This briefing note takes a step back from the big questions about whether there should be further tax devolution and whether there should be a move to a needs-based formula. Instead, it focuses on the more technical – but important – question of how devolved taxes should interact with the block grant and the Barnett formula. And, more specifically, it examines how the formula interacts with business rates, which are already fully devolved to Scotland and Northern Ireland and are set to be fully devolved to Wales from April 2015. This is important because it has implications for the debate about ‘fair funding’ and lessons for how to adjust funding mechanisms as further taxes are devolved.
The current treatment of business rates by the Barnett formula for Scotland and Northern Ireland is flawed, and could be reformed to better meet the stated policy aims. The calculations presented in this paper suggest that these flaws have resulted in Scotland receiving around £400 million more and Northern Ireland around £130 million more in funding this year than they would have if a ‘corrected’ version of the formula had been in place when the fiscal consolidation began in 2010. By next year, 2015–16, these figures will have grown to £600 million extra for Scotland and £200 million extra for Northern Ireland. In the context of block grants and business rates revenues that together total around £30 billion and £11 billion, respectively, this means funding will be over 2% higher than it would have been had a ‘corrected’ Barnett formula been introduced in 2010. Put another way, the cuts Scotland and Northern Ireland will have had to deliver between 2010–11 and 2015–16 will be more than one-fifth smaller than if the ‘corrected’ formula had been in place during this period.
The appendix is available to download here.