Posted on Thursday 17 January 2013 by Ulster Business

John Simpson

The Scottish Government and the Welsh Assembly are both taking ambitious steps to create more flexibility in the model of devolution that is delegated to their administration.

The Scottish Parliament has already been extensively involved in the Scotland Bill (now an Act) which paves the way for tax changes and changes in the delegation of some taxes from 2016. If the vote for Scottish independence is passed, then the increased flexibility for a range of taxes will, of course, become an even more radical framework. However, even if Scotland remains within the UK, likely changes have been identified.

Interestingly, a parallel debate has been taking place in the Welsh Assembly and a similar range of changes to the devolution of taxation has been researched by a special Commission (the Silk Commission).

By comparison with Scotland and Wales, the debate about greater devolution of taxation powers in Northern Ireland has been much narrower and has focused singularly only on the merits and implications of the devolution of corporation tax.

For both Scotland and Wales there are proposals which might allow:

• permission to vary the rates of personal income tax.
• devolution of taxes on land and buildings transactions.
• devolution of taxes on the disposal of waste to landfill.
• each Government to supplement their capital budgets with extra borrowed funds.

Other debated proposals include the devolution of air passenger duty, initially on long-haul flights, and the devolution of the aggregates levy.

The prospective changes for both administrations would be based on two principles.

First, the redistributive effect of the current UK-wide system, via the Barnett formula would be retained, but with significant modification. Second, the devolved Governments would move from a system where their chief responsibility was the allocation of approved expenditure to a system where a significant amount of revenue was determined by the devolved Government, which would then have to make decisions on sources of revenue to balance against expenditure plans.

In the reports by the Calman Commission in Scotland and the Silk Commission in Wales, there has been a broad ranging review of other possible sources of tax devolution. In neither case is there a strong preference to seek discretion in VAT or national insurance.

There is uncertainty about the merits of devolving corporation tax.

The Welsh Commission offers the ambiguity of saying that it does not recommend that corporation tax be devolved and then adds "unless it is devolved in Scotland and Northern Ireland, in which case devolution would also need to be offered to Wales." The current Scottish Government envisages that with a full range of tax powers it "could reduce corporate taxation" and also "harmonise the tax and benefit systems to create a fairer and simpler regime."

In the headline reviews of proposals for Scotland and Wales there is little emphasis on the effect of changed taxation as a major incentive to strengthen the local economies. Implicitly, there is a stronger motivation to use variations as an instrument of social policy.

In terms of effective discretionary decisions, there are three aspects of the devolution debate that may have implications for each of the devolved Governments. There are (i) the merits of variations in tax rates for the big revenue earners such as income tax or corporation tax, (ii) the permitted supplement to capital spending through a specific agreement to allow devolved Governments to borrow, and (iii) the implications for the adjustment processes for amendments to the Barnett formula to compensate for the transfer of some significant revenue raising authority to each Government.

On income tax arrangements, the core proposals for Scotland and Wales are that a designated part of income tax collected should be directly assigned to each Government. With basic income tax rates currently at 20p in the £, 10p would be assigned and the rest would go to the Treasury. Then, each Government might decide whether its share should be increased or decreased by altering the income tax rate up or down from 10p.

In principle, this flexibility would either allow the Government to finance more costly Government services or to reduce some services to offset an income tax reduction. If the devolved Government altered its rate of income tax, that would not affect the adjusted transfers under the Barnett formula. On recent evidence, Ministers in the devolved Governments may be reluctant to use this type of instrument.

Northern Ireland stands apart from the others in the willingness to seek devolution of corporation tax and to meet the cost (if there is an acceptable agreement) through a reduced Barnett allocation.

Each of the devolved Governments now wishes to supplement its capital budget by being permitted, by Treasury, to borrow funds either from the National Loans Fund – an arm of the Treasury – or in the market. Stormont is ahead of the others with an annual permitted £200m borrowing limit. This is about 20% of the annual capital budget. Critically and controversially, the Treasury has been reluctant, so far, to allow other forms of borrowing to supplement this total.

From 2015-16 Scotland, under a new feature, will be allowed to borrow up to 10% of its capital budget. Proportionately this is lower than the Northern Ireland arrangement. A similar arrangement for Wales has been agreed in principle but the scale and mechanism is still under discussion. The Treasury seems to expect the added cost of permitted borrowing to be a charge on delegated revenues so that the Governments will realise the need to use this power sparingly.

The most difficult and complex aspect of changing the devolution arrangements lies in the search for an agreed mechanism to adapt the Barnett formula to the changed circumstances. This is a serious problem for Northern Ireland if corporation tax is devolved. It will be a serious issue in each area if there is a significant shift in direct revenue raising ability which must be taken out of the Barnett formula.

The problem is relatively easy in the first year of a change: the assigned or devolved revenue can be deducted from Barnett. However, the adjustments in the following years are potentially complex. If the devolved revenue is raised or lowered as a result of devolved decision making, then the Barnett allocation stands as a separate calculation.

The formula to adjust the Barnett allocations when there is significant delegated responsibility (as with corporation tax) has already proved to be contentious between Stormont and the Treasury.

Stormont Ministers have argued for a formula that asks for a smaller deduction in Barnett to take account of secondary effects on the economy of any growth in the economy as a result of the changed company tax rates. The Treasury have been reluctant to endorse this.

The Welsh have examined four options, none of which allows for secondary effects. The Treasury, dealing with Stormont Ministers, will be ready to quote from the detailed ideas from Wales about how to adjust the Barnett block grant to take account of the consequences of UK-wide decisions or inflation adjustments.

The preferred option, from the advice in Wales, is for an annual proportionate reduction in the Barnett block grant. The grant would be reduced by the appropriate initial deduction and would then change annually as a proportion of the grant before the change in tax devolution.

Northern Ireland has been asking for a simpler form of corporation tax devolution but is asking for a generous formula in calculating the cost in terms of deductions from the Barnett formula. These issues are now part of a much wider UK debate for decision making in 2013.


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