Devo plus: transferring tax powers

Victor Hewitt explains the mechanics of tax devolution and the main principles for working out which tax rates should be devolved.  Taking responsibility for raising revenue is a sign of maturity for political leaders.

When they were negotiating the Good Friday Agreement our political parties neglected to give any consideration to the devolution of taxing powers.  Hence when the first Executive took up office the only form of taxation that was within their control was the regional rate, a property tax somewhat similar in principle to the powers conferred on local authorities in Great Britain.

More than a decade later, the argument for devolving tax-varying and tax-raising powers has advanced considerably in Scotland with the publication of the Calman report and the Scotland Act passed in April 2012 which confers powers on the Scottish Parliament to vary income tax and to raise new taxes.

In Northern Ireland, however, the issue has advanced in a piecemeal fashion.  A significant effort has gone into the campaign to bring corporation tax down to the 12.5 per cent enjoyed by the Republic of Ireland (an initiative, it should be noted, that was started outside the Executive and the Assembly) but that argument has yet to be won with the Treasury.

More successful have been the negotiations over holding down air passenger duty to preserve Northern Ireland’s only direct trans-Atlantic flight and variations to the aggregates levy to help local quarry owners.  What has not happened has been a meaningful debate on the merits of devolving taxes in general, nor has any serious work been done on the mechanics of doing so or the economic implications.  This is the so-called ‘devolution plus’ or ‘devo+’ option.

One of the practical problems of considering the devolution of taxes is that whereas we know which taxes apply in Northern Ireland, we do not have an accurate measure of how much money they raise each year.   This is because our public finance system doesn’t require such information.  Public expenditure totals are agreed with the Treasury and incorporated in the total public spending of the UK and this, in turn, is financed by the proceeds of all taxes and borrowing.  There is no need to calculate a separate Northern Ireland tax figure.

A by-product of these arrangements is that the implicit subsidy from other UK tax-payers to financing public spending in Northern Ireland is not visible, though it is undoubtedly large.  The current estimate is that of the £19 billion of public expenditure each year in Northern Ireland (spending by the Executive plus pensions and benefits and spending by other UK departments), not more than half would be covered by tax revenue raised in the region.

Since revenue figures are not collected on a geographical basis, these have to be estimated by a variety of means of varying accuracy.  The table opposite shows estimates of the amount raised by the main tax types in Northern Ireland in 2008-2009, the latest year for which these calculations exist.

It is immediately apparent that in terms of revenue yield, the major taxes are income tax and national insurance contributions, value added tax and the various duties connected to fuel, alcohol and, especially, tobacco.

What economic principles should govern the transfer of any of these taxes to the control of the Executive?  That must depend on the purpose for which the right to vary the tax is being sought.  Obviously taxes are a means of raising revenue but they can also fulfill other functions, such as discouraging the consumption of what are considered harmful products and services such as alcohol, tobacco and gambling or, if environmental concerns are uppermost, activities that generate carbon emissions.

A critical issue for the Executive is what lowering any UK tax would cost in terms of a compensating reduction in the total of public expenditure in Northern Ireland compared to the future economic benefit that might be gained.

There is no realistic prospect of the UK Government absorbing a tax loss since Northern Ireland already contributes quite disproportionately (through the hidden subsidy mentioned above) to the national deficit.  This pretty well rules out any lowering of taxes on income or VAT.

A further complication is that changing the rate of tax does not change the revenue it produces in direct proportion.  The sensitivity of revenue to tax changes (the elasticity of the tax) varies widely across products and services and changing a tax rate can set in train a very complex series of events as the economy adjusts.  The latter point is very evident in the debate over what the cost of a lower corporation tax rate would be.

Apart from the corporation tax, the only other tax that looks a good candidate for devolving to the Executive in terms of the longer term cost-benefit ratio is air passenger duty which, in simple terms, is a barrier to us connecting to the wider world.  Northern Ireland desperately needs more, not less, connectivity in a globalised world economy.

The ability to manage taxation and to match revenues to expenditure is the mark of a mature system of government.  The present arrangements in Northern Ireland have a very long way to go to maturity.