Why Wales is richer than opponents of independence claim

Dr. John Ball, Lecturer in economics at Swansea University

Some eighteen months ago Cardiff University’s School of Governance published a report that –amongst other things – suggested that Wales was exceptionally poor and that the current budget difference was some 24% of GDP.

Since then, this somewhat arbitrary figure has been gleefully seized upon by those who delight in maintaining the fiction that Wales is poor, will remain poor and consequently too poor ever to consider becoming a sovereign state.

It’s time to put aside this misleading and ill-informed “Wales is Poor” headline and consider the facts.

However, before going any further, it may seem strange that when asked the question “can Wales afford independence?” the answer is always no!

Why? Quite simply, no country in the world pays its way. A balanced budget is fiction. All countries, to a greater or lesser extent, borrow.

The budget deficit (the annual difference between government taxes and spending) is itself dynamic and any report – such as that produced by Cardiff University – is at best a snapshot.

This can be illustrated with a look at the UK economy. At the end of 2010, the UK budget deficit was over £160bn representing 8% of GDP.

At the beginning of the current financial year the deficit was £46bn with a target of £37bn by year end and whatever the level, the gap is filled by borrowing.

Incidentally, the National Debt (that is the total of all borrowing) for the UK currently stands at £1.8trillion, or 100% of GDP. And Wales is poor?

Data

A closer look at the Cardiff report is interesting. In summary, the report suggests that there is a gap between taxation and spending of £13bn, representing 21% of GDP.

Part of the report suggests 24% but this latter figure includes capital. But although perhaps technically correct, I am concerned here with current spending, which was the point of the report.

When comparing two factors, the first thing is to be clear as to definitions. Since the report chooses a comparison with GDP, it is important to note that this definition of a country’s economic wealth is in itself deficient.

GDP is made up of final goods and services, it follows then that much of Wales’ economic activity is not counted.

Steel. tinplate, car engines are not by definition final goods and only appear in a GDP calculation when they become final goods – for example as a new car for sale. So this much-vaunted gap is not what it seems.

It has to be said that, in fairness, the university report is a brave attempt to present a picture of the government spending and taxation; it is not an analysis of economic activity or a calculation of Wales GDP.

The reality is that any examination of the Welsh economy suffers from a paucity of accurate and reliable data.

Almost all economic data which would be of use is actually collected on a UK wide basis; it, therefore, follows that some form of best estimate is the only way forward. Indeed, the report clearly states that:

Some taxes (are) relatively straightforward but for others it is quite complex as revenues are not necessarily reported where they are generated and there may be different interpretations on what the underlying activity or how to capture it might be.

For example, disaggregated HMRC administrative data is readily available for Capital Gains Tax but arriving at VAT estimates is more complicated as different sources are used for the four sectors that make up VAT receipts.

These figures do not represent the distribution of revenue by the location of the tax collecting office.

Aside from the difficulties of capturing data and the need to use estimates, a careful look at the figures further challenges the poverty argument.

Three allocations to expenditure make interesting reading:

• A defence cost allocation of £2bn is excessive and some 3% of GDP (more than any other country!)
• Incoming pensioners is a further cost of £2bn (is this actually a “cost” to Wales?)
• There is a £3bn “accounting adjustment” – such a balancing figure is quite normal in such research, but this amount is excessive

This amounts to some £7bn, which now makes the difference between revenue and expenditure of approximately £6bn, or 10% of GDP, notwithstanding the definitional issues noted above.

This deficit is of course still high. Addressing the deficit presents a challenge.

Damning

Staying with the report that started the current discussion, it is informative to look at differences in taxation.

Income tax accounts for 25% of revenue in the UK, only 19% in Wales while Corporation Tax accounts for 6% of revenue in the UK but just 4% in Wales – a reflection of the amount of external ownership of businesses active in Wales.

The percentage of revenue from National Insurance payments was approximately the same for Wales and the UK.

In addressing the deficit the first challenge is to improve the amount of revenue earned from existing taxes. The poor position of income tax relative to the UK is a reflection of low levels of skill and consequent low levels of personal income.

National Insurance payments in Wales grew by 12% in the period from 2010, this is interesting since it reflects the concurrent growth in part-time working and low pay.

The National Insurance threshold is low and many will not earn enough to reach the income tax threshold.

Indeed, recent research has suggested that anything from 40% to 53% of those in work do not earn enough to pay income tax.

This, combined with a less than satisfactory contribution from income and corporation tax is a damning indictment of past and present economic policy.

Tax

The percentage of VAT in Wales is a little more than the UK, which seems a little odd, but this figure should really be treated with caution for two reasons.

• The University report, although a reasonable estimate, it followed the approach of other research and was not actually based on businesses but on other proxies, such as population.
• That with the current amount of external business ownership, it is difficult to estimate the amount of VAT actually collected in Wales but which for tax purposes is allocated to the business headquarters outside Wales. This is particularly important because VAT is a substantial source of tax revenue.

There are other possible sources of taxation that could be open to a Welsh government, for example:

• Water (in its last annual accounts, Severn Trent reported a revenue of £1.5bn)
• Tourism is apparently worth £2bn to the economy and yet Wales must be the only country in the world with an active tourist industry but no tourist tax
• A land value tax is an idea currently being debated by economists. This is perhaps the most interesting and exciting; some estimates suggest that such a tax might raise some £6bn – this amount is perhaps over-optimistic and some would accrue to local government, but provides an indication of how much such a tax might yield.

Penury

In addition to raising funds through taxation, governments also raise revenue through borrowing.

Finance is raised by selling Government Bonds that carry an annual interest, a redemption rate and can be denominated in a currency other than the domestic currency.

Although the life of such bonds varies, interestingly some countries (including Ireland) have successfully issued bonds with a one hundred year maturity.

There is, of course, concern that this debt will be borne by future generations, although it can rightly be argued with such funds properly used in a new, exciting and innovative nation-state, they will ultimately be the beneficiaries.

There would be a market for such Welsh Government Bonds. Government bonds of all types and all countries are sought after investments because of their relative security; even countries with doubtful economies successfully issue bonds.

Recent bond issues have been taken up by investors in Argentina, despite that country defaulting more than once on repayments and recent bond issues have been in demand by European countries that were hit by the 2008 recession, notably Greece.

In conclusion, a word of caution. Without accurate data any analysis of the Welsh economy must be treated with, at best, a degree of uncertainty.

Although the picture painted by the Cardiff University report of a country in penury is overstated.

Nevertheless, in all honesty and when compared to other countries, especially the small nations of Europe, Wales is relatively poor and this needs to be addressed.

But of course, Wales being a relatively poor country now in such a wealthy part of the world is one of the core arguments for independence.

Therein lies the challenge. It doesn’t have to be like this!

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