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Financing Devolved Government: Some Aspects of the Holtham Report James Foreman-Peck.

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Presentation on theme: "Financing Devolved Government: Some Aspects of the Holtham Report James Foreman-Peck."— Presentation transcript:

1 Financing Devolved Government: Some Aspects of the Holtham Report James Foreman-Peck

2 The Report Formula-based block grant and tax varying powers A technical report What types of taxes devolved? What relation to needs-based block grant? Looks at tax revenue consequences of tax variation Implications of assymetric devolution- tax rise v tax cut

3 Practicalities In the event of Welsh tax devolution, do you think it more likely that taxes will go up or go down? How do you feel about the likely outcome? But Commission thinks higher rate income tax cut would increase revenue a lot- as would raising the lower rate! However decreases might be at the expense of the rest of the UK p66 Relocation effects – greater size of English population matters Tax cut 2-3 times tax rise effect (one paragraph)

4 A basis for concern about tax raising powers? Equity Brewer et al, Mirrlees Commission A higher basic tax rate affects the following; The amount of gross income taken in tax and withdrawn benefits when people enter work at low earnings is too high: for most groups it is close to 100% before individuals are entitled to the working tax credit, and they remain high even with it. The marginal rate of 73.4% that many low to moderate earners face when having tax credits withdrawn is likely to be above the optimal rate even if peoples decision to work a little harder is relatively unresponsive.

5 5% + Pseudo Tax Differentials?– Regional Price Indices and Regional Equilibria



8 Is this a lot or a little? What does it mean for economic behaviour and tax revenue? A simple case (basic rate tax yield £2850m tab 6.1) one pence rise T=tax revenue=tax rate (t) x wage (w)x amount of (taxable) work done (L), t=0.2 T=t.w.L(w,t) =?£175m for one pence (t=0.01 ) (or (0.01/0.2)*2850=£142m With behavioural response T=t.w. L(w,t) = £163m ( L=0.932, e= ?) =change in GVA per head/ worker? Migration response, £132m. L=0.754, e 1 +e 2 = A 5 percent rise in taxes lowers employment/work by 1.25 percent

9 Higher rate increase- is this effect plausible? Total higher rate, raises £1300m T=t.w.L(w,t) =?£16m Extra 1p raises £16 million with no response ((.01/0.2)*1300?) With behavioural response T=t.w. L(w,t)= £3 million, L = 0.23, 77% fall in higher rate work done Migration response -£92 million House price effect? High wage earners in Wales are in the public sector

10 Because total tax receipts (T) are the product of the METR (t) and taxable earnings or income (w.L), the elasticity of income with respect to the tax rate (e) is related to the change in taxable income with respect to the marginal tax rate as T/t = t. ((wL)/t) + wL = (wL/wL) t. ((wL)/t) + wL = (e +1)wL And the proportionate change in tax revenue is (T/t)(1/T)=(wL/T) (e+1)

11 In the simple case where average =marginal tax rate the share of income taxes in earnings (T/wL) is t. Hence (T/t)(1/T)=(e+1)/t With no behavioural or migration response e=0 And proportional rise in tax revenue is the marginal and average tax rate

12 (T/t)(t)=(e+1) = increase in tax revenue from a proportionate increase in the tax rate 1p in £ is 5 percent so with no response 5% of taxable income e= we lose 25% and get 5% of the remaining 75% extra tax revenue If T=twL= £2850m, 5% is £142.5m and with the response only £107 m Employment or work rate change implied is a fall of 1.25 percent (0.25*5)

13 1 p across the board with no reaction £201m With behaviour and migration £132-92=£40m 75%, e=-.75 Ip across the board is not a 5% tax increase because income tax is only a proportion of tax paid by households say one half. 2.5% increase in tax lowers employment by 1.87 percent A smaller economy with lower labour force participation.

14 Simulating the Effects of a Welsh Income Tax Increase: the Model ( from Fiscal Devolution and Dependency Applied Economics Labour force consists of two groups; one sufficiently well paid and skilled to seek work elsewhere should conditions warrant (across the border in particular) and another group that is not- it is by contrast immobile. The immobile labour force produces goods traded on world markets and with prices determined there. The mobile labour force makes goods and services that are, and must be, consumed more locally. This second group are likely to respond to tax differentials by moving, whereas the immobile group can only respond by increasing or decreasing their willingness to work.

15 If a Welsh income tax rate were higher than that across the border, some people would move to take advantage of lower tax obligations. This may in due course affect the wages of mobile labour -the maximum likely effect is that the wages of these people would rise by sufficient to cover a higher Welsh income tax than in England, so as to equalise the advantages at the margin of working in either place. A consequence of such an adjustment is a fall in mobile employment and the Welsh working population.

16 A one percentage point increase in income tax (that is, taxes that function like a proportional income tax). For an increase in the tax across the UK, manufacturing or traded jobs in Wales fall by about 500, other private sector jobs decline by around 4000 and working population diminishes by a little over 2000, mainly through migration. (under 0.2 percent fall in working population and about 0.5 percent fall in jobs) There is some offset from greater government spending A differential Welsh tax increase, reflected in a compensatory wage change has no effect on the traded sector. But it does reduce non-traded employment by an extra three quarters of the impact of a UK-wide tax increase, by around a total of 7000 jobs (total say 0.9 percent). Working population falls by about 0.3 percent.

17 Conclusion Holtham concludes or guesstimates that devolved tax policy could significantly alter the size and work rate of the Welsh economy (And I think thats right)

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