Facing up to the hard financial facts of devolution

The Labour Party has committed itself to transferring economic decision-making from the faceless bureaucrats of Whitehall to Wales, Scotland and the regions of England. Go and tell that to our Nelly, as my Lancashire forebears might have put it.

This sceptical reaction is a bit unfair, for Labour has established a regional policy commission to explore all the options. It is not due to report until late April. But there are at least two very good economic reasons for doubting whether the full-scale devolution of tax and spending powers can take place for the foreseeable future.

The first point is that, as in any country, the population of the richer regions subsidises people in the poorer regions. This is just as it should be. However, in other countries it is the wealthy who want to stop shelling out for their feckless poorer compatriots - the Milanese who want to stop supporting Naples, and the Catalans who would prefer not to subsidise the Galicians.

Unfortunately, it is the poorer regions that are keenest on devolution in the UK. They will end up making it clear to the apathetic majority how big the existing regional subsidies are and will need to remain after devolution. Although many Scots, on their tenth visit to see Braveheart at the cinema, firmly believe that Scottish oil revenues have underwritten the rest of the nation for more than two decades, the fiscal arithmetic is complicated and controversial.

The second point is that there is a conflict between genuine devolution of powers to tax and spend and control of the public finances. The Shadow Chancellor ,Gordon Brown, is keen to appear as responsible with his budget as the most hawkish City financier could wish, but it is hard to believe that elected regional governments would share this concern.

The first set of obstacles is very thoroughly laid out in a recent report from the Institute for Fiscal Studies*. Assigning public expenditure and tax revenues to the different UK regions is tricky, for both practical and conceptual reasons. The practical obstacle is the limited availability of data. It is one that would diminish after devolution, when new figures could be collected.

The conceptual difficulties are in a different league. Many categories of government spending, like defence and the interest on government debt, benefit the country as a whole rather than a particular region. Defend the South-east and you defend the Welsh with the same expenditure. Others are concentrated on one region but have spillover benefits into others, such as road-building programmes. Then there are difficulties like assigning the existing stock of government debt between regions, and deciding on Scotland's rights to oil tax revenues.

The Treasury splits out general government spending that can be assigned to particular regions each financial year - that is central plus local authority spending. None of defence or overseas spending is "identified" by region, but large parts of housing, environmental, education, health and social service expenditure can be. Altogether, a regional split for nearly three-quarters of government spending is available.

Comparing these figures, the IFS finds that within the English regions, per capita spending is below average in the East and West Midlands, East Anglia and the South-west. Comparing the separate countries, spending is 16 per cent higher in Wales and 22 per cent higher in Scotland than the English average.

The differences are accounted for by a mixture of the regional pattern of automatic spending such as social security, specific regional aid, local authority differences, and the special formula which raises expenditure in Wales and Scotland.

There are also big differences in the regional distribution of tax revenues. For example, the South-east accounts for a higher proportion of income tax and national insurance, VAT, business rates and petrol duty. It has higher earners and higher spenders than the average. But it has lighter drinkers and smokers, so makes a smaller contribution to tobacco and alcohol duty revenues.

Total tax receipts per capita from the South-east are 16 per cent higher than the national average. Scotland manages 98 per cent of the average, Wales only 83 per cent.

These differences do not matter at the moment, but they will become more explicit as devolution rises up the political agenda. According to the IFS calculations, to fund the existing pattern of spending, either regional tax rates would vary hugely or big explicit transfers through grants from central government would be required. As the tables show, a basic rate of regional income tax could vary between 19 and 45 per cent. Transfers could range from a pounds 256-a-head subsidy from South-easterners to a pounds 633- a-head grant to the Welsh. Neither will be easy to sell politically.

The other obstacle to devolving economic policy is the need to keep control of the government spending total. This directs attention to a key economic question about devolution: why? (In political terms, the answer is obvious.) Is it to gain more economic efficiency in taxation and spending, or is it to make economic policy decisions more democratic by giving higher priority to different regional preferences? There is already tension between these two functions, with the Government determined to cap local spending and the authorities keen to exercise their own choices.

The efficiency case rests on better information about needs being available to bureaucrats at the regional or local level, and applies in the case of education or public libraries, for instance. Devolution could actually increase this efficiency by introducing more electoral control over those local decision-makers. This would clearly be superior to decision-making by quango, whose members have no efficiency incentives.

The Labour Party rests its arguments on the choice case, however. As deputy leader John Prescott put it: "The aim of decentralising power and regenerating our regions forms an integral part of our strategy for achieving a stake-holding society in Britain."

One of the questions the regional policy commission will therefore have to answer is how much choice regional bodies will be allowed to increase taxes and expenditure. It is hard to believe that they will get a carte blanche when Labour frontbenchers are not allowed to say anything that might possibly hint at an extra spending commitment. And if so, the economic democracy argument looks a bit thin.

The IFS suggests that it might be possible to have the best of both worlds. A new regional tier of government could permit greater efficiency in the implementation of nationally set public spending policies, while local authorities would be allowed to raise a certain amount of extra taxation to finance extra spending. This is neat, but it is not devolution as we would recognise it. Facing up to the economic arguments will make the politics of devolution much harder.

* 'Financing Regional Government in Britain', Laura Blow, John Hall and Stephen Smith. IFS pounds 7.50.