Y Comisiwn Annibynnol ar Independent Commission on Ariannu a Chyllid i Gymru Funding & Finance for Wales Final report Fairness and accountability: a new funding settlement for Wales full text July 2010 ISBN 978 0 7504 5613 5 © Crown copyright July 2010 WAG10-03153 E0180910 Independent Commission on Funding & Finance for Wales Content Preface 1 Chapter 1: Introduction 3 Chapter 2: The options for fiscal devolution in Wales 7 Chapter 3: Replacing Barnett with a needs-based formula 16 Chapter 4: Tax devolution - evidence and constraints 30 Chapter 5: Tax devolution and the block grant 46 Chapter 6: Addressing the accountability deficit - income tax devolution 57 Chapter 7: Devolution of other tax-varying powers to Wales 74 Chapter 8: Devolution of borrowing powers to Wales 103 Chapter 9: The way ahead 114 Annexes Annex 1: Recommendations from the Commission’s final report 123 Annex 2: Recommendations from the Commission’s first report 126 Annex 3: Developments in the debate on funding devolved government since the Commission’s first report 128 Annex 4: Assessing relative needs: supplementary information and analysis 134 Annex 5: Tax devolution: supplementary information and analysis 146 Annex 6: Current borrowing powers in Wales 155 Annex 7: Dealing with risky taxes 157 Annex 8: Conceptual and practical issues in devolving income tax 165 Annex 9: Independent Commission on Funding and Finance for Wales 172 Annex 10: Stakeholder engagement 175 Annex 11: Abbreviations used in the report 180 Annex 12: References 181 Independent Commission on Funding & Finance for Wales CHARTS AND TABLES Table 3.1 Summary of indicators included in our assessment of relative needs 20 Chart 3.1: Distribution of needs across Wales, England and Scotland 23 Chart 3.2: Weighted expenditure need per head by need factor 24 Chart 4.1: Sub-national taxes as a share of total tax revenue 31 Chart 4.2: Tax autonomy of sub-central governments by type of tax, share of 32 sub-national tax revenues Chart 4.3: Property taxes as a percentage of GDP 33 Chart 4.4: Variations in tax burdens across the USA 34 Chart 4.5: Populations close to the Wales - England and Scotland - 37 England borders, 2008 Chart 4.6: Traffic flows in Wales, 2005 38 Chart 4.7: Daily commuting flows between Wales and England, 2001 39 Table 4.1: Revenues raised in Wales by UK-wide taxes, 2007-08 40 Chart 4.8: UK-wide tax revenues raised in Wales by tax type, 2007-08 41 Table 4.2: National taxes that are not suitable for devolution to Wales 44 Table 5.1: Exposure of the Welsh budget to risks under alternative models 54 of devolution Table 6.1: Estimated number of income tax payers and revenue raised in Wales, 57 excluding savings and distributions, 2009-10 Chart 6.1 Year-on-year growth in income tax receipts, excluding tax on savings, 58 Wales and UK Table 6.2: Gross revenue raised by increasing the higher rate of income tax 61 in Wales Table 6.3: Annual income required to generate financial advantage from moving 63 out of Wales for a range of costs, over a ten year horizon Table 6.4: Revenue raised by increasing the higher rate of income tax in Wales, 64 including behavioural and migration response Table 6.5: Gross revenue raised by increasing the basic rate of income tax in Wales 64 Table 6.6: Maximum saving (before moving costs) from moving in response to 65 a change in the basic rate of income tax Table 6.7: Revenue raised by increasing the basic rate of income tax in Wales, 66 including behavioural and migration response Independent Commission on Funding & Finance for Wales Chart 6.2: UK income tax receipts as a share of total public sector receipts 69 and comparable English spending Table 6.8: Estimated impact on the Assembly Government’s budget resulting 71 from an increase of one pence in the basic rate and higher rate of income tax Chart 7.1: UK non-North Sea corporation tax receipts 75 Chart 7.2: Estimates of corporation tax receipts in Wales, 2008-09 76 Chart 7.3: Distribution of chargeable dwellings, Wales 2009-10 83 Chart 7.4: Average council tax rate and average property band value relative 84 to properties in band D Chart 7.5: Lyons Inquiry analysis of council tax and point value property tax as a 85 proportion of household income Chart 7.6: Comparison of current council tax and a hypothetical flat tax: annual tax 87 by band Table 7.1: Distribution of second homes: selected local authorities in Wales 88 Chart 7.7: Trends in UK capital gains tax revenue and chargeable gains on 89 property and land sales Chart 7.8: Trends in stamp duty land tax receipts in Wales 90 Chart 7.9: Trends in UK receipts from landfill tax, aggregates levy, air 93 passenger duty Table 7.2: Revenues raised by landfill tax, aggregates levy and air passenger 94 duty in Wales and Scotland, 2006-07 Table 7.3: Tourism in Wales: key statistics, 2008 97 Table 7.4: Household expenditure on alcohol in Wales, 2006-07 98 Table 7.5: Approximate turnover generated by Welsh natural resources, 2008 99 Chart 8.1: UK public sector net borrowing 104 Table 9.1: Summary of estimates of Welsh relative needs derived from 115 regression analysis, based on varying assumptions Chart 9.1: Welsh relative funding projections - two scenarios of nominal 116 spending growth Table A3.1: Summary of the main differences in the tax recommendations of the 133 Commission on Scottish Devolution and the Independent Commission on Funding and Finance for Wales Independent Commission on Funding & Finance for Wales Chart A4.1: Percentage of core and non-core functions in each devolved 135 administration, by country Chart A4.2: Weighted expenditure need per head by need factor, difference 139 from England average Chart A4.3: Regression residuals 143 Chart A4.4: Residual frequency plot 144 Chart A4.5: Predicted values and residuals 144 Table A4.1: Impact of relaxing the conservative assumptions on relative need 145 that were made in the first report Table A5.1: Income and tax, Wales 2009-10 148 Table A7.1: Historic data for selected taxes 160 Table A7.2: Risk premia 161 Table A7.3: Covariance of selected taxes with GDP growth 162 Table A8.1: Proportions of tax payers earning above the higher-rate threshold 171 Table A8.2: Average income tax per capita and tax elasticity 171 Independent Commission on Funding & Finance for Wales Preface On behalf of my fellow Commissioners, David Miles and Paul Bernd Spahn, I have pleasure in presenting our second and final report. The themes of the report are fairness and accountability, the two areas where we believe existing arrangements for financing Wales require improvement. Fairness is not simply due to Wales but to all constituent parts of the United Kingdom and we have tried to make proposals that are fair to all parties and not at all special pleading in the Welsh interest. Devolution inevitably brings new elements into the relationship between the state and the citizen but we believe clear responsibilities and the powers to discharge them are necessary to any arm of government and we conclude that improvements in the accountability of the Welsh Assembly Government are possible that strengthen, not weaken, the coherence of British government as a whole. In our first report we looked at “the pros and cons of the present formula-based approach to the distribution of public expenditure resources to the Welsh Assembly Government”, as we were charged to do. In this, our final report, we have attempted to “identify possible alternative funding mechanisms including the scope for the Welsh Assembly Government to have tax varying powers as well as greater powers to borrow.” Identification is one thing, recommendation is another. No area could be more essentially political than taxation. Therefore this report has been more difficult for a technical body like the Commission to write than was its predecessor report. We have found it relatively easy to say, on the basis of constitutional considerations and public finance best practice, that a body like the Welsh Assembly Government should bear the responsibility for raising some of its own revenue through taxation. The devolved government starts from a position where virtually all its resources come from a grant from central government; almost none comes directly from the people who elect it. Enhancing the accountability of the devolved government to the people of Wales by reducing reliance on a grant from the UK Government and increasing reliance on revenue that comes directly from its voters has advantages - both to the people of Wales and to the rest of the UK. But how much revenue, which taxes, levied on whom - those are all political matters that must be settled by democratic decision. To be sure, economic reality and the integrity of the UK impose constraints on what it is practical or advisable to devolve. We have done our best to examine those constraints and sift the various possibilities for devolving tax powers. Indeed, we have asked whether the constraints rule out any devolution of taxation at all. The sifting process has led us to reject some strategies while identifying others that look more promising. In some cases, we have felt able to recommend a particular course of action. In other cases we have confined ourselves to pointing out the alternatives and some of the implications of following any particular approach. In that way we hope to have guided discussion into fruitful channels without pre-empting any essentially political debates or decisions.