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Scotland’s independence referendum is fuelling controversy about one of the UK’s thorniest issues – the share-out of public spending between England, Scotland, Wales and Northern Ireland.

It is governed by the 35-year-old Barnett formula, which has failed to close a gap whereby Scotland gets £1,623, or 19 per cent, more identifiable public expenditure per head than England.

Critics complain that it has enabled Scotland to adopt policies such as free social care for the elderly and free student tuition that have not been affordable in England.

Politicians and business leaders south of the border warn that the referendum will feed demands for financial devolution within England, even if the Scots vote No to independence.

“The Barnett formula is an anachronism and needs to be radically reformed,” Ross Smith, policy director at the North East Chamber of Commerce, the English region closest to Scotland, told the Financial Times.

All the main Westminster parties have pledged to give extra powers to Scotland if it votes to stay in the UK, including control of income tax, whereby the Scottish government would raise about 40 per cent of its £30bn annual budget.

Under Labour and Tory plans, Barnett would remain in reduced form to determine annual changes in the remaining block grant from Whitehall – defying calls in England and Wales for the formula to be scrapped.

But Scottish nationalists warn that pressure from England and Wales is likely to result in the formula being changed or scrapped – to Scotland’s financial cost – unless their country votes for independence.

Mr Smith said: “If Scotland is going to have the freedom to flex policy to its own circumstances, then it’s got to have the risk that goes with that and be more responsible for raising its own finances in a way that is fair to other parts of the UK.”

Dave Sparks, chairman of the Local Government Association and Labour leader of Dudley council in the West Midlands, said the Scottish plans were a devolution “time bomb” and that demands for financial autonomy in England would “fester” unless dealt with. The LGA says the system means England loses out by £4.1bn a year. It is due to put forward proposals for replacing Barnett with a system based on social need after the September 18 referendum.

The formula was devised by Lord (Joel) Barnett, Labour Treasury chief secretary, in the late 1970s. It allocates changes in UK departmental spending programmes to the devolved nations according to their share of population.

According to Treasury figures, Scotland’s identifiable public spending per head was £10,152 in 2012-13. That amounted to 116 per cent of the UK average compared with 97 per cent for England, 110 per cent for Wales and 124 per cent for Northern Ireland.

The gap has narrowed only slightly since the 1970s. Commentators believe Scotland gets more than if spending were allocated by need, though the cost of serving a sparse population is a factor. Nationalists say the higher spending is not a subsidy because it is balanced by Scotland’s North Sea oil and gas tax contribution.

There have been many calls for the formula, originally intended as a short-term measure, to be scrapped – no least from Lord Barnett, who wants it replaced with a needs-based system, taking account of factors such as levels of income, which are higher in much of Scotland than in many English regions.

Lord Barnett, now aged 90, said recently: “You can’t have major financial changes and continue with a formula that is not based on need.”

Philip Davies, Tory MP for Shipley, told the FT: “We can’t carry on with a system whereby largely English taxpayers’ money is used to prop up free tuition fees in Scotland, free prescriptions, free hospital car parking in Wales – all these things which aren’t able to be delivered in England.”

The Welsh government is also pressing for reform, believing a needs-based system would give it a bigger share. But some observers are sceptical about whether the pressure will be enough to convince the party leaderships.

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The beginnings of the Barnett formula

The history of the spending share-out dates back to efforts to keep Ireland, not Scotland, within the UK – ultimately unsuccessfully.

In 1888, George Goschen, chancellor in Lord Salisbury’s unionist government, introduced the Goschen formula or proportion. It allocated elements of spending to England and Wales, Scotland and Ireland in the proportions 80:11:9, relatively generous to Ireland, which generated little tax.

The system continued in a modified form for more than 70 years and became increasingly favourable to Scotland because it was not adjusted for its falling population.

Lord Barnett introduced the population-based formula that now bears his name in 1978 as part of the Labour government’s crackdown on spending. It was designed to replace piecemeal bargaining with ministers with a single annual settlement.

Some say the Treasury designed it to equalise per capita spending over time but Lord Barnett did not expect the formula to last “a year or even 20 minutes”. It has lasted 35 years because governments have shied from reform, fearing it would fuel Scottish nationalism.

In theory, population-linked increases should have closed the gap but it has narrowed only a little. In 1977, Scotland got 22 per cent more per head than England; now the figure is 19 per cent. One reason is that Tory governments gave Scotland extra money, such as for nurses’ pay; also, for several years, the formula was slow to reflect population changes. It has been applied more strictly since 1997, and the population share regularly updated, but still a gap persists.

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