Hiding the fiscal facts

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Nation.Cymru carried a piece yesterday about the response by Transport Secretary Chris Grayling to a claim by Plaid that Wales isn’t getting its fair share of infrastructure spending. 

The claim that Wales doesn’t get its fair share is a long-standing one, and I suspect that it’s true although it isn’t quite as black-and-white an issue as its sometimes presented.  It appears to many of us in the west and north of the country that the allocation of capital spending within Wales is as unfair as the allocation of capital spending between Wales and England; there seems to be the same concentration on the south east, in and around the capital city.  But merely looking at share of capital expenditure in relation to percentage of population is an over-simplistic way of doing the calculation.  As an example, we know that the cost of building a mile of road will depend significantly on where that mile of road is built – it will cost more in the centre of Cardiff than in the middle of Powys, for instance.  But the difference in ‘cost per head’ of population living in the area will not be in the same ratio as the difference in absolute cost; and neither will the calculated economic benefit.  In addition, the timescale for many infrastructure projects is lengthy; what looks like an unfair share in one year can potentially end up looking very different over many years.  Fairness is an elusive concept when it comes to sharing out infrastructure investment.

But there was another point in the Minister’s response which caught my attention.  He said “I do not think that the Welsh can ever claim that their money is siphoned off to pay for the rest of the country, given the amount of support from taxpayers elsewhere in the UK that goes into Wales...”.  This is, of course, the standard unionist line about taxpayers in England subsidising Wales out of the goodness of their hearts.  It is, though, as over-simplistic as the idea that fairness in infrastructure investment is as easy to work out as spend per head.  The problem is that we simply do not have figures which are accurate and comprehensive enough to determine whether there is a fiscal transfer between England and Wales let alone the size of that transfer; such figures as we do have are inevitably based on estimates and often arbitrary assumptions about the way expenditure should be split.

The GERW figures published two years ago were a useful attempt to analyse income and expenditure for Wales as part of the UK, despite the fact that they were misused by some who attempted to present them as being in some way relevant to the concept of an independent Wales.  There are, though, always going to be problems with such figures.  To take one example, any analysis of expenditure in or on behalf of Wales will assume that Wales needs to pay a percentage of the costs of central administration of government activities.  This is not unreasonable in itself; clearly where the UK Government provides services from which Wales benefits then, under the current constitutional arrangements, it is entirely sensible to apportion part of that cost to Wales.  But it’s worth asking what then happens to that money – assuming that it’s spent once and gone isn’t the whole story.  The reality is that that expenditure largely goes on salaries, and the people receiving those salaries mostly live in England.  The personal tax those individuals pay on their income and on their expenditure (VAT, fuel duty etc.) is then all counted as English revenue based on residence.  Given that probably around 30-35% of all private income (on average) ends up going straight back to the Treasury in tax, every £million spent ‘on behalf of Wales’ but not actually in Wales only costs the Treasury a net figure of around £650,000 - £700,000.  And that’s without the multiplier effect as the people providing the goods and services purchased by those individuals then pay their taxes and buy goods and services themselves…

Now, within a unitary state, none of that really matters.  It’s just a question of book-keeping because there is ultimately one Exchequer and one big cheque book.  But it does matter when people start talking about ‘siphoning off’ and ‘subsidies’, because the truth is hopelessly obscured.  There’s another aspect to what Grayling said as well – every time unionists like him talk about subsidising Wales they effectively undermine their own case for the union, which is that we pool and share.  Still, I suppose that I shouldn’t complain too much about that.

Daft - or worse?

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The Western Mail’s editorial column on Saturday told us that “…a report from the Wales Governance Centre calculated that an independent Wales would be faced with a £15bn funding gap immediately”.  The most charitable interpretation that I can put on that is that the author of the editorial has completely failed to understand the report to which the piece refers – because it told us no such thing, and the authors made that entirely clear at the time.

What it did tell us, assuming that the methodology and figures are broadly correct (a reasonable assumption overall, although the devil is, as always, in the detail), that in the financial year 2014-15, the gap between revenue raised in Wales and the total of expenditure in Wales and expenditure elsewhere which is assumed to be for Wales, there was a deficit of around £15billion.  In short, insofar as it demonstrates anything about systems of government, it shows that Wales is performing very poorly under the current system.

The figures are all historical, not projections, so to arrive at any interpretation of what that means for independence we have not only to make the same assumption about the accuracy of the figures and the methodology, we have also to make the following additional assumptions:

1.    That Wales had become independent at some point prior to the financial year 2014-15, and

2.    That the government of an independent Wales had decided to pursue exactly the same taxation and expenditure problems as the UK Government actually did over that period.

And if we want to project the figures forward – under either scenario – we have to either identify what would be different, or else take the lazy approach of assuming that nothing will change.

The first of those 2 assumptions is obviously untrue.  As for the second, well I suppose it’s conceivable that an independent Wales run by the British Labour Party or the Conservatives in Wales might decide that the best way to run Wales is in the interests of the financial services sector in London and the South East of England, but if there was a credible party of government in Wales still taking that view, I somehow doubt that we would be any nearer gaining independence.  If we don’t do things differently, what would be the point?  It might be argued that, if Wales were suddenly to become independent tomorrow, then we would by definition inherit all existing taxation and revenue policies for the first year, and that, if nothing else changed, then the extent of the fiscal deficit would be roughly the same as it would have been under the current structures.  But in the first place that scenario is utterly unrealistic, and in the second, it still requires the assumption that the future is the same as the past - and the GERW report made no attempt to predict the future.

For anyone to turn a report highlighting the extent of Wales’ failure under the current systems and structures into some sort of categorical ‘proof’ that the current system serves us well, and that the alternative would be disastrous, requires that he or she be either daft or else blinded by his or her own commitment to the UK.

The first possibility certainly fits with the charitable interpretation that I mentioned above; but the less charitable interpretation is that the statement was a deliberate lie, perhaps based on the belief that if you tell a lie often enough it will be believed.

Setting the 'right' level

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I’ve talked a couple of times recently about pensions in the context of the GERW study, and the way in which the total apparent revenue and expenditure in Wales in such an approach is impacted by demographic flows.  But the issue raises another question as well because whilst the level of pension is consistent across the UK, the level of wages is not.

The new state pension is currently set at £155.65 per week (although not everyone will get that, of course).  The average wage in Wales is £473.40 per week and that in the UK as a whole is £528 per week (source).  So in Wales, the pension represents around 33% of average earnings, but in the UK as a whole it represents around 29% of average earnings.  This makes it look superficially more generous in Wales than in the UK as a whole.  (And much of what I say in this post could also be said about other benefits.)  But in the context of GERW, this is another factor which inflates the size of the fiscal gap in Wales compared to the UK as a whole.

Is this an argument for ‘regional’ levels of pension?  No doubt some would see it as such, but for me it raises two other, rather different issues.  The first is this: ‘at what proportion of average salary should the state pension be set?’.  It would be nice to believe that that question had been answered – or even asked – in setting the current level of the pension, but it doesn’t seem to have been.  It’s been more a question of starting where we are and determining the basis on which any rise in pensions has been calculated, usually with political advantage more to the forefront of the mind than any rational consideration about the ‘right’ level of pensions. 

It is, however, an issue that an independent Wales would need to consider, even if many nationalists would prefer not to think about it at present.  I’d like to believe that an independent Wales would be aiming to ensure that the average income of retirees was higher than the 33% level rather than lower; but the underlying point here is that there’s nothing particularly special about the position in England.  An independent Wales would not be bound by what has happened or will happen across the border.  And whilst making international comparisons is never straightforward because of differences in other factors, most EU member states pay pensions at a higher rate compared to average earnings than the UK.

But it’s the second issue which concerns me more, and that is that the apparently more generous level of pensions in Wales is actually more to do with the low level of wages than the high level of pensions.  Because the highest-paid jobs are elsewhere, partly because of the centralised nature of the UK, Wales ends up as a (comparatively) low-wage economy compared to the UK as a whole.  But there’s nothing necessary or inevitable about that; it’s a direct result of our status and role within the UK.  It follows that changing that status is key to changing the nature of our economy.  And changing the nature of the economy is the key to setting the level of pensions.

Who subsidises who?

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I referred yesterday to the impact of flows of people to and from Wales on the size of Wales’ fiscal gap.  It’s a point which is worth exploring further.  Movements of people are complex – not all movements at 65+ for instance are from England to Wales; the best we can say is that there is a net flow amongst that demographic.  Similarly, not all movement of young people goes the other way; again, the best we can do is talk about net movement.

But for the sake of simplicity, and to illustrate a point, let us take ‘Dan’ as a notional example.  Dan was born in Wales, received all his education in Wales, and graduated from a Welsh university.  Failing to find a suitable job in Wales, he took himself off to London, where he enjoyed a reasonable career, working his way up the greasy pole to a middle management rôle before retiring at 65.  He then moved back to Wales, and spent the next 20 years living here, although he was in declining health towards the end of his life and needed a lot of hospital treatment.  He died in a care home in the land of his birth.

Using the GERW methodology (and this is not a criticism; I don’t have a better one to use, and it helps to understand Wales' situation), the cost of Dan’s education was paid for entirely out of the Welsh current account, as was the child benefit paid to his parents.  And when he returned to Wales, his state pension, together with all his health costs in his declining years, were also all paid for out of the Welsh account.  From a purely Welsh perspective, Dan was, overall, something of a net burden on the taxpayer.

However, during his working years, all Dan’s income tax and national insurance, as well as the stamp duty when he bought his various homes and the VAT and fuel duty he paid when he spent his earnings, all went into the English current account.  From a purely English perspective, Dan was very much a net contributor to the state’s revenues.

In a very real sense, in this example, Wales gave England a massive subsidy to pay to train Dan and make him work-ready, and then to look after him when he was no longer productive.  English GDP gained at the direct expense of Wales.  Yet, when a notional fiscal transfer was made from England to Wales to cover the Welsh fiscal gap, many people chose to call that transfer a subsidy to Wales as a result of the largesse of English taxpayers.  It’s a perverse way of talking about what looks to me more like a payment for services rendered.

Of course I’ve over-simplified, and even if the whole of the fiscal gap created in this particular way were to be eliminated, there is reason to believe that there would still be a large gap facing Wales.  But what the example illustrates is the cost to Wales of not having the jobs and salaries which would enable those who choose to do so to stay here and contribute to Wales.  Even if we had those jobs, some would still choose to go elsewhere, and some from elsewhere would still choose to come here.  But surely a reasonable aim of policy would be for the net movement to be at or close to zero?

All the parties in the Assembly elections are talking about creating more jobs, and more highly-paid jobs, in Wales, and it’s impossible to argue with that.  Empirical evidence over recent decades, however, would suggest that it’s a great deal easier to talk about it than to do it.  The question for nationalists is whether we believe that this can ever be achieved under current arrangements or whether independence is in fact, not an impossibility until this problem is resolved but rather a key part of resolving the problem.

Problems and opportunities

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Last week, one Labour MP told us that we should leave the EU because the shrinking working age population in the Eurozone is a “ticking time bomb” which means that taxation inside the Eurozone will need to rise to pay for an ‘army of retired people’.  She’s right on the demographic issue, that’s undeniable, but what is unclear to me is why anyone would not understand that the UK faces exactly the same issue, or why leaving the EU makes any difference.  It is a simple fact that a falling birth rate coupled with increased longevity will create a problem for any country, including the UK, where the state pension is paid for out of current revenue rather than out of past savings.

Such a pension fund has some similarity with a giant, state-sponsored, Ponzi scheme, where payments to the increasing numbers of pensioners depend on recruiting ever more people to contribute to the scheme.  The logic of that is that maintaining the level of the state pension requires that the population continues to grow (which is, incidentally, one of the ways in which immigration by people of working age brings a net fiscal benefit); that the level of taxes paid by those of working age continues to increase; or that the age at which people can claim their pensions continues to rise.  The real question should be about how we move away from a Ponzi scheme towards a properly funded pensions system, but that would be a major project requiring long term political consensus rather than the regular chopping and changing which characterises UK Government pension policy – under both parties.

The issue of population growth, or lack of, was also referred to in the recent Government Expenditure and Revenue Wales (GERW) report.  The report drew attention to the disparity between the population growth in Wales since 2008, at 2.2%, and that of the UK as a whole, which was 4.5%.  This has a number of impacts for those of us concerned about the fiscal gap in Wales.  A higher proportion of pensioners coupled with a lower proportion of people of working age means both that the demand for public expenditure (on pensions and health) is disproportionately high, whilst the revenue raised from people in employment is disproportionately low (without even considering the wage differential). 

The fiscal problem in Wales is exacerbated by a flow of retirees into Wales and a flow of young people out.  Some claim that we cannot be independent until we have resolved that issue; but I’m in the other camp which is inclined to believe that independence is actually a key part of the solution.

Given the impact of humanity on the planet, and the aspiration for ever-higher material living standards, an overall policy which depends on continual population growth is pure folly.  I’m not alone in believing that the falling birth rate in developed countries is a good thing rather than a bad thing; stabilising the world population is a sensible, not to say necessary, aim.  But much of what passes for economic policy seems to be ignoring the demographic, and implicitly assuming that falling population growth is a temporary problem.  In reality, it’s a long term opportunity, but it requires adaptation.

Never unknowingly undersold

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It seems that I may have been a little unfair to the leader of the Conservatives in Wales the other day, when I said that “His faith in the power of a penny off tax to turn round an economy is touching”.  From today’s news, it appears that I undersold him by a penny, and omitted the proposed 5p cut for the more well-off taxpayers.

Coming hot on the heels of a report drawing attention to the huge fiscal deficit which Wales has, promising to maintain spending on health and increase spending on schools along with a host of other costly pledges, and at the same time cutting the income available to pay for it looks more than a little reckless.  He talks about turning Wales into the ‘low-tax capital of the UK’, but where is the evidence that doing so will bring any economic benefit in the long term, let alone the short term?

I suppose that deliberately proposing to increase Wales’ fiscal gap will allow unionists such as himself to continue to argue that Wales can’t be independent because of the ever larger fiscal transfer from the rest of the UK, but it doesn’t look like the action of anyone who seriously wants Wales to take more responsibility for its own financial future.

Comparing apples and pears

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One of the difficulties faced by the authors of the Government Expenditure and Revenues Wales study (GERW) was that information on many items of expenditure and revenue was not available separately for Wales, so they had to make estimates.  And any estimate will always be based on one or more assumptions.  There’s nothing at all wrong with that; it’s the only way of producing even an outline idea of Wales’ position.  The problem arises in deciding which assumptions to make; different people would make different assumptions – and I suspect that the same people might make different assumptions as well, if the context were different. 

That question of context is one of the reasons why a study aimed at analysing Wales’ position in the past (2014/2015) within the UK will never produce the same answers as a study aimed at considering Wales’ position in the future as an independent nation.  GERW was clearly aimed at doing the former not the latter, and it seems to me that the assumptions made are reasonable in that context, and that the document therefore helps a great deal to aid understanding in that context. 

If we were to attempt to look to the future rather than the past, even within the context of the continuation of the union, we would need to make a range of additional assumptions about future policies and their impact on revenues and expenditures, and we would also need to change some of the existing assumptions on apportionment of revenue and expenditure.  I won’t cover all of those, but it’s worth considering a few just to give a flavour of the differences which would emerge.

Firstly, what would be the position in relation to the national debt?  What would Wales’ share be?  At the time of the Scottish referendum, the UK Treasury indicated at one stage that it would continue to be responsible for the whole of the debt, even if Scotland became independent.  That was more about reassuring the lenders than about establishing a start position for negotiation; and the SNP’s response (that Scotland would take a share) was similarly about establishing and maintaining international credibility.

But on what basis should we estimate Wales’ share of the debt?  GERW uses a per capita basis, but there are other approaches.  Part of the reason for the debt is current expenditure, so if Wales receives more in benefits should we take a larger share?  But part of it is also about funding infrastructure projects, where Wales receives less money than our fair share, so should our share of the debt be less than on a per capita basis?  And even after establishing a base line (difficult enough in itself) at the point of independence, if we want to project forward we need to make assumptions about future budget deficits or surpluses, borrowing patterns and rates of interest.  None of these factors is entirely straightforward or uncontroversial.

Or take defence spending.  GERW uses a per capita basis – entirely reasonable to estimate Wales’ share of current spending.  But the UK spends around 2% of GDP on defence – other countries spend less (Germany, for instance, spends around 1.1%).  What would an independent Wales spend on defence?  And GERW draws a clear distinction between spending for Wales and spending in Wales; much of the current spending on defence goes outside Wales, which means that we pick up the cost in the GERW figures, but don’t get the whole GVA benefit, or the multiplier effect.  In an independent Wales, whatever we spend on defence would be in Wales as well as for Wales.

Or take pensions.  How do we assign the costs of pensions?  Wales has a higher proportion of pensioners than the rest of the UK taken as a whole.  Part of the reason for that is that people choose to retire to Wales.  Who should pay their pensions?  In a unitary UK, the question doesn’t arise, but in the scenario of an independent Wales, it most certainly does.  When citizens of the UK retire to France or Spain for example, their pensions are paid by the state in which they contributed when they were working, i.e. the UK.  France and Spain do not pay those pensions.  So, in an independent Wales, would Wales be expected to bear the cost, or would the arrangements be the same as they are for any other member country of the EU?  The latter seems likely, but even then there is a further complication – does that apply to existing retirees or only to new ones?  The latter would seem to me to be easier to implement and manage, but the historical commitment might well be a factor which those negotiating a share of the national debt would wish to take into account.

My purpose in all the above is in no way to disparage the work of those who have produced GERW; indeed, we should be grateful to them.  It is, rather, to give a flavour (there are many more points which could be made) of why a study of Wales’ current position cannot simply be extrapolated without significant change to a conclusion about the position of an independent Wales at some future date.  And that's a project which will require a lot more work.