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The taxing problem of Welsh politics

The Welsh government is going to start holding the purse strings. www.shutterstock.com/John Williams RUS

The taxing problem of Welsh politics

The Welsh government is going to start holding the purse strings. www.shutterstock.com/John Williams RUS

Yet again, the recent Welsh assembly election campaign was primarily about how best to spend public money. But recent developments mean devolved elections in Wales will soon focus on how best to raise public money, too.

For the most part, spending by the Welsh government has been funded by an annual block grant determined by the Barnett formula that it gets from HM Treasury. There has been little direct link between revenue from taxes in Wales and the amount of money that Welsh government ministers have to spend on devolved public services.

In this regard, Wales’s funding framework has been highly unusual from an international perspective: there aren’t many governments in the world with significant legislative and spending powers, that don’t also have a correspondingly important responsibility for raising tax revenues, too.

However, the way that Wales is funded is now set to change dramatically in coming years with the advent of tax devolution. Advocates of fiscal devolution hope it will increase the financial empowerment and accountability of future Welsh governments.

Tax devolution proposals

Council tax has so far been the only revenue source that directly affected the level of devolved spending. As of April 2015, non-domestic (business) rates were also fully devolved, and from April 2018, the UK stamp duty land tax and landfill tax will cease to apply in Wales, to be replaced with devolved taxes.

Most significantly, the Welsh government will be given responsibility over a £2 billion share of Welsh income taxes, without the need for an affirmative vote in a referendum to give it this power. This means that the assembly will gain control over 10p of each tax band, so, for example, a basic rate income taxpayer will pay 10p in the pound to the UK government, and 10p to the Welsh government. Higher rate payers in Wales (some 145,000 this year) will start to pay 30p in the pound to the UK government, and 10p to the Welsh government.

Taken together, revenues soon to be under the control of the Welsh government amounted to £4.2 billion in 2014-15. Once devolved, these revenues will also increase the borrowing capacity of the Welsh government.

The Welsh government will also able to introduce “new” taxes using its devolved powers, subject to the approval of both Houses of Parliament and the Welsh assembly. It appeared that Plaid Cymru’s proposal for a “sugar tax” might have been the first new Welsh tax, before George Osborne introduced a similar measure in his March budget.

Manifesto tax promises

These new tax powers represent a historic change in Wales’ devolution settlement, and introduce a new aspect to assembly elections: for the first time, tax policies featured prominently in the parties’ manifestos this year.

The reform or reduction in business rates was a recurring theme in the parties’ election promises. The Conservatives and Plaid Cymru wished to extend the small business rates relief to more businesses, for example. While providing less detail, Labour also committed to tax cuts for small businesses.

Looking at council tax, the Welsh Conservatives emphasised that it has been increasing faster in Wales than in England and Scotland, and proposed a freeze over the next five years. The Liberal Democrats wished to reduce council tax for homes improving their energy efficiency; and Plaid Cymru proposed to address the regressive nature of council tax, by reducing payments from lower valued homes and offering relief for those on lower incomes.

On stamp duty, Plaid Cymru wished to raise the value threshold at which the tax becomes payable in Wales to £145,000 – up from £125,000 – while the Conservatives pledged to increase the threshold for first-time buyers to £250,000.

The Liberal Democrat plan for an “incineration tax” was the only new tax being proposed for Wales, which they hope will “further encourage recycling”.

A flavour of things to come

As the biggest devolved revenue, it is income tax that offers the largest lever to vary levels of taxation and expenditure in Wales. Changing tax rates away from 10p will have an immediate impact on the Welsh Budget, and economic behaviour.

The Welsh Conservative party announced that it will seek to cut income tax rates, suggesting a fall of 2p in the basic rate, and 5p in the higher rate, as part of their desire to make Wales the “low tax capital of the UK”. The Liberal Democrats planned to reduce tax rates for the lowest and middle-income taxpayers first, while Labour and Plaid Cymru pledged not to increase tax rates in the next assembly term.

However, it hasn’t been decided how and when income tax will be devolved to Wales. To account for the extra revenue from devolved taxes, a downward adjustment will be made to Wales’ existing block grant from HM Treasury. The yet-unanswered multi-million pound question is how this block grant adjustment will be changed over time.

Apart from tax policy decisions and the performance of the Welsh economy, it is this method of adjustment that will ultimately determine the effect of tax devolution on the Welsh budget. The year-long row over Scotland’s fiscal framework proves that this issue will be the subject of intense political negotiations in Wales, too. There will be hundreds of millions of pounds at stake, and some of the methods proposed in the Scottish negotiations could lead to very large cuts to the Welsh budget if applied to Wales. Negotiations on these matters will be at the top of the ministerial in-tray for Wales’ next finance minister.

These outstanding issues and uncertainties somewhat subdued the debate on income tax policy for this election campaign. This contrasts with the situation in Scotland, where a concrete timeline and an agreed fiscal framework allowed the tax policies of each party to take centre stage in the election campaign. The result might be a flavour of things to come in future Welsh elections, too.

The 2016 result has seen Labour holding on to power in the Senedd, and it remains to be seen how much they will seek to use the newly devolved fiscal powers. The tax policies of other parties may come into play through any deals struck with a Labour government without a majority. Meanwhile, in light of rather disappointing results this time around, one would expect the Welsh Conservatives will wish to make tax a much more prominent issue in Welsh politics in coming years.

By the next Welsh assembly election in 2021, Wales’s new fiscal framework should be a lot clearer, with new rules in place, allowing parties to fight over how to raise public money, as well as how to spend it.

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