Cynulliad Cenedlaethol Cymru

the Welsh Government is obviously moving in a very fast-changing environment at the moment and, certainly, the principles that the Welsh Government has put out for tax policy are very good principles on which to organise. Certainly, I mean, there's always an underlying contradiction, isn't there, in tax policy between wanting to raise as much money as you can on the one hand, given your rates and thresholds, in order to fund public services and take care of inequalities through the spending side, compared with the tax side, when you're trying to look at fairness and progressivity in the tax system that can sometimes work in contradictory directions? So, the obvious way to raise as much money as you could from the Welsh tax base right now would be to increase very significantly the basic rate of income tax. But, obviously, that works very much against the progressivity principles that are laid out here. And this is not unusual to Wales; this is obviously a consideration for all tax systems.

I think the principles, as I say, are very good principles on which to organise. I would say at the moment—and this perhaps comes into the question about changing the legislation in order to be a bit more reactive to changes in tax policy that have been made in Westminster—the big changes in land transaction tax have been made very, very rapidly, and in some form they've actually scrambled to respond to tax decisions that have been made in Westminster. That's not a criticism—it's just saying that the time frame for working out changes to tax policy has been dictated by this process rather than by the budget cycle or by the tax cycle that you'd normally expect for decisions like this to be made.

You mentioned the consultation on the change to the tax legislation and the facility or the ability to allow the Government to make immediate changes. I was going to ask, really, what you see as some of the strengths and the weaknesses and some of the risks around that, potentially.

We're not legal experts, so I'm sure there are colleagues who would be able to give more information about when it's appropriate to use emergency measures, for example. Anything that would improve the flexibility of the Welsh Government's response to these overnight changes to tax rates and frameworks in England would be, on the face of it, a good thing. This has been a long-standing principle that the Westminster Government has had secrecy over its finance Bills and over its budget. It's not any change in what has been happening in Westminster, but the new development, of course, is that those have been switched off in Wales and Scotland so there's going to be a response. So, I would say that anything, on the face of it, that potentially puts provisional regulations in place that could then be, at relatively short notice, approved by the Senedd would be, on the face of it, a good thing. But the details of when to put in place emergency legislation is above my pay grade, probably.

Okay, there we are. Diolch yn fawr iawn. Shall we move on to Rhianon?

Thank you. Just briefly in regard to the ability to be flexible and more agile in this regard, what specifically would you be thinking in terms of tax leverage, given the comments that you've just made?

At the moment, of course, there's a contradiction going on as well—it's another contradiction. So, we have the devolution of more taxes on the one hand, which is definitely giving—. Taxes are having an impact on the overall size of the Welsh budget, as we know, but on the other hand, of course, as we leave the transition period we've got the discussions about the United Kingdom Internal Market Bill and the replacement for the structural funds, both of which are potentially leading in a more centralised direction. There's obviously a lot to work out on that, but particularly when we're looking at who would be responsible for economic policy—that's a real question. So, we've got on the one hand giving responsibility for the Welsh Government to be responsible for its tax base, and to improve economic performance in order to reap the rewards of that through the tax system, but we have, of course, that potentially countervailing development where some of the most important tools in economic development are potentially going to be controlled by another Government. It's not really a political point, it's more of a point about accountability, and that is the whole point of the Silk commission—to make sure that particular taxes or decisions are held, obviously, in the public mind by one level of Government, and potentially we've got a mixing of that going on at the moment.

Thank you for that, that's interesting. So, the Welsh Government recently published its tax policy work plan, which included the aim to strengthen, of course, the Welsh tax base. Do you feel it has—you've partly answered—? Do you feel it has the necessary tools to grow the tax base in line with the Welsh tax policy framework? I'm really trying to unpick more specifically what it would look like if it did.

I think one of the good things about the tax policy outlook and the work plan is it is really short, and that's a good thing because it means that you're able to read—and it's concisely written—what exactly they are planning to do. I think it's a very readable document. It's only a few pages, and that's really to be commended. They're working in a very, very difficult, fast-moving environment right now, where we've got income taxes way below projections, and even more challenges and risks and uncertainties on the expenditure side. So, on the one hand, we're dealing with the annual tax budget cycle, and on the other hand, we're dealing with a real extraordinary event in terms of the public finances. So, there's the kind of the short-term point. Then, the long-term point about tax policy is, of course—. We've mentioned this before, and all of you will know this too: the long-term way to improve the Welsh tax base is through highly skilled and highly paid jobs. That all takes a great deal of time, and it's working through mechanisms that aren't necessarily directly related to tax policy. Tax policy is one of them, but it's also to do with some of the competences that have been held by the Welsh Government since day one—so in terms of skills policy, in terms of infrastructure. So, there's this kind of temporal discrepancy, where we might have a tax change or a policy change now that won't feed through into the tax base for a number of years. So, again, that accountability question is a decision right now, but we might not know the consequences of that until an administration or two away from right now.

Okay. So, just a simple 'yes' or 'no', really: do you think that the Welsh Government has the policies in place to grow the Welsh tax base?

As a typical academic, I'm afraid I'm going to have to—. This is a really complex question. On the one hand, you've got new tax powers, and the package of powers on the skills, education, infrastructure side. But, you know, this is in the context of a fast-changing policy landscape, where some of the tools that we're talking about in this space are potentially working in the other direction.

That balance, you know, isn't always in our gift, in terms of—

That's correct.

The things that are in our gift, in terms of—. I understand your difficulty in answering that. The things that are in our gift: is the Welsh Government tax policy, as is, capable of growing the Welsh tax base? Briefly. 

Well, as a document, as I mentioned earlier, the principles make a lot of sense, certainly as a way of organising tax policy. But, as I mentioned, it's a much broader—. Whether or not the tax base grows is only in part due to the tax powers themselves. So, you have to have feed-through from those powers in order to have any impact on the other end in terms of the tax base. So, what you would want to see—. In the same way that the future generations principles are increasingly embedded in Welsh Government policy decisions, you'd want to see that on the tax side, so that, across the whole suite of Welsh Government policy areas, there'd be the impact of what this might mean for the tax base, because that's clearly going to be important in the budget. Now, obviously, this is starting, but I think that that is the way to embed this more deeply. The tax policy principles on their own are not going to deliver that increase in the tax base that—

But you don't have any specific policies that you think could be implemented that would maximise the Welsh rate of income tax.

We need to avoid straying into political questions, really. I think the point is around whether the Government has the tools to make a sufficient impact, really, isn't it? I don't know if Ed or Guto want to add anything further.

I think that you've answered as much as you are able to answer on that.

Thank you.

Okay. Thank you, Rhianon. Siân.

Just in relation to the enabling Act—. No, in terms of the innovative Welsh taxes that have been proposed by the Welsh Government, obviously, we've seen over the summer the concern by the Minister about the process being quite protracted and challenging with regard to negotiations with the Treasury over some of these mechanisms. This was probably foreseen when these mechanisms were originally proposed, because we saw the equivalent mechanism through the legislative competence Orders, back in the late 2000s, which were very rapidly replaced because of concerns over the complexity of negotiations over those.

And, again, it goes back to the accountability point—that what you want here, if the UK Government agrees that a certain area should be subject to Welsh Government taxing power, is for the Welsh Government to then take responsibility for the policy decisions it makes in that political space. And so, where you've got these incredibly complicated negotiations over spillover effects, over a very, very complicated level of detail over the regulations, over the rates, over the tax base, these are the types of questions where that accountability, potentially, gets obscured. And there certainly should be questions about spillovers. Certainly, there may be effects on the other side of the border, but you would hope in that situation that there could be a discussion of the broad principles over which that tax might create spillover effects, rather than a minutiae trawl through regulations, which really should be the Welsh Government's responsibility after that tax has been devolved. 

Can I just ask—? Obviously, I'm wondering how suitable the Barnett formula is for calculating changes to the Welsh block grant, and how effective the needs-based factor is in addressing the funding needs for Wales. I'm sure you'll have plenty to say about that. 

Yes. I think the needs-based factor was a welcome addition to the fiscal framework in that, for the first time, it acknowledged that Wales had different levels of relative need compared with England and relative spending per person in Wales should reflect those different levels of need. However, even though that principle has been acknowledged in the fiscal framework agreement, the way it's actually been implemented leaves a lot to be desired. As you say, the Barnett formula and the needs-based factor determine annual changes, from year to year, rather than the overall level of the block grant. That's how most of central Government grants are determined across the world. So, the outcomes, in terms of relative spending per person, are still the product of historical accident, and it depends on the size of the previous grant funding, what happens in relative growth in population, how fast spending grows in England.

On that note, the very rapid growth in spending over the last two years has had some interesting consequences. First of all, the needs-based factor has resulted in a lot more additional funding than we would have expected when the agreement was signed in 2016. So, it's around £360 million of additional funding over the last three years for the Welsh Government, as a result of the needs-based factor being in place. And, this year in particular, as spending grows by something like a fifth, Wales receives £105 per person for every £100 of additional spend in England. The resulting increase in the Welsh block grant in percentage terms is still lower than the increase in comparable spending in England, so what we will see this year is an extreme example of the infamous Barnett squeeze—what we saw over the first decade of devolution and caused relative spending in Wales to converge down to the level in England.

The fiscal framework, four years ago, stated that Wales was, of course, to receive £120 per person for every £100 of comparable spending for England. However, with the massive increase in spending this year, that figure is significantly out of date now, and I think that should be updated at the spending review. A rough calculation that we've made suggests it's around £116 per person now, so we've seen a decade's worth almost of increase in spending causing relative spending in Wales to fall down to the level in England and, of course, when relative spending reaches 115 per cent of the level in England, then, the needs-based factor itself changes from 105 per cent to 115 per cent. So, over the course of the next spending review period, that could add a significant amount of additional funding to the Welsh Government, and it's then that the Barnett squeeze effect will be fully mitigated, when the needs-based factor does turn to 115 per cent.  

Diolch. Alun, you wanted to come in.  

Yes, and thank you. I'm grateful to Guto for that. I was just following up the points that Llyr was making. When I first read this agreement between the Welsh and the United Kingdom Governments, I had a great sense of being underwhelmed, if I'm completely honest. It's Barnett with a couple of bells and a couple of whistles, essentially. It's got a far grander name and, I presume, the document was a far grander document, but the guts of it are the same. Joel Barnett would understand this, would recognise it. And, so, is this where we need to be, is the question, I suppose, I'm getting at, because it still essentially ties the Welsh Government and our own decisions in the Senedd to decisions that are taken by the United Kingdom Government in quite a profound way. Isn't it really time that a real fiscal framework and a needs-based formula and the rest of it were based on something that is more than Joel Barnett's envelope from a time when I was in comprehensive?

I think the fact that this was the only change in the Barnett formula for over 40 years made that agreement significant. But you're right in saying that it was essentially trying to patch up a system that's probably not fit for purpose, with adding this needs-based factor at over 105 per cent for what they called 'a transitional period', before it became 115 per cent. I think how they got to that 105 per cent itself was probably more political bargaining between both Governments rather than a rational discussion of what relative spending levels in Wales should be and how do we get to that. On that point, I think the fact that, as I said, they acknowledge the principle that relative spending need in Wales is different from the English average, but they've used this 115 per cent figure, which obviously came from the Holtham commission report, but that estimate itself was based on data—. Most of it was based on data from the 2001 census, so it's already two decades out of date. Whether or not that estimate of relative need should be updated is another question, I think, that needs to be considered, and would have been considered if we were going back to first principles and trying to devise a rational system of sub-national government and how to finance devolution. But, obviously, as has always been the case with the Barnett formula, it's been a product of the political negotiations at the time, and that's why you now have different fiscal frameworks at work in the three devolved countries—almost totally different fiscal frameworks in each of the devolved countries—because it's been the product of political negotiation rather than a more rounded approach to devolved finance.

Okay. Diolch yn fawr iawn. We've got around about 10 minutes left, and I know we have three people who want to ask questions. So, we move on to Mark next, and then we'll go from there.

Can I just ask about what gets a Barnett consequential and what doesn't? The example I've found most striking in my period here is HS2. I read that there was what was described, at least to me, as a decision that Scotland would benefit from a consequential, but not Wales. Assessing HS2 and how it works, it seemed to me that it led to a significant shortening in journey times from Scotland to London and many key English cities, but it didn't have material benefit to Wales except, perhaps, a little in north Wales. So, that struck me as totally the opposite decision from what I would expect, and it was then explained to me it was because rail infrastructure is devolved to Scotland but not to Wales. Do you think that's a sensible or coherent basis on which to make these decisions?

That particular example, I think—. So, the overall comparability factor of when the Treasury goes through its spending review to determine what is devolved and not devolved, essentially, only the Treasury gets to decide that. They do consult with the devolved Governments, but that, obviously, is up the UK Government. And then you do get some anomalies like the HS2 finance, which isn't part of rail spending in Wales, but it's classed as an England and Wales project. And I think two perverse factors that come from that decision is that the overall comparability factor for the department in the spending review, at this forthcoming spending review, will drop significantly for the transport department. So, for every extra pound spent over the next five years via the Department for Transport, Wales will get a significant amount less because HS2 now accounts for a larger share of that Department for Transport budget. So, not only are we losing out directly on that additional funding from HS2, we also lose out from non-HS2 spending because that affects the overall comparability factor. So, it does strike me as pretty odd, that feature of the Barnett formula.

Yes, and it goes to the arbitrary nature of much of this. I just would add that it's not all double bad news in the sense that Guto made it to be—although I agree absolutely with his point—because HS2 is going to be such a large component of expenditure, overall money put into the Department for Transport will increase, so there will be more money coming through the consequential, although the percentage points that Guto made are completely correct.

So, the increase in spending on an England and Wales ostensible project of HS2 does lead to some increase in consequential because overall spending is going up.

Yes, it's two different—. It's both increases, yes. There will be two different rates of increase because more money will be put into the Department for Transport, so even though the percentage consequential comes down, there'll still be more money put through the system. However, that money will be outpaced by that that will be going to Scotland with its 100 per cent consequential on that.

Okay. And overall, do you think this comparable model for adjusting the block grant is fit for purpose?

So, right now—and Guto can come in as well—it's working pretty well in terms of the way that the three different—. The three block grant adjustments for income tax are really doing what they were supposed to do in protecting the differential impact of economic shocks on the tax base. I don't know if Guto wants to come in on this particular point.

Yes, and I think COVID-19 probably will be a bit of a litmus test for this comparable model and for the principle of linking the block grant adjustments to comparable revenues in the rest of the UK. I think the last major shock to revenues, the great recession from 2007 to 2009, caused a big drop in revenues that are now devolved, but because that link in the block grant adjustment through comparable models to revenues in England and Northern Ireland reduce the block grant adjustment, that essentially would have cushioned the blow for the Welsh Government budget had that been devolved at the time.

So, as I said, the separate block grant adjustments for basic rates, higher rates and additional rates of the tax bases at each tax rate, I think that might well protect the Welsh Government from what we—. At the moment, although it's far too early to tell definitively, we're seeing an increase in income inequality, so you'd imagine that the basic rate tax payers will be affected more by the COVID-19 crisis, and the fact that that's relatively more important for the Welsh tax base as a whole, that separate block grant adjustment will be a positive thing for the Welsh Government to protect it against that increase in income inequality across the UK.

Thank you. I'm sorry, I'm just thinking about that last answer, actually. The fiscal framework is an improvement on where we were; I think that's a fair analysis, but you still get the feeling that it's the child of the Treasury rather than a joint endeavour and the answers you've given to previous questions lead me to that conclusion.

In terms of borrowing and where we are currently on borrowing, where would you say would be a fair place for the Welsh Government to be? Because the Treasury's view is, 'Every penny you borrow is essentially a penny I borrow, and therefore I want to control everything that you do and I want to micromanage that control as well.' It's the impression that's certainly given. To what extent do you think it's fair and reasonable for a Government of Wales to be able to pursue its own policy and its own approach to borrowing? Because at the moment, you know, borrowing is absolutely critical to our ability to invest, I would have expected, as a consequence of COVID.

I think, as you say, the nominal limits that have been placed on capital and resource borrowing by the Welsh Government are pretty arbitrary things and they aren't—. At the moment, they haven't been updated over time, so they don't really bear any relation to the fiscal capacity of the Welsh Government or changing economic circumstances, so the fact that interest rates have fallen since the agreement was signed, and I think, as was the case in the Scottish fiscal framework agreement, those sorts of arbitrary limits are very much the product of the Chancellor in the UK Treasury at the time.

I think one practical solution, maybe, would be to look at the UK Government's own fiscal rules and this is something that's been brought up by Eurfyl ap Gwilym. So, the Conservative manifesto, for instance, said that the debt interest payments of the UK Government should not exceed 6 per cent of tax revenues. So, if you apply that principle to the Welsh Government budget, then the cap on Welsh Government borrowing would be the point at which debt interest payments reached £300 million a year, or something like that. First of all, it would reward Welsh Government when its revenues increased and it would increase the scope to borrow when interest rates are at a historic low, as they are at the moment, to be able to respond to economic crises. So, I think that's a pretty sensible approach. Of course, you do need some rules and limits on the Welsh Government's ability to borrow as part of the UK, but that would be a sensible way forward.

Diolch yn fawr. Nick Ramsey, then.

Thanks, Chair. Good afternoon. The Wales reserve enables Welsh Government to save up to £350 million of surplus revenues for both resource and capital, but limits the amount that can be drawn down. Do you think that the size, annual limits, and rules regarding movement between capital and revenue reserves are appropriate, or should they be changed and made more flexible?

I think the biggest risk to the Welsh budget this year is on the spending side and the actual size of the amount of consequentials that they're going to be receiving from the UK Government. There are restrictions on the use of the Wales reserve and, as you said, the Welsh Government is already drawing down the maximum allowed from the Wales reserve this year, and that could potentially mean that there's around £150 million of unused resource spending in the Wales reserve that the Welsh Government won't be able to use this year. It seems like a weird year, given the crisis that we're in, to limit the Welsh Government's use of its own reserves. I think, on the other side of that, that the Welsh Government should be able to carry forward however much it wants into next year. So, say that it keeps some funding unallocated in the budget in anticipation of, maybe, a large unexpected increase in demand later in the financial year, if that need doesn't arise, then it should be able to carry forward that funding to next year. In terms of accountability and in terms of planning, I think, even if it's on a temporary basis, that those restrictions on the Wales reserves should be something that the UK Treasury allows this year, at least.

Why aren't they? What's the issue, as you see it, from their point of view?

I haven't really seen the rationale behind limiting the Welsh Government's ability to manage its budget from the UK perspective. Obviously, I think the Wales reserve is a step up from what came before in terms of budget flexibility, but obviously, as I said before, the rules and the limits that were placed on the Welsh Government's capacity in terms of borrowing and its reserve were and are the product of an agreement that was signed in 2016, when the world looked very different to what it does now, so I think that there should be at least a temporary relaxation of those fiscal rules.

Yes. Okay. Thanks. And in your view, what are the key elements to ensuring a fiscal framework fit for purpose, and are there other international fiscal frameworks with good practice? I think you've just said, haven't you, that agreements that are signed a few years ago aren't always completely up to scratch now, so is there any good practice elsewhere in the world that the Welsh Government and UK Government could learn from?

Certainly, one of the things that's quite unusual is the borrowing limits; they're very tight for capital and current spending in a sub-state Government perspective, particularly if you're looking at Belgium, for example. The block grant adjustment system is working pretty well, and this goes to Alun Davies's point: this is an infrastructure that's built around keeping the Barnett formula, and, as long as the Barnett formula continues to be the basis on which public expenditure management at the territorial level is done in the UK—which I don't see any reason for that to change, and, in fact, it's become more embedded in the UK system since the Smith commission after the Scottish referendum. So, I think, given that, there are limits on how far we can—the innovations we can adopt from abroad. I do think, on the public expenditure side, there really is strong assertion of Treasury control in terms of borrowing limits, in terms of flexibility to switch between capital and current spending and use of the Wales reserve. And those things, I think, particularly given the uncertainty and the risk on the public spending side for Wales—those are the ones that you'd want to see immediate flexibility on.

Thanks.