The Barnett formula and the union

After a dull campaign, the results of the Scottish election surprised. The SNP consolidated the referendum ‘yes’ voters into party supporters, but lost their overall majority in the Scottish parliament. So another referendum on independence is off the agenda for now. The Conservatives came back from the dead to be the main opposition, by harnessing anti- independence voters. And Labour, squeezed in the constitutional middle, recorded their worst result ever. Their attempt to present as the real anti-austerity party, protecting public services with (relatively modest) tax rises, tested to destruction the notion that Scotland is a left of centre, communitarian sort of place, willing to put its hand in its pocket to help the less well-off via more progressive taxation. Scots may say that, but 70 per cent of them voted for the low tax parties – the SNP and the Conservatives.

So Scotland stays in the UK. It may be different, but won’t pay different taxes. What remains different is how Scotland is funded – our old friend the Barnett formula.

Seldom has a piece of elementary algebra been the source of so much argument. The Barnett formula is simplicity itself. The devolved Scottish budget changes by a population share of comparable budgets in England. So if English health spending goes up by £100, the Scottish budget goes up by £8.50. For some this primary school arithmetic cements Scotland’s unfairly privileged position in the UK public finances; for others it is an engine designed to drive devolved spending down irrespective of need. Whichever, if either, is true, Barnett is now baked into the territorial constitution of the United Kingdom.

How did we get to this? The Barnett formula was a government administrative device used to calculate the budgets of the Scottish office (and later the Welsh and Northern Irish offices) in the Treasury’s annual spending round. Primarily an administrative convenience, it was also a way for the Treasury to avoid territorial special pleading. But from its origins in the late 70s its scope was gradually extended to cover more of the budget, and its political salience grew: ‘getting your Barnett share’ of growth was a virility symbol for Scottish secretaries, and taking no more than that share of cuts a defence mechanism. So by 1999, Barnett was the obvious solution for financing devolution: it involved minimum change, though as a result the funding of sub-state government in the UK was unique in the world. Nowhere else uses such a formula.

Barnett was designed to fit into an incremental system of budgeting, which the UK has operated with since the 1960s. It bears no relationship to any measure of need (except population), nor to local taxable capacity. Instead the budget depends mainly on the previous year’s budget. Scotland started out at the launch of Barnett with higher expenditure than the UK average (as did Wales and Northern Ireland, to differing degrees). It might be expected that the arithmetic of Barnett would cause spending levels to converge. After all, each year the devolved budget gets a population share of change, and over time it becomes the dominant part of the budget. Such a Barnett convergence is feared in Wales, but has shown little sign of happening anywhere in the UK (save perhaps in Northern Ireland).

It’s not wholly clear why this hasn’t happened, but a significant factor is relative population decline. Over the years of the application of Barnett to Scotland, England’s population has grown, but Scotland’s, by and large, has not. Relatively fewer heads to spread the cash around offsets the convergent effect of the formula. Whatever the reason, Barnett is the main cause of the fact that public expenditure in Scotland, taking Barnett and non-Barnett spending into account, is just over 10 per cent higher per head than the UK average.

Barnett is certainly popular in Scotland, and is popular in the Treasury too, perhaps unsurprisingly: it’s simple, formulaic, and easy to operate in practice. During the referendum campaign, it became a symbol of sharing resources across the UK in a way which was advantageous to Scotland. And that is why in the dying days of the independence referendum campaign each of the main political parties explicitly committed to retaining Barnett. It may be that the so-called vow in which they did so was critical to the result. We shall never know for sure.

But Scots were also promised tax-raising powers. This will make the Scottish parliament – and if extended the Welsh and Northern Irish assemblies – more like sub-state governments elsewhere in the world, which rely on a mixture of shared central resources and their ‘own resources’, taxes which they control themselves. All such systems need a way of balancing the contributions of the federal centre and the local tax base to spending, and different systems, with different allocations of risk, are seen worldwide. The challenge in the Scottish case has been marrying the explicit commitment to Barnett as the way of sharing central resources to the very substantial tax devolution proposed in the Scotland bill now completing its passage through parliament.

This was the argument of the so-called ‘fiscal framework’ for the Scotland bill, which went to the wire in negotiations between the Scottish and UK governments. In this the SNP administration in Edinburgh showed a remarkable commitment to retaining as many of the advantages of the Barnett formula as they could. Of course, their objective is complete independence, with the consequent abolition of Barnett or any other sharing across the UK, and their manifesto commitment in relation to funding the Scottish parliament was ’full fiscal autonomy’, under which public spending in Scotland would rely only on Scottish resources. The intellectual gymnastics in asserting that partial tax devolution required UK guarantees to the Scottish budget while their own policy was quite the opposite were an exact parallel to the arguments of the independence referendum about the fiscal effect of separation on Scotland. Like Lewis Carroll’s Red Queen, the SNP like to believe impossible things before breakfast, or at least say them before votes.

In the event a deal was done, in terms which were advantageous to the Scottish budget. The main issue of contention, in the event, was whether it should be exposed to the effect of relative population change on tax income – which on the face of it is an obvious consequence of tax devolution. Nevertheless SNP ministers refused to accept the devolved powers unless the UK underwrote this risk. Treasury ministers agreed to do so, at least for the first five years of the new powers, judging (probably correctly) that the accountability benefits from tax devolution were worth sustaining that inconsistency. In any event, the demands on the Treasury from doing so are no higher, and potentially rather lower, than retaining Barnett in total.

Tax devolution to Wales and Northern Ireland is on a different course. The income tax base in both countries is much weaker than in Scotland, and the revenue yield from tax changes proportionately much smaller. The Welsh government priority is to ensure Barnett convergence does not reduce relative spending in Wales below present levels, which is understandable given Wales’ relative poverty and spending need. In Northern Ireland, the debate is about the devolution of corporation tax, so as to compete with low corporation tax rates in the Republic. This has gone on for a number of years, with the main Treasury concern being the risk of ‘tax stealing’ as companies notionally relocate profits to Belfast. If UK corporation tax rates continue to trend downwards, this may become an academic issue only.

Barnett, once an administrative convenience, has become a constitutional fixture. No one designing a federal or quasi federal system of government from scratch would have looked upon the Barnett formula. But it is baked into the development of devolution in the United Kingdom. We will be living with it for a long time.