Thoughts on Holtham

I've just read the Holtham Commission's final report. As with the first report last year, it's clear and thorough, yet it didn't strike me as being a particularly groundshaking piece of work. When I'd finished reading it I found myself asking, Is that all?

 
   

  

Gerald Holtham	David Miles	Paul Bernd Spahn

 
   Fairness and accountability: a new funding settlement for Wales
   Summary
   Full text

 
1. A fair funding formula

On the subject of replacing Barnett with a needs based formula, the report couldn't be clearer. In fact everything was already clear in the first report, and the Commission then published a working paper which outlined how a needs based-formula would work in December last year. The basic indicators are:

• Number of children
• Number of older people
• Ethnicity
• Income poverty
• Ill health
• Sparsity

And these come together in this rather neat graphic showing how they vary between Wales, England, Scotland and Northern Ireland:

    

But—perhaps tacitly acknowledging that there are political difficulties in implementing a new formula because of how Barnett benefits Scotland—the report repeats its recommendation that a floor be put in to protect Wales until a proper formula is agreed. Despite both Peter Hain saying, and Peter Black believing, that a floor has been put in place, it hasn't. The report also says the 114% floor they suggested before was deliberately conservative.

The political impasse will be hard to break. In my opinion it can only be broken in one way: to acknowledge that Scotland will get substantially less money on a needs-based assessment, but to make up for that by giving Scotland a fair share of the revenue from North Sea oil and gas in its waters in compensation. At present Barnett is trying to be two different things at the same time, and until the two things are separated, there will never be an acceptable political solution. But this will involve the UK government having to concede the principle that—in part at least—it is Scotland's oil and gas. That is a big bullet for the UK to bite.

 
2. Borrowing

This is the most uncontentious part of what the report has to say. Wales already has a £500m "overdraft" facility for short term balancing and, perhaps by coincidence (or perhaps not) the Treasury announced yesterday that Wales would be able to access the small discrepancy between what the Welsh Government spends each year and what it is entitled to spend: the year end flexibility that equates to about £200m. Taken together, these should cover short-term fluctuations.

The block grant already includes elements for capital expenditure, but there is no scope for independent long-term borrowing for infrastructure improvement. Up to now the Treasury have resisted this on the grounds that Wales and Scotland do not have a guaranteed income to service any long-term debt because each comprehensive spending review is only for three years. It was on this ground that the Treasury made such a fuss over the funding for the new Forth bridge in Scotland, effectively trying to tell the Scottish Government to do it by PFI or not at all. Of course the idea that Wales and Scotland might not get any money in the next CSR was laughable, and the report poured scorn on it.

So what is being recommended is that borrowing should be allowed only for capital expenditure. Holtham envisages that this would be on the same basis as local authorities can borrow now, namely through the National Loans Fund or Public Works Loan Board because (at Treasury rates) this is the cheapest way of doing it. I won't question that this is cheaper than borrowing commercially, but it fails to take account of the Treasury's eagerness to cut back on all borrowing. It may well be that other sources will be the only way of actually getting money, so I'd urge Westminster not to prevent us going to commercial lenders. We might well be able to devise new methods of borrowing that are similar to PFI in that the borrowing is not classed as public borrowing, but ensure that what would otherwise have been private profit for the PFI consortia is recycled back to the public purse instead.

 
3. Setting tax rates as well as spending money

Where this final report breaks new ground is on the ways in which the Welsh Government can be made responsible for not just spending money, but for how the money it spends is raised. The point of principle is that any body that spends large sums of public money should also be at least partly responsible for justifying how that money is provided.

After considering the pros and cons of each form of existing tax, it draws very much the same conclusions as Calman: that income tax is the best tax to be devolved. In two respects what Holtham proposes is better than Calman (and in my opinion should therefore apply to Scotland as well, though the report doesn't say that). The first improvement is that instead of "everything but 10p" applied to both tax bands (basic and higher ... but I guess also the new rate as well) it should be half of each tax band. The second improvement would be that the Welsh Government could set different rates for each tax band.

I have to say again that there is a basic flaw in one of the premises in the report, which I first commented on in this post. Holtham takes it for granted that a person's tax rate would be based on residence. I believe it would be much better to base it on workplace. I find Holtham's idea that Wales might set a lower higher rate in order to encourage high earners to live in Wales rather bizarre.

I'm also slightly disturbed by the idea that the differential of either rate form England should be no greater than 3p. I say that based on what happened in Scotland when the SNP (with LibDem support) wanted to abolish Council Tax and replace it with a Local Income Tax. As I read it, they would have done so if they could do it within the 3p variable rate ... but the sums didn't quite add up. They would probably have worked with 4p. So the proposed 3p limitation very much ties the hands of any government that wants to do something radical with the tax system.

As with Calman, there are several more minor taxes that could be devolved, but the big question is over corporation tax. This is where I find the report rather too tepid. It's definitely a candidate tax, but the final recommendation is a rather weak:

The Assembly Government should seek discussions with the UK Government and the other devolved administrations about the feasibility of devolving corporation tax.

But I suppose it's better than ruling it out altogether. We know that the ConDem coalition wants to reduce CT in Northern Ireland, and therefore it must make sense to establish a mechanism for a variation in Wales and Scotland too.

 
4. Contol of more than one lever

But the big criticism I have of the report is that it appears to me to be missing the point of what taxes can be used for. The whole section on tax is predicated on the idea that if a government puts up rates of tax it will have more to spend on services, and that if it lowers rates of tax it will have correspondingly less to spend ... but that treats the economy as something static.

I see tax as a tool to give the Welsh economy an international advantage. So if we, for example, by lowering business taxes encourage more companies to locate in Wales, or to expand their existing operations in Wales rather than in another country, we will have more jobs. What we lose in company taxation we gain by having more people paying income tax and fewer people out of work and on benefits.

So, at a minimum we need control over at least over two levers in order to gain an overall benefit. Control of some income tax alone just results in the one-dimensional:

higher tax rates
= more to spend on services (or vice-versa)

Adding the extra lever results in the two dimensional:

lower business tax rates
= more jobs
= more income tax
= the same to spend on services

But the vital third dimension is:

lower business tax rates
= more jobs
= more income tax and fewer people on benefits
= more to spend on other services

Holtham says yes to the first lever, maybe to the second, but doesn't even contemplate us getting any benefit from the third. That's what I find so disappointing about it. Yes, I've presented it in a simplified way, and I don't want to imply that it's as easy as that. Like flying a plane, you need a lot of skill and coordination to keep it in the air, let alone to get it to fly in the direction in which you want to go.

In this context it is worth asking why the Scottish government has never used its one lever to vary the basic rate of income tax by 3p. To my mind it is only because there is nothing with which to balance that variation. You can't get a plane to turn using just the rudder, you need control of the ailerons and elevators as well.

 
5. Political reality

OK, so it's not as much as I would have wanted, but it's probably a good reflexion of what any current UK government is likely to give us. It would be unrealistic to expect Wales to get much more fiscal autonomy than is currently being proposed for Scotland on income tax or Northern Ireland on corporation tax. But there really is no reason why we should expect less than they are getting.

But how do we implement these proposals? Or are we not going to implement them at all ... since there is a feeling among some commentators that this report will simply be kicked into the long grass? My feeling is that we must implement these recommendations in some form.

The report runs through what things can be implemented simply by agreement between Westminster and the devolved administrations, and concludes that nearly everything can be done by agreement; but that tax setting powers is a change that will require ratification in a referendum in the same way as the Scots were asked a separate question on tax-varying powers in the 1997 referendum.

I have to say that I question the need for this. There is no suggestion that the Scots are going to have to approve Calman in a referendum, so why should we have to go through it in Wales? As I said before, the previous tax varying powers for Scotland were so inadequate that they were never used, and could never realistically be used. What the Holtham Commission are proposing will give Wales broadly similar fiscal responsibilities as are (according to the ConDem coalition) now going to be given to Scotland without a referendum. Nor is anyone suggesting a referendum in Northern Ireland to set a mechanism to vary the rate of corporation tax there. Why treat Wales differently?

In the end, the over-riding principle is No representation without taxation. Spending cannot be done in isolation from the responsibility of having to justify to taxpayers why their money is being spent. This set of proposals is way short of the fiscal responsibilities I want us in Wales to have. So let's not set another hurdle for us to jump over before we can take this first step towards fiscal responsibility.