Funding arrangements for the Scottish, Welsh and Northern Irish governments should be reformed

In a new report published today, researchers from the Institute for Fiscal Studies, the Fraser of Allander Institute at Strathclyde University, and University of Stirling Management School look at the lessons from the COVID-19 pandemic for the funding arrangements of the devolved governments of Scotland, Wales and Northern Ireland.

The report, funded by the Economic and Social Research Council, focuses on reforms that would make the arrangements more robust and responsive in the longer term and for future crises. But its recommendations are also relevant now given the emergence of the Omicron variant of the coronavirus.

The report does not take a view as to how serious the situation posed by Omicron is. However, given how decisions on different elements of the policy response are taken by the UK and devolved governments – most obviously with the former deciding overall funding and the latter public health restrictions – effective coordination between the two is vital. Better decisions on when and how to respond are more likely if the governments pool their knowledge and collaborate on policy development, than if decisions are taken unilaterally.

The Treasury has already provided some additional funding to the devolved governments. But if it is decided that more stringent measures and significant additional economic and fiscal support are needed, two ideas discussed in the report may be particularly relevant:

• First, the devolved governments should be provided with minimum funding guarantees (as they were in the first year of the pandemic) or enhanced borrowing powers (as devolved governments in many other countries were). Such measures would provide devolved governments with additional financial ‘headroom’ above the funding they receive via the Barnett formula. Without them, the devolved governments will not know how much funding would be available to them until funding and policies were announced for England, potentially forcing them to play ‘catch up’ and delaying their policy responses.
• Second, in case the expected wave of Omicron cases – or some future outbreak – impacts some parts of the country much harder than others, HMRC should examine the feasibility of making the furlough and self-employment income support schemes (SEISS) available on a geographical basis. It may turn out to be impractical without risking significant fraud or error if HMRC is unable to obtain good data on where jobs are based. But if feasible, devolved governments could be given the option of paying for furlough and the SEISS to be reinstated in their territories if they want to tighten public health restrictions significantly. Thresholds for hospitalisations, for example, could also be agreed above which the UK government would pay for the schemes, to provide extra support to areas facing the most serious situations. 

The report examines the case for a number of permanent reforms to funding arrangements to make them more robust in future:

• While minimum funding guarantees for the devolved governments may be useful during extreme crises, they are not appropriate in normal times. This is because in order to be most useful they need to be set significantly above the increases in funding generated by the Barnett formula. But increasing funding for Scotland, Wales and Northern Ireland by more than England on an ongoing basis would be unfair. And an alternative of automatically allowing the devolved governments to defer the impact of lower-than-expected funding to later years would provide most of the benefit that guarantees would provide in normal times without this problem.
• Allowing the devolved governments to borrow to fund discretionary spending would provide additional flexibility to respond to unforeseen events. Even fairly substantial borrowing by the devolved governments would have little impact on overall UK borrowing and debt. But it would raise concerns about fairness given England would lack such borrowing powers. An annual discretionary borrowing limit of 1% of the devolved governments’ resource budgets would provide useful additional flexibility while minimising any equity concerns.
• The Scottish Government’s usual annual borrowing limit to address tax and welfare forecast errors should also be doubled to £600 million as a starting point. The updated limit, and the Welsh Government’s equivalent limit, should then be indexed over time rather than being fixed in cash terms.
• To provide further flexibility, drawdown limits on the Scottish and Welsh reserves should be enhanced. Consideration should be given to increasing the total amount that can be held in reserves and, at the very least, existing limits should be indexed rather than fixed in cash terms.

David Phillips, an Associate Director at IFS and one of the authors of the report, said:
‘With the Omicron variant of coronavirus surging across the UK, it is vital to learn lessons from earlier waves of the pandemic for the devolved governments’ funding arrangements.
‘If new policy and spending announcements start to come in quick succession, the devolved governments should swiftly be given some combination of the funding guarantees successfully deployed last year, and/or enhanced borrowing powers, to allow them to respond in a timely and effective way. Without such measures, they could find themselves uncertain about how much funding will be available until announcements are made for England, potentially holding up policy development and implementation.’

David Eiser, a Knowledge Exchange Fellow at the Fraser of Allander Institute and another author, said:
‘Currently the devolved governments cannot borrow to fund discretionary resource spending. There is a strong case to change this on a permanent basis to provide them with additional flexibility to respond to unforeseen events. Set at a modest level, such as 1% of their resource budget, this would pose no meaningful risks to the UK government’s overall fiscal stance or fiscal targets.
‘For similar reasons, there is also a good case for extending the devolved governments’ existing – and very restrictive – drawdown limits from their reserves.’

David Bell, Professor of Economics at the University of Stirling and also an author, said:
‘It is not only the fiscal frameworks where change could be beneficial. Effective communication and coordination between the UK and devolved governments is vital for effective policymaking given the interactions between funding and policy decisions taken by these two levels of government. There were improvements during the early stages of the COVID-19 pandemic but stakeholders have told us these have not been sustained.
‘Sustainable improvements will require a strengthening of formal arrangements for coordination and communication such as the Joint Ministerial Committee. But culture change is also important. While there will always be genuine disagreements between governments with different priorities, both the UK and devolved governments should aim for a consultative and collegiate approach to issues where their funding and policy decisions interact.’