If the Welsh diverge upwards from English rates of income tax it might prompt some higher earners in Wales to relocate but the vast majority of people are unlikely to up sticks unless the income tax variations are very significant.
A five per cent to ten per cent long term variation in income tax rates is probably needed to have any significant effect on people’s choice of residence.
Since April 2018 the Welsh Government has responsibility for some of the taxes paid in Wales, including the Welsh Rates of Income Tax that came into force in April 2019. Ministers said they would not change them before the 2021 Assembly election, but that means we could be a year away from a major announcement on income tax in Wales
Before any divergence on income tax we call for research that looks at different types of taxpayers and their attitude to paying more or less tax in return for greater or less social funding; for example, to what extent free education, free prescriptions, free social care, increased local authority funding will affect their willingness or otherwise to accept paying more income tax. The Welsh must look at any impacts on housing costs and geographical differences such as the ease of travel across the Wales-England border.
While genuine cross-border migration is costly, it is likely to be easier for those with multiple homes to change their tax residence within the UK, especially given the ease of commuting between Wales and England. This is not only a question of high earners leaving Wales but also of high earners choosing not to come to Wales.
We suggest if Wales introduced a one pence increase in the top rate of income tax, it would not in itself have much impact on the behaviour of what is after all a relatively small group of high income individuals in Wales. But a divergence in income tax rates between Wales and England may have a greater effect, particularly among middle and higher earners, on the choice of where to live. The Wales-England border is much more porous than that between Scotland and England.
The Welsh must consider how much increases in income tax rates would actually increase the tax take. This is because the increase in revenue from taxpayers who remain in Wales and continue to report high incomes is offset for example, by more Welsh taxpayers migrating to England to work because of the higher Welsh rates. It is even possible that such behavioural effects could exceed the direct increase from raising the rate. There is also the longer term issue of relocating to avoid WRIT but returning after retirement and requiring health and social care support out of a Welsh “pot” they have not paid into.
Welsh income tax is a delicate balancing act beset with pitfalls and tinkering with tax rates can have unintended consequences.
An additional rate of income tax of 50% for incomes over £150,000 was introduced in the UK in April 2010. The rate was subsequently reduced to 45% from April 2013. A 2012 HMRC report concluded that there was a considerable behavioural response to the rate change: around £16-18 billion of income was estimated to have been brought forward to 2009-10 to pre-empt the additional rate of tax. But the report indicated that determining the true longer term underlying behavioural response to the additional rate was more challenging. The conclusion from the 2010/11 Self-Assessment data was that the underlying yield from the additional rate was much lower than originally forecast, and that it was quite possible that it could be negative. The report points to difficulties in quantifying the longer term effect of the additional rate because of the perception that it was a temporary increase.
The power to vary income tax rates in Wales applies only to non-savings and non-dividend income which leaves Wales particularly exposed to taxpayers mitigating their liability through switching from earnings to dividends or from pensions draw-down to investment/capital withdrawal.
Are there lessons from Scotland?
Complexity arising from income tax rate (and, in particular, tax band) divergence is a real concern. While it may be tempting to think that software will work it all out, our experience of the Scottish income tax and rate band variations is that it is now more difficult to work out a Scottish resident’s tax liability and be sure that it is correct than before the variation. Also, not everyone has access to software and it is generally accepted that taxpayers should not have to pay for software to work out their devolved taxes.
Since April 2018 there have been five rates and bands in Scotland. The experience from Scotland is there is no clear evidence of significant effects on migration but this is probably because of a lack of awareness of devolved income tax rates.
Finally, those on lower incomes are less likely to be able to respond to income tax divergence but they may be affected. This is the case for individuals who pay income tax and who are also in receipt of welfare benefits, such as universal credit.
By Ritchie Tout, Vice-Chair of Chartered Institute of Taxation’s (CIOT) Welsh Technical Committee.
This article first appeared in the Western Mail newspaper on 26 February 2020.