The system of territorial funding in the UK is descending into chaos

The system of territorial funding in the UK is descending into chaos. If the coalition’s present plans for devolving financial powers are taken forward after the election, the number of people who will be able to understand how revenues are raised and funding allocated among the component parts of the UK will drop below the already tiny number who fully understand the Barnett Formula.

In Scotland, the Smith Commission proposals will cede almost complete control of income tax to Holyrood along with half of VAT revenue and Air Passenger Duty. It will also result in some welfare funding coming to Scotland.

In Wales, Stamp Duty Land Tax and Landfill tax will be devolved to the Assembly and there may be a referendum to see if the Welsh people wish for some control over income tax. David Cameron has also promised to set a “Barnett floor” for Wales in the post-election spending review.

This will effectively set a level below which funding per head in Wales cannot fall, preventing the Barnett formula from equalising per capita spending throughout the UK, an outcome which follows from its mathematics.

"Perhaps a less rushed timetable might have led to a more coherent outcome"

To complete the picture the bill to give the Northern Ireland Assembly power to set a “Northern Ireland rate of corporation tax” is currently making its way through the UK Parliament while local authorities in and around Manchester have been given control of £6bn NHS funding.

Not only will these changes lead to much greater asymmetry of fiscal powers across the Celtic nations, they also confuse the Barnett Formula, which the Smith Commission committed to maintain, and the principle of needs-based funding – allocating revenue support on the basis of some assessment of need.

The Barnett Formula may have reflected need back in 1979 when it was invented. Since then it has distributed rough justice, particularly at the expense of Wales.

It has been relatively easy to calculate and, as the single most important source of revenue to the Celtic nations, allowed the Treasury to keep a tight grip on overall levels of public spending.

But by giving Scotland control over some welfare spending, which is largely driven by the needs of the disabled and the elderly, and by conceding that the Barnett formula doesn’t reflect need in Wales so that a floor on per capita spending is necessary, the system of block grants is now a hybrid system with even less rationale than the Barnett formula.

Yet the Barnett Formula will still play a critical role in determining the overall spending power of the governments in Edinburgh, Cardiff and Belfast.

The issue that has failed to attract the attention it deserves is how the formula will be adjusted in the light of all the changes in tax and spending powers.

Even in the case of Scotland after the implementation of the Smith proposals, the majority of the funding available to the Scottish Government will still be determined by the Barnett Formula. The Scottish Government will only be able to increase its spending if it raises more in taxes than it loses due to the way the Barnett Formula adjustment has currently been set.

The reduction in Scotland’s grant will increase at the rate that the equivalent tax base in the rest of the UK grows. Scotland will therefore have to grow its tax revenues faster than those in the rest of the UK, or raise its tax rates, if it wants to increase spending.

But the adjustment to the grant is inevitably going to be more complex if new taxes in Wales and Northern Ireland and new spending powers in Scotland are involved in the Treasury’s block grant calculations. Perhaps a less rushed timetable might have led to a more coherent outcome

David Bell is a fellow of the Centre on Constitutional Change and Professor of Economics at the University of Stirling.