Greater decentralization of fiscal powers is a risk to be taken on all sides – Institute for Fiscal Studies
The UK is no longer the fiscal monolith it once was. Until the devolution agreements of the New Labor era, fiscal and spending policy for all constituent nations was established in Westminster. Today the Assembly of Northern Ireland, the Welsh Senedd and the Scottish Parliament almost completely control spending on public services. They can choose how to allocate their budgets between health, education, economic development, etc.
However, the budgets they have to spend are largely set from Westminster. They are still based on the venerable Barnett Formula, a supposedly temporary solution put in place in the dying days of the Callaghan government. It allocates funds to other nations through a complex mechanism which broadly means that the grants they receive from the Treasury change in proportion to changes in funding in England.
Even here there has been change. The Scottish and Welsh governments have some control over income tax, as well as a handful of smaller taxes, and therefore have some ability to raise incomes or change taxes to promote growth. After a long period of stagnation, the Scots made use of their income tax powers, raising rates on high incomes and reducing them, slightly, on low wages. The changes have been real and substantial, increasing revenue by around 4% to Â£ 500million. Given that Scotland’s population is less than a tenth of that of the UK, this equates to over Â£ 5 billion in UK terms.
Good for them. They used their powers to collect more money to spend on utilities. Exactly the point of devolution. Except that they don’t have any money at all. That’s the conclusion of a Scottish Tax Commission report released this month.
How can that be? Well, the devolution agreement means that the amount of money the Scottish government receives depends on the tax revenues collected in Scotland. And because incomes have grown less rapidly in Scotland than in the rest of the UK, incomes have grown less rapidly. This is not a âLaffer curveâ effect. Income has not gone down because taxes have been increased. It’s just that the Scots were unlucky. Income north of the border has increased less quickly than elsewhere.
But that’s devolution for you. It brings responsibility, accountability, potential reward, and risk. In this case, the risks crystallized. The Scots could have had the same amount of income with lower tax rates if devolution had not taken place. On the other hand, if their economy had grown faster, decentralization would have provided a fiscal dividend.
Another commission released its interim report last week – the Independent Tax Commission for Northern Ireland, which I was invited to chair by Conor Murphy, the Minister of Finance. We have been given the task of examining options for tax transfers to Northern Ireland. Currently, like Wales and Scotland, the Northern Ireland Assembly controls most public spending. Unlike the other two parliaments, and apart from commercial and national rates, it has no power over taxation. Nine months of work in the commission convinced me that there are many possibilities for tax devolution. We know from the experience of Scotland and Wales that income tax can be at least partially devolved, as can stamp duty on real estate transactions. There is no reason in principle that a slew of other taxes should not eventually devolve on the three nations.
In the context of Northern Ireland, there is a special case for corporate tax devolution, given the much lower rate applied in the Republic and the urgent need to increase investments, and therefore the productivity and wages, in the low-wage and low-productivity countries of Northern Ireland. economy. This will only be possible with the cooperation and flexibility of the UK government. Any reduction in the Republic’s tax rate would significantly reduce the income of the Northern Irish executive for at least a number of years. Previous negotiations on this have partly failed on the question of how to deal with this loss of income.
Excise duties on gasoline, alcohol and tobacco could also be devolved. Given its land border with the Republic, optimal rates in Northern Ireland may well be different from the rest of the UK. In addition, devolved governments are responsible for public health but cannot change alcohol rights. This is one of the reasons Scotland has been forced to follow the path of a minimum unit price for alcohol, increasing profits for those who sell alcohol rather than increasing tax revenues. .
Of course, there are challenges. Northern Ireland is small. Its population is almost exactly that of Kent and only a third that of Scotland. Its sheer size means that economic growth and tax revenues could be volatile. The administrative costs of devolving some taxes could also be high relative to revenues. As the Scottish experience illustrates, devolution is a double-edged sword. With the potential reward comes the risk. And devolution can only work on the basis of a productive and trusting relationship between, in this case, Westminster and Stormont.
Yet for all decentralized nations, the real price for them and for Westminster is the possibility of a more mature relationship, among themselves and with their electorates. Without substantial powers of taxation. they will remain suppliant, asking for alms. Or, as we see so often from the Scottish Government, blaming Westminster for all sorts of wrongs. Greater decentralization of fiscal powers may be the best way to put relations on a more mature basis. Like a parent cutting the strings off the apron, the UK government should perhaps be prepared to allow decentralized nations more freedom to make their own decisions. And their own mistakes.
This article first appeared in The Times and is reproduced here with kind permission.