Cynulliad Cenedlaethol Cymru

I guess I should say: it's a pleasure to be with you, and thank you very much for the opportunity to appear before the committee. I know my predecessor was a frequent witness before the committee, and I look forward to continuing in that tradition. So, thank you very much for this opportunity.

I think maybe what I should say about timetabling issues is that 2020 has been a challenge for everyone when it comes to either doing economic and fiscal forecasting or making fiscal decisions, and so, I think, in some sense, we've had to, out of necessity, move away from this idea that we and the Treasury bring together, at two discrete points in the calendar, on the one hand an economic and fiscal forecast, and then, on the other hand, a set of Government policies that get wrapped up and presented to Parliament and to the public, and also communicated to devolved nations in a way that may have worked under ordinary circumstances, but wasn't going to work in the context of a fast-moving pandemic, and the fact that both the economic backdrop was changing rapidly, as was the Government's policy package.

I think both we and the Treasury do want to resume normal service once conditions normalise, but, from our perspective, we recognise that the Government had to take decisions more or less on the fly to deal with the fact that both the conditions in the pandemic were changing and there was a need to update and refine the Government's economic policy response. So, I think, in that sense, we didn't get the usual notice that we get in order to provide a forecast date, although we note and, I think, are encouraged by the fact the Government has actually now given us the standard 10-week notice for the run-up to the budget. So, that's an encouraging sign from our point of view, that at least the timetable for financial decision making in Government is starting to normalise, although we also note the fact that the Government has, since the budget, made a number of important fiscal policy announcements, again, out of necessity, but outside the usual forecasting practice. That disrupts our lives as forecasters; I know it also creates challenges for the Welsh Government, because they suddenly get big windfalls of Barnett consequentials that they have to suddenly decide how to spend at short notice. I noted in their own draft budget they've allocated some of that money now, but they're waiting until the final budget to decide how they want to spend the rest of it. It's not an ideal way to make fiscal policy, but I think it's understandable in the circumstances. I think the big test is, as we hope conditions normalise, do we manage to resume normal service in terms of timetabling and notice periods, both for ourselves, but I think also for devolved government.

Yes, because we haven't really had a normal timetable for a number of years now, have we, really, given all sorts of events in the last two or three years. So, timetabling, of course, is one aspect, but in relation to the UK spending review then, were there any particular policy announcements that you had to consider when you were producing your forecasts?

I think what we did was we wrapped up all the policy announcements that the Government had made up until that date, the vast bulk of which had been made over the summer, but some further announcements were made in the run-up to the spending review itself. One challenge that we faced was that we don't get the outcome of the spending review itself until very close to the date of the forecast, so in scrutinising the departmental expenditure limits aspect of Government spending policy, we don't get a lot of opportunity to scrutinise and kick the tyres on the Government spending plans, and we have to more or less take on faith what the Treasury says about the deliverability of those spending plans, both for the departments that are seeing big increases in their budgets and whether that money is going to get spent, but also the consequences for non-priority departments, or non-protected departments, and then whether what they're being allocated is credible. That's always an issue when we're looking at the spending side of the budget. I think it was a particular challenge this time around, because there were such big increases in spending on the one hand for health, and it was hard then to assess within the overall spending what consequences that would carry for smaller departments that weren't seeing those kinds of dramatic increases in their budgets, and potentially facing some quite challenging spending consequences.

One thing that we tried to draw attention to in this spending review was that the Government did save about £10 billion a year—it took £10 billion a year out of public spending in the context of the 2020 spending review. It did it rather quietly, it didn't really show how that money was being saved beyond the 2021 financial year, because, of course, this was a one-year spending round, it didn't show a medium-term perspective. We don't know what's going to happen to most departments' budgets after 2021, but the Government did take £10 billion out. Where that's going to be found, department by department, after the next financial year is a matter that the Treasury is going to have to come back to when it does its next spending review.

Okay. Nick, I think you indicated you wanted to come in. There we are, you're unmuted.

I'm here. Diolch, Cadeirydd. I think Richard Hughes just touched on the interesting issue that's been rumbling on over the last few days about this accusation of the Welsh Government sitting on money, and I know then there was a retort back from the First Minister about how the UK could be argued to be sitting on money as well. So, from what you've just said, Richard, it sounds as though Welsh Government can have an issue if they have too little money provided to them through consequentials or whatever, but also, we're in an interesting situation here where, if you get a lot of money dumped on you in one go, then that can also cause issues. It's not something we've faced as a problem before, but I think you said that that's just the way it is. Is there any way that, if we enter this sort of problematic situation again in future, that money could be provided in a way so that you don't have this huge glut in one go or it's obvious that that money will be spent over time? 

I think it's certainly an issue that surprises are a bad thing in both directions. They're obviously worse when people are taking money away from you, but they also pose challenges if you're trying to manage a Government's finances when you're suddenly given big windfalls that you have to spend. I think it's particularly challenging in the context of the positive surprises, I have to say. They're obviously to deal with very critical issues to do with the pandemic, but spending windfalls that are also constrained to one year—trying to find ways of spending money that you can turn off in April of 2022 is not at all easy. There is some flexibility, obviously, within the devolved financial framework that allows carryover of expenditure from one year to the next, but for the moment, those are characterised in nominal terms at a small fraction of the additional spending power being devolved to Wales. 

As I said, one hopes that, once you get beyond the period where the Government in England is having to spend these large sums to tackle the pandemic, that these positive surprises, or indeed negative surprises, will be less of an issue. But it is a combination of the fact both that the Government is making very dramatic fiscal decisions in-year, but also the fact that you don't have a medium-term horizon, so you can't plan this spending over three years, you have to spend it within the financial year it's given to you, subject to the fairly limited financial flexibility you have for carryovers. We would like to see a return to medium-term budget planning, because that also gives us more confidence about the forecast and, in particular, about the spending aspects of that forecast. So, I think another test for when we return to normal times is: can we get the timetables back to being more predictable, but also can we get a return to medium-term budget planning so we can have a bit more confidence in what we say about the medium-term part of public spending, both for the UK as a whole but also what it means for expenditure planning at each level of government?

Well, I'm sure we'd all agree with that. Rhianon. 

Yes, thanks. So, just a practical question, if the Chair will indulge me. With regard to having large sums of money dumped upon us, or the opposite of that—and I can think of a few examples looming—how is it therefore possible to model, very, very briefly, from that information only? 

We model it in terms of—we listen to what the Government says they're going to spend the money on. To the extent that it is, so, welfare-like spending and it depends on what's going on in the economy, that depends on our forecast for employment, our forecast for incomes. So, things like the coronavirus job retention scheme, the furlough scheme, that depends on take-up, it depends on the conditions of employment, but it does have an expiration date. So, if it's got an expiration date of 31 March, as it did when we were doing our forecast, we cut the spending off then. We don't try to second-guess the Government about whether or not that spending carries on beyond its deadline. And we apply the same principle to Government spending plans on the health service. The COVID-related spending is ring-fenced within departments' budgets. In principle, it is meant to run out at the end of the next financial year, and so we forecast a cliff edge of all that spending suddenly coming to an end. We flag as a risk that there may be some overhang of costs that the health service has to carry, either related to long COVID patients being treated within the health service, or the fact that you've got delayed activity that then needs to catch up once the COVID patients are taken out of hospitals. For the moment, we take on faith what the Government says about the time-limited nature of COVID spending, but I think it is certainly a risk for the fiscal outlook that there are longer term pressures left in the health services or other aspect of public services to cope with the legacy.  

You do have an aspect of that on faith. That's all I wanted to find out. Right, okay. Thank you. 

Okay. Thank you, Rhianon. We'll move on to Mike Hedges, then. 

I used to say to your predecessor when he used to come along here and he used to produce these straight-line graphs, I used to say, 'What happens if we have a recession or a flu epidemic?' We now know the answer to both of those. [Laughter.] Straight lines do not remain straight lines. And I think that is important. And the point I'm trying to make, or trying to get across and get your view on is: we have all these predictions, but if I can use the word, they're all steady-state predictions. But we're in what I would describe as an unsteady state at the moment. So, turning to your predictions on our tax take, and, as you know, we're unfortunate that we don't have any countercyclical taxes, so we only have the downside of recession; none of the advantages of some of the increases that occurred during recession in terms of taxation. So, after a very long-winded introduction, the question I've got is: how accurate do you think these predictions of our tax take are, and are you concerned that these could be thrown out at almost any time by further increases in the pandemic? And did you predict, for example, that we were going to have the second strain, which was itself causing more problems, and possibly a third strain coming in the future? Cutting to the chase, how accurate do you think your predictions are, and when will you be revising them? I know they'll be wrong, you know they'll be wrong, but it's about how wrong they are and when we'll get a revision.

I'm pleased to say that there aren't many straight lines in the first forecast that I presented to you, so to the extent that you've had a critique of my predecessor's practices, they've been quite seriously addressed in our latest forecast.

Let me perhaps just say a few things. Let me first pick up on your point about uncertainty about the future and the sort of deterministic way in which macroeconomic and fiscal forecasts have been traditionally produced, both by ourselves, but I think also by most macroeconomic and fiscal forecasters, which is that you are right that they tend to always assume that you go from a position of disequilibrium back to trend, and if you're on trend that you stay on trend, and that,  basically, both the economy and the public finances trend towards their equilibrium point and that includes if they stay there. And that is one of the reasons why you've seen a lot of straight lines out of the OBR in the recent past, because basically the economy was more or less close to its trend rate of growth. And we're not Cassandras or doom mongers; we aren't sort of constantly predicting recessions around the corner, but it is evidently the case that, on average, recessions happen in this country and other advanced economies once every 10 years, and major crises, financial crises or others, happen roughly once every two decades, and pandemics seem to happen once a century, as it turns out, or perhaps twice.

Let me say a few things about how we've tried to address that in the forecast that we did in November, and then a bit about where we stand now relative to those forecasts, because obviously the world is moving quickly and has already moved on since 25 November. At the time of our November forecast, I think there was unprecedented uncertainty about the outlook, and that continues to be the case. And it was for that reason that in our November economic and fiscal outlook we didn't just present a single central scenario, but actually three different scenarios for the economy and public finances, and they were conditioned on three key assumptions: one was an assumption about the course of the virus; the second were assumptions about the effectiveness of public health restrictions required to try and contain its spread; and the third were assumptions about the roll-out and effectiveness of the vaccine. And depending on different assumptions about those three conditioning elements of the forecast, we've produced an upside scenario, a central scenario and a downside scenario. We also presented—because at the time there was uncertainty about the outcome of the Brexit negotiations—an alternative scenario, in case we ended up leaving the EU without a deal.

I think it is fair to say that, looking at the coronavirus aspects of that forecast, the November lockdown was clearly not successful in bringing cases down to manageable levels. The Government's test, trace and isolate system, which it had put great stock in at the time in terms of helping to control and tamp down flare-ups of the virus after the lockdown ended, has clearly been overwhelmed and we've now got a much more virulent strain of the virus, which emerged just after we produced our forecast in the run-up to Christmas. I think, relative to what was assumed under our central scenario, all these factors have contributed to the fact that the Government is probably going to need to maintain a much tighter level of overall public health restrictions than we'd forecast in our central scenario, which underpins the fiscal forecast that you've seen in the Welsh taxes outlook. So, at least in the near term, we're going to have to reassess what it means to have a much tighter set of public health restrictions in the near term for the path of the economy and for the path of the public finances UK wide, but it looks at least in the near term that the path of the economy is going to be closer to our downside scenario than it was to our central or to our upside scenario.

At the same time, looking to the medium term, the roll-out of the vaccine seems to be proceeding apace, and so there is reason to be hopeful about a return of economic activity over the medium term towards something closer to our central scenario, which assumed that the vaccine was rolled out to the bulk of the population during the second half of this year. At the same time, while the vaccine roll-out is happening more or less in line with what we expected in our central scenario, we've got a more a more virulent strain of the virus to contend with, so what that means is that it stands to reason that the number of people that you have to inoculate before you can start lifting general public health restrictions has probably increased, so that point where you reach a crossover in terms of the number of people that you inoculate allowing you to actually reduce public health restrictions and for economic activity to start to normalise has probably been moved somewhere further out, further into the distance in terms of time. So, the balance between the vaccine roll-out going well, but the number of people you have to vaccinate in order to bring transmission down with this new more virulent strain of the virus, is something that we're going to have to reassess, along with the Government's public health officials, as we produce our next forecast, which is going to happen on 3 March and underpin the Government's budget.

I think the implications of all that for your own thinking is I'd really encourage you to think about the range of scenarios that we produced within the economic and fiscal outlook, accept the fact that the near term is going to be tougher because we are facing a much bigger challenge with the new strain of the virus, and probably tougher public health restrictions, and then keep an eye on the vaccine roll-out and what the timetable is in terms of that allowing us to get back, over the medium term, to something that looks more like our central scenario, which was the one that underpinned the Welsh tax system.

Thank you, Mike. Siân Gwenllian.

Yes. So, since the referendum, our forecast has baked in, as it were, the economic consequences of an average free trade agreement. So, we looked worldwide over time at what is the impact on trade activity of moving from the close economic relations that we had with the EU as a member state, and then how much economic output do you lose by going to what would have been the average kind of free trade agreement that advanced countries conclude with each other. So, that has been factored into our forecasts since the referendum, and we had to base it on an average free trade agreement because we didn't know what kind of trade agreement the Government was ultimately going to conclude with the EU.

What that did over the long term was reduce the level of output by about 4 per cent relative to our pre-referendum forecast. Had we left the EU without a deal, and basically with no free trade agreement at all, that would have further reduced the level of output by about 2 per cent over the longer term. One unalloyed bit of good news that has happened since our forecast is that we reached a free trade agreement and so that additional 2 per cent loss of output hasn't materialised. We are, in the course of our forecast for the budget on 3 March, going to reassess, looking through the details of the agreement, whether that 4 per cent is robust and the right number, and how the agreement we've struck with the EU compares against an average FTA. So far, independent experts who've looked at the deal, as well as the governor of the Bank of England, who obviously take a very active interest in these matters, have come up with estimates that are fairly close to the 4 per cent assumption that we have made as being a long-term consequence of moving from being an EU member state to the kind of deal that we have.

There are still quite a few details to be sorted out. In particular, negotiations around the services side of the agreement have really only just started, and so there may still have to be an element of us trying to forecast the outcome of those negotiations rather than actually having to assess the details of an agreement that has been reached. But, on the goods side, we will take a detailed look at the deal. We don't expect to have to radically alter our estimate of what it means for output and for trade intensity between ourselves and the EU compared to what we've already factored into our forecast.

Mark Reckless has asked to come in here.

Yes, your analysis focuses on the long-term supply impacts of potentially higher trade frictions. What about the nearer term demand-side impacts of import substitution, given the size of the deficit that we have with the European Union against which trade frictions are being applied, particularly when we have a gap at the moment relating to COVID?

In the near term, we hadn't assumed any significant impact either on supply or demand from the deal itself in our central scenario. The Bank of England actually had some disruption to demand and supply at the turn of the year as the deal was introduced. That is something that we're going to have to look again at in the context of our forecasts. There have clearly been challenges at the border, as we saw over Christmas. There are concerns being expressed by business at the moment about the ability to trade even between Great Britain and Northern Ireland. Some of that was COVID related, but we're going to have to look at to what extent is that disruption the temporary impact of just businesses getting used to the need to deal with those trade frictions. We will also have to assess how much of that might well be a permanent reflection of the fact that we have a different kind of trading relationship with the EU on different terms, and what that means for including things like the substitutability of EU imports for domestically produced UK goods. The substitutability of demand and supply also depends on whether UK suppliers can actually reorient their supply from EU consumers to UK domestic consumers, which is not something that happens overnight.

Okay, thank you. Back to Siân, then.

Maybe I could address this question to Andy, my colleague.

Yes, sure. Andy. 

This revision is entirely driven by judgments we've made within the UK-wide forecast that we think will have equivalent effects on the Welsh rates. So, this figure is, roughly speaking, a 10 per cent downward revision to the tax take, which comes from a variety of sources. So, in our central scenario, the economy forecast assumes there's around about a 3 per cent scarring to real gross domestic product. We've also assumed that the labour share of income will be a little lower than in that original March forecast. So, that, in a sense, is additional scarring to the tax base. And then because the income tax schedule is progressive, lower real income growth also loses you what we term 'fiscal drag'. So, the idea of income growth pushing more income into higher tax brackets, you get less of that. So, those are really the three big drivers of the downward revision, both to our UK forecast and to the Welsh rates forecast.

So, have you taken the UK average and just applied that to Wales? Is it 10 per cent across and then you're just using that? There could be an argument that it'll be greater in Wales.

So, the way we produce the forecast is to think about the tax take at the UK level where we have the most timely data on overall receipts. HMRC gets the money in, and that's the most up-to-date information we have. And then, we forecast the Welsh rates by forecasting the share of that tax take that will apply in Wales. Our analysis of the past is that the Welsh rates share has been declining very gently, but we think that we can put most of that down to things that you wouldn't expect to persist, in particular, the fact that the personal allowance has been raised in real terms very dramatically over the last decade has cost more in Wales than in the UK as a whole, because of the earnings distribution, but, at the UK level, that's not predicted to—. The Government policy is not to continue that, so that doesn't persist in the forecast. So, the answer is 'yes'. What we're seeing at the UK-wide level, we have assumed will be seen at the Welsh level. We thought that it was likely, because the pandemic has had such a dramatic sectoral impact, because the sectoral composition of the economy in Wales is different to that at the UK level, that that would drive some differences, but when we looked at it there were just pluses and minuses and the average came to zero. There's a chart in the Welsh taxes outlook that we put in there because it shows nothing, and my colleague Professor Charles Bean thought that it was the line with the least explanatory power he'd ever seen in 40 years of looking at these things, so we feel confident in assuming that what's being seen in the UK will be seen at the Welsh level.

It would be interesting to see a little bit of that detail, really, to understand which sectors and what's happening with the different sectors, if that's possible. Diolch, Gadeirydd.

Yes, okay. Diolch, Siân. Diolch. We'll move on now, then, to Rhianon Passmore.

Thank you very much, Chair. Just a brief point for explanation, then. In regard to your comments around the instability around services and the assumptions on forecasts in regard to COVID being in the central range, which you've said is over-optimistic now and that you don't expect anything significant to change by 3 March, I'm just slightly interested in that, but I don't want to go off on a tangent—I'm just mentioning that, if you do wish to comment on what you've just said as far as I can understand it.

Going into the line of questioning, you noted that Welsh taxpayers had lower average incomes in 2017-18 when compared to the UK, so can you explain how this has impacted on your forecasts? I note what you just stated to Siân Gwenllian. Can you explain how this has impacted and what assumptions have you made regarding average incomes for your forecasts for 2025-26? Thanks.

On the general point about the fact that there is a great deal of uncertainty both about the virus but then there is residual uncertainty about the impact of the trade deal that we've arrived at for goods trade, but also uncertainty about what sorts of arrangements are going to be arrived at for services, I think it really argues for, and we really encourage, policy makers to take a range of scenarios seriously and not just plan for the best. By all means, hope for the best, but plan for the worst. I think, in that sense, it does just mean that policy makers need to aim more for the fact that they don't have a certain outlook in those regards, and that means that there could be further bad news on the receipt side, but also consequently there could be further decisions coming out of Westminster that you're going to have to cope with in terms of resourcing decisions. 

In terms of how we construct the forecast for the tax base for the Welsh rate of income tax, we do take as our starting point the survey of personal incomes, the last of which was done in 2017-18, so some time ago. That gives us a differential in earnings between a UK taxpayer and a Welsh taxpayer, and that gap is the jumping-off point for our forecast. We obviously update it to bring it up to the baseline year for us, which was 2019-20, and then project it forward. Because what we haven't seen over the recent past, and what we don't expect to see over the future of our forecast, is a significant diversion in average incomes between Wales and the rest of the UK, as Andy has suggested, we basically use the assumptions underpinning our rest-of-the-UK forecast for average earnings in order to condition our forecast for the Welsh rate of income tax. We do make one adjustment, which is an adjustment for population. What we do think we know with some certainty, and based on the ONS projections, is the fact that the Welsh population is declining relative to the UK population. That lowers the forecast by about 1 per cent over the five years of the forecast, but other than that, we don't forecast significant diversion in the earnings base for taxation between Wales and the UK other than the starting point gap that we already had on the basis of what we saw in the 2017-18 survey of personal income.

[Inaudible.]—your first comments. I'm still struggling with this. Obviously, in terms of how you produce your forecasts, are you saying that what you produce is just basically something that's just within a range and we have to look at the whole range, as policy makers? To my mind, it undermines the whole position of what you're supposed to be doing, if what we're doing is looking at what you are doing and you're saying, 'Well, actually, guys and gals, this is just our best estimate', and I know that you're going to say that it is your best estimate, but, on a very simplistic level, it's not much use to us if you say, 'Well, you've just got to look at the whole range and guesstimate your way through'. I mean, is that as good as it gets?

I appreciate that, and we do produce a central forecast and that is the one on which the Government based its budget plans and it's the one on which the Welsh Government is basing its budget plans. But what we do is try to produce a bounded range around that that reflects some quite sophisticated analysis about where we thought the virus was going and where the Brexit negotiations were going. We don't create the amount of uncertainty that there is about the current state of the world and about the future; what we do try and do is analyse it and communicate it and produce a kind of bounded range of possibilities. Now, of course, the world could end up outside those ranges; nobody thought we were going to have a global pandemic, who knows what future risks we may face, which are completely unrelated to the pandemic?

But, I think what we've tried to do is continue to produce a central forecast on which the Government and you can plan, but also try and illustrate the extent of uncertainty based on what we can understand about the course of the virus, its consequences to the economy and its consequences to public finances, as well as the uncertainty that was created by the Brexit negotiations. I think if we just gave you a central forecast, that would be even more misleading in that we would be giving you a false sense of certainty and security about where the world is going and I think we have to be humble as forecasters that, already, a bit more than a month after we produced our forecast on 25 November, we've had another national lockdown, we've had a more virulent strain of the virus and the world has turned out to be different even from the one that we predicted. So, we've tried to show the consequences of various decisions and a path for the economy consistent with those in the near term, but if the future turns out to be brighter than we'd thought, then maybe we end up more toward the upside of that range.

Okay. I note that. I don't know if there's a problem in terms of the conversation, Chair, but I was trying to interject—

Yes, okay. Just to explain, there is a bit of a hum on your microphone as well, so I think it may not be ideal—

Oh, it may not be picking up, because I've got—

Well, no, maybe technicians are turning you down in order to avoid the hum, and then, obviously, we're not hearing any interjections. But what I would ask is that we don't dwell on this, because forecasts are what they are and I think we have to accept that forecasting is something that, as Mike said earlier, is going to be wrong, it's just how wrong it is is the question, and that depends on external factors, in fairness. So, we need to proceed.

I do accept that.

And can I just say, as well, we have 12 minutes left in our originally allocated slot, but I'm going to allow an additional five minutes because we were late starting? So, we do need to proceed at a quicker pace if we can.

Thank you, Chair. The only thing I was going to add to that is that the uncertainty around services and around the trade deal around Brexit, we did know very well in advance. Going on to my line of questioning, you also mentioned that the Welsh share of the UK population is continuing to decline, which you expect to reduce the Welsh share of income tax payers. So, how influential would the slower population growth be—I've touched upon this—in reducing Welsh rates of income tax revenue as a proportion of UK revenues?

It lowers the amount of tax you collect by about 1 per cent. What that means for the proportion of UK revenues, I think it's probably about the same, unless Andy wants to correct me.

Yes, that's right.

Okay, thank you. That's clear. And finally, Chair, your methodology for forecasting the Welsh rates of income tax revenues involves applying the share that will be subject to the Welsh rates to the UK forecast. So, do you feel using UK-wide macroeconomic data is appropriate for forecasting Welsh rates of income tax revenue, and how will you utilise that outturn data to refine your model, bearing in mind everything you've just said so far? 

Andy, do you want to say a few words about this?

Yes. So, as I say, we have looked in quite a lot of depth at whether there are better ways of doing it, and whether there are different assumptions we could use given our current methodology. So, the current methodology allows us to use the most up-to-date data about tax receipts, but they are only available at the UK level with some information about tax from the PAYE system at a regional and Welsh level. So, what we do is we bring together information from the survey of personal incomes, which is the most detailed source at the moment. As you know, there's no outturn yet for Welsh rates. When we got the first outturn data for the Scottish income tax liabilities, it was quite different to what you would derive from the survey of personal income. So, that's a source of uncertainty, and we're not going to know the answer to that for quite some time. But we have looked at whether there should be convergence or divergence assumed within the forecast, and we can't see a reason for it. That's not to say that it won't happen, for all the usual uncertainty reasons, but I think the Welsh Government's chief economist's report looks in even more detail that we have at whether divergence or convergence has been a feature of the past and should be a feature of the future and reaches the same conclusion. So, it may feel simplistic that we do a UK forecast and we apply a fairly flat share to derive the Welsh rates, but we do think it is using the information we have available to the best of our ability.

When we do have Welsh outturn, we will be able to calibrate to that, and so, at the moment, you have uncertainty about a starting point for the forecast and uncertainty about the growth thereafter. Once we have an outturn data point, you reduce dramatically the first of those sources of uncertainty.  

Okay. Thank you very much. We'll move on at a canter now, then. Nick Ramsay. 

Right, cantering. Morning again. How have you modelled the Welsh and UK Government's programmes to support employee incomes during the pandemic?

That sounds like one for me also. 

Go on then. 

So, by far the largest of these is the furlough scheme on which HMRC has very quick admin data. So, we know in almost real time what the claims are. There is a lag in people submitting claims. So, we had enough information to then assume how our forecasts for the economy and the terms of the extended scheme would interact, and that's how we modelled the UK-wide cost of the scheme. Because the claims have a postcode attached, admin data can provide information at the Welsh level. The scheme covers some income tax, so there's a kind of direct link between the CJRS and our income tax forecast.

On the self-employment scheme, again there's admin data to tell us where those self-employed people live. So, the forecast can take on data that is accurate in that sense. And the forecasts for the claims that have not yet been made is a relatively simple one because take-up for the first two grants was of a fairly similar rate. That also has tax consequences, which, in our UK forecast, we forecast that on the basis of when the cash is paid, but, for the Welsh rates, it's a liabilities basis, so you have to shift that back in time. That's a bit complicated, and the fact that the self-assessment system has some pretty generous deferral policies within it is going to make life a bit difficult over the next year or so in just understanding what the true picture for liabilities in 2021 was because the cash payments of those liabilities could be far and even further into the future than normal. But the short answer is that we have a lot of admin data and they're relatively short-lived schemes, so we're reasonably confident of how they have been modelled. But the underlying uncertainties of the assumptions that drive the models are still very great.

And turning to the issue of data, you've said that only real-time information earnings data is used for your forecast, given the absence of timely information on other forms of non-savings and non-dividend income. What sort of challenges does this present when you're trying to model the WRIT revenue, and how confident are you in its reliability?

So, the survey of personal incomes has all the relevant sources of income, and then we can uprate those through time. By far the largest—I think close to 90 per cent—comes from the PAYE system, which means that the real-time information can be used, so moving from 2017-18 to 2019-20 for that part of the liabilities, there is good information. What's happening in the current year is, obviously, difficult to interpret because of how the CJRS has affected things and how the pandemic itself has had a much harder impact at the bottom of the earnings distribution. The other part of NSND income, almost all of that, the rest, comes through self-assessment, and so there are long lags between the liabilities and the cash. We have the same problem at the UK level as at the Welsh level. Self-employment income that the ONS data sources—they have the same problem as well, that they don't have a great deal of information until that tax data is available. So, everyone is faced with the same problem. The information is not perfect, but it is a small fraction of overall NSND income.

Thanks. And finally from me, you've said that you'll consider any age-related changes in the distribution of taxpayers and average incomes across age groups in future. What sort of benefit do you think that this will give?

I think, in more stable times, this kind of methodological change would just give us a better handle on what has driven movement in the Welsh share in the past and whether they should be pushed forward into the forecast. So, we would like to have that. It will help when we have the SPI updated, when we have the outturn, and when we marry the population projections and the tax data. So, it's just a more sophisticated model to underpin things and allow us to factor in trends that we are aware of. I would say that, at present, the gain from that is small relative to the uncertainty around how the pandemic has just affected labour income in general.

Diolch, Llyr.

Diolch, Nick. Alun Davies.

Thank you very much. I've been enjoying listening to the conversation this morning. Both of you used the word 'uncertainties' repeatedly in answering questions, and, given the times that we're living in, nobody's surprised by that. But your forecasts don't seem to contain much uncertainty at all—they're all pointing downwards, and they're all pointing downwards in not an unsurprising way, because, when I look at your analysis over time and then taking the forecast forward, there don't seem to be any discontinuities. There seems to be a continuation of trends or a deepening of trends. The income tax take, for example, seems to have been on this trajectory for most of the last 20 years. Is that a fair view of what you're saying?

I should maybe say two things about the longer term trends and about—. You're right to say that this forecast that we've produced is both lower in the near term because of all of the disruptions created by the pandemic, but, at least in our central forecast, it's also lower—for revenues, it's lower over the medium term, because we are assuming, in our central forecast, there's a long-term scarring effect from the pandemic on labour incomes and therefore on the income tax take, and that has consequences for UK revenues, but also for Welsh revenues. That, at the moment, is an assumption based on the historic consequences of large economic shocks on earnings, on productivity, on investment, and the fact that you pay a cost in terms of human capital, you pay a cost in terms of forgone physical capital, there are consequences for the matching of employees to jobs that never quite get back to where they were pre shock, and therefore there are some negative long-term consequences from just experiencing shocks like the pandemic, but also shocks like the 2008 financial crisis. This is just the long-term legacy of the fact that we have recessions and we have shocks. And so, in that sense, there are consequences from this most recent shock that echo over the longer term over our forecast for the tax take.

It is also the case that you'll have seen there have been some trends in the way in which Government has made tax policy that also reduced the tax richness of earnings over time, and there are two things in particular: one is the fact that, at least in the recent past, the Government has raised the personal allowance significantly, and that just takes more and more people out of the tax system, and, therefore, for a given level of earnings happening, particularly at the bottom end of the earnings distribution, you just don't get as much tax from that. And a second, long-term trend that has eroded the tax base for personal taxes has been an increasing trend towards self-employment and incorporation. In particular, if somebody moves from being an employee to working through a corporate vehicle, they end up paying much less tax on their labour earnings because it's taxed, basically, at the corporation tax rate rather than at the personal income tax rates, and that just reduces the amount of revenue that you're getting from a given level of economic activity over time. This trend has been something that started more than a decade ago, but continues to erode the taxes—it has eroded taxes over time and continues to do so over the medium term—as this kind of increasing informality of the economy and more and more people working for themselves and contracting out rather than working long term for an employer becomes something that is more common across more sectors of the UK economy.

But, in Wales, that's not the full explanation, is it? Because if you look—. In the numbers that I read—and I apologise if I've got this wrong—it seemed to be average earnings that were lower and therefore consequently lead to a greater decline in relative terms of tax paid, rather than because of self-employment. When I read your forecast and look at the historical data, it seems to me that this relative decline in tax income predates the 2008 crash as well. It seems to be from around 2004 onwards. So, those are Government decisions rather than economic drivers.

That's right. I speak subject to correction by Andy, but, because Wales has more taxpayers that are closer to the personal allowance, it is more susceptible to changes in the first allowance, meaning people drop out of tax altogether and you don't get any tax at all on their income. But maybe Andy will want to add something further to what we've seen in terms of longer term trends and the tax take in Wales, compared to the rest of the UK.

Yes. So, I think that's right. There's definitely a greater effect of raising the personal allowance in Wales than in the UK—so, more people have dropped out of paying income tax, or a greater proportion. As you say, there is also an effect of average income per taxpayer, which seems to be spread across the different types of income. There's a very large gap at self-employment, but it's not a gap that's risen dramatically. The gaps are large across all income types, except for pension income. They have risen a bit. We couldn't find an obvious driver that said that that should continue indefinitely. That's not to say that we've reached the right answer, but we keep looking to try and—. If there's a clear reason to assume this trend will continue, then, obviously, we would do that. We haven't found a clear driver yet.

The other part of this is there's an interaction between lower average earnings and the progressive tax system that means that fiscal drag—the number of pounds of tax you get per pound of income—is lower and has risen more slowly, where, again, if we had something to pin a judgment about average earnings growth diverging, that would automatically or mechanically flow through the forecast to lower the affected tax rate as well. So, what am I saying? Those trends are clearly there in the past. There are some of them that are policy related where the policy is not expected to continue, and there are some of them that we haven't found an obvious reason to think that it should persist. I've read through the—. Each budget's chief economist's report looks at this gap and how it might evolve, and, as I said, we've yet to find something that we think is firm enough that we should be forecasting either divergence or, indeed, convergence of recovery, of narrowing of the gap.

Okay. That's interesting; I'm grateful to you for that.

In terms of the role that you play on the devolved income tax analytical working group, how does that support the preparation of your forecasts?

It's a very useful working level group, which brings together analysts from ourselves and the Treasury and Westminster, from the Welsh Government and also from the Scottish Government and Scottish Fiscal Commission. We have shared interests in what you can get from the available data, and, as I've said a couple of times, we have much more timely data at the UK level, and we have to make some bridges to the less timely but more detailed data at the devolved levels. And we're also able to share lessons across institutions. So, both the Welsh and Scottish institutions are invited to what we call the challenge meetings that we hold while we are producing our forecasts, and that working group doesn't need to wait for a challenge meeting, that working group is ongoing and then its insights can be brought to the challenge meetings and brought into the forecasts. 

Can I just—? Thank you, Alun. Can I just say we're running short of time now, so—

I'm happy with that.

Oh, you are. Okay. There we are. Thank you, Alun. Right, Mark, then. We've got five minutes left for Mark's line of questioning.

I've got questions about LTT; I'll just try and fold it into a single question. Could you let us know how you've used the land transaction tax outturn data to evaluate your forecasts, and what changes, if any, you've made to your forecast model, particularly in the context of the reductions in the forecast, both for commercial and residential, over coming years?

Andy, do you want to take that one?

Yes, sure. So, as you know, we've not been doing this job for you for that long, so the evaluation was just looking at our first in-year forecast. It used the same methodology that we do when evaluating forecasts and models across our work. At this stage, the methodological questions have really been about how narrow or wide the bands of the distribution of the property market should be that underpin the forecast, because that can be important. It's particularly so when you have such a progressive tax schedule as you do with LTT. We would expect, over time, as we can evaluate more forecasts, to be able to refine the methodology further. But the obvious point to make at the moment is that it's not the LTT model that is going to drive surprises on the forecast, it's our ability to forecast house prices and house transactions, where, at the UK level or the Welsh level, obviously, the restrictions on the market have been very important, and we're just seeing, I think, developments that are surprising us at all levels in how house prices are responding, how people are responding to where they want to live. So, it's the housing market forecast, rather than the—when we put that housing market forecast through the LTT model, that is going to be the source of surprises. I would be surprised if we didn't have big surprises to talk about next time we speak.

There we are. Okay. Thank you so much. Can I just ask, then, as well, have you utilised landfill disposals tax data from the Welsh Revenue Authority in your forecast models as well?

Yes, we used the latest published data to ensure that, at the OBR level, we're not seeing taxpayer confidential information, but we're at the first half of the year and it's—[Inaudible.]

There we are. Richard and Andy, can I thank you both for joining us this morning? We're very grateful to you for your evidence and for the work, obviously, that the OBR does in forecasting Welsh taxes. You will be sent a copy of the transcript, of course, to check for accuracy. With that, I'll thank you both for your presence.

As a committee, we will now take a very short break of two or three minutes. It's a technical break, just to make sure that our next set of representatives are able to join us. Diolch yn fawr iawn. Thank you.

Jon, do you want to start? Jon needs to be unmuted, I'm afraid. We can't hear a word he's saying. 

The WLGA's response to the budget and settlement was in our initial press release that was issued on 22 December. It was a broad welcome to what we described as a 3.8 per cent cash boost for our budgets next year. The 3.8 per cent translates as a £172 million increase in aggregate external finance. In the press release response—I can't remember whether I shared this with the committee or not, but I'll certainly send our press release and briefing to the clerk afterwards—there were welcoming words from all the political groupings within the WLGA, not least from Councillor Andrew Morgan, as the WLGA leader. We'll come on to other details later, but I think the broad headline, the 3.8 per cent—it was welcome. We know there's still detail to be worked out in the specific grants, and doubtless that'll be worked out over the coming weeks, and in the run-up to the final budget announcement and the final local government settlement.

Thanks, Chair. As we're all aware, whatever the headline increase is in the settlement, we always end up with a range of increases—or in certain years, that's been decreases—and this is down to the funding formula. This year we have a range between 2 per cent and 5.6 per cent. In an historical context, I think that's quite a large range, but in saying that, when you do look at the distribution of the increase, I think about 17 authorities are within 0.5 per cent of the average of 3.8 per cent. I think we've been aware for some time—both my colleague Dilwyn and I sit on the distribution sub-group, which is the group that looks at the funding formula—and we've been aware for some time that it does create a range of—. I've been aware since we saw the distribution sub-group report that it was going to create a range of increases. So, leaders have been concerned about this for some time; they prefer to have a floor mechanism in place, just to help with year-on-year financial stability. We know that this year, there are two authorities that fall below 3 per cent—Ceredigion and Wrexham. WLGA leaders—not just the leaders of those authorities, but the WLGA leaders—wrote to the Minister on 11 December, asking for a floor to be put in place. I think when the Minister published the settlement, she made clear why she wasn't putting that floor in, but we still think that there is a discussion to be had there. There's an open door, and I think we'll still press for a floor in the settlement uplifts.

So, does the need for a floor suggest that the funding formula isn't performing adequately, would you say?

It's a good question. The formulas are very evidence based. We know there are criticisms of the formula and there are challenges to it, but the application of the—. It's a political decision whether or not to put the floor in, and it does override the formula to an extent, but I suppose it recognises the fact that the funding formula can't reflect every single factor that drives the need to spend. There are other things, and that's why there's almost a kind of political override there. As we pointed out to the Minister in the letter that we sent to the Government on 11 December, there are extraordinary things driving need to spend at the current time—I don't need to go into them—and I think that was part of the rationale for requesting a funding floor.

So, is the floor a way of avoiding the political fight around the formula, then? Is that what we're saying, in a way? Dilwyn wants to come in.

Quick comment: every such change in the formula would give them more money. It's a fixed amount—if you change the formula there'd be winners and losers. People talk about formulas all the time. You talked about a funding floor in percentage terms. I haven't got the figures in front of me, which I should do, but my understanding is that Ceredigion does quite well per head of population compared to other authorities, and the bottom tends to be Cardiff, Monmouth, and the reason for that is because they get a lot of money from more expensive properties under their council tax.

The problem with the floor is that it has to take money off somebody else. There are no additional moneys coming in. The question I really want to ask is: if you want the funding floor, why don't we just give every local authority exactly the same amount of money per head? That would create chaos for some of the authorities that do well and give lots of money to those at the bottom. Why is the floor in terms of percentages, not in terms of absolutes, and why isn't it a funding floor at a certain sum per head?

Okay, thank you, Mike. And Nick.

It seems to me that the argument about the funding floor reminds me of the fiscal framework arguments—it's very difficult to change the whole Barnett formula without annoying people, but if you put a floor in, that can actually have some merit. So, I'm quite interested with the idea of a floor going on.

Just in terms—. Mike is right that rural authorities have traditionally not seemed to have done so well. I'm not sure that per head of population really solves that, does it, because you're going to have a lot of people living in a smaller area in an urban area, and it's cheaper to deliver services to them than it is over a wider rural area. But, yes, just interested in your views. Do you think, moving forward, it is easier to have this floor and develop what we've got at the moment, rather than just chucking it all in the air and trying to develop something new?

Okay. Jon can respond to this and then we'll move on then. Diolch.

Just picking up those comments there, Mike Hedges is absolutely right, it's a swings and roundabouts game, or a robbing-Peter-to-pay-Paul kind of exercise, to a large extent, the floor. He is right that Ceredigion, in terms of aggregate external finance—that was just recently announced—they are above average. They stand at £1,500, more or less, compared to an average of £1,470. There's a big rural factor in there. 

I think, just to address the final point of Mike's about the floor, it's always been used quite judiciously, I think. In England a couple of years ago, they started giving everyone similar kinds of increases and it just doesn't work, because the needs and the pressures are different across differing authorities. And just to address Nick Ramsay's question, yes, I think developing what we've got is the best way forward. I always think that keeping some aspects of a floor or a safety mechanism, just to inject a little bit of reality into a formula that really can't cover everything, is probably a sensible idea.  

We've just been through a session with the OBR and they used the word 'uncertainty' a great deal in terms of their analysis, because of the obvious pandemic and the rest of it. I'm interested to what extent do you think the Welsh Government has been able to protect your organisations through this period, and to what extent the very significant additional funding that you've received over the year has actually, first of all, made good for potential losses and, secondly, enabled you to respond on behalf of your own communities.

Jon.

Okay, if I kick off on that. The use of words like 'unprecedented' has become just so common, but it's absolutely true. I think in the early days at the end of March, early April, that was when we started to really think about the types of pressures that we were going to face during the pandemic. There were a lot of worries about income loss in local government as well, and what gradually developed was a hardship fund and it gradually grew, I suppose—it grew organically in the early days, the original hardship fund. By the time we got to the end of the first quarter of this financial year, I think it was about £110 million. This was highlighted in the first supplementary budget.

We did a lot of work—and I mean a lot of work—with civil servants trying to size the problem, scale the problem, not just on income pressures—. Sorry, not just on expenditure pressures—social care, free school meals, housing, enforcement, et cetera—but also we began to get a clearer picture on income loss as well. There was then an additional announcement of around about £80 million for income loss, covering things like loss of income for car parking, leisure centres, et cetera, et cetera. It gradually grew into—. By the time we got to August, I think the Welsh Government had been—. A funding guarantee had been announced by UK Government. From memory, I think that was about £1 billion or £1.2 billion. We also got some kind of funding guarantee. So, there was an additional £260 million announced then, which gave us a clear picture, then, of the size of the hardship fund for claims that had already been made and for future claims, and it provided local authorities, I think, with a lot of—. I think the phrase was at the time 'bankable assurance'. There were a lot of worries at the time about financial sustainability. There certainly were in England. There was a lot of talk of what were formally called section 114 notices. Confidence in the system was rather weak. The funding helped. All these funding announcements helped.

Another thing that really helped was that we, with the help of civil servants, averted a cash flow problem as well in that we front-loaded RSG payments into the first couple of months. In the first couple of months of the new financial year, the 22 local authorities had about £1.6 billion flying directly into their coffers. The pressures at the time weren't just of providing funding for services; we were facing losses in income, potentially, and from council tax, but we were also paying out, or starting to pay out, absolutely enormous amounts of money in terms of grant support for businesses as well. That turned out to be, I think, almost £0.75 billion going out the door in the first three months.

So, I hope that kind of answers the question. I think it's worked very, very well. I speak to my colleagues from the Local Government Association, from the Convention of Scottish Local Authorities in Scotland, from the Northern Ireland Local Government Association in Northern Ireland, on a weekly basis, and I'm pretty confident in saying that the system that we developed here—and we worked hard with civil servants to develop a claims based process—has worked well. I'm not saying it's perfect; it isn't. There have been frustrations in terms of the claims process, in terms of definitions of income that can be claimed for, et cetera, et cetera, but the work we've done with the Welsh Government and politically on this, because the Minister at one point was meeting weekly, sometimes more, with leaders over the course of the very early summer. And I think it has worked well from my perspective. I can let Dilwyn comment from how he sees it from the authority perspective.

Okay, that's good. Thank you. In terms of where we're going now, Jon, you welcomed the settlement this year in your opening response. Does this mean now that, given where we are, which isn't where any of us would want to be, and the difficulties that public sector organisations are going to continue to face in the next period, that you believe that local government is able to sustain the services going forward into the new financial year?

Yes, certainly. My comments there were about the general uplift in base budgets in the settlement. That is welcome. There is a question mark, though, isn't there, over COVID funding in 2021-22. I know there is some hint in the Welsh Government budget about that funding. We know that local government in England—I think the Chancellor announced an additional £1.5 billion for local government in England. They have a very different system and actually, I'd say that, just listening to the deputy chief executive of the Local Government Association yesterday in a finance seminar, they're still short for this year. So, I think they've got a shortfall of about £2.3 billion. So, I don't think we're too worried about funding services this year because, as I said, that COVID fund, that is now a fund of about, I think the total is about £557 million, of which there is still about £255 million remaining in the budget. There are still claims for quarter 3, both in terms of additional pressure and income loss to go in, so that's fine, but, yes, back to your question: there's just a question mark over COVID funding in 2021-22, and the assurances that we've been given by the Welsh Government are that we'll be having discussions on that soon, and it will be addressed in the final budget announcement.

I'm still not in the habit of this not having to switch off the mute, so I end up muting myself. Good afternoon—sorry, 'morning', I should say. You've noted the significance of the additional COVID-19 funding and its role in supporting financial stability in the next budget period. The Welsh Government is allocating only £77 million of the £766 million resources available to it in this budget. Do you agree with this approach?

Do you want me to kick off?

Not a controversial question at all, of course, so—. [Laughter.] You may say it's a bit too political. 

Well, listen, the approach is what the approach is. And actually, if you want more political responses to these types of questions, I've got at least three leaders on the local government committee tomorrow. There are concerns—I mean, I can certainly tell you that—about the COVID funding next year, especially in relation to social care funding. Quite a substantial part of the hardship fund is allocated for social care. Certainly from the pattern of expenditure that I've seen, in the first quarter we were paying out to providers to prop up the sector something in the order of £40 million in the first three months of this financial year, and then that kind of fell away to about £20 million per quarter. I've certainly heard calls for some kind of transition funding going into next year, and in theory, that funding supports voids in care homes and props up some of the rates paid, and I think in terms of stability for the sector, there will be ongoing calls for funding. But, as I said, I'd expect this to be addressed in the coming weeks and in the run-up to the final budget announcement.

We just heard from the Office for Budget Responsibility that, often in these situations where you've got a lot of money coming to you in one go, it's not easy to simply get it out there straight away, and that poses its own sort of problems. I presume local government goes through some similar issues if it has to spend a lot of money in a short time.

Yes. It has been difficult. There have been frustrations, especially when you have to pass money on to third parties. You can see that it's most stark, I think, in that kind of context in the social care environment. I know that, initially, there was a lot of criticism from providers about the speed at which local government was getting money out the door, but, look, it all depends on—. It's not just about getting money in; it doesn't just fall through the consolidated funding straight through into local government coffers and then Dilwyn throws it out the door in Gwynedd. The guidance has to be written; we have to have systems in place, checks and balances, and these are the types of things that slow things up. But, I think, looking at the way that local government has got money out the door to organisations in the social care sector, and business grants as well, the amount of money we've nearly—. I said we've got £0.75 billion out the door, but, actually, when you add on firebreak grants to businesses, and when you add on the Christmas restriction grants, that money is going out the door almost immediately. Now, we're sending out these non-domestic rate grants very quickly and, indeed, some leaders, Councillor Morgan, Councillor Rob Stewart, have actually lobbied Ministers to get this money out even quicker. So, I think we're trying our hardest. 

Well, I'll ask you the £1 million question, well maybe the £1 billion pound question given the discussion over the last few days: do you think that, overall, local government is going to have sufficient additional resources in this budget to maintain service delivery? And if something's going to have to give, which areas would you say that that would be, or will it vary from authority to authority?

Would the WLGA—[Inaudible.]—the private social care sector? I wonder whether the draft budget allocations in that area is something that you could deal with. It was described as vulnerable and under financial strain as a result of the pandemic, and I know local government does find its support in that area challenging.

And Darren is back by the way, so we'll come to Darren after we've spoken to either Jon or Dilwyn, whichever one wants to respond to that.

I think all three of you, as we are, are well aware of Welsh Government's stated priority for closer integration of health and social care—I think that's at the centre of its vision in 'A Healthier Wales'. To what degree do you see this as being reflected in the draft budget? And what more would you wish to be done?

Maybe Darren could respond to this first.

Sincerest apologies for my broadband totally failing.

It's not your fault. It happens.

I think it's essential, and we've seen through COVID how important it is that local government and the care sector work effectively with the NHS. There are discussions ongoing, as I'm sure everyone will know, about how we can do this more effectively in the future, but one can't work without the other. I think that effective funding of both health and social care is vital and there are some welcome increases, but we've still got a long way to go in terms of dealing with the fallout from the pandemic and the pandemic itself.

Good. And, Darren, on some of the specific areas, what's your assessment of the ongoing costs associated with PPE, test, trace and protect, and indeed the vaccination programme? Are these adequately dealt with in the draft budget do you believe?

At the moment, with the predictions that we've got, there is cover, but we are talking very, very large sums of money. If you look at the cost of PPE, so far it's around £100 million; for setting up the field hospitals, it's £150 million. And we are still in that unknown territory, really, of how much longer are we going to be dealing with the disease itself, but also the fallout, and then catching up on the backlog of really important care that hasn't been provided to people because the NHS is at that nearly overwhelmed point in dealing with COVID.

Thank you.

Okay. Thank you. Jon wanted to respond to a previous question, I think. Did you, Jon?

I did, just to add to what Darren had said. We welcomed the extension of the integrated care fund and the transformation fund into next year. I think we see these as key in terms of supporting joint working in the future.

Just getting back to the private sector question—the provider market—again it's about the additional funding that they've had through the course of this year in the pandemic, and the important thing is to make sure that there's some kind of transitional arrangement into next year, because what we're being told is that they've found that funding essential just in order to survive. And we're not even addressing issues about a real living wage: it's a whole-workforce issue in the social care sector as well. But that's a different question.

Thank you very. So, to Darren firstly. The draft budget allocations for 2021-22 cover pay increases, or will cover the pay increases now for NHS staff. So, what other implications are there for staff costs as a result of the draft budget, and, obviously, in light of the known recent staff shortages due to COVID-19?

I think the pandemic has shone a light, really, on how close we're sailing to the wind in terms of staff numbers and staff capacity, and I think, before the pandemic struck, there were worryingly high vacancy rates in parts of Wales in certain front-line health professionals. So, it's more than about the budget for the NHS; it's also the budget for the training of health professionals for the future. Health Education and Improvement Wales have done some calculations relating to that—if you look at the agency spend that we have needed to have through the pandemic to support staff on the front line, but if money been spent on increasing the numbers of nurse training places, other health professionals. Because I think what we've seen through COVID, it isn't—. If you ask people about health professionals, they generally say doctors and nurses, but the team is much, much wider than that—the work that's going on in community with GPs, with pharmacies and also that close working, which we've touched on already, with social care. Workforce has been the key limiting factor in terms of our ability to deal with the pandemic. You can buy beds, you can buy more ventilators, up to a point, but it's the workforce itself that's our limiting factor. And I think, if there was an area where investment was needed in the future, and particularly with some of the service transformation things that have come forwards through COVID, investment in workforce and training are the key issues for us.

And in terms of scale and the range of how much of a risk this is in terms of resilience for the NHS moving forward, how would you rate that in terms of that risk, bearing in mind the cost of agency staffing and the pre-COVID issue around increasing capacity around multidisciplinary teams?

I think it's a very, very big risk, and resilience is a part of it. Prior to the pandemic, we were wanting more doctors, wanting more nurses, wanting more pharmacists working in Wales. But, with the NHS being close to capacity in normal times and then the COVID burden on top, I think it's probably the key issue that we also saw through COVID higher levels of sickness than we were anticipating. There's long COVID to deal with, because many—[Inaudible.] Unfortunately, some staff lost their lives through COVID, and that's as serious as it gets, really.

But also the other concern is about staff reaching the end of their careers who might retire early—[Inaudible.]—pressures of dealing with COVID. So, we know staff resilience, staff numbers, are right at the top of the list of concerns for our members, and we're doing all we can to support members through this unbelievably unprecedented tough time.

Okay. And I'd just like to say thank you from myself in terms of the huge amount of work being undertaken by everybody across the NHS. Thank you.

I've just got one more question, if I can just bring it up on my high-tech phone. So, this is a question for WLGA. The Minister for Housing and Local Government says the implication of pay awards for 2021-22 will need to be accommodated within local government budget planning in light of the provisional settlement. So, for the WLGA, what is your assessment of that funding gap as a result of this, and the impact on other services? You've mentioned social care and education previously. I don't know whether we've got our colleagues from the—

Yes. Jon.

Jon.

Okay. Yes, I'm not sure I can put a figure on any funding gap, but I can certainly tell you that the—. I suppose, in local government terms, we've got the £1.4 billion bill for teachers' pay and we've got a £2.4 billion bill for those on National Joint Council terms, which is everyone else. So, all in all, we've got a pay bill of about £3.8 billion. So, whatever the outcome of any pay award is will have a significant impact on our budgets. Now, the Chancellor's spending review statement at the time of the spending review set out the parameters for public sector pay. The real difficulty, I suppose, for the Chancellor is that he doesn't really have any locus on the pay negotiation for those on NJC terms, because that is an England-and-Wales negotiation between local government as the employers on one side and the unions on the other. So, it will be interesting to see how that negotiation goes. And the Minister's warning is apposite, isn't it, that anything that does get negotiated has to be funded from within the envelope. So, first of all, we've got to keep an eye on what's happening in terms of that NJC negotiation, and I expect they will start in earnest around about January time, but they can be quite protracted and they can go all the way up to—won't reach any conclusion up until—the summer. And the other part of this is the independent teachers pay panel in Wales, and how the Welsh Government responds to that. So, yes, it's a risk. That's probably the best thing I can say in response to Rhianon Passmore's question.

So, in that regard of it being a risk, and it being an unknown and an iterative process—. And I note that you said that this can be a lengthy negotiating process; I don't want you to feel that you need to go into details that you cannot. However, how much of a risk is that, bearing in mind the scale and volume of the amounts of money that we're talking, and the scale of the impacts that that could have on services?

Well, just on those broad figures that I gave you at the outset, where I said that the local government wage bill was £3.8 billion, every 1 per cent increase is £38 million—I suppose that's how I quantify the risk. So, it's substantial. The pay increase this year was around about 2.75 per cent, if I remember rightly. In our own assessment of pressures for 2021-22 we actually just rolled over the assumptions for this year. Now, if that doesn't transpire, obviously, our assessment of pressures is going to be a lot lower than what we'd assessed prior to Christmas. So, big figures involved there.

Oh, sorry, Rhianon. Very briefly, then, please.

Thank you. I don't know if the Chair needs me to ask my final supplementary.

Sorry, I thought you'd concluded. Yes, please do, but I'm just mindful of time.

No, no, that's fine. It's partially been answered but, in regard to the teachers' pay deal, and, in terms of individual allocations to authorities, how do you, as an individual authority, recognise the teachers' pay deal? How are you managing that?

Dilwyn.

Diolch, Cadeirydd. Well, two comments and a question. You also have, of course, the full-year effect of last year's teachers' award—the teachers' awards don't, unfortunately, go, in terms of budgeting for local authorities, from April to April. We've talked about health working closer with social services—really important. I would just like to see primary and secondary health work a little closer together. The question I've got is: there is a belief, not one I tend to agree with, that there's some sort of service transformation, some sort of digitalisation, that can save large sums of money for both health and social care and local government, and I sometimes think about having a robot doing the street cleaning. [Laughter.] Do you see this actually happening—there being large savings by transforming services by digitalisation? Because you know in local government the last major transformation was when they cut the amount of time people in social care spent when they were visiting people—really good in terms of governance and efficiency, really bad for people on the receiving end.

Let's go to Darren first, then, on this.

I think recent experience tells me that it's—[Inaudible.] I think my problems with broadband today are a great example. But, taking that point seriously, I think there are enormous opportunities, particularly—it depends what you mean by 'transformation', Chair, but I think we've seen great opportunities for working more efficiently where, rather than going to the GP and then getting a letter from your GP to be sent to the consultant in hospital and waiting for a letter to come back then for you to get an appointment, connecting GPs, patients and consultants together all at one time, in that it's done immediately, rather than with several weeks' delay, is brilliant; remote consultations for people that have access to digital technology, and just the way that we are now doing things electronically, with access to the patients' information for all health professionals. So, traditionally, it's been the GP that's held that information, now it's much more open to others who can play really important roles, and Welsh Government's working toward sharing that information where appropriate with colleagues in social care as well. So, that kind of information sharing and communication are great opportunities. I'm not so sure about the robot side of it. But, in all seriousness, those sorts of things are happening with robot-assisted surgery as well.

Digital we've been forced into using, I think, perhaps more quickly than we might otherwise have been because of the pandemic, but there are great opportunities in taking it forward. But we also must ensure that those that don't have access to digital technology, or broadband that works, like myself, are not excluded.

And from a local government perspective, Jon.

I think the point that Mike Hedges is making is around some of the claims that have been made around efficiency and transformation in the past—I think if I sense Mike's angle correctly I think he's quite right. I think these have been overblown, and I think back maybe over a decade to the efficiency and innovation board, some of the claims made by the National Procurement Service in the early days—you know, savings of tens of millions of pounds. Rarely do these materialise. I think, however, that local authorities still are relying on savings and transformational activity to help bridge budget gaps, but it's a term I use advisedly, because it just helps bridge the gap, it doesn't bridge the whole gap. If you look at some of the small services that have had funding reductions over the last 10 or 11 years of anywhere up to 50 per cent in real terms, regulatory services, housing services, libraries, et cetera, et cetera, this hasn't been achieved in terms of greater efficiency, it's just that these services have been cut. And it's almost a moot point as to what's an efficiency and what's just a service cut. So, what I'm saying is that I completely agree with what Mike Hedges is saying there, I think, which is that sometimes the way savings are quantified is overblown, but there is a part for them to play. But, let me say, it's been really difficult for this year. A lot of authorities have had to put their savings plans on hold, they've rolled them over into next year. We did a survey, a financial planning survey, of treasurers just before Christmas, and they were reflecting the fact that there had been major difficulties this year and that that will continue next year. All this data we're feeding back to Audit Wales as well so that it in some way appears in their financial resilience report. But transformation savings will still play a part. 

Thanks very much for the question. I think recovery and the catching up on work that we've had to suspend because of dealing with the COVID crisis is absolutely enormous. And we understand the difficulties that Welsh Government are facing with the settlement from UK Government, and we fed into the comprehensive spending review engagement process in England and set out the scale of the challenge that we are facing. We've had many months now of some services being totally suspended. Other things, like some orthopaedic services, are having to be run at approximately 50 per cent of their usual capacity. Providing non-COVID care is much more difficult because of social distancing; there are approximately half the number of people on a ward that would normally be there for recovery post surgery, and things happening in community care. There will definitely be a very large cost—very difficult to put a figure on—to enable services to recover. It's an enormous challenge and probably as big a challenge as COVID itself. 

Thanks very much. We, as do our members, regularly engage with colleagues in Welsh Government. The health and social services finance team update monthly on the challenges that we are facing, and I've been speaking to my colleagues in the NHS Confederation in England who engage with the Westminster Government on these issues. When you're dependent, to a large extent, as we are in the current circumstances, on the consequential changes to the budget through the Barnett formula, it is exceptionally difficult to plan ahead. And I think we've been asking for five-year funding plans from Wales but understand the reliance on the Barnett consequentials, particularly in a time of crisis like this. I think it has highlighted some of the difficulties in how Wales and other devolved nations are funded.  

Thanks very much. Dilwyn alluded to it in his final comments: one of the things that's becoming increasingly clear is the link between people's health and well-being and the state of the economy and their own financial well-being, and there are going to be very serious, significant knock-on impacts from the hit that the economy is looking highly likely to take for health services and for local government as well.

Darren, do you want to go first, and then we'll go to Jon? Jon's indicated. You go first, then, and then we'll come to Darren.

Diolch. Thanks, Chair. We have been doing some work. There were political discussions that have been ongoing in the national partnership council, and, indeed, going back to 2019, I think the Welsh Government provided just over £1 million for local authorities to boost their corporate capacity to prepare for Brexit, and I think we really welcomed that—certainly, Councillor Rob Stewart did, who has WLGA kind of responsibility in this area. So, that financial support has been invaluable. We've been having discussions under the EU advisory panel as well, which is, I think, chaired by Huw Irranca-Davies. I think, under the auspices of all of that, we commissioned some work from Grant Thornton. That's been really helpful in just kind of assessing the impact, suggesting the outcome that works. From memory, it suggested that a slim trade deal would result in a 6 per cent reduction in Welsh exports and, obviously, that comes with all the impacts you'd expect. So, we've certainly done some work with Welsh Government and it's been very helpful, and I know that there's been a chief execs group as well who've been working with senior Welsh Government officials on this. But, when the deal was announced, I don't think it was as bad as had been anticipated, so the risks around this were somewhat lessened.

Okay, thank you. The last word to Darren, then.

In relation to leaving the EU, I think we were planning for the worst and hoping for the best—that's the best way to put it. But many of the key issues that the health service across the UK and particularly in Wales were highlighting as concerns, such as continuity of supply for medicines and medical devices, and sharing of information on things like the pandemic, were in the agreement before COVID arrived, so that's borne some fruit. There will be increased costs. We have serious concerns about the workforce, and some of the research that we've done shows that it's more likely to be the social care workforce that will be more affected than the healthcare workforce due to the salary thresholds related to the agreement. To put a figure on it is quite difficult, but we're in a much better place than we'd planned to be at this point.

I suppose in terms of considering the budget in the context of whether it's a normal year, in some way there is a continuity, because the growth in the core budget broadly continues the trend seen over the most recent two years in the Welsh budget, and certainly differs from the austerity budgets that we saw up to about 2018. But, of course, that is said in the context of extreme uncertainty over current budgeting given the coronavirus pandemic, which makes this draft budget much more of a draft than usual. 

There are three main areas, I'd say, where this is particularly different from a normal year. Firstly, the Welsh Government has decided not to allocate a very large part of its COVID-19-related funding that it has been allocated for next year. In a normal budget across this Welsh parliamentary term, for example, the average unallocated fiscal resource at this time of the draft budget had been around about £162 million. This year, it's five times that amount, so £811 million in the 2021-22 draft budget. Obviously, it reflects the extreme uncertainty that is facing all the Governments in the UK at the moment. 

Second is that the UK Government itself has a very large COVID reserve for 2021-22—about £21 billion—and that means, depending on the way those are allocated in the course of the new year, that there will be additional resources for the Welsh Government on top of what they have at the moment. And if they were allocated in the same way that we've seen so far, that would mean an additional £660 million for the Welsh Government. But the Welsh Government, of course, can't bank on that funding, because unlike the case so far this year with the guaranteed funding, we don't have that so far for next year. So, it can't bank on that funding.

Finally and briefly, thirdly, the pandemic is obviously meaning that budgetary flexibilities are going to be incredibly important. Last week, the finance Minister mentioned that she was expecting a letter from the Treasury regarding whether they can carry over this year's funding into next year's funding. If that is the case, that will make a huge impact on next year. Obviously, we would very much support that.

Yes, those are three key considerations, absolutely. David, anything to add to those?

Not really; I think Ed said a lot there, and I would agree with and echo his comments. I agree that the core budgets continue the trend, but it's far from a normal budget, just because of the degree of uncertainty that is faced, both in terms of the level of the budget and how the Welsh Government will end up needing to spend that. Looking ahead, will the biggest pressures be on exactly the same areas in the coming year, or will we see different pressures emerging? So, for example, will we see some of the longer term pressures, from mental health issues, longer term health conditions, from child safeguarding and things like that—will those pressures start to emerge? That will need a different type of allocation of funding than in this year.

Yes, absolutely. Okay. Thank you. Thank you so much for that. Rhianon, then, we'll come to you.

Thank you very much, Chair. Very interesting. In regard to the questions that I have, both Wales Fiscal Analysis and the Institute for Fiscal Studies noted reductions of around £10 billion in 2021-22 in day-to-day spending within the spending review. So, when compared to previous announcements, what are the short and long-term implications of this on the Welsh Government's budget?

Can I come in on that one first?

Yes, sure.

The first thing I'd note is that while £10 billion has been taken out of the core budget in cash terms, the real-terms reduction is a little bit smaller. Inflation is a little bit lower than they thought it was going to be. Also, the budget is still increasing in cash terms and real terms, but over the two years from 2020-21 and 2021-22, real-terms budgets are going up 4 per cent a year—in real terms each year. But, of course, it still is less money than was initially planned to be spent in this year. I think the difficult thing in saying, 'What is the implication for the Welsh Government?' per se is that this was the first time we actually had departmental allocations of that money. So, we don't know where this £10 billion was otherwise going to be spent. If we hadn't had this, we don't know how much extra the Welsh Government would have got. We know about £4 billion of the £10 billion comes from overseas aid. We don't know where the other £6 billion would have been spent had it not been cut from the budget. Now, if we assume that—[Interruption.]

Sorry, I think Mark still has his microphone on. You carry on, David. You carry on.

I was going to say I think if we assume that, say, half of this actually would have been Barnettable, that means about £150 million less for the Welsh Government. If about two thirds had been Barnettable, that's about £200 million less. 

Guto wants to come in here as well. Guto.

From what I can see, it hasn't made a huge difference for next year. It perhaps would have been a greater increase in the core budget had that cut not been made, but I think especially over 2022-23 and 2023-24, I think it's then that you will start to see it bite. If you look at the projected size of the Welsh budget over the next three years, pretty much all of the growth comes from NHS increases and school spending and increases in England. Everything else doesn't grow at all, even in nominal terms. So, that means that the consequentials passed on, if the Welsh Government passes on those consequentials to healthcare in Wales—that potentially means austerity for other areas of the budget. On top of that, the Chancellor's current plans also assume no COVID-related pressures after next year, and that we go back to pre-COVID health, NHS and school spending in England, which, given the obvious increasing demands, probably looks quite unrealistic. So, although it perhaps hasn't bitten this year for 2021-22, it certainly might have an effect in later years, unless the UK Government changes its plans.

So, to summarise—and please stop me if this is incorrect—you're saying that, with regard to the £10 billion reduction, we are £200 million, approximately, worse off, but then there are the unquantifiable known impacts that there are going to be in terms of COVID, which, currently, we don't have mitigation for in terms of next year. Is that fair, or was that too simplistic?

On the first point about how much less the Welsh Government has, we don't know for sure, because we don't know how that money would've been allocated. Once we take off the money for aid, two thirds of the remainder would've been Barnettable, so spent on things like health and education and so on and so forth. It's about £200 million if that was the case, but we don't know for certain, because they never set out departmental plans beforehand.

Okay. So, the best guess. Right. Thank you. That's interesting. My next question is around capital funding. The Minister for finance has suggested that the capital funding announced at the spending review does actually put a limit on what the Welsh Government can achieve. So, how important might capital and the infrastructure it funds be to economic recovery? Obviously, it sounds a bit of a leading question, but what is your view with regard to the impact of capital spend on economic growth?

I’m very happy to be led there, because it’s very important—there are no words put in my mouth on that. I mean, going back to Keynes, of course, economists have recognised the need for fiscal stimulus and capital funding in jump-starting recoveries, and particularly now, given record low interest rates, it means that borrowing levels are much more sustainable. Just recently, the OECD very strongly warned Governments not to repeat the mistakes of 2010, when capital spending was cut back prematurely at the start of the last decade. So, this is clearly going to be important in the context of the recovery, particularly—and we might come on to this later—in the pressures on the NHS. Right now, we’re quite rightly focused particularly on the COVID-related pressures, but there are going to be non-COVID-related pressures as those delayed referrals and consultations come online after COVID. The idea that we can just go back to normal on healthcare spending is just not really a reality, so capital is going to be needed across the board. We do have a cut in the capital budget down here, and instead we have seen more of a focus on the UK Government infrastructure projects, with the Welsh Government not really knowing the size of its capital block grant, particularly because we’ve only had a one-year spending review. So, these long-term time horizons, which are obviously important in capital budgeting, we just don’t have at the moment.

Thank you. That’s very clear in terms of—

David wanted to come in as well.

I was going to say, I think well-spent capital investment can provide not just a boost to demand—so, it puts money into businesses and hence their workers’ pay packets and businesses and shops and so on and so forth—but it is, of course, a boost to the supply side of the economy, by improving the quality or ease of private and public sector activity. But, to get this double dividend, I think it’s really important to spend it wisely. There are two implications from that. Firstly, as Ed was saying, when there’s a lack of a time horizon to plan projects, that means it is more likely that spending will be, if you like, less wise or less well planned, or even just less deliverable. What we’ve seen sometimes in the past, when there have been large increases in capital spending announced, is that if that comes with too short a lag, it doesn’t get spent. Traditionally, Governments at UK level and Welsh Government level have underspent their capital budgets, especially when they’ve gone up a lot. So, I think that means planning in advance, avoiding overly large and rapid surges, and also, I think, maybe focusing on not necessarily always the big, shiny projects. If the focus is on boosting demand and getting money out quickly, it’s better to focus on smaller shovel-ready projects, including backlogs of maintenance and things like that that can have a sort of immediate impact and more of the money stays in the local economy rather than leaking out in big capital goods.

Okay, thank you. And just very briefly, in regard to the current Treasury assumption of a post-COVID world that has wider impacts in terms of the current financial spend that we think we have, how much of a risk is that, bearing in mind the numbers and scale of different impacts that this may have across the piste, whether it's health impacts, well-being, or in terms of even the capital spend that we're talking about or lack of?

So, in terms of the long-term OBR projections, the OBR settled forecast is that the economy will be about 3 per cent smaller in real terms than it previously was forecasting, and that's because of the sort of scarring effect of the COVID-19 crisis; that industries will shrink; some people will lose their jobs, and it will take time for them to find new jobs and for new businesses to grow. That's really uncertain, so the OBR has an upside scenario where there's no hit, and a downside scenario where there's a 6 per cent hit.

But all of this is actually on the economic side. I think what you're asking about there is 'What about the spending pressure side as well?' And I think that we do know from past economic crises that economic crises are associated with an increase in long-term health conditions, particularly mental health conditions, and that will potentially require investment. And, of course, this wasn't just a normal economic crisis; it was a unique crisis, not just the economic crisis, but a social crisis and a health crisis as well. So, I think there could be upward pressures on a range of areas, not just health but social care services, housing services, public health services. Quantifying that is difficult at this stage, but I wouldn't be surprised if we do see not just the revenue side affected in the long-term, but also the spending need side. 

Okay. Thank you for addressing that. 

And, finally, the spending review details changes, as you've stated previously in previous committees, to comparability factors for Wales. So, to what extent are these felt, in your view, in the 2021-22 draft budget?

Can we come to Guto or Ed first on that?

Yes, I can take that. The largest change was in the Department for Transport's comparability factor, as you probably know, due to high speed 2 line growing as a share of the overall Department for Transport's budget, and Network Rail being included in the Department for Transport's departmental expenditure line budget for the first time. On our calculations, if you used an alternative way of calculating comparability factors, which we think would be a reasonable way of doing it, if HS2 was treated as an England-only project, and if Network Rail was taken outside of the Barnett formula, as is the case in Scotland, it doesn't really make a huge difference for next year's budget, but if, in future years, the Department for Transport's budget grows, then Wales gets a smaller share of the additional consequentials. So, we think, for the next five years, that could mean around £500 million fewer consequentials being passed on to the Welsh budget in aggregate over that time period compared to an alternative way of calculating. 

Of course, the Treasury would probably see that as fair because we did get—. It's essentially off-setting consequentials that we did get from a general rise in the Department for Transport's budget due to HS2 over the recent years. It wasn't a full share, but we did get a certain share of that increase in the Department for Transport's budget, but now Wales will be losing out essentially on non-HS2 budget growth over the next decade. And I don't think it would be a problem or it would be an issue if Wales was getting a fair population based share of reserved transport spending, but I think analysis from the Welsh Government, and people like Professor Mark Barry, has shown pretty comprehensively that that isn't the case. So, we're losing out on our share of reserved spending, and now we're losing out on what is devolved and consequentials as well.

That's basically a double-whammy. And how is that being addressed in your—. I don't know whether you can answer that, but in regard to the conversations that are ongoing, I presume. I'll ask that to the Ministers at a different point. Thank you, Chair. 

Thank you very much. David, yes, sorry.

I was going to say I have a slightly different interpretation of this, and I think it kind of relates to the formal devolution point. So, based on the formal devolution, I think what has happened with the Barnett formula is largely appropriate. So, I think the question is about: do the Welsh Government and the Welsh Parliament, the Senedd, think that the existing devolution arrangements for rail devolution—do they think they're appropriate? So, I don't think the Treasury is abusing the rules, it’s just, 'Are the rules appropriate for devolution?' I guess would be my respective. Broadly though—because I think there is one area of rail infrastructure that is devolved to the Welsh Government, which is the Valleys lines—I think there could therefore be a question about the extent to which should there be some, at least, comparability for rail infrastructure spending that goes for that part that is devolved to Wales. So, I think the raw picture, from my sense, is that if you agree with the devolution settlement, then the rules are being followed, apart from this, potentially, one area, where I think it's more arguable, on the Valleys lines.

Okay. And I won't ask you then about the Scottish position, because I don't think we've got time, but I think that's worth us looking into.  

Yes. I think, to your fundamental question, most of us could give you a one-word answer, but we won't do that now. Alun Davies then. Alun next.

I actually don't disagree with Mr Phillips's point of view there, but the question is, of course, political decision making over budget allocations and over the settlement itself, rather than the structural allocation. But in terms of where we are, the OBR forecasts that we discussed earlier this morning were quite interesting, quite fascinating in some ways, because—. I don't know if you saw the session, but both representatives used the word 'uncertainties' in answer to almost every question, but their forecasts were remarkably consistent. Remarkably consistent. If you look back over their historical data and their look ahead—their focus—then you will see the same lines on the same graphs going in the same way in largely the same order, and it appears to me that this longer term issue you have, and I'm talking about tax revenues here, there's a real crisis building up in terms of where Wales is, in terms of its ability to fund its ambitions.

And it appears to me that the Welsh Government budget—both the draft budget we're debating at the moment and the budget last year, and I've no doubt the budget next year—don't really address these fundamentals at all. They're very marginal events unless you're going to significantly make change, and I'd be interested to hear your views on that. The long-term trends of reduced tax take from a smaller proportion of the population over a period of time leads to a smaller ability of the Welsh Government to meet its budget ambitions. Is that your reading of it? And do you believe that either this draft budget, or any other budget you've seen for that matter, actually addresses these more fundamental issues?

If I can start there. Obviously, when you're in a situation of fiscal devolution, you want there to be a healthy tax base, a strong working economy, growth in those key resources for your budget. I think, at the moment, given where we are, in terms of public spending and the economy, it's just keeping our heads above water for the moment, because right now our favourite topic of the fiscal framework is kicking in in a way that is quite helpful to the Welsh budgetary position. So, you're exactly right that we've had a big reduction in the forecast tax receipt, particularly in income tax, but that's almost entirely offset by a smaller reduction to the Welsh block grant. So, from a budgetary perspective, it's a relatively low priority. But, obviously, from the longer term economic perspective, I share your concern about what this means for the economy. We know unemployment is extremely high at the moment. That's going to take a long time to work out a system, and a lot of effort in areas that are within Welsh Government competence, in the economic development portfolio. So, these are real questions of economic growth. On the budgetary side, I think it's less high priority on the list right now in the middle of the pandemic, but medium term, it's definitely an issue.

And if I may come in there as well. One thing I'd actually refer to is the great report that Ed and Guto did a couple of years ago now, looking at the risks and opportunities with the Welsh tax base and looking at the risks associated with a more rapidly ageing population, which were there, but, actually, maybe not quite as significant as people expected, given that, actually, older adults, just before retirement age, often have the highest income tax receipts. And pensioners have been getting richer, relative to the rest of the population.

The big challenge, I think, on the tax base, is productivity and how to raise productivity up to the UK-wide level. And, if I could, I'd link that back to some of the challenges in the next couple of years, because when we look to recovery from the COVID crisis, we have seen a short-term fall in income tax revenues, but, as Ed said, the thing that was protecting the Welsh Government's budget from that impact—. If we saw a strong recovery, and that recovery in Wales broadly kept pace with the rest of the UK, well, the budgetary impact wouldn't be that significant and we wouldn't have the long-term economic problems that would result from it. But I think what will really affect the extent to which the Welsh economy recovers and how it compares to the rest of the UK is how good policy is at supporting and enabling the sort of changes we'll need to the economy to deal with recovery. So, the types of jobs that will replace some of those that are lost might differ, might require different skills, might be even in different places. So, thinking about active labour market policies, policies to support areas that are struggling to recover from the crisis, policies to improve education and retraining and so on and so forth, I think they're going to be really important for the recovery from the crisis and not just Welsh people's livelihoods. But then, to some extent, if this goes better or worse in Wales than elsewhere, the Welsh Government's budget.

And does the budget do that?

I think, at this stage, it's too early to say whether the budget would do this or not. I think what one would want to look at is how the Government might be spending some of the additional COVID funding coming through, so what—[Inaudible.]—has been used to not just deal with the impacts of COVID, but, actually, also set up areas for recovery. But we might, I guess, see more of that when this £800 million is allocated across departments and, potentially, further amounts, if some of the £21 billion of UK-wide reserve is allocated.

Okay. But to pursue where we are with the pandemic, I think you were saying that household spending in Wales had recovered in November to pre-pandemic levels. I was surprised, frankly, to see that; that's not where I would have put things. Certainly, we did have a lockdown for the first week of November, and my feeling was, at the time, that the economy was open, largely. People were still watching their box sets rather than spending, and I was surprised to see that. I was wondering if you could provide some background to that. And then, that's going to be impacted now by what's happened since, obviously. But are there any implications of policy as a consequence of that?

Yes. So, I think the first thing I'd say is that whilst—. So, this is part of a broader study that colleagues of mine—and I was a bit involved in—looking at what has happened to consumer spending during the course of the pandemic, and what we found is that, in the first lockdown, there was a very large fall in spending. There was a recovery during the summer, and then the second lockdowns were not associated with such a large fall. And, actually, because Wales exited the second lockdown in November, Wales was the one area where spending, at that point, was broadly in line, overall, with the pre-pandemic level. But I think it's really important to say that the composition of spending was quite different. So, what we've seen is quite a large reduction, obviously, in spending on hospitality—pubs, bars, restaurants—even during that period when you saw the full bars and pubs in Cardiff, and also a fall in spending at the physical retailers on the high street, but a big substantial increase in spending with online retailers and also online service providers and online deliveries, like Deliveroo and Just Eat and so on and so forth. So, I think, whilst the fact that people were better able to take advantage of the opportunities to substitute spending meant that the overall economy and consumers were able to respond better to the second lockdown and the subsequent exit from that, the impact on local economies was still pretty significant. So, I think I would say it's a nuanced picture. We think consumer spending has held up much better in subsequent lockdowns, but a lot of that is not going into the local economy, it's going into these online retailers, online service providers, rather than being spent in local shops, local bars, local restaurants and so on.

That's fascinating; I'm grateful to you for that. So, the lesson, potentially, looking ahead now into the spring, is that we could anticipate a significant bounce-back of spending when we come out of the current restrictions, but that that spending will continue to be a very different sort of spending, different patterns of expenditure than, perhaps, we would have anticipated a year or 18 months ago. So, essentially, what COVID does, if you follow this thinking, is to lead to a revolution, if you like, in changes to spending patterns that were taking place anyway, but that have been turbocharged by the policy responses to the pandemic.

Well, I think that at this stage it's unclear about the extent to which all of the trends will persist. I think we would expect it—

[Inaudible.]

We would have accelerated—. We would have expected it to accelerate some of the trends that were already there towards online shopping and homeworking. The final quantitative extent to which it has accelerated them is the bit that's uncertain, but the fact that it will accelerate them to some extent, I think, is less uncertain.

I think you might see different impacts on different sectors. So, at least during the lockdown period, and even after lockdown, it's the hospitality sector that saw the biggest fall—bigger than physical retail. But, in the recovery, you might think that more of the retail can stay online, whereas people will still want to go out to bars and restaurants, and you might see a flip around between the physical retail and the hospitality sector as things go back to normal in terms of the long-run impacts.

Thank you very much.

Okay, thank you. We're over halfway time wise, but we're not quite halfway through in terms of Members wanting to ask questions. So, we'll go to Mark next for some questions, and then we'll come to Siân and others who I know want to pursue specifics within the draft budget. So, Mark, if you want to ask your questions.

The committee's previously heard about some issues raised by the Barnett formula through the pandemic, however, the UK Government's delivered a number of funding guarantees outside of the formula. What's your assessment of the change in this process and the potential implications of it going forward?

Ed, do you want to kick off?

From our perspective, it's extremely welcome news that we've moved away from the system of having to wait for allocations to be made for English spending before consequentials are confirmed for Wales. We go back just as recently as July when there was massive uncertainty about the extent to which policies announced at the summer economic update would be additional, and this has really provided welcome certainty. It's now £5.2 billion after that recent increase and it gives much more certainty around the fiscal fire-power, if you will, of the Welsh Government, and how it's going to be able to respond to the crisis and make it easy to assess its ability to support individuals, businesses and public services in the way that we've talked about so far. So, that's been a huge advantage and we'd like to see that continue.

I think, on the flipside, there's been a lack of transparency around the UK Government's spending plans, particularly how much of the funding guarantee has already been triggered by allocations in England in the usual way, and also the extent to which UK Government allocations have been UK-wide spending or England-only spending—things like the test and trace programme will come under this category. So, that's made it a little bit difficult to assess the likelihood of the funding guarantee increasing before the end of the financial year, and difficult to match up allocations made by the Welsh Government relative to the UK Government for England, like the extent of support for businesses and so on. I think we'll get a much clearer perspective about transparency in the allocations after the supplementary estimates this month, but in general, it's something to really have been welcomed.

I would echo that. I would echo the point that it's provided a lot more certainty and made it easier to plan this year for the Welsh Government. I would also echo the issues around transparency, both how the Barnett allocations compare to the guarantee levels at the UK level and how the Welsh Government spending compares to the guarantee. I would, however, say that I think that the guarantee, if you like, is a bit of a sticking plaster; it doesn't really address some of the longer term issues with the Welsh Government's budget position. So, I think it's a sticking plaster for two reasons. Why? Firstly, because giving such a guarantee every year could actually end up being unfair on England, because what it would mean is that the Welsh, Scottish and Northern Irish Governments would be guaranteed at least as much extra spending as in England, but potentially more extra spending if the guarantee was above what they should get by the Barnett formula. So, I don't see that as being, potentially, a fair long-term policy to put in place. So, I think if more certainty or more flexibility for the Welsh Government is required, going back to the fiscal framework rules would be a better place for the long term.

I also think there's potential for some sort of uncertainties or confusion around the application of the rule. We've seen this in Scotland a little bit, where there were complaints that the Scottish Government didn't get any funding as a result of the announcements, I think it was last week now, for the extra business rates grants in England. But, of course, that's because that was still subsumed within the guarantee element. So, I think there's still room to improve the clarity of communication and transparency, and also we need to think about, actually, what kind of policy is this for the long term, because in the long term, I think it's less of a good policy.

I think Ed wants to come back as well—

Just very, very quickly. I think just on David's last point, I understand the point about that potential unfairness, but this is a real minimum level of flexibility compared with the UK Government's ability to raise revenues whenever it wants through debt management. This is just providing a very minimum level of flexibility to the Welsh Government, so I wouldn't be—just a point raised by David there.

Can I quickly ask you about the EU trade deal? Clearly, the draft budget was published in advance of that. Are there any particular areas where you'd expect to see changes for the final budget, given the trade deal now?

From my perspective, it depends what would be reserved versus devolved spending, so there are clearly going to be impacts. As you mentioned, the trade deal was still being negotiated at the time of the draft budget, so there are going to be changes. I think there are particular concerns about Holyhead, Fishguard and areas that are affected disproportionately by the trade deal, but whether or not that's devolved or reserved spending, I think, is a question for the Government.

Okay, thank you. Right, we'll move on to Siân then. Diolch.

Thank you, Siân. Yes, I'd expect the sort of issues you've raised in England to be issues for Welsh local authorities as well, although probably to a somewhat lesser extent in Wales than in England, as my understanding is that Welsh local authorities rely less on sales, fees and charges income, and less on commercial income and investment income in particular, to help fund their budgets. And it's also very clear from England as well that these income streams vary massively in their importance to different types of local authorities, and you can see neighbouring authorities where one relies on income from parking for 1 per cent of its budget and another relies on it for 15 per cent of its budget. I'd again expect there to be different impacts across Wales, although, again, probably not quite to the extent we see in England, where we have seen some authorities adopt very different sorts of strategies to income raising.

I wouldn't say that the gyms and the parking are the main income areas where I'd expect to see losses going forward. I mean, there were two that we looked at in that one particular report, but I think probably bigger issues for local government will be what continuing public health restrictions there are and how that will affect the wider economy, and that will affect business rates revenues and council tax revenues. In the coming year, it's not just the impact of council tax revenues in the coming year, but the way the accounting system works is that the impacts on council tax so far don't get reflected in councils' main budgets until 2021-22. They're currently held on what's called a 'collection account', a separate account. So, councils will have to deal with the losses of income from council tax in the current year, next year and onwards. Pension costs could potentially go up in future if the economic crisis hits investment returns, and, as was mentioned in an earlier answer, a range of services will see an increase in their demand—social care services, housing services, due to the long-run effects. So, I'd expect there to be a whole range of issues—parking and gyms being a small part of it—and a whole range of income pressures and cost-side pressures for local government.

[Inaudible.]—I'm afraid, sorry.

I have a question I'm sure David can answer. The Government have borrowed record amounts, but they've borrowed it at very low interest rates, and we know that, every 50 years, the tax take of the country, of Britain, increases by about 20 times. Are you as relaxed as I am about the borrowing?

I would say that, at the moment, interest rates are very low, so the average interest rate paid on new borrowing in 2020 was about 0.3 per cent. That compares to about 1.9 per cent in 2015, which was already at historically low levels. So, borrowing is cheap, and if you're going to focus on existing rates of interest, one would say that, actually, yes, we've got scope to borrow, we can use that borrowing to boost the Government recovery and even potentially as a long-term part of policy. But I don't think that is a risk-free option, because at the same time as the rates are much lower, and the cost, given the current rates, is much lower, exposure to interest rate rises has increased substantially. That's not just because the level of debt has gone up a lot, it's also because a large fraction of that debt is now effectively, via the quantitative easing programme, financed by the Bank of England base rate. Each 1 per cent increase in the Bank of England base rate increases the debt interest payments by Government substantially more than it would in the past, by about £9 billion, £10 billion a year.

So, on the one hand borrowing is cheap. The risk would be if we did see an increase in interest rates to more normal levels over the next few years without a concurrent increase in the rate of economic growth, because historically, when interest rates have gone up, it's been associated with growth also going up. The risk would be if we had a stagflation situation where we had to have interest rate rises but we didn't have the economic growth, we didn’t get the productivity growth returning. That's the risk of higher borrowing. I think, actually, if we borrow and we're at a supply constraint in the economy and the borrowing is pushing against that, well that can be what stokes inflation, and then that pushes up the need for higher interest rates. It looks cheap and it looks like a good deal, but we do need to bear in mind the risks that come from borrowing as well.

I don't disagree with anything you've said there, though I think inflation is very low down our economic risks at the moment as things are, so I think that we're more likely to have deflation rather than inflation, but that's just a personal view, and I won't ask you to comment on that.

The other question I've got I think is for Guto, because you said that increasing income tax is a more progressive approach to tax collection than rises in council tax. It goes against everything I think I know. Income tax is easily avoided by either becoming non-dom or by, more likely, being paid by dividend rather than by tax. To me, income tax—. You never hear the rich complain about income tax, because they have so many ways of not paying it and they don't really care about it. Whereas council tax has got faults—one of them is we haven't got enough higher level—. I've had arguments with people here at this meeting over it in the past, but in general council tax does tend to be less unfair because people in the bigger houses tend to have the most money.

David has done work on modelling the impact of council tax across the income distribution as well. Because of the higher personal allowance, broadly, raising income tax is progressive because it takes a higher share of income away from richer people. I think that's what the evidence suggests. Obviously, at a very, very high income, we don't really have data on the very highest income earners, and there's not an awful lot of them in Wales anyway. But council tax as a share of people's income is broadly flat if not decreasing as you go higher up the income distribution. I think the evidence points towards income tax being a more progressive way of raising tax, and that's what our argument has been—we've probably mentioned it before—that, going forward over the next few years, if we put the tax-raising burden on council tax, that's a less progressive way than raising income tax and then funding public services so that councils can avoid raising council tax, or indeed you go ahead and reform council tax and make it even fairer. David has done more work on council tax in Wales, but that certainly should be another action issue going forward over the next few months—what you do with the income tax powers and how you balance that against local taxation as well.

Okay. Very, very briefly, then, because we have a few minutes left, and I know Nick has some questions he wishes to ask.

I thought David wanted to respond—

Yes, sorry, David. I saw you nodding. 

—about income tax being so easily avoided. 

I was going to say I think I would agree with what Guto said. Given the current tax structures, there's no doubt that raising income tax is more progressive than raising council tax, notwithstanding this issue you make that there is tax avoidance with income tax. It's largely through the self-employed and those that take their incomes in more complex forms, some of whom are at the top of the distribution; some actually are quite low down in the distribution. Following on from what Guto was saying, I don't think we should necessarily be thinking about the current tax structures as being fixed. Wales does now have income tax and property taxes devolved, and it can come up with a fairer, more efficient and less easily avoided way of taxation. It might mean less reliance on income tax for productivity and actually making the council tax more progressive, more up to date, and so on and so forth.

David, can we engage in this discussion outside this meeting? 

Yes. [Laughter.] But it is very interesting and, of course, there is a lot that could be done. 

Yes.

Thank you.

Thank you very much. Okay, thank you, Mike. We move on to Nick, then, for the final few questions. 

Diolch, Cadeirydd. The first question I was going to ask, about the OBR estimates for devolved taxes, I think David and Gareth covered that earlier, actually, so I think we can leave that. So, moving on to land transaction tax and the changes that are being proposed to that in this budget, do you have any thoughts about that and the possible effects on revenue and the housing market? Who'd want to take that? Ed.

Yes, I can take it.

Guto.

The additional properties being bought is a particular concern in a lot of local authorities in Wales, and it does have a slightly different impact across different local authorities. If you look at Gwynedd, two fifths of residential transactions are now additional properties being bought. There has been a marked increase in the proportion of higher rate residential transactions in recent months. Once the repayments are made, that might come down, but there's certainly been an increase in the proportion of transactions being made up by higher rate transactions. 

So, I think it is probably a good objective, a good target for the Welsh Government to intervene. It does raise quite a lot of additional funding. I haven't looked in detail in terms of what elasticities the OBR are assuming in that, but it doesn't appear that it was impacting the number of transactions taking place that much. So, if the aim is to limit and reduce the transactions rather than to raise additional revenue, it might not be doing that, and you'd have to increase tax rates by greater numbers to have any real impact on the additional properties.

And probably, on a general point, if ensuring sufficient housing stock for local people in certain areas is the objective, I think that a recurring property tax might be—. The council tax premiums that we've seen in some local authorities in Wales is probably a more effective way of influencing the housing market. 

Nick. We have to move on, sorry. Last question.

Okay. Well, if I can ask the last one and roll it into a slightly broader question about something raised earlier, first of all, the reconciliations for WRIT cannot be made until outturn information is available around 15 months after the end of the financial year. So, to what extent are the implications of the pandemic for Welsh taxes likely to be felt in future years? And if, very finally, Chair, I can ask—. Earlier, I think David Phillips was talking about the Welsh budget and I know there were questions about spending implications and the support available for different parts of the economy affected by the pandemic. Of course, the Welsh Government's objective is to build back better and build back greener, as they keep saying, so, perhaps, should we be looking at the budget and rather than seeing how it's been supporting the older types of sectors of the economy, seeing to what extent it would give us a way forward to supporting potential future areas of expansion? And do you think that the current budget is at least looking in that direction? 

We haven't got 10 minutes to answer but, certainly, Ed, if you want to go first and then I'll ask David to conclude then.

I can take the first question; maybe David the second. Just briefly, as you mentioned, the reconciliation process is not a matter of very great concern in the here and now. We know, in Scotland, there has been an issue with a lower than forecast income tax receipt requiring reconciliation, but the level of risk in the Welsh fiscal framework is a lot lower, as we know. The negative effect of devolved taxes right now is about £35 million, but that's offset a little bit by increases in land transaction tax and landfill disposals tax, so we're talking at the moment of a relatively small amount. The big point here is that that is completely offset by the needs-based adjustment in the Barnett formula. This past year alone, that's delivered £248 million to the budget. So, the question of income tax is really small change at the moment, particularly when we're dealing with the pandemic. At the moment, it wouldn't be high on the priorities list. The one thing it does do is—the smaller the total income tax receipt, the less useful income tax changes are as a tool in the budget. We're up to about £20 million less for each penny decrease in the income tax right now, so as a policy tool it becomes slightly less useful, but from a budget management perspective there is little concern right now.

Thank you. And the final word to David.

Thanks, Ed, for giving me the hard part of that question. [Laughter.] I was going to say, I think—. I'm not sure I can answer the question in full, but I would make two points.

The first is—and I made this point previously in the Scottish Parliament—that, I think, when looking to policy on business support, a very careful balancing act has to be made between supporting viable businesses and not holding the economy in aspic and preventing the reallocation of workers and capital to areas that might be more suited for the future. What that means is that, hopefully, if the virus starts to abate and we see a resumption of normal life during the summer of this year, we'd want to see a move away from just supporting existing businesses to continue going on, through to, actually, can we allocate some of this business support money to supporting businesses that could have opportunities to grow but are currently finding it difficult to access capital, for example, because of constraints and bad debts that have arisen during the crisis. That's the first point I would make.

Secondly, I think I would say, in terms of looking at the budget, the important thing to look at would be is there a plan in place to identify—. It's very difficult for Governments to pick winning firms or even winning sectors, but is there a flexible approach laid out there for business support that could respond rapidly as we see where the land lies in six months or 12 months or 18 months, and what the long-term effects of the pandemic are? Or are these plans too rigid and too much based on long-term sectoral things that actually might turn out to be not flexible enough, if the opportunities for growth do change in this new world?