Wales should depart from Scotland on taxation

Gerald Holtham argues that income tax powers should enable us to change higher and lower bands differentially

The Calman Commission report, now largely embodied in the Scotland Act, was a considered piece of work that received a good deal of unfair criticism in Scotland.  Much of the criticism was politically motivated and analytically inaccurate.

At its core were proposals for tax devolution, notably the sharing of the income tax base between the Scottish and the UK governments. That approach, based on Canadian practice, is sensible and many criticisms made of it were wide of the mark. However, I remain persuaded that the precise form of the income-tax sharing adopted in Scotland is not ideal and would not work at all well in Wales.  It is a great pity it was not amended in the Scotland Bill as some of us proposed to Scottish Parliamentary Committees. If Wales is to get some devolution of income tax, it must not be done the Scottish way.

Writing on ClickonWales on Monday Jim Gallagher, Secretary to the Calman Commission, claims that objections to the Calman proposals “have melted away”. Some may have melted but it would be more true to say that others have foundered on the rock of Treasury obstinacy and determination to concede as little as possible.

What is the issue? As Mr Gallagher says, the new Scottish rate of income tax will be a single rate levied on all taxable income. This has the grave drawback that any increase or reduction in the rate has the same effect on the marginal tax rate of lower and higher income-earners. The devolved government cannot alter the marginal rates of higher and lower tax payers differentially.

The justification given for that is “decisions about redistribution… lie at the UK level”. Whatever you think of the politics of that position, it is based on a misunderstanding. Take current rates of income tax at 20 and 40 per cent; the ratio between them, one measure of progressivity, is two. If the Scottish government raises “its” income tax by 2p, the rates will become 22 and 42 per cent, a ratio less than two, so progressivity is reduced.  Similarly a cut in the tax would increase progressivity on this measure. The attempt to reserve ‘redistribution’ to London is a vain one.

Yet the effects of altering the basic and higher tax bands are economically different so a devolved government should not be forced to yoke the changes together. In Wales, higher rate tax-payers contribute nearly one third of all income tax receipts while making up only about 13.5 per cent of all tax payers. The harsh truth is that Wales could hardly afford to raise income taxes on this group. If someone is making a million pounds a year, for example, they should be contributing nearly £400,000 a year to the inland revenue. If Wales raises its income tax by 2p that would cost such wealthy tax payers another £20,000 a year. If they live in Abergavenny or Hawarden, it is easy to move to Ross on Wye or Chester.

There are only about 700 tax-payers in Wales earning £500,000 or more each year. It takes just 100 of them to move to cancel the revenue effects of an increase in higher rate tax and turn it negative. And we don’t know the numbers of English residents who would be deterred from moving in.

Some 90 per cent of the Welsh population live within 50 miles of the English border, while nearly 14 million people live within 50 miles of the border in England. Every day 100,000 people commute across that border to work one way or the other. The scope for tax avoidance if the Welsh higher income tax rate differs from the English is enormous. Raising the rate would surely cost revenue over time – not for any fanciful economic effects like the infamous Laffer curve, but just because it is so easy to move.

Yet, on the Scottish proposals, cutting the higher rate would involve cutting the basic rate, too, which would be expensive, costing perhaps £150 million for every 1p off the rate in Wales.

The conclusion is that a Welsh Government would never change such an income tax rate. If Wales is to acquire income tax powers it needs to be able to change higher and lower bands differentially. It can then cut higher rates if it wants to attract high earners, or not, as it chooses. It can then raise the basic rate if it wants to raise revenue, or not, as it chooses. It should share the income tax base by being allocated at least half the tax points in each band. That would still only give the Welsh Government revenue of about £2 billion compared with spending of £15 billion each year – so allocating two-thirds of each band would not be too much.

Devolving taxes in this way has another advantage. Because income tax is progressive, tax receipts tend to rise slightly faster than incomes and, because of that, GDP as well.  In Wales income tax has tended to rise 1.23 times as fast as real income. Consequenty, if the Welsh government took a proportion of each tax band, its revenue would rise at that rate.  But if it merely had a tax of so many pence across all incomes, as in Scotland, its revenue would grow only at the same rate as income. Devolving  a proportionate share of tax bands rather than a flat rate tax would result in devolved taxes having greater buoyancy, reducing dependence on a block grant over time.

These are strong arguments, which were put forward in the Independent Commission on Finance for Wales that I chaired. They are not ones that should be allowed to melt away. It is to be hoped that the Silk Commission will give them due weight.

And there is no reason to despair and conclude that if the Scots got an inferior settlement, at best Wales is condemned to getting the same. It is possible for logic to win. The Calman Commission proposed a formula for how to reduce Scotland’s block grant when more income tax was devolved. The Welsh Commission pointed out that formula had clear flaws and proposed an alternative. The SNP-dominated  Scottish Paliamentary Committee agreed and argued that the Calman formula should be dropped and the Welsh formula adopted. In almost the sole concession concerning the Scotland Bill, the Secretary of State for Scotland agreed with Scottish Ministers to adopt the Welsh formula. The SNP played that up as a concession which greatly reduced the risks of the arrangements to Scotland – as indeed it did.

I firmly believe that we were right in our proposals for how to devolve income tax as we were right on the offsetting grant formula. The Silk Commission should gird its loins and insist on the right approach. Then in due course, no doubt, if income tax is devolved to Wales, Scottish arrangements will again follow the Welsh lead.

Gerald Holtham chaired the Commission on Funding and Finance for Wales and is a trustee of the IWA.

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