Budget Special 4: Wales should be able to cut the top rate of income tax

Gerald Holtham says the chance of persuading the UK Government to lower Welsh corporation tax is about as much as finding Elvis alive in Cwmbran

Cutting Corporation tax is in danger of becoming a policy idol in Wales. It is a potentially useful measure but far from flawless and probably inferior to other measures. It should be explored but the emphasis on it is becoming disproportionate.

Of course there is nothing to be said from a Welsh viewpoint against Madoc Batcup’s proposal that the UK government should itself set a lower corporation tax rate in those areas of the UK which have lower than average GVA. That would give Wales or parts of it a competitive advantage at no cost to the Welsh budget.  The catch is that the UK government would have to give up many hundreds of millions, possibly billions, of pounds of tax revenue with the prospect of losing still more if companies from the more prosperous parts of the UK relocated.  In the present fiscal climate that cannot be attractive.

Moreover, the regional disputes about who should qualify for what would be fearsome.  And this is a government that has not shown conspicuous objectivity or courage in such matters – witness its attitude to Barnett reform.

While Madoc is surely right that a case can be made for the proposal under European law, it is far from cut and dried. The government would have to argue, perhaps in court, with European partners who have been gunning for the low Irish rate of corporation tax for a long time. Weighing up the political advantages and drawbacks for the UK Government, I think you could get a pretty good price from Messrs William Hill or Paddy Power against it being tempted to follow this route. Not quite as good odds as finding Elvis alive in Cwmbran but going that way.

The Irish proposal explicitly assumes that the Northern Irish government would pay for the tax cut from its own budget via reduction in the block grant. Wales would surely have to do the same. It would have to accept devolution of the tax in order to be able to cut it.

So back in Dylan Jones Evans’ world of the hand-up not the hand-out, what could Wales expect from cutting corporation tax? The first thing to say is no-one knows for sure because there are different ways to impute corporation tax receipts to a particular area. Much would depend on the basis for allocating the tax. The Commission which I chaired on Welsh financing pointed out the central importance of using an appropriate formula. The UK government surely will not and should not allow companies to reduce their tax bill through the brass plate technique of moving their registered office while leaving all their productive activities where they are.

You can obtain estimates for Welsh corporation tax receipts at present anywhere between £650 million and over £1 billion a year. Halving the tax therefore stands to cost at least £300 million, probably nearer £400 million, compared with the £270 million estimated for Northern Ireland. That is the same order of magnitude as the shortfall of the Welsh block grant below what it might be if allocated on the basis of relative need.  Welsh politicians have made a fair old fuss about that £300-400 million. Would they be insouciant about writing off the same again in the hope of stimulating business?

Moreover as a revenue source the tax is highly cyclical. Accepting its devolution would involve accepting year to year volatility in Welsh budget receipts amounting to hundreds of millions of pounds. Those are the reasons that our Commission made proposals and recommended further discussion but stopped short of a full-on recommendation to devolve the tax. And the Calman Commission in Scotland rejected devolving it entirely. If Northern Ireland is allowed to cut corporation tax, it would be outrageous if Welsh politicians did not have the option of doing the same, using relative GVA as a criterion as the Commission proposed. Nonetheless it isn’t obvious whether doing so would be the best use of £400 million.

Dylan Jones-Evans points to a study saying a cut could create 16,000 jobs, which if true, would mean each job was being created at a cost of a good £25,000. There are lots of ways to create jobs if you are prepared to pay that much. But if reducing business taxes can make a more radical difference, the Welsh government already has an instrument to hand.  Business rates raise about £900 million a year in Wales. The government could declare allowances that effectively halved those rates.  It could do it now – and put intra-Wales regional differentials in too if it wished.  Somehow, it has not found the case so compelling.

And here’s a funny thing. Lots of people are relaxed about cutting corporation tax but if you suggest cutting the top rate of income tax they demur, finding it unfair or contrary to their preferences on income distribution. But ultimately what’s the difference? Few working class families own shares and draw dividends. High incomes are paid out of profits. Higher-rate income tax in Wales yields about £1.3 billion. Reducing the rates by 10p would cost less than £400 million, perhaps around £250 million. And it would affect not only executives in corporations but also small self-employed business people and those in partnerships. There is no reason to think it would have less effect than halving corporation tax in terms of attracting or stimulating business.

However, while the British government seems ready to devolve some income tax powers to Wales it shows no sign of agreeing to devolve powers to alter basic and higher rates differentially. So this idea too currently resides in the land of ‘if’.

The scope of the Welsh government to stimulate activity through tax incentives seems likely to remain limited or expensive. Meanwhile, we have to focus on the hard slog of raising educational levels and improving procurement to increase the efficiency of public investment. There is also scope to borrow for more investment, certainly through local authorities and conceivably using other vehicles.

Gerald Holtham chaired the Welsh Government's Independent Commission on Funding and Finance and is an IWA Trustee

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