Welsh Devolved Taxes and the Fiscal Framework

04 July 2016

Article by Christian Tipples, National Assembly for Wales Research Service

Darllenwch yr erthygl yma yn Gymraeg | View this post in Welsh

Money

Image from Pixabay. Licensed under the Creative Commons.

Devolved taxes in Wales

On 1 April 2018, stamp duty land tax (SDLT) and landfill tax (LT) will be devolved to Wales (PDF, 693KB). These new Welsh taxes will be known as land transaction tax (LTT) (PDF, 809KB) and landfill disposals tax (LDT) (PDF, 990KB) respectively.

It is the intention of the UK Government to also devolve the aggregates levy and partly devolve income tax (PDF, 322KB) to Wales although it is unclear what the timescales are. Once all taxes have been devolved, it is forecast that the Welsh Government will directly raise approximately 25% of its own budget with the remaining 75% coming from the Welsh block grant, funding allocated by the UK Government to Wales.

This is a significant proportion compared to the current 6.6% raised by the Welsh Government. Devolution of tax raising powers will require an adjustment be made to the Welsh block grant. An essential part of the devolution of new tax powers and greater financial accountability for Welsh Government will be the need for a fiscal framework for Wales.

It is crucial that the system agreed for Wales is fair or there could be a considerable impact on Welsh Government budgets going forward.

What is a fiscal framework?

“Comprises all arrangements, procedures, rules and institutions that underlie the conduct of budgetary policies of general government”

Why does Wales need a fiscal framework?

A fiscal framework is the rules and institutions used to set and coordinate fiscal policy. It comprises two key elements (PDF, 1MB):

  • Fiscal rules
  • Fiscal institutions

It establishes regulations relating to matters such as:

  • Interactions between Welsh and UK fiscal policy
  • Block grant adjustment for Wales
  • Welsh deficits and debt limits
  • Welsh Government borrowing
  • Fiscal forecasting.

Such a framework will establish the boundaries in which both the Welsh and UK Governments will operate once taxes have been devolved to Wales.

How will a fiscal framework be negotiated?

This is unclear at the moment given negotiations are at an early stage. However, Scotland could be a good example to look at given the Scottish Government has recently concluded talks with the UK Government over its own fiscal framework. Negotiations took over eleven months to conclude showing the complexities of agreeing a suitable fiscal framework.

What are the likely challenges to agreeing a fiscal framework?

There were a range of concerns identified by both the Scottish and UK Governments which will have relevance to the Welsh Government when entering negotiations on a fiscal framework for Wales.

The principles

Negotiations were guided by a set of principles outlined in the report published by the Smith Commission (PDF, 399KB) which was responsible for recommending further powers to be devolved to the Scottish Parliament. Two key principles focused on during negotiations were the no detriment principle and taxpayer fairness.

Key fact

The Scottish Government emphasised the no detriment principle whilst the UK Government focused on taxpayer fairness during negotiations.

No detriment principle

The Smith Commission proposed (PDF, 399KB) Scottish Government and UK Government budgets should be unchanged as a result of the decision to devolve further powers to the Scottish Parliament. The fiscal framework would therefore need to deliver results consistent with this principle in order to implement a fair framework for both Governments.

Discussions on a Welsh fiscal framework will likely follow the same principles with both the Welsh and UK Governments ensuring no party is worse off as a result of devolving taxes to Wales.

Taxpayer fairness

The Smith Commission also commented (PDF, 1MB) that changes in taxes only applying to the rest of the UK should only affect spending in the rest of the UK. Similarly, changes in taxes only applying to Scotland should only affect spending in Scotland. If this principle was undermined then the Scottish or UK Government would need to reimburse the other depending on who the decision-making Government is.

Block grant adjustment

A major barrier for both Governments was the adjustment of the Scottish block grant and in particular how adjustments would be indexed to account for future population growth. A paper led by the Institute of Fiscal Studies (PDF, 503KB) concluded that:

it is impossible to design a block grant adjustment system that satisfies the spirit of the ‘no detriment from the decision to devolve’ principle at the same time as fully achieving the ‘taxpayer fairness’ principle: at least while the Barnett Formula remains in place.

A compromise was reached as both parties differed on the preferred model for adjusting the block grant. The block grant adjustment would be calculated using the UK Government’s ‘Comparable Model’ whilst achieving the outcome of the Scottish Government’s preferred model during a five year transitional period.

This will be a key area of discussion for the Welsh Government given the model will play an essential role in determining a significant proportion of the Welsh Government’s future budgets.

Population

When considering an appropriate model for adjusting the block grant, a key area of concern for the Scottish Government was population growth (PDF, 503KB). Given the slower population growth in Scotland compared to the rest of the UK, the Scottish Government was mindful of the need to agree on a model which took relative population growth into account. This would protect the Scottish budget from the effects of slower population growth.

Is the Scottish block grant adjustment the answer for Wales?

Historically population growth in Wales is also slower when compared to the UK. However, in recent years, growth in income receipts have been significantly slower than in the UK.  This has been due mainly to the UK Government policy of increasing the personal allowance which has resulted in many lower income earners no longer paying income tax.

A recent study by the Wales Governance Centre (PDF, 612KB) showed how if implemented income tax devolution in 2010-11, the Welsh Government budget would have been reduced by over £100 million a year by 2013-14. Agreement on a model which takes into account the unique situation in Wales will therefore be vital.

Funding Floor

The UK Government announced in its 2015 Autumn Statement and Spending Review a minimum funding level for Wales of 115% of comparable spending per head in England. This will last until the end of the current UK parliamentary term. How this is integrated into the fiscal framework will be an important element of negotiations for the Welsh Government.