The Barnett formula – is it working for Scotland’s businesses?

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The Cabinet Secretary for Finance, Kate Forbes, recently tweeted that the Scottish Government “could do a lot more if consequential funding from the UK Government was based on business need rather than population share.”

This blog explores these issues and asks whether the Barnett formula is working for Scotland’s businesses during the coronavirus (COVID-19) pandemic.

The Barnett formula – allocates funds based on population share

As outlined in a recent SPICe blog on Barnett funding, the Barnett formula is used to allocate resources to Scotland, Wales and Northern Ireland when the UK Government spends money in areas that are devolved to the relevant administrations, such as health or local government. 

The funds received by devolved administrations are known as “Barnett consequentials” and allocate a population share of funding to each devolved nation.  So, for example, if the UK Government allocates an additional £1,000 million to health in England, then the Scottish Government will receive an amount equivalent to 9.7% of this (£97 million) as the Scottish population is equivalent to 9.7% of the English population.

The previous blog highlighted that the Scottish Government has so far received £3,520 million in Barnett consequentials.  But is this an appropriate amount, or does the Scottish Government need more in order to provide the same type of support as is being provided in other parts of the UK?

The Cabinet Secretary’s tweet and responses to parliamentary questions made specific mention of the needs of business and did not refer to the wider Barnett consequentials e.g. in relation to health.  This blog will also focus on the business support measures and associated Barnetts.

Do the Barnett consequentials reflect “business need”?

There has been much discussion and debate around the business support measures introduced by the Scottish Government and how these differ from those introduced in England.  This issue is discussed in detail in a separate  SPICe blog on non-domestic rates-related FAQs.  .

In responding to a question in the Scottish Parliament, the Cabinet Secretary argued that the different structure of the business population and the different thresholds for the small business bonus scheme in Scotland means that a Barnett share of English funding doesn’t necessarily provide for an equivalent level of cover in Scotland:

“…in Scotland considerably more than three quarters of non-domestic rate payers are in the small business bonus bracket, which means that there are more of them. Our rateable value cut-off for the small business bonus scheme is £18,000, rather than £15,000 in England or £12,000 in Wales. That means that more small businesses here are getting a £10,000 grant…That means that we are trying to push that funding as far as possible. I have a responsibility to ensure that businesses are getting the support that they need, but there is a gap between what Barnett consequentials can do in Scotland and what we know the need is in Scotland.”

In terms of assessing whether the Barnett formula allows Scotland to offer the same level or type of support as in England, it is not so much the numbers of businesses requiring support that matters, but whether they represent a higher proportion of businesses in Scotland than in England and whether the existing relief schemes are comparable.

Scotland does indeed have a higher proportion of smaller properties that would potentially be eligible for the £10,000 coronavirus small business grant.  Eligibility for the £10,000 grant is determined by whether a property is eligible for the Small Business Bonus Scheme (SBBS) in Scotland, or Small Business Rates Relief (SBRR) in England (even if they are not actually claiming this relief).  However, this higher proportion of eligible businesses is due to a combination of two factors:

  • differences in the distribution of business properties; and
  • differences in the pre-existing relief schemes to which the £10,000 grants are linked.

The valuation roll provides details of the rateable value of all properties in Scotland so can help in assessing the impact of these two factors. The remainder of this blog sets out analysis based on the valuation roll for Scotland as at end March 2020.  However, the valuation roll does not give any information on which properties are linked to a single business.  There is no way, for example, of identifying individual shops that form part of a chain.  As such, the following analysis can only offer a broad indication of eligibility for support and the relative position between Scotland and England.  A more exact assessment would require data linking multiple properties to individual businesses, which is not in the public domain.

There are differences between Scotland and England in the business property population…

According to analysis by the Institute for Fiscal Studies (IFS), 70% of properties in England have a rateable value (RV) of below £15,000 (the threshold for small business rates relief in England).  In Scotland, SPICe analysis of the valuation roll shows around 76% of properties with a rateable value of below £15,000.  So – on this measure – Scotland does have a higher share of smaller properties potentially eligible for support.  If Scotland only had 70% of properties with a RV below £15,000, this would mean around 15,000 fewer properties eligible for a £10,000 coronavirus business support grant (before taking account of multiple properties).  So, the implied “cost” to the Scottish Government of offering the same level of support to properties with a RV of less than £15,000 is £150 million, due to Scotland’s higher share of such properties.   

…but the underlying support schemes determining eligibility also differ

Another factor in the higher number of businesses in Scotland eligible for the £10,000 grant is that the pre-existing schemes which determine eligibility also differ.  In Scotland, the SBBS is available for properties with a rateable value of up to £18,000, while the equivalent scheme in England has a cut off of £15,000.  This means that, in Scotland, there are over 8,000 more properties potentially eligible due to the higher threshold for the underlying scheme that determines eligibility.  Again, this is before taking account of multiple properties.  This has cost implications as the Scottish Government will incur additional costs in providing £10,000 grants to these properties.

However – it’s not quite that simple, as the Scottish Government also saves some money because it is offering some properties a £10,000 grant that would get a £25,000 grant in England.  Properties with a RV of between £15,000 and £18,000 that are in the retail, hospitality and leisure (RHL) sectors would get a £25,000 grant in England, but only qualify for a £10,000 grant in Scotland – again, before accounting for issues around multiple properties. 

What is the net effect of this policy choice?

SPICe analysis of the valuation roll would suggest that the net effect for the Scottish Government is roughly zero:

  • There are around 3,000 properties in the retail, hospitality and leisure (RHL) sector in Scotland with a rateable value of more than £15,000 but less than £18,000.  The Scottish Government saves around £45 million by giving these properties a £10,000 grant rather than the £25,000 grant they would get in England.
  • There are around 4,000 non-RHL properties in Scotland with a rateable value of more than £15,000 but less than £18,000. It costs the Scottish Government around £40 million to give these properties (who would get no grant in England) a £10,000 grant. 

And once again, this does not take account of additional grants for those businesses with multiple properties.  However, the analysis suggests that the estimated additional costs of the Scottish Government’s policy are broadly in balance with the estimated savings made.  So effectively, the Scottish Government has used the same pot of money but chosen to allocate it differently, which is of course in line with the principles of fiscal devolution.

What does this mean for funding of the devolved nations?

Obviously, this matters a lot for the small businesses receiving grants – and there are both winners and losers.  But what about from the perspective of funding devolved nations? 

Fiscal devolution typically involves a devolved nation taking on a greater share of financial risks.  In such a context, the funding mechanism would not necessarily be expected to always fully recompense a devolved nation for additional costs – especially when some of those additional costs are due to policy choices made by the devolved nation.  In this example, the Scottish Government’s decision to set different thresholds for its small business rates relief scheme represent a distinct policy choice that will, by its nature, have associated costs.

However, some commentators, such as the IFS have argued that in such unprecedented circumstances, the approach to funding should be more flexible.  But an issue with this approach would be determining how far these arrangements go.  So, in relation to businesses, adjustments could be made so that funding reflects the different size composition of the Scottish business base.  But taking that approach further, it could also then be argued that adjustments should be made for differences in the sectoral composition of the Scottish economy – for example, to allow for its higher dependency on tourism, or indeed aquaculture.  The Cabinet Secretary also made the point that the UK Government provided around £450,000 of consequentials in relation to fishing, but that – due to the Scottish economy’s greater dependence on this industry – the Scottish Government had provided £23 million in support.  So, the question arises as to whether the UK Government should meet these additional costs, or whether that is a policy decision for the Scottish Government, who can use the Barnett consequentials in a way that best meets its own particular needs.

One size does not fit all?

Can any single formula or funding approach hope to account for the multitude of differences in the economies and structure of four devolved nations?  And where would it end if you tried to tailor the funding to specific needs? 

To give another example, in relation to the health funding for coronavirus, should consequentials account for the range of factors that might influence the demand for health services e.g. different age structures, population density, ethnicity, rural-urban split?  As yet we don’t even understand how many of these factors might be influencing health outcomes, so it would be incredibly complex to try and adjust for them through a “needs-based” funding formula.  And if you wanted to go down this route, it would probably need a new formula for every different policy area – and then would need to be adjusted for any exceptional circumstances.  So, it would undoubtedly be complex to try and find any straightforward alternative to the Barnett formula. 

That said, the Cabinet Secretary is not the only one to have raised concerns about the appropriateness of the funding mechanisms for devolved nations in the light of the current coronavirus crisis.

The IFS has argued that, in the context of coronavirus:

“The UK government should…consider bypassing the Barnett formula, especially if it is clear that the coronavirus is having very different impacts in different parts of the UK or the cost of particular policy responses will vary significantly.”

The Fraser of Allander Institute has made broader points about the ability of the Scottish Government to respond to external shocks such as the current health crisis.  But this goes deeper into the territory of whether borrowing powers and other elements of the fiscal framework are appropriate for dealing with such extreme events.  Which is probably a topic for another blog…

Nicola Hudson, Senior Analyst, Financial Scrutiny Unit