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The Unlocked-step: Where next for tax devolution in Wales?

At the Conservative party conference in Birmingham this weekend, Secretary of State for Wales Stephen Crabb MP has announced one of the most widely-trailed decisions of the Welsh political summer.  The controversial income tax lockstep, which would have required any changes to Welsh marginal tax rates to apply equally to all rates, is to be scrapped from the Wales Bill currently working through Parliament. It will be little missed.

But this announcement is ultimately one of missed opportunity.  Fruitful though intergovernmental discussions have clearly been, shuttle diplomacy between Gwydyr House and Cathays Park on this issue has been outpaced by far more significant moves elsewhere in these islands. The narrow margin of the Scottish independence referendum and the sudden (re)appearance of the English question has underlined the problems of the asymmetric “devolution on demand” model that has been the hallmark of the UK’s decentralisation process to date. Post-referendum, parity of treatment all-round will be an essential ingredient in creating a lasting and stable settlement, whether that is federalism or otherwise. Although it is a step in the right direction, removing the lockstep does not meet the parity test when it comes to finance powers for Wales: the political agenda elsewhere in the UK has simply moved on.

Recall that retaining parity with model set up in the Scotland Act 2012 was the primary reason given by the Treasury and the Wales Office for the imposition of the lockstep in the first place (see the interview with the Chief Secretary of the Treasury, Danny Alexander in this BBC report).  With Labour and the Conservatives said to be close to a deal on devolution of all powers to set tax rates and vary bands, this parity condition is about to be comprehensively shattered. Whether Wales is ready or not, Scotland and Northern Ireland are about to be granted major new tax powers that will put Wales’ efforts to attract inward investment and jumpstart economic growth at a considerable disadvantage among the devolved countries in the Union. And for parties and political leaders in Cardiff Bay and Westminster keen to draw a line in the sand on the constitutional question, the status quo in Wales means that the Pandora’s box that resulted from asymmetric devolution in the UK will remain ajar, at least in one part of the British Isles.

Put simply, the parity condition means that the two remaining locksteps: the restriction over setting bands and the requirement to hold a referendum will have to be reassessed.  The case for a referendum was contestable at the time of Silk Part I (see Wales Governance Centre evidence here), but in the post-indyref lens its retention seems even more curious. Where are the demands for Northern Ireland to hold a referendum before it receives corporation tax? Or a plebiscite on Scotland’s far more comprehensive form of income tax devolution than could ever have been dreamed of in 1997? The risk of Wales’ referendum requirement is not that the vote will be lost; rather, it is that the vote will never be held, thwarting the new UK-wide ambition for durable settlement-all-round.

Status quo remains an option for Wales of course.  But it is an option that is now riskier from a tax competition standpoint, given the much more significant economic levers than had originally been proposed for the devolved administrations. In a matter of weeks, the Northern Ireland Executive will be endowed a game-changing economic lever in corporation tax; and if the recommendations by the Conservatives’ devolution commission chaired by Lord Strathclyde are implemented, Scotland will be granted a far-reaching form of income tax devolution. Under Strathclyde, all responsibility over income tax rates and bands would be devolved to the Scottish Parliament with the exception of the personal allowance.

Policymakers and budget setters are right to be concerned about the risks of devolving income tax to Wales: the Silk Commission’s calculations are sensitive to the base year chosen to assess how the proposed system would have performed against the Welsh block, and tax devolution would subject the Welsh budget to more volatility and forecasting risk. The Welsh Government and all political parties in Wales have also expressed concern about minimising the funding gap first identified in the reports of the Holtham Commission.

But rather than kick the whole question into the long grass, there are two straightforward solutions to this that would allow Wales to properly manage the forecasting uncertainty and road-test income tax devolution.

First, with the underfunding gap perhaps at its lowest level for a decade, a reasonable accommodation on fair funding is likely to be achievable with a Treasury interested in an all-round settling of the constitutional question, perhaps the “Barnett Floor” [see previous link] or a “Barnett Plus” solution recently trailed by the First Minister.

Second, for an interim period of 3-5 years, immediate assignment of the proceeds of income tax (but not power to vary rates and bands) would acclimatise the Welsh public to paying a Welsh rate of income tax and allow the system to be thoroughly road-tested before proceeding to full income tax devolution.  During this interim period, the Treasury would bear the risk of any deviation from the Welsh income tax forecast provided by the Office of Budget Responsibility, meaning that there would be no risk to the Welsh budget. As a long-term solution, income tax assignment without the ability to vary tax rates makes little sense: it would not enhance the accountability of the Welsh government over public finances and was rejected early by the Holtham and Silk Commissions. But as an interim measure, assignment would represent a no-risk, real time trial of a new Welsh income tax, allowing political parties and both governments to assess the impact of devolving tax powers. It would also allow time for these discussions to coalesce using real-life data and would allow a complete course reversal later on if the system was shown to work against Wales’ interests. If the system were deemed likely to work, it would be enough evidence to proceed to full tax devolution without a new plebiscite that “would make the March 2011 referendum look like a triumph of participatory democracy” (Scully 2014).

The Scottish independence referendum and the strident return to the stage of English Votes for English Laws have shown the limitations of the asymmetric model of devolution in the UK. In the challenge to design a durable “settlement-all-round” that works for all parts of the United Kingdom, policymakers must now give serious reconsideration to the two remaining locks on tax devolution here in Wales that have the potential to impede such a settlement for many years to come.

This article first appeared on the Wales Governance Centre

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