Ed Poole and Guto Ifan explore the potential of VAT devolution in Wales.
“It is a commonplace for political science research to identify substantial flaws in public knowledge of politics. However, knowledge of devolved politics in Wales appears to be particularly poor, with Carwyn Jones (First Minister for nearly six years) enjoying lower public visibility than even some minor party leaders at the UK level. More generally, the paucity of knowledge (and perhaps also the lack of clarity of the Welsh devolution settlement) help to generate confusion about who should be held accountable for policy successes and failures: many voters have no clear sense of which level of government is responsible for what.” Roger Scully (2015) Public Attitudes to Devolution in Wales – a Permissive Consensus?
Nearly two decades into Wales’ devolution journey, and during a summer in which Scotland’s First Minister was meeting European leaders to discuss potential new relationships between a devolved government and the EU, the biggest story in Wales’ post-Brexit debate became the oft-raised spectre of whether a referendum on devolution could even be won if the Welsh people were asked to vote again.
From the perspective of public opinion data, this focus seems frustrating and rather eccentric. Almost every survey on the powers of the Assembly over the past decade and more has shown strong majority support for devolution. But if Assembly politicians enjoy low public visibility and if knowledge of devolved politics is so poor, perhaps the persistence of this sentiment is not all that surprising. A challenge has been thrown down to identify ways in which the visibility of the devolved institutions and their politicians can be improved.
The power to tax is “indispensable to the existence of every civilized government”. If governments cannot raise revenues from their citizens to pay for services that benefit them, that oft-hated but intrinsic democratic link between citizens and their elected government is broken. On this fundamental point, Wales’ devolved institutions are in a remarkably unusual position from an international perspective. The National Assembly is responsible for more than half of all public spending in Wales and holds primary legislative powers over the bread and butter issues that commentators are repeatedly admonished to focus on. Yet during the first two decades of devolution the Assembly has had virtually no powers to raise its own revenues. It is perhaps hardly surprising in such circumstances if public awareness and interest in such institutions is fragile, or as Andrew RT Davies suggests, that “the National Assembly has been unable to establish itself in people’s minds as a cherished home of Welsh democracy”.
Although challenges to prevailing orthodoxies are made in any field, there is a consensus in the literature that devolution of public spending responsibilities should be accompanied by the assignment of significant own sources of revenue. In theory at least, because the Welsh Government is responsible for important fields of public policy, the devolution of some taxes should promote greater awareness of the economic consequences of policy decisions and a closer accountability link at the ballot box between voters and Welsh politicians. Forthcoming reforms mean the Welsh Government will soon become responsible for raising a larger share of its budget from Welsh taxes.
This blog assesses whether current proposals will go far enough, exploring the option of mirroring the Scottish fiscal settlement by devolving half of Value Added Tax (VAT) revenues to the Welsh Government. Not only have Welsh VAT revenues been far more buoyant than other major taxes, such that VAT has become the largest source of revenue in Wales (in contrast to the rest of the UK and Scotland, where income tax remains the largest source), but the post-Brexit legal landscape permits a total rethink about VAT devolution. Just yesterday for example, the think-tank Reform Scotland called for the full devolution of VAT to the Scottish Government after Brexit, arguing this would allow a wider range of options on tax policy.
Fiscal decentralisation – how does Wales compare?
Figure 1 compares levels of fiscal decentralisation in Wales with other sub-state countries and regions. The degree of fiscal autonomy varies according to their share of total government expenditure (along the horizontal axis), and their share of total government tax revenue (along the vertical axis).
Figure 1: International Comparison of Wales’ Fiscal Decentralisation
Until very recently, Wales and Scotland were in a highly unusual position (given their expenditure responsibilities) in their ability to raise tax revenue. However, recent and forthcoming reforms mean the respective positions of Wales and Scotland on the chart above are moving “northwards”, as more revenues are devolved and assigned.
In Wales, business rates were fully devolved in April 2015, joining Council Tax as the only revenue sources directly affecting the level of devolved spending. From April 2018, the UK stamp duty land tax and landfill tax will be replaced with two devolved taxes in Wales. Most significantly, the Welsh government will be given responsibility over a £1.9 billion share of Welsh income taxes, corresponding to Scottish Government powers after the Scotland Act 2012.
However, the situation in Scotland has moved on. Under the Scotland Act 2016, the Scottish Government will soon have full control over income tax (except on savings and dividend income). This will grant more revenue and significantly more freedom to Scottish ministers, who unlike their Welsh counterparts will be able to vary tax thresholds and bands as well as setting tax rates.
In addition to other minor devolved taxes (Air Passenger Duty and the Aggregates Levy), half of VAT revenue will also be assigned to the Scottish Government. Tax assignment means that revenues collected in Scotland will form a direct part of the Scottish budget, although Scottish ministers will have no control over the setting of the tax base or the rates of tax. Symbolically, VAT-assignment for Scotland means that over half of the Scottish Budget will in future come from own-source revenues.
As can be seen in figure 1, even after all currently scheduled tax devolution has taken place, the Welsh Government will still only raise a small share of total Welsh tax revenues, especially compared with Scotland and other sub-central governments around the world. As a result there will still only be a limited link between the performance of the Welsh economy and the funds available for Welsh ministers.
What can be done?
Income tax powers comparable to Scotland would transfer significantly more revenue and powers to the Welsh Government. It would also allow for a wider range of devolved tax policy measures (such as varying and creating tax thresholds) than is possible under partial income tax devolution, enhancing what political parties could offer voters at Assembly elections. Of course, full income tax devolution would also make it even more crucial for the eventual fiscal framework to mitigate unfair risks to the Welsh budget, such as those discussed in a Wales Governance Centre report on partial income tax devolution.
Another option would be to assign half of VAT revenues raised in Wales to the Welsh Government, as will be the case in Scotland. Although this would not directly increase the rate-setting powers of the Welsh Government, it would create an additional accountability link between the Welsh budget and the performance of the Welsh economy. Assigned VAT revenues are used internationally to give regional governments a financial stake in economic performance; for example, they are a major source of revenue for the Lӓnder governments in Germany.
In 2014-15, around £5.2 billion was raised in VAT revenue (gross of refunds) in Wales. A similar arrangement as Scotland would see £2.6 billion assigned to the Welsh Government budget. This would mean that over a third of total devolved expenditure would be financed by devolved and assigned taxes (up from 21% under current proposals), and would bring Wales further in line with other sub-central countries and regions, as shown in figure 1.
If VAT was assigned to Wales under the same method as Scotland, the ultimate effect on the Welsh Budget would depend on the relative growth rate of per capita VAT revenues compared with the rest of the UK. If per capita revenues in Wales grew relatively quickly, then the Welsh Government would gain, and if per capita revenues in Wales grew relatively slowly, it would lose out.
But as shown in figure 2, VAT revenues have grown faster than the other major taxes such as income tax in Wales in recent years. Revenues per capita in Wales have tended to grow as fast, or even slightly faster, than per capita revenues in the rest of the UK since 2000. These trends suggest that the Welsh Government each year would have had more to spend on devolved services had VAT been assigned from 2000. In 2014-15, we estimate the budget would have been around £40 million higher than under full block grant funding, with a cumulative impact of hundreds of millions over the fifteen year period.
Figure 2: Growth in VAT revenue per head in Wales and UK (2000-01 = 100)
The relative buoyancy of VAT compared with direct taxes reflects Wales’ lower income levels and how the tax places a relatively higher burden on lower income households. Assignment of VAT revenues would mean that there would at least be a direct link between these revenues and public services for Welsh taxpayers.
The devolution of VAT rates has so far been dismissed in the UK, given European Union rules which prohibit variation of VAT rates within a member state, except in a few special circumstances. The UK’s exit from the EU may open a debate on devolving rate-setting powers to Wales. Although there would be significant practical hurdles and the potential for economic distortions, setting VAT rates might give Welsh ministers a powerful macroeconomic lever, and perhaps could be used in conjunction with other tax powers in considering the overall progressivity of the tax system in Wales.
Thinking again about ways in which Brexit might help us improve the accountability of our own institutions might be one way of preventing the spectre of re-run referendums from stalking Welsh devolution as it did the UK’s membership of the European Union.