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Do the hard economic facts pour cold water over the flames of Welsh independence?

Yes, it’s time for some hard facts. The debate on the strength or otherwise of the Welsh economy burst into life in 2016 with the publication of a report by Cardiff University’s Governance Centre.

This suggested Wales had a serious imbalance between taxation revenue and government spending amounting to some 24% of GDP. A careful look at the figures in the report make for interesting reading – things are simply not that bad.

The first step is this - quite simply, no country in the world pays its way, all countries run a deficit and borrow to balance the books. This requires realism in accepting that there will be in all likelihood a deficit and that the deficit will rise and fall as the economy grows or contracts.

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

Interestingly, illustrating the dynamic nature of budget deficits, Wales Governance Centre’s latest report to be published later this year, suggests a deficit of 17%

The dynamic nature of budget deficits is further illustrated with a look at the UK economy. At the end of 2010, the UK budget deficit was over £160bn representing 8% of GDP, at the beginning of the current financial year the deficit was £46bn with a target of £37bn by year end (though this has been revised downwards) and whatever the level, the gap is filled by borrowing.

The National Debt (that is the total of all borrowing) for the UK currently stands at £1.8 trillion, or 100% of GDP. The world’s richest nation – the United States – has a current budget deficit $779bn; its National Debt stands at an eye watering $22 trillion, compared with GDP in 2017 of $19 trillion, or 116% of GDP.

In summary, the original Cardiff University report suggests that there is a gap between taxation and spending of £13bn, representing 21% of GDP – part of the report suggests 24%.

This latter figure includes capital and although perhaps technically correct, we should be concerned here with current spending, which was the point of that report.

When such a bold and easily repeated figure such as “24% of GDP” is banded about, it must be remembered that when comparing two factors, the first thing is to be clear as to definitions.

The report choses to compare with GDP, it is important to note that this definition of a country’s economic wealth is in itself deficient. GDP is made up of final goods and services, it therefore follows that much of Wales’ economic activity is not counted.

(Image: Mirrorpix)

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

The university report is a bold attempt to picture government spending and taxation; it is not an analysis of economic activity or a calculation of Wales GDP.

The reality is that any examination of the Welsh economy suffers from a paucity of accurate and reliable data. Almost all economic data which would be of use is actually collected on a UK wide basis; it therefore follows that some form of best estimate is the only way forward. Indeed, this is clearly stated in the Cardiff report and is a brave attempt at de-composing the UK figures.

Aside from the difficulties of capturing data and the need to use estimates, three particular expenditure allocations make interesting reading.

A defence cost of £2bn is excessive and some 3% of GDP (more than any other country), incoming pensioners is a further cost of £2bn (this clearly is a cost to the UK [English] revenue) and there is a £3bn “accounting adjustment” – such a balancing figure is quite normal in such research, but this amount is excessive.

This in total amounts to some £7bn, which makes the difference between revenue and expenditure of approximately £6bn, or 10% of GDP, notwithstanding the definitional issues noted above. This deficit is of course still high and presents a challenge.

Staying with the report that started the current discussion, it is informative to look at differences in taxation; income tax accounts for 25% of revenue in the UK, only 19% in Wales while Corporation Tax accounts for 6% of revenue in the UK but just 4% in Wales – a reflection of the amount of external ownership of businesses active in Wales.

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

In addressing the deficit the first challenge is to improve the amount of revenue earned from existing taxes.

The poor position of income tax relative to the UK is a reflection of low levels of skill and consequent low levels of personal income.

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

The National Insurance threshold is significantly lower than for income tax and means many do not earn enough to reach the latter.

Recent research has suggested that anything from 40% to 53% of those in work do not earn enough to pay income tax. This, combined with a less than satisfactory contribution from income and corporation taxes is a damming indictment of past and present economic policy.

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

The first is the university report, although a reasonable estimate, it followed the approach of other research and was not actually based on businesses but on other proxies, such as population.

The second is that with the current amount of external business ownership, it is difficult to estimate the amount of VAT actually collected in Wales, but which for tax purposes is allocated to the business headquarters outside Wales. This is particularly important because VAT is a substantial source of tax revenue.

There are other possible sources of taxation that could be open to a Welsh Treasury. A detailed discussion is outside the context of this article; suffice to say that there are other possible sources of taxation. Take a few examples. For many years the potential revenue from water was at best a guess – even a joke - now there is hard evidence.

In its last annual accounts, Severn Trent reported revenue of £1.5bn and a profit just short of £1bn. Staying with utilities, Wales is a net exporter of electricity — one of only five countries in the whole world that does so.

(Image: Khrizmo/Getty Images)

Tourism is apparently worth £2bn to the economy and yet Wales must be the only country in the world with an active tourist industry but no tourist tax.

A land value tax is perhaps the most interesting and exciting; some estimates suggest that such a tax might raise some £6bn – this amount may be optimistic and some would accrue to local government, but provides an indication of how much such a tax might yield. The Welsh Government has commissioned a study on the potential of such a tax.

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

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

There would certainly be a market for Welsh Government bonds; bonds of all types and all countries are sought after and seen as safe investments because of their relative security, backed by sovereign countries.

As with all economic data, a word of caution. Without accurate Welsh based data any analysis of the Welsh economy must be treated with a degree of uncertainty, although the picture painted by the original Cardiff University report of a country in penury is quite clearly overstated.