The Welsh government has published 'Future options for Income Tax devolution in Wales'. The independent report, commissioned by the government, compares keeping the current partially devolved system with moving to full devolution. The authors conclude that while full devolution would provide greater control, it would also carry greater financial risk.
The report, prepared by the Fraser of Allander Institute at the University of Strathclyde and Bangor University, explores four models of non-savings, non-dividend Income Tax devolution and their effect on the net tax position for the Welsh government.
The four models are:
- Partial devolution of Income Tax rates (10p in each band) with the Block Grant Adjustment (BGA) calculated on a by-band basis. This is the current approach in Wales.
- Partial devolution of Income Tax rates (10p in each band), with a single BGA.
- Full devolution of Income Tax rates and thresholds, with a single BGA. This is the current approach in Scotland.
- Full devolution of Income Tax rates and thresholds, with the BGA calculated on a by-band basis.
Currently, the UK government reduces each of its basic, higher and additional Income Tax rates by 10 percentage points for Welsh taxpayers. Since devolution in 2019, the Welsh government has set the Welsh Rates of Income Tax (WRIT) at 10%, meaning that Welsh taxpayers pay the same overall amount of Income Tax as those in England and Northern Ireland.
What is the Block Grant Adjustment (BGA)?
The BGA reduces the block grants paid by the UK government to the devolved administrations in Wales and Scotland. The reduction is intended to reflect the revenues that the UK government would have received in the absence of devolution. The method by which this is done can vary.
- In Wales, where the WRIT applies to each of the three tax rate bands, an adjustment is separately calculated for each tax band.
- In Scotland, there is a single adjustment to the block grant.
The devolved administrations effectively gain (or lose) on the difference between the tax revenues they collect and the amount of BGA that is deducted from their block grant. The report examines how sensitive this difference is for the Welsh government under the four modelled scenarios.
Effects of differences in earnings growth
The report analyses how the four models are affected by changes in earnings growth.
- The two partially devolved models tend to have smaller effects on the net position, whereas the fully devolved models are, on the whole, riskier.
- The fully devolved models can lead to more positive net positions, but have the potential for more negative effects. This is particularly so if wages grow more slowly in Wales than in England and Northern Ireland.
- In some earnings scenarios, the by-band BGA systems lead to larger swings in the net position.
- The report, however, highlights that for one of the most significant scenarios, differential growth in earnings between Wales, England and Northern Ireland, the effect on the net position is smaller for by-band BGA systems.
- This is due to the higher share of additional rate taxpayers in England and Northern Ireland, particularly in London and the South East of England.
Effect of UK government policy
The report shows that:
- For UK government changes to the higher and additional rate thresholds, the by-band BGA systems have a bigger effect than the single BGA models.
- The UK's threshold freeze consistently benefits the by-band systems, but not the single BGA ones.
- The report notes, however, that if the higher rate threshold were to be increased in the way it was under the Chancellorships of George Osborne and Philip Hammond, the reverse would be true. The Welsh net tax position would be severely worsened under the by-band BGA arrangements, but not with a single BGA.
- Full devolution of Income Tax rates and thresholds creates significantly more variation in the net position, except for changes involving the personal allowance and where there is differential growth relative to England and Northern Ireland.
Risk appetite and interdependence
While full control of Income Tax rates and bands would allow the Welsh government greater control over the tax system as a whole, the report highlights that Income Tax rates cannot be set in a vacuum.
- When considering a single BGA system, changes in UK government-set Income Tax have a direct effect on the BGA, and an increase in UK government tax rates would result in a worse net position for Wales.
- Since WRIT is applied on top of UK tax rates, a change in UK rates would not affect a by-band BGA.
- In the event of a change to full devolution, though, the UK and Welsh governments would need to negotiate the BGA method, and the report notes that the current precedent for full devolution in Scotland is a single BGA.
Conclusion
The authors conclude that there is no single optimal model among the four that were modelled, as each has benefits and drawbacks.
- Partially devolved systems offer less control, but also reduce how much the Welsh government is exposed to changes outside its control.
- A decision on changing Income Tax devolution in Wales would need to balance the government's risk appetite against a realistic assessment of the possible negative outcomes.
- Changes in UK government policy and how WRIT would interact with UK Income Tax rates and thresholds would also need to be considered.
The report does not examine other areas that could potentially be devolved, such as setting the personal allowance and its taper or setting Income Tax on dividends and savings income.
Useful guides on this topic
Welsh Income Tax (subscriber guide)
Since 6 April 2019, Wales has been able to set its own Welsh Rate of Income Tax
Welsh Income Tax: Am I a Welsh taxpayer
Who is a Welsh taxpayer? What if I move across the border during the tax year? What about non-UK residents who work in Wales?
External links