving at least if not more than the 11/80 of that in Wales for the reason that Scotland has more public schools and teachers to finance. Further, using the Goschen proportion as a benchmark could enable a territory to make a special claim for a particular service that the territory has chosen to negotiate. (McLean, 2003) Since the Groschen formula serves as a benchmark for further negotiation with regard to the budget allocation in each territory, debates coming from different territories continuously arises leading to serious problems on the part of the Treasury. In line with this problem, the use of the Barnett formula simplifies the whole bargaining process for of the Treasury by legally allowing the distribution of a block grant rather than on a programme-by-programme percentage increase.

The Treasury also prefers the use of a convergence formula since it works on the increments in the public spending instead of the usual absolute public spending. The benefit of applying incremental solution in the computation for the public spending in each territory is that it minimises a bias allocation of funds for the public expenditure in each devolved area. For example: If England decided to increase spending on its domestic services by a certain amount, Scotland, Wales and Northern Ireland should also receive an equal amount to the spending of England which will be added up to the block grant of each territory in proportion to the ratio between the England’s population and the population of each devolved territory. (McLean, 2003) It should be noted however, that Scottish Ministers are not bound to allocate this extra funding to domestic services but can redistribute the money whererever they choose.

There are a lot of significant problems attached with the kind of financial arrangement that applies an incremental solution in the computation of the public spending in each teritory. First, given that Scotland has a much higher public expenditure as compared with England and the rest of the devolved territories, the short-run implication of a sudden shift from the use of the Goschen formula to the Barnett formula could have resulted in a problematic adjustment on the part of Scotland. (McLean, 2003)

During the period wherein the financial arrangements in the UK suddenly shift from the use of the Goschen formula to the Barnett formula, Scotland needed to keep its public expenditures as low as possible since the public expenditures in England is much lower than the public expenditures in Scotland. Since the application of incremental solution in the computation for the public spending in each territory will be based on the expenditures in England, it would also mean that the allocated grant for Scotland will also be much smaller in terms of its monetary value.

Alternatively, according to McLean (2003), the application of the Barnett formula promises a better long-run effect since the use of the convergence formula could result in an equal public spending per person throughout each of the three devolved territories in the UK. With regard to what McLean (2003) claims to be beneficial to everyone is not always true because some of the devolved territories have a very small population growth due to either married couples who have decided not to procreate or purely due to migration such as in the case of Scotland. (McCrone,1999) In line with this matter, the public expenditure on the major services in each devolved territories are fixed.

The House of Lords Debate (2001) mentioned that one of the main problems related with the use of the Barnett formula is that it fails to protect Wales and other poor territories since the structure of the formula is not capable of doing so. Basically, poorer territories have greater public spending since they need to extend additional financial support on the public housing and social services in order to boost its economy.

According to Smith, Rice and Carr-Hill (2001), to be able to establish a more situable redistribution of funds formulae hroughout the UK, there is a need to acknowledge and balance the supply versus the demand. (Smith, Rice and Carr-Hill, 2001) The problem with the existing formula is that it focuses only on the supply-side and disregards the entire demand of each devolved territories. For example: In line with the use of the Barnett formula such that each devolved territory is given a grant fund for the entire public expenditure of each territory, hospital services are using the ‘age-weighted population’ to determine the fund allocation for health service. (Smith, Rice and Carr-Hill, 2001: 237) This method does not reflect the actual expenditure for the health service in Scotland. In fact, it only creates a dilution with regard to the actual expenditure of its health service.

Aside from the difference in the cost of goods and services in different territories, another point of consideration is the fact that richer territories could generate a higher GDP than the poorer territories. In other words, richer territories tend to pay higher taxes than that of the poorer territories. (Baran and O'Donoghue, 2002)

Based on the economic point-of-view, considering the convergence formula attached with the use of the Barnett formula such that each territory would receive an equal grant given to Europe, clearly reflects an unequal allocation of funds since it promotes the concept of a ‘free-ride’ for the benefit of the poorer territories at the expense of the richer ones.

Another problem with the use of the Barnett formula is that there is a limitation in its arithmetic functions such that the use of a population-based approach is not appropriate when it comes to the computation of the programmes within the Departmental Expenditure Limits, the Annually Managed Expenditure (AME) items; as well as the other expenditure outside the Departmental Expenditure Limits. (HM Treasury, Online ,2007)

In the case of Scotland, its share in the UK population suddenly decreases when people started to leave the country to migrate in other places, due to the fixed-population weight in the Barnett formula, Scotland’s share in the allocation of public fund also decreases whereas its public expenditure will remain the same. (McCrone,1999) In 2002, Scotland’s share in the UK Government funds fell from the usual 11% down to 10.23%. For this reason, Adams, Robinson and Vigor (2003) and Morgan (2002) concluded that the application of the Barnett formula in the financial arrangements in UK does not give equal justice to all.

UK’s Public Expenditure in Scotland, Northern Ireland, England and Wales since Devolution

There are a number of changes made in the control of public expenditure in the UK before and after the devolution settlement. Since devolution in 1999, a new public expenditure budgeting control aggregates has been implemented throughout the UK based on Departmental Expenditure Limits (DEL) and the Annually Managed Expenditure (AME). (See Table I –New and Old Public Expenditure Systems in UK on page 17)

Basically, the DEL includes not only all the running costs of the Government departments but also the other purchases of goods and services including the grants and other subsidies that are paid to the private sectors. DEL also includes all types of loans (newly issued loans – payment for loan principal). Those public expenditures that are directly related to the social security benefits, housing revenue account subsidies, Common Agricultural Policy, Export Credits Guarantee department, self-financing public corporations, net public service pension and the National Lottery are included under the main department programmes of AME.

In line with the changes in the financing responsibilities of the UK Government, the usual responsibility of the Contribution Agency will be passed on from the Department for Social Security down to the Inland Revenue. (HM Treasury, 2000) The major responsibility with regards to grant in aid that is paid to the British Council will also be passed on from the Department for International Development to the Foreign and Commonwealth Office whereas the responsibility for the funding of students, who are currently enrolled under the health care professions has become the responsibility of the Department of Health instead of the Department for Education and Employment. These major changes were necessary since the chosen departments who handle the new responsibilities are more qualified to handle the assigned tasks.

With regard to the fund allocation in each of the devolved territories, the HM Treasury reported that during the fiscal year 2006/2007, the actual allocation of monetary fund allocated per person in Scotland, Northern Ireland, England and Wales is £8,623, £9,385, £7,121, and £8,139 respectively. (HM Treasury, 2006/2007) Based on these figures, the UK-wide average per-capita expenditure on services in Scotland, Northern Ireland, England and Wales will be 117%, 127%, 97%, and 111% respectively.

Despite all the major changes in the financial arrangements in the UK since devolution, the huge discrepancy noted in the fund allocation awarded to Scotland, Northern Ireland, England and Wales clearly shows that the use of the Barnett formulae does not really provide an equal and fair allocation of government funds as it claims to be solving. In line with this, there is really a need to develop a new formula that could minimise and prevent the bias distribution of the UK government funds.

Conclusion

The government has made an effort to solve the problems related to the financial arrangements in the UK since devolution in 1999. The public expenditures of devolved territories such as Scotland have been totally distorted because of the application of the Goschen and Barnett formulae. Evidence shows that the local authorities practice a bias judgement with regard to the allocation of funds among the English regions such that London, in particular, receives significantly more funds than that of Scotland.

The implementation of the Barnett formula since devolution is more beneficial on for Scotland as compared with the use of the Goschen formula. Based on the HM Treasury report during the fiscal year 2006/2007, Scotland alone has been receiving a grant from the UK Government more than the amount of financial support being received by England and Wales.

Although the use of the Barnett formula is beneficial to Scotland, this tool will never be useful in areas related to taxation, unemployment rates, and the health needs of the people in each territory. According to the HM Treasury, Wales had a requirement for greater government funds to solve the social and economic issues compared to the needs of Scotland. (HM Treasury, 1978) However, with the application of the Barnett formula, Scotland was to be given a higher monetary than that of Wales.

Up to the present time, a perfect formula that can resolve the major concerns of the devolved territories with regard to an equal distribution of Government funding has still yet to be found. In line with this, several studies have been made on how to solve the financial distribution problem throughout the devolved territories in the UK. Perhaps in years to come, a better financial tool will be developed to solve the unequal allocation of funds.

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The figure noted above does not include the ‘non-identifiable expenditure’ such as defence and interest incurred on debts.