From this month onwards, a portion of Income Tax paid by Welsh taxpayers will stay in Wales to directly fund public services.
The First Minister, Mark Drakeford has previously indicated that he would not increase Welsh Income Tax rates during the current assembly term unless he was “compelled to do so”. Jeremy Miles used his speech at the Labour conference to call on the party to campaign “unashamedly” use these new tax varying powers during the next assembly term in yet another sign that the 2021 election will be fought on competing tax policies. So, what are the policy options?
Devolved Income Tax raises £2 billion pounds in revenue for the Welsh Treasury so any changes to Income Tax rates would have a sizeable impact on the Welsh budget. For instance, putting 1p on the Basic Rate would generate £182 million in additional revenue.
Given the funding pressures faced by Welsh local authorities and Wales’ aging demographic profile, social care may well be first in line for additional funds. This could prove to be a more progressive alternative to further steep increases in Council Tax, particularly because the increase in the Personal Allowance means that the lowest 20% of Welsh earners are not liable to pay any Income Tax.
Of course, tax rises are not the only policy option. Since the Welsh tax base is heavily skewed towards Basic Rate payers, cutting the Additional Rate by 5p would have a relatively marginal effect on the size of the Welsh budget (£26.5 million). Policy-makers might hope that cutting the tax rate for the highest-earners would make Wales more attractive for investors and encourage more Additional Rate payers to move here, strengthening the tax base in the process. Putting aside the question of whether such a policy would be popular with the electorate, predicting behavioural response to tax policy is an inexact science.
While cutting the Basic Rate of Income Tax would likely have broader support, doing so would come at a considerable cost to the Welsh Treasury — £182 million for each 1p cut, assuming no behavioural response.
Subject to the UK government’s agreement, the Welsh Government also has powers to propose new taxes in devolved areas. The Welsh Government has previously mooted four new taxes including a Social Care Levy, Tourism Tax, Vacant Land Tax and Disposable Plastics tax. The First Minister has since announced that the government will be introducing a Vacant Land Tax to encourage development of empty plots. Although this tax is unlikely to be a big revenue-raiser, it will allow the Welsh Government to test the waters with their new tax powers.
The devolution of Income Tax is likely to have a broader impact on future Welsh government policies by issuing new incentives to increase the size of the tax base and encourage faster earnings growth.
According to current forecasts, Wales is projected to be around £9 million a year better off as a result of tax devolution. Forecasted revenues were revised upwards in March due to stronger than expected self-assessment receipts for January.
On the employment front, the latest data for Wales is promising. Historically, there has been a persistent gap between the employment rate for working-age adults in Wales and England. However, the latest data from the Labour Force Survey suggests that this gap has since closed. Whether this convergence is sustained will play a key role in determining whether Wales is better off as a result of tax devolution.
The most recent data on Welsh earnings is less positive. In 2017-18, the annual percentage growth in pay in Wales was 0.8%, 2.1 percentage points below the increase in UK earnings. Based on a three-year rolling average, wages are now growing relatively slower in Wales than the UK as whole. The relatively slower wage growth can be attributed to relatively larger pay increases for earners within the highest earning decile in the UK.
In 2019-20, the highest-earning decile of taxpayers (in terms of non-savings and non-dividend incomes) will contribute around 38% of Welsh Income Tax, more than the lowest-earning seven deciles. The highest-earning 1% of taxpayers alone will contribute over a tenth of devolved tax revenues.
Income tax devolution represents an important step-change in the history of devolution. Even with no major changes to tax policy, trends in the workforce and earnings are already influencing the funds available to the Welsh Government. Over the next 24 months, expect to see the political parties honing their positions on devolved taxes. Faced with pressure to differentiate themselves from other parties in the race, the next Welsh Assembly elections may well be fought on competing tax policies.
Cian Sion is a Research Assistant in the Wales Governance Centre, working as part of the Wales Fiscal Analysis team. The team recently published a briefing note on the latest trends in the Welsh Income Tax base. The full document is available for download here.