IFS: Next Welsh Government faces a challenging funding outlook – but ‘needs-based’ funding could make things worse

After increasing by an average of 2.5% a year in real terms so far in the 2020s, the Welsh Government's funding for day-to-day (resource) spending is set to increase by an average of just 1.1% a year over the next three years. Funding for investment (capital) spending has increased by even more over the last few years but is now set to fall by an average of 1.3% a year.

In both cases, this more challenging funding outlook is driven by the UK government's decision to have lower growth in overall spending across the UK in coming years as it seeks to reduce a large budget deficit and stabilise debt levels. In the context of spending pressures in areas such as health, social care and special educational needs provision, it will mean whoever is in government in the next Senedd term will face difficult decisions on tax and spending. Indeed, without increases in revenues – whether through a boost to Welsh economic growth or increases in tax rates – and/or major improvements to public sector productivity, cuts to some services are highly likely to channel money to other services with growing spending needs. This is important context for any promises made during the election campaign.

It has been suggested that a move to a needs-based funding formula for allocating funding to the Welsh Government could help address these challenges. At least on the basis of currently available assessments of Wales's relative spending needs, such a move could in fact exacerbate the challenges. The 2010 Holtham Commission estimated Wales's spending needs per person were around 14% to 17% higher than those of England. We estimate that UK government funding for the Welsh Government was 25% higher per person in 2024–25 than the amount spent on comparable services per person in England. That is the equivalent of around £1.5 billion a year more than would be received if funding was instead 17% higher than in England.

These are among the key findings of the Institute for Fiscal Studies' first Welsh election briefing note, funded by the Nuffield Foundation.

The briefing note examines how and why Welsh Government funding has changed over time, and the outlook for the coming Senedd term, which will shape the tax and spending options available to the next Welsh Government. Further detail can be found later in this press release.

David Phillips, head of devolved and local government finance at the IFS and co-author of the report said:

‘After falling during the 2010s, the last six years have seen real-terms increases in Welsh Government funding, mostly as a result of increases in UK government funding. Yet UK government decisions now mean that growth in funding is set to slow over the next few years.

When seen alongside a range of pressures on the state, lower growth in funding  will mean whoever is in government after the next election will face difficult choices over taxes and spending on different services. Without an increase in revenues, or a major improvement in public sector productivity, cuts to some services are likely. This is important context when assessing the proposals the different parties put forwards. Reductions in some taxes or increases in spending on priority items are feasible but will require tough choices elsewhere in a Welsh budget that will already be under some strain.'

Martin Brogaard, Research Economist at the IFS and co-author of the report said:

‘The Welsh Government receives substantially more from the UK government per person than is spent on comparable services in England – around 25% more in 2024–25 according to our estimates. This is substantially higher than available estimates of Wales's relative spending needs.

But those estimates are based on data that are now almost 20 years old. The UK and Welsh (and ideally other devolved) governments should jointly commission a new independent assessment of the relative spending needs of the different nations of the UK. This would allow for a more informed debate about how much funding the Welsh Government and other devolved governments should receive. And better information on how funding compares to needs would help the electorate judge the performance of the Welsh Government.' 

Further detail on changes in Welsh Government funding over time:

• After falling during the 2010s, Welsh Government funding has increased since 2019–20 – for both resource and capital spending. On as close to a like-for-like basis as possible, resource funding in the current financial year, 2025–26, is set to be 16.3% higher in real terms than 2019–20, or 11.9% higher per person, after accounting for population growth.
• Higher funding since 2019 entirely reflects a £3.2 billion real-terms increase in UK government funding. Devolved business rates revenues have fallen in real terms (by £0.3 billion), but the net contribution of other devolved funding sources has increased (by £0.3 billion). The partial devolution of income tax is making a positive contribution to the Welsh Government's budget despite it keeping devolved income tax rates in line with those in England. This reflects the fact that the UK government's policy of freezing tax thresholds boosts revenues from each tax band by relatively more in Wales than in England.  
• On as close to a like-for-like basis as possible, capital funding has increased by 38% in real terms since 2019–20, again reflecting increases in UK government funding.
• The coming parliament is set to see a slowdown in funding growth for both resource and capital spending purposes. This funding slowdown will necessitate tough trade-offs between different spending areas and different investment projects. Restrictions on Welsh Government borrowing prevent it from borrowing more to offset this.

Further detail on funding relative to England

• After increasing during the 2010s, the relative funding advantage of Wales relative to England is now set to fall, with UK government funding for devolved Welsh services falling from around 25% above English levels in both 2019–20 and 2024–25, to around 21% above English levels by 2028–29 under current spending plans and population projections. That latter figure is still £0.9 billion higher than if funding per person was 17% higher than in England (the upper end of the Holtham Commission's relative needs estimates).
• The projected decline in Wales's funding advantage reflects something called the ‘Barnett squeeze': the population-based increments in funding under the Barnett formula are a smaller percentage increase in Wales (and Scotland) because funding starts from a higher level. This is true even accounting for the additional 5% top-ups to funding increments that the Welsh Government has received since 2018 as part of the Welsh fiscal framework agreement with the UK government in order to slow the squeeze.

ENDS

Notes to Editor

Recent changes and the future outlook for Welsh Government funding is an IFS report by Martin Brogaard and David Phillips.

This report is the first in a series of Welsh election briefings from the IFS funded by the Nuffield Foundation. Co-funding from the Economic and Social Research Council (ESRC) through the Centre for the Microeconomic Analysis of Public Policy is also gratefully acknowledged.