This is a guest post by Gerald Holtham, who chaired the Welsh Government’s Independent Commission on Funding and Finance in Wales and is adviser on finance to the Welsh Government. The question he addresses – of how to manage a reduction in the block grant to allow for tax devolution while maintaining the Barnett formula – is a highly timely one, given the ongoing discussions about the ‘fiscal framework’ for Scotland (for which this is the key issue) as well as corporation tax devolution for Northern Ireland and moves on income tax devolution for Wales announced in the Spending Review. (My own comment on this post can be found here.)
In all the discussions about tax devolution for all parts of the UK, a key issue has not been clarified. That issue is how to reduce block grants when a tax is devolved. Indeed there still appears to be no general agreement between the devolved governments and the UK Government about how to proceed. It is a particularly knotty question in discussions about income tax but also VAT and it has the capacity to delay devolution to Scotland and to stall it altogether for Wales.
There is little problem in the first year of devolution. An estimate can be made of the revenue foregone by the Westminster government, given prevailing tax rates, and that can be deducted from the block grant. Subsequently the deduction can be revised when actual revenues differ from the estimate. The difficulty comes for subsequent years when the deduction must be expected to grow with the economy and its tax base but must not be affected by changes in tax rates by the devolved administration – otherwise devolution of tax powers is not real.