Jonathan Edwards argues that the Welsh Government should have more confidence in the potential for growth in the Welsh economy

December 3rd, 2012

The title of the recently published report of the Commission on Devolution in Wales, commonly known as the Silk Commission, is Empowerment and Responsibility.  The report has trenchantly argued, both from first principles and from international comparisons, that it is good practice for a government of any level to be empowered to raise at least part of the expenditure for which it is responsible. In essence it concluded that there is an important link between empowerment and responsibility.

Empowerment and Responsibility

This is the first of a series of articles debating the recommendations of last week’s Silk Commission report on tax and borrowing powers for Wales. Tomorrow: Shadow Secretary of State for Wales Owen Smith contributes.

However, the current position of the Welsh Government is anomalous in this respect. It has welcomed the Commission’s recommendations to transfer taxes such as stamp duty, aggregates levy, landfill tax, business rates and air passenger duty. But in addition it recommended that the Welsh Government should have the power to vary part of the income tax raised in Wales, to ensure that it would be responsible for a significant part of its income.

Before the Silk Commission published its report Owen Smith the shadow Secretary of State for Wales announced that “income tax as a power probably oughtn’t to be devolved [to the Welsh government] right now”, giving the reason that “in the short term Wales would be left worse off” because “we don’t have the relative tax base in order to provide Wales with the volume of money that our needs require”. But as explained below this is not the issue. Given the actual proposals made by the Silk Commission, and the evidence it produced in respect of income tax receipts in Wales, it may be that Owen Smith may wish to revise his comments.

The Welsh Government currently has no powers of taxation and relies on the block grant from Westminster for its budget, which is calculated each year using the Barnett formula. Under the proposals of the Silk Commission in respect of income tax the basic, higher and additional rates of income taxes levied by the UK government in Wales would be reduced initially by 10 pence in the pound and the amount of money the Welsh Government received through the block grant reduced by a comparable amount. The proposal is that part of the Welsh budget would be funded by tax revenues raised by the Welsh Government in Wales and part by block grant. On day one the Welsh Government would be no better off and no worse off.  It would then be up to the then Welsh Government to vary those tax rates as it saw fit.

If a share of Welsh income tax is paid to the Welsh Government in exchange for a smaller block grant is Wales likely to be better or worse off?  If we leave aside the new powers that the Welsh Government would then have to change rates what would happen if it left rates exactly the same as those in England under these proposals?

There is a common consensus that public expenditure across the UK is at an unsustainably high level. While the Labour Party and the Coalition Government may argue about the speed at which it should be reduced, and the budget balanced, it is clear that UK expenditure is likely to be constrained for many years to come.  On the other hand it is also agreed that the UK economy needs to be stimulated to boost jobs and improve wages. It seems very likely therefore that for the foreseeable future Westminster policy (whichever party is in power) will be to increase income tax revenues faster than expenditure.  If this policy is successful then income tax take will rise faster than expenditure. If the same approach were adopted for Wales as for Scotland then the block grant under the Barnett formula would be reduced to reflect this rise in income tax receipts.

If the Welsh income tax base increases at the same rate as the UK income tax base, then the effect should be broadly neutral, although the Welsh Government would increase the amount of its budget raised by tax and the amount it received by block grant would be reduced proportionately. Under the Commission’s proposals the size of the Welsh tax base is not relevant. As the Commission points out, ‘The important determinant is the relative growth in tax revenues in Wales compared with the rest of the United Kingdom”.

It is the clear policy of the Welsh Government to close the economic gap between Wales and England. This need has also been acknowledged by the Coalition Government and the recently published Heseltine report has underlined the importance of re-balancing the UK economy outside London and the south-east of England.  If these policy initiatives are successful, then the Welsh income tax base has a good chance of rising more rapidly than that of the UK as a whole.  Even during the recent past Wales would have been better off if the Commission proposals had been adopted. As its report points out, “Between 2000-2001 and 2009-2010, on average, income tax revenues, excluding savings and dividend incomes in Wales have grown faster than across the United Kingdom as a whole”.  Figure 5.1 on p.94 of the report shows this graphically.

Figure 5.1: Growth in income tax revenues excluding revenue from savings and dividend income, 2000-01 = 100 (a)

 Source: Commission Calculations

Carwyn Jones is somewhat lukewarm to the Commission’s proposals to devolve income tax. He seems to assume that the efforts of both his government in Cardiff and those of the Coalition government (and future governments) in London will fail and that the Wales tax base will inevitably grow more slowly than that of the UK, notwithstanding the trend of the last ten years.

According to Eurostat figures the UK is one of the most regionally unequal countries in Europe. Other countries such as Germany, Italy and France have been able to reduce their regional GDP disparities. The Welsh Government should have more confidence in the potential for growth in the Welsh economy, and its ability to do something about it given the right policy tools. The rapid transfer of income tax varying powers, and the acquisition of borrowing powers would provide the Welsh Government with a much greater ability to take greater control over the Welsh economy.  The devolution of income tax to Wales would also provide a stream of tax receipts which, according to the recent joint statement by the Welsh and UK governments, would be the key to allowing the Welsh Government to borrow to invest on a significant scale. This is at a time when the capital investment block grant to Wales is currently being cut by 41 per cent over the four years up to 2014-2015.  Such borrowing also has the prospect of stimulating the Welsh economy and increasing the Welsh income tax base.

Given that the Silk Commission gave a possible timetable for the devolution of income tax to be introduced in 2018 and be operational by 2020 there is no time for further delay in trying to remove an important constraint on the right of the Welsh Government to borrow in order to invest.

The Commission considered that resolving the issue of ‘fair funding’ (that is, Wales’s under-funding by the Barnett Formula as highlighted in the Holtham Report) would be necessary before their tax proposals could be taken forward. However, this matter was outside their remit and is probably more a recognition of the view taken by the Welsh Government itself. Nonetheless, the two issues are completely separate.

Whatever level of ‘fair funding’ may be agreed between the Welsh and UK governments, this will not affect the calculation of the actual amount of money to be taken out of the block grant in exchange for a share of income tax receipts. The block grant, however calculated, will be a reflection of the UK government’s spending priorities from time to time, while the income tax reduction will be a reflection of Welsh income tax receipts.

Such an exchange of income tax receipts may vary as a percentage of the block grant, but the calculations are separate, and the issue of ‘fair funding’ will be no more ‘locked-in’ after any transfer of tax varying powers than it is now. On the contrary, the institutional changes recommended by the Commission to accommodate tax varying powers could serve to highlight the unfairness of the UK Treasury’s current position.

In the meantime, such a hurdle provides the possibility of infinite and unnecessary delay. Despite the First Minister’s concerns the Labour party itself has failed to confirm that it would change the Barnett formula in accordance with the Holtham recommendations. If the Labour Party really believes in fair funding for Wales then the Shadow Secretary of State Owen Smith should now, following the publication of the Silk Commission’s report, give the firm undertaking that the Labour Party will implement the Holtham recommendations were it to return to power in Westminster, and remove the fair funding hurdle.

In summary, the Welsh Government seems reluctant to accept an important power over income tax which would make them more responsive to, and responsible for, the needs of the Welsh electorate. Whether they would be better or worse off has nothing to do with the size of the Welsh tax base but its rate of growth compared with the rest of the UK.

Such a power would also provide them with an ‘independent revenue stream’ which would enable them to borrow significant amounts to invest in infrastructure projects, such as schools, hospitals and roads and thus stimulate the Welsh economy, as well as providing much needed capital assets. The issue of fair funding is an unnecessary hurdle to the transfer of income tax powers, and at the very least the Labour party should confirm that they will implement such funding if returned to Westminster.  The Welsh Government must be willing to seize the powers and responsibilities recommended by the Silk Commission, rather than let Wales’s fiscal destiny be entirely controlled by Westminster.

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Jonathan Edwards is MP for Carmarthen East and Dinefwr and Plaid Cymru’s Treasury spokesman in the House of Commons

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