Options for reforming the devolved fiscal frameworks post-pandemic – Institute For Fiscal Studies

The COVID-19 pandemic has been a significant challenge for all tiers of government across the world. In the UK, the devolved governments of Northern Ireland, Scotland and Wales are responsible for most of the public services significantly impacted by the pandemic, and have designed and implemented large parts of the public health response to it. They have also been responsible for designing and administering grants and property tax reliefs for businesses.

They have had to discharge these responsibilities and manage their budgets in the context of fiscal frameworks agreed before the pandemic – although the UK government made modest, but important, temporary changes to funding arrangements in 2020–21. These changes, in combination with the enormous increases in funding made available by the UK government, and the fairly symmetric impact of the pandemic across the four nations of the UK, meant the risk of a major funding crisis for the devolved governments was averted. But this ‘success’ does not mean there is not room for improvement to the existing fiscal frameworks in order to make them more robust to future shocks, or that the same ad hoc changes would necessarily be appropriate if another extreme adverse shock occurred.

This report considers a range of options to reform the existing fiscal frameworks, with two main objectives in mind: first, to make them more robust to future crises, including a potential reintensification of the COVID-19 pandemic during Winter 2021–22; and second, to help the devolved governments support economic and social recovery from the pandemic.

Options for reforming the frameworks

We distinguish between reforms that we recommend as permanent changes to the frameworks, to address what might be considered underlying design weaknesses, and those that could be made as temporary changes during crises.

Appraising these options

Our appraisal of these options draws on a review of the performance of the existing frameworks and ad hoc changes during the pandemic, principles set out for the design of the frameworks, consultation with the UK and devolved governments, and some simple quantitative scenario analysis. From the perspective of the devolved governments, we assess the extent to which reforms would provide greater clarity over funding, more flexibility to respond to fiscal shocks, and greater insurance against the risk those shocks are asymmetric. From the perspective of the UK government, we also consider the reforms’ potential impact on its control of overall public sector borrowing and debt, and their fairness to all parts of the country, including England. Our appraisal of options is also informed by a review of subnational frameworks in other countries, focusing particularly on their performance (as well as the wider experience of intergovernmental coordination) during the pandemic, drawing on several case studies.

Recommendations

Our review leads us to reject some changes to the fiscal frameworks, recommend others, and argue that whether some changes should take place depends in part on subjective views about the nature of the UK’s political union. This is particularly true for changes to the degree of redistribution and insurance to be provided to the devolved governments, and the nature of intergovernmental coordination.

Key recommendations

        Our assessment of potential permanent changes

1. The funding guarantees provided to the devolved governments in 2020–21, which provided the devolved governments with extra up-front funding and funding certainty, should not be provided on a permanent basis. In ‘normal’ times, it is less likely that there will be substantial in-year increases in planned spending in England, as was the case last year. The benefit of providing greater up-front funding certainty to the devolved governments is therefore outweighed by the risk that the use of funding guarantees would result in the devolved governments seeing a significantly larger increase in funding than England, which would be unfair. However, the risk that the devolved governments have to make late in-year cuts to spending if funding for England is cut later in the year should be addressed by guaranteeing that they will be able to defer any such cuts, perhaps by extending the scope of their borrowing powers to cover this eventuality.
2. More generally, there is a case for a modest extension to the scope and scale of the devolved governments’ borrowing powers in ‘normal’ times. The ability to borrow to fund discretionary resource spending would provide additional flexibility to respond to unforeseen events and therefore reduce the need to hold back funding instead. Even fairly substantial borrowing by the devolved governments would have little impact on the UK’s 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 these equity concerns.
3. The Scottish Government’s annual borrowing limit for addressing forecast errors should be increased to £600 million on a permanent basis. This limit, and the Welsh Government’s equivalent limit, should then be indexed to changes in overall block grant adjustments, rather than being fixed in cash terms.
4. To provide further flexibility, drawdown limits on the Scotland and Wales Reserves should be enhanced and potentially abolished. 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.

   Our assessment of potential temporary changes during shocks

5. The additional flexibilities we recommend as part of the normal operation of the devolved fiscal frameworks would not be sufficient during an extreme and rapidly moving adverse shock like the COVID-19 pandemic. In such circumstances, some combination of a reintroduction of funding guarantees and extensions to the devolved governments’ borrowing powers is likely to be warranted. This would ensure that policymaking is not held up by having to wait until funding becomes available via the Barnett formula, after policies have been announced for England. The UK government should also be prepared to bypass the Barnett formula if a shock is having clear and significant asymmetric impacts across the UK, but it is likely to be very difficult to rapidly develop a bespoke needs-based formula for such purposes.
6. Beyond this, we do not consider it practical to set out in advance the criteria for determining when an extreme adverse shock is occurring, or the changes that should apply to normal funding arrangements if one is identified as happening. This is because such shocks are, by definition, difficult to foresee and the most appropriate response will differ depending on the nature of the shock. Instead, decisions will inevitably have to be made in an adaptive and ad hoc way. But we should be clear in advance that policy will be nimble if such shocks do occur.
7. Improved collaboration between the UK and devolved governments could help identify how a shock is impacting (or is likely to impact) across the nations of the UK, and inform the design of an appropriate fiscal response. A genuinely collaborative approach, aimed at forging consensus, would also provide greater legitimacy to any decisions taken, which could be important if a shock is affecting part of England particularly badly and it makes sense to top up only England’s funding.
8. To aid such improvements, formal channels for communication and coordination should be strengthened, and we agree with recommendations for a permanent intergovernmental secretariat to serve a reformed Joint Ministerial Committee. However, a change in culture at both UK and devolved government levels is also needed to maximise the benefits of collaboration and coordination.
9. A particular focus for intergovernmental coordination should be where policy responsibilities significantly overlap, interact or are likely to have spillover effects on other parts of the UK. In the context of the COVID-19 pandemic or a future pandemic, this includes (central) responsibility for the biggest economic support measures such as the furlough scheme, and (devolved) responsibilities for public health restrictions. Given that devolved governments cannot really exercise full control over the latter in the absence of appropriate economic support measures, a feasibility study into making furlough-type support available on a geographical basis should be urgently undertaken and published. If it is feasible, such support could be made available both if disease cases or hospitalisations exceed particular thresholds (paid for by the UK government) or at the request of a devolved government (paid for by that government).