Written evidence submitted by Nevin Economic Research Institute (NERI), relating to the funding and delivery of public services in Northern Ireland inquiry (FPC0002)

The impact of the lack of a functioning Executive on budgetary management and strategic decision-making across Northern Ireland Departments.

The absence of devolved government in Northern Ireland certainly has an impact on the efficient management of Northern Ireland’s public finances, but this impact should not be exaggerated. Spending decisions in Northern Ireland are in large part determined by the total resources available to the state. That decision is taken in Westminster and there is no structured dialogue between the UK government and the Northern Ireland Executive during that process. Northern Ireland budgetary outcomes are a residual of broader departmental allocations within the rest of the UK government. It is correct that the UK government has, on occasion, made supplementary budget provisions for Northern Ireland. However, in almost all cases these allocations were short term and even more short-lived. They were tied either to intergovernmental agreements or latterly to political agreements between parties. The fact that there has never been any formal involvement of the Northern Ireland Executive in decisions regarding the long run position of Northern Ireland’s public finances necessarily distorts the public spending decisions taken by these ministers.

The point is underlined by the most recent political agreement that restored the devolved administration, New Decade, New Approach. NDNA contained a commitment to ‘multi-year budgets’ in order to enable more long term and strategic decision making with regard to public expenditure. In theory, the Northern Ireland Executive would be able to look at the latest Spending Review from UK government and make spending plans over 4-5 years or the life of an assembly term. While an effort was made in this regard with the draft Northern Ireland Budget in 2020, it was quickly overcome by events surrounding the pandemic. Even if it had been possible to proceed with that budget, two main problems would likely have arisen. In the first instance, while the Northern Ireland Executive can make assumptions about the likely path of the block grant based on the Spending Review, it is just that, an assumption. A quick comparison of Spending Review allocations to Northern Ireland and the actual outturn spending shows the pitfalls of attempting multi-year budgets under these assumptions. Spending reviews are often superseded by budgets that follow them. In other instances, a change of political direction in the UK government can cause similar disruptions. This highlights the second fundamental problem with Northern Ireland’s budgetary settlement.

Northern Ireland receives funding for public expenditure in current and capital allocations from the UK government. However, the notion that the Executive receives a cash transfer is erroneous. What it receives is in effect a credit facility from the UK government. This means that the allocation for that year must be utilised within that year. This constraint often leads to perverse public spending decisions, particularly on the capital side of expenditure. If circumstances prevent the full utilisation of a spending allocation in one financial year, the Northern Ireland Department of Finance must attempt to see if that allocation can be spent by another department in the allotted timeframe. Such a process actively disincentivises long term or strategic spending decisions. Why should departments not be able to carry over surpluses or draw down on the next year’s allocation if they can show that such a course of action is sustainable over the medium term?

The absence of devolved government obviously impairs public spending decisions in Northern Ireland. However, the belief that a return to devolution would automatically mitigate this situation is not well founded. The UK needs a more efficient and reactive approach to devolved financing and without this any Northern Ireland Executive will likely face the same issues.

The financial situation facing Northern Ireland’s public services, including the police, health, education and children’s social care, and the consequences of budgetary pressures on the delivery of those public services.

Northern Ireland’s public services are not sustainable under the path of public spending outlined by the most recent UK budget. However, this does not mean that departments have been over spending or have not been making efficiencies over the years. Rather it is the case that the funding allocated to Northern Ireland is not responsive to the needs of local public services. While it can be argued that significant reforms could make Northern Ireland’s public finances more sustainable, this does not rest solely on a lack of will within devolved departments. Rather it reflects the public spending environment that departments have been subjected to over the last number of years.

Health spending has been a particular concern for many years. In the 11 years between 2011 and 2022, the department for Health went from accounting for 41% of Resource DEL to 51% in the last financial year. While Health expenditure has increased substantially in most western European economies, this rate of increase is concerning. A recent report from the Nuffield Foundation commissioned by the Northern Ireland Fiscal Council outlined that there are many areas where health spending in Northern Ireland is unavoidably higher than that in the rest of the UK due both to the absence of economies of scale and demographic factors which cannot be ameliorated. They also highlighted that there are areas where differences in expenditure cannot be explained by factors specific to Northern Ireland.

The structural deficiencies in the Northern Ireland Health Service are well established and have been the subject of a number of independent and expert reports. The most recent of these reports, the Bengoa Report, received widespread acceptance among stakeholders and politicians alike. The Bengoa Report in 2016 highlighted that without investment in the necessary reforms, the NHS would require 6% real terms increases in expenditure every year. Health spending has only exceeded that level twice in the past 10 years. However, the structural reforms highlighted within the report are not cost free, they require investment in order to be fully integrated into the health service. At a time when the health service is not receiving enough funding to stand still, it is almost impossible to envisage a scenario whereby a minister would be able to allocate the necessary funds for these much-needed reforms.

Public spending in Northern Ireland has faced significant constraint for a number of years and this has obviously led to a diminution in the scale and scope of public services provided to the public in that time. However, it is the compounding effect of this public expenditure constraint which is going to amplify the impact for public services in the years to come.

The effectiveness of the Barnett formula in calculating the amount of money the UK Government makes available to Northern Ireland for providing essential services.

As mentioned previously, the NI Executive’s block grant funding is presented as the Total Departmental Expenditure Limit (DEL) within the budgeting framework. It is split between resource DEL and capital DEL. Through the application of the Barnett formula, the Scottish Government, Welsh Government and NI Executive receive a population-based proportion of changes in planned UK government spending on comparable services in England, England and Wales, or GB.The Barnett formula therefore determines changes to each devolved administration’s funding with reference to changes in DEL funding for UK government departments; it does not determine the total allocation for each devolved administration afresh each time it is applied.

One important thing to note is that the formula has been considered a robust mechanism for public expenditure allocation for 20 years, despite it’s apparent intended temporary use. It largely replaced the need for direct negotiation about public expenditure allocation between UK Treasury Ministers, Secretaries of States and Ministers of devolved administrations, which were very time consuming. In terms of the ability to provide essential services, there comes an extent of surety of funds which should allow for surety of provision of essential services. However, as discussed in the first answer, which points to the range of issues which make this a bigger challenge than is appreciated. 

Attention also needs to be paid to the Barnett squeeze. This has been an issue discussed in many previous documents concerned with public finances in years gone by, but most recently has been raised by the Fiscal Council who point out that ‘Put simply, this ensures that when the UK Government increases spending in the rest of the UK on services for which the Executive is responsible in NI, the Block Grant rises by broadly the same amount in pounds per head. But spending per head was much higher in NI than England when the formula was introduced, so this produces a ‘Barnett squeeze’ with the percentage premium of the Block Grant over equivalent UK government spending shrinking over time.’. Obviously this has implications for the ability of any NI Government to provide essential services.

Others, including the Holtham Commission in Wales, called for a reassessment of the Barnett formula and advocated for a needs based assessment. Introducing a needs-based system or a system of fiscal equalisation to replace the Barnett formula would ensure that spending power for public services actually is equalised on a per capita basis among the regions. However, a needs-based approach to public expenditure could also be one part of a proper system of fiscal equalisation. The OECD define fiscal equalisation as:

‘a transfer of fiscal resources across jurisdictions with the aim of offsetting differences in revenue raising capacity or public service cost. Its principal objective is to allow sub-central governments to provide their citizens with similar sets of public services at a similar tax burden.’

A needs-based system must acknowledge that not all regions have the same capacities and not all regions have the same cost base.

Alternative options for increasing revenue in Northern Ireland which could be open to the NI Executive or UK Government in bringing NI’s finances onto a more sustainable footing.

In many ways the framing of this very question depicts the problem with the state of Northern Ireland’s public finances, where the conversation revolves continually around options for Northern Ireland to raise more revenue to make the public spending trajectory more sustainable – or likely – as in, not requiring cuts to public spending as the revenue is not there to support it.

A much more sensible conversation and framing of this question & one which needs to get to the heart of UK Government policy when thinking about how to balance the books better, is to give central priority to the underperformance of the NI Economy (and indeed the UK government in a comparative sense) and to focus on getting Northern Ireland onto a path of sustainable economic growth.

In terms of current fiscal powers, Northern Ireland holds limited responsibility for revenue raising, while the devolution of its public spending powers is extensive. The NI Executive is responsible for the majority of ‘identifiable’ public spending (i.e., spending identified for the specific benefit of Northern Ireland) amounting to almost £9 in every £10 spent, including spending on social security. This contrasts with the Scottish and Welsh Governments which have more local revenue raising powers, but less powers over expenditure.

It is important to point out that the Independent Fiscal Commission looked at the issue of fiscal devolution in a technocratic sense, further discussions beyond this about the devolution of revenue raising powers however would obviously bring into discussion a much broader range of issues. To this end, discussions in terms of further devolution of revenue raising powers need to be grounded in the context of the condition of public finances in the UK. Differences in the state of public finances within the UK and differences in the allocation of public finances within the UK are central to this picture. Given recent developments in and around the sustainability of UK public finances, this discussion is imperative. 

The UK has amongst the lowest levels of public spending and the lowest levels of government revenue of all high-income Western Europe (on a per person basis). This would suggest that the UK could significantly increase their public spending without increasing taxes to levels in excess of Western European norms. The NI Executive should seek to progress further discussions across the UK about public provision in the UK and the sustainability of public finances to deliver this in the medium- to long-term.

On differences in revenue raising across the UK, there has been very little discussion about the revenue raising capability in each part of the UK, and its relationship with the health of the local economy. This means that devolving taxes without taking these considerations into account risks increasing regional inequality, and also perpetuating the long-standing debate about Northern Ireland’s “fair share” of public resources and tax revenues. It is rarely acknowledged that its current financial position is a function of its place in the UK’s transfer union and the powers which have been devolved to it.

For the NI Executive to embark on the further devolution of tax powers for the purpose of trying to meet the shortfall of public expenditures would be risky. It ignores the fact that whilst the performance of the NI economy is different, it is part of the broader UK economy and the performance of the NI economy is impacted (and indeed, often impacted more deeply) by decisions regarding UK public expenditure. 

It also needs to be said that progressing towards further devolution of revenue raising powers in efforts to improve public finances in NI or to increase the sustainability of Northern Ireland’s public finances is not without its risks. To this end, whilst the NI Fiscal Commission recommended that if the NI Executive were to have the capacity to raise serious amounts of revenue, or effect significant redistribution through the tax system, then income tax was the most appropriate major tax – the NI Fiscal Commission also cautioned of the risks involved in doing so. If taxes are devolved to the NI Executive then the NI Executive’s budget will, in part, be determined by how much revenue those taxes raise in Northern Ireland. That could well lead to a more volatile budget. It could lead to the budget rising or falling, relative to what it might have been in the absence of further devolution. In the context of a lagging economy compared to the UK as a whole over a considerable timeframe, these risks should be given careful consideration.

A final point. It does not follow that the further devolution of fiscal powers will automatically right any of the weaknesses in the NI economy. Devolution cannot assist with economic development, but the fundamental importance of the economic, social and institutional geography of the place has to be of paramount importance. Devolution of any tax will not act as a panacea to the economy. In this sense, it is important not to be taken by the simplistic view that merely devolving greater fiscal powers will bring greater economic growth. Such ‘silver bullet’ thinking is misguided.

Priority must be given to achieving sustainable economic growth as the key mechanism. This is a sure fire way of putting NI’s public finances on a more sustainable footing.

It must also be said that whilst it is the case that the NI Executive has made policy decisions to forego substantial amounts of revenue than would be the case had it matched policy in other parts of the UK, it is important to not understate or overstate the impact of these policy divergences. The NI Fiscal Commission estimated that the range of policy divergences where the NI Executive charges its citizens and businesses less or provides more cash support than in other parts of the UK (so called ‘super-parity’) cost around £600 to £700 million in 2020/21, or some 4% of the Northern Ireland Budget. In terms of not overstating the impact of these policy divergences, the obvious point to make is that this is the total cost and ranges across numerous areas of policy divergence. Whilst water charges make up a large proportion of this – so does the not introducing of higher tuition fees for students in Northern Ireland as does the cost of welfare mitigations. The point here is that careful consideration needs to be given to appreciate the opportunity cost of revenue lost versus spending saved.

April 2023