What is devolution, how is it changing and where might it go next?

Recent UK governments have ‘devolved’ power to Scotland, Wales and Northern Ireland. This is a simple idea, but the UK brand of devolution is complex. Its stability has been threatened by both the Covid-19 pandemic and Brexit.

Threats to the UK’s political unity have been met by ‘devolving’ power to the smaller nations – Scotland, Wales and Northern Ireland – by successive governments in Westminster. The economic components of these changes mainly focus on extending tax-raising powers.

This process of expanding fiscal powers was in train when the economy was hit by the Covid-19 pandemic. Further change came with adjustments to the UK regulatory framework – such as the Internal Market Act and the Subsidy Control Bill – following Brexit. These external shocks have cast doubt on the stability of the fiscal frameworks that control tax and spending by the devolved administrations in Edinburgh, Cardiff and Belfast.

What is the constitutional framework of the UK?

The UK is unusual in not having a written constitution that codifies the powers and constraints on different levels of government, including which levels of government control tax and spending powers. A codified constitution enables disputes between state/province and federal/national governments to be resolved in court.

In contrast, the UK parliament in Westminster is ‘sovereign’: laws that are challenged in the courts can be rewritten. Rather than providing explicit legal protection, the UK has relied on the integrity of politicians to deal equitably with different groups and interests within UK society.

This is known as the ‘good chap’ theory of governance. It has been called into question – with some arguing that recent events, for example around the Brexit referendum, mean that good behaviour among politicians can no longer be taken for granted (Blick and Hennessy, 2019). Nevertheless, it continues to shape political and economic relationships between the UK government and the other nations.

The UK is a union made up of the four nations – England, Scotland, Wales and Northern Ireland. The tax powers of the individual nations are limited. England comprises 84% of the UK population and UK economic policy is inevitably heavily influenced by economic conditions in England.

What is the history of devolution in the UK?

Opposition to the UK’s political arrangements in the smaller nations, though never absent, has become increasingly strident in recent decades. This opposition precipitated referendums on devolution in Scotland and Wales, and an independence referendum in Scotland in 2014. Though armed conflict in Northern Ireland was halted by the Good Friday Agreement in 1998, substantial support for reunification with the Republic continues.

In an effort to provide greater autonomy for the devolved nations, the UK government sought to amend the status quo by passing a series of acts, beginning with the Scotland Act 1998, that first brought new legislatures into place in Scotland, Wales and Northern Ireland, and subsequently increased the political and economic powers of these bodies. This process has come to be known as devolution.

Enhanced economic powers have been a central pillar of devolution. These largely address fiscal issues – taxation and government spending. The economic justification for increasing the fiscal powers of lower levels of government goes back to the 1950s and 1960s (Tiebout, 1956; Oates, 1969). A key argument is that lower levels of government are better placed to respond to the preferences of their electorates and that actual or threatened mobility deters local politicians from imposing punitive taxes to fund unpopular spending.

Alongside its highly centralised political governance, the UK also had a more centralised tax and public spending system than most other advanced economies (McCann, 2021). The OECD estimated that in 2014, subnational government revenues in the UK comprised 1.6% of GDP and 5.9% of total public tax revenue. This compares with OECD averages of 7% of GDP and 31.6% of public tax revenue (OECD, 2016).

The ‘Barnett formula’, which has been in existence since 1979, largely determines funding for the Scottish, Welsh and Northern Irish administrations. They receive an allocation of their population shares of any increases in spending agreed by HM Treasury for England.

At each budget, the Treasury calculates the ‘block grant’ for the devolved nations by applying this formula. This has been advantageous for Scotland and Northern Ireland because since its introduction, the Barnett formula has provided higher levels of public spending per person than in England. Its continued application maintained their spending advantage because each time spending per person in England rises, their budget increases by the same amount.

What is absent from the Barnett formula is any recognition that the needs of different parts of the country are not equal. By applying the same increase in spending across component parts of the UK, it is not responding to differences in unemployment rates, levels of poverty, poor public health and so on.

Most advanced countries set their subnational financial arrangements to support areas that experience disadvantage. This issue was particularly relevant for Wales, which suffered significant economic decline that application of the Barnett formula failed to mitigate. This issue has been allayed by ad hoc adjustments to the formula.

What is also absent from the formula is any legislative underpinning. It is calculated and administered by the Treasury, which is free to change how it is determined. This provided useful flexibility during the pandemic, as we shall see, but is frustrating for the devolved administrations, which have no right to appeal Treasury decisions.

Have there been recent changes to devolution in the UK?

Following the Scottish independence referendum in 2014, the Smith Commission was established to respond to demands for greater fiscal autonomy. Its most significant proposal was to give the Scottish government powers to set the rates and bands of income tax. These were in addition to powers to share in VAT revenues and a number of smaller taxes that were devolved to Scotland in 2012.

Together, these comprised approximately 35% of tax revenue raised in Scotland in 2020/21. Proposals to assign similar powers over income tax to the Welsh parliament were included in the Wales Act of 2016.

Arranging for tax revenues to be retained in Scotland and Wales meant that the Barnett-determined annual block grant had to be adjusted. Less revenue flowing to the Treasury would otherwise cause a significant reduction in the funding available to those living in England. This is where it gets complicated. The formula for adjusting the block grant, unsurprisingly known as the ‘block grant adjustment’ attempts to apply two principles – ‘no detriment’ and ‘taxpayer fairness’ – in its design. Unfortunately, these are arguably inconsistent (Bell et al, 2016).

How have Covid-19 and Brexit affected fiscal devolution in the UK?

Significant changes to the fiscal architecture in Wales and Scotland were underway when Brexit and then the pandemic occurred. These shocks severely strained relationships between the UK government and the devolved administrations.

Brexit brought them under strain because of conflict between Westminster and the devolved administrations over powers returned from the European Union (EU). These included competition policy, state aid and trade. Brexit also ended EU structural fund support for deprived areas, which was particularly important for Wales. The approach taken by the UK government to deal with these returning powers has not been popular in Wales and Scotland.

In Northern Ireland, the changes do not apply, because, under the Protocol to the Trade and Cooperation Agreement (TCA), Northern Ireland remains part of the EU single market for at least the next four years. This has raised issues associated with the movement of goods between Great Britain and Northern Ireland, since they are also crossing a boundary of the EU single market. Fractious negotiations between the UK and the EU over this issue have yet to be resolved.

For Scotland and Wales, the Internal Market Act replaced EU competition policy. It sets ‘mutual recognition’ rules for trade within the UK, meaning that if a good is accepted for sale in one nation, it must be accepted in all the others. This will deter them from legislating to establish different product standards in areas where it is felt that the devolved parliaments have a legitimate interest – such as building standards.

The Subsidy Control Bill, required by the EU to prevent the UK from competing unfairly with its companies, makes the UK Secretary of State for Business, Energy and Industrial Strategy (BEIS) and the Competition and Markets Authority the ultimate arbiters of what financial support to companies is allowable. Again, Scotland and Wales feel that their powers to support economic development are being infringed. This is especially the case as the Scottish and Welsh governments have had no role in post-Brexit deals.

Most nations at least consult their province or state governments when negotiating trade deals, especially where their specific interests are at stake. Agriculture has more economic importance in both Wales and Scotland than in England, yet the UK government did not consult the respective governments during trade negotiations with Australia and New Zealand, both major agricultural exporters.

Finally, although included in the 2017 Conservative Party manifesto, the UK government took until January 2022 to announce the introduction of the ‘Shared Prosperity Fund’ as the replacement for EU structural funds. The delay and lack of consultation was keenly felt in Wales where the 2014-2020 round of EU funding was worth £800 per person per year (Bell, 2017).

The pandemic posed another set of challenges to the fiscal frameworks of the devolved nations. But in this instance, the lack of legally binding fiscal arrangements between the UK government and the devolved nations was perhaps advantageous. The health and economic costs of the pandemic caused an increase in UK borrowing of around £300 billion within the course of a single financial year.

The devolved authorities shoulder the main responsibility for public health within their territories and were confronted with massive unbudgeted cost increases. Spending on health measures were increasing rapidly in England, which would normally trigger additional funding – ‘consequentials’ for the devolved nations via the Barnett formula. Yet the governments in Scotland, Wales and Northern Ireland were unsure whether these would materialise and over what time scale. Their powers to borrow are very limited and well below what was required in response to the pandemic.

HM Treasury responded quickly with offers of substantial financial guarantees to the devolved governments. These were based on the implied Barnett consequentials and gave them assurance about their funding to combat the pandemic. This was an ad hoc short-term response that might have been impossible if constrained by restrictive funding regulations or legislation.

Where might devolution go next short of full Scottish independence?

The fiscal powers available to the devolved administrations have increased dramatically during the last decade. A recent report reviewing possible powers for Northern Ireland provides a useful overview of the options.

Some argue that the powers should extend to ‘full fiscal autonomy’ – which would mean that the devolved administrations would keep all taxes raised within their borders, control all public spending affecting their citizens and make an annual payment to the UK government for central services, such as defence, foreign affairs and debt interest.

This would mean that there would be no sharing of risk between the nations. It would also mean that issues of fiscal sustainability would focus almost entirely on the devolved nations.

Indeed, the additional risks that have already been taken on by the Scottish government through the block grant adjustments have not improved its fiscal position. As a result, there may be some hesitation within the devolved governments around accepting additional fiscal powers. One approach would be to let Edinburgh, Cardiff and Belfast choose how far to extend their own fiscal powers on the clear understanding that they must live with the consequences (Bell et al, 2021).

Conclusion

The challenges of Brexit and the pandemic have strained the UK’s version of devolution in different ways. They highlight the advantages and disadvantages of somewhat loose fiscal arrangements between different levels of government. But these fiscal arrangements were already scheduled to change before the unexpected challenges posed by Brexit and the pandemic.

Together, they have stretched the policy bandwidth of all of the governments and perhaps contributed to a worsening of intergovernmental relations. Whether the UK as a union of four nations will be less resilient as a result of all of these changes remains to be seen.

For economists, part of the lesson from these events is the need to consider that the process of economic policy-making, whether as a result of agreed plans or in response to external shocks, is not costless and that the policy production function, like any production process, has finite limits.

UK policy-makers may respond to any increased demand for Scottish independence with the promise of ‘more powers’, but any further reform should consider the overall fiscal system – both in Scotland and the UK – as opposed to relying on further piecemeal reforms targeted at individual taxes or spending responsibilities.