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Options for a Welsh Income Tax

November 26th 2015

The Chancellor’s Autumn Statement and Spending Review clears the path to partial income tax devolution. What are the options for a future Welsh Government?


What is a Welsh rate of income tax?

The Wales Act 2014 allows the National Assembly for Wales to set a Welsh rate of income tax. It would only apply to income from earnings or other non-savings or non-dividend (NSND) income.  Welsh tax payers would no longer have to pay 10p in the pound of their NSND income to HMRC, and would instead pay whatever rate the Assembly sets.

The Assembly could apply different rates to different tax payers, but it could not adjust tax bands or tax allowances and reliefs.

How would it affect the Welsh Government’s budget?

The Welsh Government would keep any revenues raised by a Welsh rate of income tax. The Office for Budget Responsibility estimates that a 10p rate would raise £2.1 billion in 2016/17. The Welsh block grant, determined by the Barnett formula, would be reduced by the amount the Treasury estimates it loses by no longer collecting 10p in the pound in Wales. Needless to say, the calculation of the reduction is absolutely critical.  There would also be pro rata adjustments if the UK income tax base shrinks, e.g. because of a recession.

One issue that is not widely acknowledged is that the Treasury, in theory, could unilaterally reduce the block grant – and indeed removing the requirement for a referendum makes this more likely. In the St. David’s Day Agreement, the Secretary of State for Wales has made clear that the commitment to a funding floor is made in ‘expectation’ that the Welsh Government will seek income tax powers. He has also said that:

“Funding arrangements beyond the next [i.e. current] Parliament will need to take full account of the Welsh Government’s new powers and responsibilities”

In other words, use it or lose it. 

Simply opposing use of tax raising powers seems to me to put a chunk of the Welsh budget at significant risk. So what are the options?

No Change?

A future Welsh Government could of course replace the UK NSND income 10p tax rate with a Welsh rate of exactly the same amount. There should be no change in the revenue raised – estimated at about £2 billion by 2019/20. However if the Welsh Government grew the income tax base, for example by increasing the number of tax payers or raising average NSND incomes – then it would generate revenue. Conversely, if employment and earnings shrank, its revenues would fall.

Any future changes by the UK Government to tax bands and allowances could have a significant effect on the Welsh tax take. This is extremely important – for example the Office for Budget Responsibility estimates that the recent increase in the personal allowance will reduce the revenue raised from income tax in Wales by £21 million in 2016/17 and £29 million the year after.  So the Assembly’s control over income tax is constrained, to say the least.

The Welsh rate of income tax would also be vulnerable to other changes in UK tax policy, such as the relative balance between income tax and national insurance (a tax on income in disguise), or the introduction of new tax reliefs.

No change to the Welsh rate does not mean no change at all. It brings both opportunities to grow the tax base, but significant risks from changes in UK tax policy that could have unforeseen and uncontrolled effects on Wales.  Some of those risks could be mitigated by setting up appropriate inter-governmental arrangements, about which discussion would need to start soon.

A lower rate of Welsh income tax?

The Welsh Conservatives have indicated that they would lower the higher rate of NSND income tax by 5p in the pound, arguing that higher rate tax payers would be attracted to Wales. They claim that this would stimulate the economy and create quality jobs.

The risk is that the prospect of saving £400 a year (estimated by BBC Wales) would not be enough to tempt higher rate payers over the border while the cut loses £200 million from the Welsh budget. Alternatively higher rate tax payers simply relocate their main residence, perhaps snapping up a bargain property in a valleys community for less than £50,000, without bringing jobs or spending power.

Both Conservatives and Lib Dems have said they would also reduce the basic rate of tax. As the vast majority of Welsh tax payers fall into this category – 55% of Welsh income tax revenue comes from tax payers with incomes under £30,000 a year according to the Office for Budget Responsibility, the impact on the Welsh budget would be substantial.

This option is, as with the ‘no change’ option, also vulnerable to changes in UK policy as well as potentially cutting Welsh spending even further if it does not generate replacement revenues.

Tax increases?

The option of raising taxes has not been floated by any political party to date.  The opportunity to raise additional revenues would surely be tempting, but with risks that it would be unpopular with tax payers some of whom may relocate outside Wales, and higher income taxes also reduce disposable incomes, albeit depending on the rate.

The Verdict?

Income Tax devolution generates opportunities to raise revenues and change individual behaviour but also significantly increases the financial risks and potential for a future Welsh Government’s plans to be undermined by UK Government tax policy.

It is true that the block grant will continue to provide 80% of the Welsh Government’s budget, at least in the short term, and it is of course right that Wales’ allocation reflects Wales’ needs and is stable.

But equally, no party can afford to ignore the potential to control around £2 billion of revenue. For sure there are risks in taking on this task, which are not only those of any tax-raising body but with specific risks arising from both the nature of the devolved tax arrangements and the nature of Wales. But there are also risks in not taking on devolved income tax – tying Welsh public spending to the whim of the UK Chancellor and being driven by the much faster and bolder pace of Scottish and English devolution.  Let’s not forget we face enormous constitutional change ahead – by 2020 the UK could have left the EU, Scotland could have left the UK, and Welsh MPs will have reduced powers in Parliament.

At the moment we are not having anything like a mature debate about how we want to pay for public services in Wales – it’s high time we did.

Victoria Winckler is Director of the Bevan Foundation

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