Spending Review 2020 – potential implications for Wales

On 25 November, the UK Government’s Spending Review will conclude. Spending decisions are likely to have wide-ranging fiscal and political implicaitons for Wales. This blog post sets out what to look out for.

The initially planned multi-year exercise has been scrapped in favour of a one-year Spending Review, which will set departmental resource and capital budgets for 2021-22, as well as updating plans for spending on public services during the current financial year.

The review will set the size of the Welsh Government’s block grants for 2021-22, which will form the basis of its own draft budget, due on 21 December.

1. Day-to-day spending on public services

The key question of the Spending Review is how much overall day-to-day spending on public services will grow by next year and how the Covid-19 pandemic has changed the Chancellor’s existing plans.

At the March budget, indicative spending plans would have seen the Welsh resource budget grow by approximately 2.3% in real terms from 2020-21 to 2021-22, with around £560 million of additional Barnett consequentials (in cash terms). Given the lower outlook for inflation now projected by the Office for Budget Responsibility (OBR), these cash-terms plans would now be worth more in real terms.

The Chancellor has indicated these spending plans will no longer apply, but it remains to be seen by how much more or less the Chancellor will decide to increase spending on public services.

Multi-year spending plans in England already exist for the NHS (to 2023-24) and for schools spending (to 2022-23), however these plans are almost certain to be revised upwards, given the pressures created by the pandemic. But it is the overall spending across all areas devolved to Wales which will be important for the Welsh Government budget.

2. Covid-19 spending

Following top-ups in October and November, the Welsh Government has been given a £5 billion Covid-19 funding guarantee for this financial year. This would suggest the UK government plans to spend some £85 billion in England on services devolved to Wales.

We would expect more details on how that funding is being allocated in England, allowing some assessment of how the level of consequentials may change over coming months. Some spending commitments made by the UK government have been conditional, or ‘demand-led’, such as business grants through local authorities and support for Transport for London, meaning eventual costs are highly uncertain. Some further clarity may provide more certainty for the Welsh budget this year, notwithstanding the lack of budget flexibilities (see point 4).

Another key question will be how Covid-19 departmental spending – worth well over £100 billion across the UK this year – is treated in plans for 2021-22. The Chancellor may decide to allocate core funding to departments and allow them draw on a separate ‘Covid-19 Reserve’ if needed.

Such an approach could perpetuate the funding uncertainties faced by the Welsh Government. Given that some Covid-related spending is likely to carry forward into future years, such as PPE costs and ‘catch-up’ funding for schools and the NHS, it would make sense to include such spending in core, baseline departmental budgets.

3. Capital budget

The 2019 Conservative Party manifesto promised substantial increases in capital spending along with a net investment ceiling set at 3% of national income. March 2020 plans suggested UK public sector net investment would be increased significantly over coming years.

The Chancellor may take this opportunity to announce additional funding or bring funding forward from future years to 2021-22. Given the further fall in long-run interest rates over recent months, it would seem an opportune moment to boost capital spending to aid economic recovery.

For the Welsh Government, it’s likely its capital block grant will continue to grow, after an increase of 8% in real terms from 2019-20 to 2020-21.[1] With almost £200 million of unallocated capital spending in its 2^nd Supplementary Budget for 2020-21, the forthcoming draft budget and subsequent supplementary budgets will need to allocate this increased capital spending.

The UK government has indicated some multi-year budgets will be set where they are most needed, for example for its major investment projects. However, this is unlikely to provide certainty for the Welsh Government around funding beyond 2021-22 to plan its capital budgets effectively over coming years.

4. The Fiscal Framework revisited

Accompanying Spending Reviews, the Treasury usually releases a Statement of Funding Policy. These technical documents contain important decisions on how devolved governments are funded.

Firstly, ‘comparability factors’ for each UK government department are published. These capture the extent to which a department’s spending is on functions devolved to Wales, and therefore how much Barnett consequentials are triggered by changes in their funding. The Spending Round of 2019 used adjusted comparability factors from 2015, when the last multi-year Spending Review took place.

One thing to look out for will be the effect of treating HS2 as an ‘England and Wales’ programme. As HS2 spending has grown significantly since 2015, the 0% factor associated with the project will have a large effect on the overall comparability factor at the departmental level. In contrast to Scotland and Northern Ireland, Wales will lose out on consequentials from HS2 and non-HS2 spending from the Department for Transport.[2]

Secondly, the comparability factors also influence the calculation of ‘relative funding’ for Wales, a key element of the 2016 Fiscal Framework agreement. Under the terms of the agreement, at each Spending Review an assessment will be made of relative block grant funding per head. When relative funding per person reaches 115% of the English level, the ‘needs-based factor’ will change from 105% to 115%, meaning larger funding increments for the Welsh Government.

In December 2016, estimated funding per person was 120% of the English level. However, the large increases in spending over recent years will likely have resulted in some convergence in relative spending levels (the infamous ‘Barnett squeeze’ effect). The likelihood of reaching 115% this year will depend on how much Covid-19 spending is included in the Spending Review ‘baseline’ (see section 2) and included in the calculation.

Lastly, the Spending Review is also an opportunity to revisit the Welsh Government’s budget management tools set out in the 2016 Fiscal Framework agreement. The limits and restrictions on current and capital borrowing and the use of the Wales Reserve were set (in nominal terms) in 2016, and have not been updated to reflect the unprecedented levels of uncertainty faced by the Welsh budget this year and beyond.

5. Post-Brexit spending

With the end of the transition period with the European Union nearing, the Chancellor will need to set out details on how spending on Brexit preparations and replacement EU funding will change over coming years.

A key question for Wales will be how the £231m increase to the Welsh budget in 2020-21 in respect of direct payments funding for farm subsidies will change in future, and whether arrangements will reflect Wales’ much higher initial levels of spending per person.

The UK Government has also said it will announce details of the Shared Prosperity Fund, three years after it was first announced. Designed to replace EU Structural Funds, the Conservative 2019 manifesto promised to “at a minimum match the size of those funds in each nation”. Questions remain over how the fund will deliver on that promise (given funding per person was six times higher for Wales than for England) and whether the funding will still be administered by the Welsh Government.

6. The economic and fiscal outlook

Alongside the Spending Review, the OBR will publish its forecasts for the UK economy and public finances. This will include the latest estimated cost of the government’s Covid-19 policy response and the assessments of the post-pandemic recovery in economic output and government revenues. These forecasts will shape the context for fiscal policy decisions ahead of the full budget in March.

At a Welsh level, the OBR’s latest devolved tax forecasts will set out the hit of the pandemic to the Welsh Government’s own-sourced revenues. These forecasts will also crucially set the stage for tax policy debates ahead of next year’s parliamentary elections.

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Wales Fiscal Analysis will be publishing an analysis of the implications of the Spending Review and the outlook for the Welsh budget for 2021-22 at an online event on December 2: https://cardiff.zoom.us/webinar/register/WN_Cn2w6VDxQCmK_j8w6JSNwQ

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[1] Flexibility around funding meant the Welsh Government delayed a £100m cut to the capital block grant from 2019-20 to 2020-21.

[2] It should be noted that as the HS2 project will increase the overall size of the Department for Transport’s budget, it will trigger some consequentials for the Welsh Government.