James Foreman-Peck and Peng Zhou assess the potential impact of varying rates of tax after devolution to Wales.
Tax devolution for Wales creates new policy opportunities but in assessing them Wales’ special circumstances must be taken into account. Although many people migrate in and out of Wales every year the flows at present are broadly balanced; net migration is very low, unlike the gross flows. The Welsh economy is very highly integrated with England, more so than the Scottish economy. As the Holtham Commission report pointed out over 1.4 million people in Wales (48% of the total) live within 25 miles of the border with England, and 2.7 million people (90% of the total) live within 50 miles of the border. Only 5% of the combined population of Scotland and England lives within 50 miles of the border between those countries. Any tax difference between the countries is therefore more likely to trigger net migration between England and Wales than between England and Scotland.
An important question is how much migration would be induced by what sort of divergence between Welsh and English tax rates. This matters because movement of taxpayers affects tax revenues; in the limit, migration could ensure that revenue was boosted by a tax cut and reduced by a tax rise. It is tempting to conclude that likely differentials will be small enough not to figure in calculations as to which side of the border to live. But while this is likely to be true for the average migrant, there could be quite a few among the many moving in both directions for whom small differences might tip the balance.
To gain some idea of the size of possible tax-induced mobility we looked at migration between local authority areas in England and Wales. We controlled for the obvious major influences on such movements – relative population size, distance between local authority pairs, house price differentials and so on – in order to isolate the effect of council tax rates that can differ substantially between local authority pairs. The objective is to deduce from these actual tax divergences how what the effects would be of a tax differential that has not yet happened – such as different Welsh income tax or sales tax rates. We use a simple model of the Welsh economy to transform estimated council tax effects into hypothetical income tax effects. Finally, we take account of some limited spillover effects of tax changes on to the economy as a whole, in particular the impact of other sources of tax revenue.
Not surprisingly perhaps, we find that changes in the Basic Rate of income tax (20%) have little effect on migration and tax yields. There is not enough money at stake for most families paying only the Basic Rate to warrant relocating. Where we do identify significant impacts is for changes in the Additional and Higher income tax rates. The higher income groups subject to these taxes can more easily move around the country and incur greater tax bills than Basic Rate paying households. Rather few people are involved but some of these could gain or lose substantially from the emergence of tax rate differentials.
The Additional Rate only affects the richest one percent of taxpayers. We find that for this Rate (currently 45% on a taxable income over £150K), Thanks to induced migration any tax cut will always raise tax receipts and any rise will always reduce tax revenue. Over a longer period the migration and revenue effects become stronger. A reduction in the Additional Rate from 45% to 40% increases Welsh tax revenue by an annual rate of £55 million after ten years.
A Higher Rate differential between Wales and the rest of the UK has the greatest impact on Welsh tax revenue because it affects both the middle income and the high income groups; in fact the greater part of a typical high income worker’s earnings is taxed at the Higher Rate.A large cut in the Higher Rate (currently 40% on a taxable income between 43K-150K) will slightly lower tax receipts in the short run (1-3 years), but in the long run even a large cut will still raise Welsh tax receipts. The encouragement to some households to immigrate, increasing Welsh taxable income is greater than the revenue lost from the reduction in the Rate. A rise in the Higher Rate to 42.5% from 40% reduces Welsh tax revenue ten years later by about £240 million a year.
We simulate some wider impacts of these tax changes. A cut reduces government spending, and thereby affects household well-being, but is perhaps partly or more than counterbalanced by greater spending on private goods and services. In addition, the composition of the labour force changes through tax-induced migration. The net effect turns out to be that tax cuts always increase output per capita but they do not always increase total tax yield.
Considering the income tax devolution permitted by the 2014 Act, tax-induced migration has only a muted effect on devolved government revenues because such a small proportion of revenue is decentralised. The additional effects above on the tax revenue generated by the devolved economy are greater, but devolved government revenues are largely insulated from them (unlike central government). Welsh output or Gross Value Added is most sensitive to the changes in the Higher Rate of tax.
Extensive tax devolution, in contrast to the limited devolution proposed for Wales in the UK 2014 Act could trigger substantial spillover impacts of migration on tax revenue. This prospect may, and perhaps, should deter substantial decentralisation of taxation.
On the face of it the negative effects of poor education and Welsh language compulsion, which are already driving out small but significant numbers of economically active people from Wales and preventing others from moving in to fill skills shortages, are far more likely to be significant drivers of people movement and tax-take than the tax change(s) themselves.
The inconvenience of any tax variation for national companies having to use different Regional tax rates in their payroll and other accounting software is also likely to reduce their incentive to invest in Wales. If it turns out that national companies with a central payroll function don’t have to implement Regional tax rates then there is even less point in having them!
It seems that every time Wales makes itself different to England it loses but the Wales based taxpayer-funded jobsworths always make sure they’re OK. Unfortunately Wales needs to raise ever more taxation to pay for these unnecessary public sector jobs so Wales’ loss-making economy has become self-sustaining.
This is an informative article that provides solid research to support what some of us have long suspected – the sort of thing the Institute was set up to do.
There is no doubt that Wales would benefit from a low tax regime, subject to two important caveats.
First, as the article makes clear, the power to fiddle a bit with rates will make little difference. Positive change can come only when the power and the will to reform the whole system is in one place, whether that place is Westminster or Cardiff Bay.
Second, a tax haven might be a good place to start but is not enough. We need something more than an economy dependent on a few multimillionaires subsidising everyone else. The tax regime must also stimulate an enterprise culture among the entire population. Only then will Wales take responsibility for her own destiny.
James,
To check are you basing your hypothesis on the idea that differential council tax rates are a spur to (internal) migration? what evidence is there that this happens now? Common sense would suggest that the main spurs of migration are work/education, availability/cost of housing (including being able to upsize) and, in later life, wanting to be close to either family or a desired location. This suggests that moving because of tax changes will be quite a long way down the list of reasons – especially as that move may occur other costs – finding new schools for children, transaction costs of finding a new, equally desirable house, and potentially increased commuting costs/times – which wipe out the benefit of living in a (slightly) lower tax regime
Whilst Mr Foreman-Peck’s maths and logic look sound enough I wonder how many potential ‘lower’ higher rate tax payers would actually pay as much tax as he suggests they might. At that level of income it becomes worthwhile to pay an accountant to avoid (as they say) paying top whack. What’s the Welsh Government’s current budget, £16bn? After ten years and throwing in a bit for inflation, with his £55m we’re looking at 3-4% of an increase by the end of a period that may well be characterised by economic and political disruption that may see the interests of Wales marginalised in the wider post-Brexit turmoil (and I’m not a Plaid supporter). Not that £55m is a trifling sum, it could pay for a fair few doctors and nurses, but we need them now and the rules may change in response to the disruption. It might be good to hear from a geographer on what makes people move relatively short distances for financial advantage. What other advantages could Wales offer the well-shod? The Cardiff City Region should be thinking about this.