Devolution across the UK: A recipe for confusion and conflict?

House of Lords
Donald Drysdale By Donald Drysdale for ICAS

15 October 2015

Donald Drysdale comments on evidence given to the House of Lords Economic Affairs Committee on 13 October 2015.

UK-wide issues

As the House of Lords Economic Affairs Committee took evidence from ICAS this week in its inquiry into the devolution of public finances in the UK, I listened particularly for points that might explain the potential repercussions of devolving tax powers.

Charlotte Barbour, Director of Taxation at ICAS, gave evidence alongside Professor Gerald Holtham of Cardiff Business School and Chair of the Holtham Commission, which reported in 2010 on Funding and Finance for Wales.  With all the talk north of the border on what could be right or wrong for Scotland, it was refreshing to follow a discussion that took a broader UK-wide perspective.

Scotland, of course, has been leading the process of fiscal devolution in the UK.  On income tax, the Scottish variable rate has existed since 1998, though never used by Holyrood;  the Scottish rate of income tax (SRIT) will be implemented from 6 April 2016, and the Smith Commission proposals to devolve wider powers over income tax may  take effect as early as  2017.  However, except for employers' payroll departments, few in Scotland are yet aware of SRIT. In the meantime the fully devolved Land and Buildings Transaction Tax (LBTT) and Scottish Landfill Tax are already here.

Other proposals for tax devolution are coming forward.  Welsh rates of income tax are expected, subject to the outcome of a referendum.  Northern Ireland will soon be setting its own local rate of corporation tax to compete more effectively with Eire.  Scotland expects to get control over air passenger duty and aggregates levy.

It's not surprising that devolved administrations are seeking differing powers, given their different elected bodies.  However, should they be given what they ask?  Devolving one tax to one territory and a different tax to another territory may not prove to be the best course of action for the UK as a whole – it may just create an unholy muddle.  For example, where is the logic in devolving corporation tax to Northern Ireland but not to Scotland, and instead assigning approximately half the Scottish VAT take to Scotland while making no such assignment elsewhere?  Such variations in approach promise confusion for taxpayers and their advisers.

In the corridors of power at Westminster and Holyrood, much of the discussions about fiscal devolution have taken place behind closed doors.  Greater transparency is needed regarding the devolved tax powers, the fiscal framework in which they exist, and the knock-on effects on the Barnett formula and the Scottish block grant, which meets the core of the Scottish Government's funding.

The Barnett formula

The Barnett formula, a back-of-the-envelope solution devised in 1978, is still used to determine annual increments in the block grants allocated to fund public expenditure by the now devolved administrations in Scotland, Wales and Northern Ireland.  It's astonishing that the main devolution protagonists, particularly those in London and Edinburgh, appear to have little understanding yet of how the block grant will be affected by increases or decreases in devolved revenues.  Should Barnett be abandoned, it is thought by some that the result could be catastrophic for the Scots. In Wales, however, there are many who consider Barnett disadvantageous and feel that there should be a new formula based on a needs basis.

Devolved borrowing powers are also a cause for concern.  An administration with tax raising powers requires some borrowing capability for budgetary management purposes – to smooth revenues from year to year.  However, existing restrictions on borrowing by the devolved administrations are severe.  Questions also arise regarding the extent to which the rest of the UK might have to bail out an administration that had over-borrowed.

No detriment

Smith proposed a 'no detriment' principle, which comes in two parts.  First, the Scottish and UK Governments' budgets should be no larger or smaller simply as a result of the initial transfer of tax and/or spending powers, before considering how these are used.  Second, where either Government makes subsequent policy decisions that affect the tax receipts or expenditure of the other, the decision-making government will either reimburse the other if there is an additional cost, or receive a transfer from the other if there is a saving.

'No detriment' has now become written in tablets of stone, but it  seems that no-one understands – or at least no-one agrees – how it should be applied.  Given that Barnett is so rough and ready, how can appropriate compensation under the 'no detriment' rule be calculated?  Smith insisted that there should be a shared understanding of the evidence to support any adjustments.  However, one of the fundamental aims of those who support devolution is to promote tax competition, and tax competition itself could give rise to claims for compensation under the 'no detriment' principle.

The need for a UK fiscal framework

Because Scotland has been driving the move towards greater devolution, a further source of instability needs to be recognised.  From a party political perspective, it can't be denied that the existing Holyrood administration may not be enthused about finding a stable solution short of independence.  They may not want a UK fiscal framework that works.

As a tax specialist I see the lack of a clearly defined fiscal framework as especially damaging to the economies of the UK's devolved territories – being, as they are, the UK's outlying areas.  Businesses need certainty to plan ahead and ensure that they can earn appropriate returns from their investment;  in the absence of certainty they may gravitate towards the south east.  Individuals may be influenced by differing rates of personal taxes and persuaded to migrate across the UK's internal borders.

Unless these issues are resolved, the process of devolving public finances across the UK can be expected to be a recipe for confusion and conflict.

Article supplied by Taxing Words Ltd

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