Is a Change to Income Tax Devolution in Wales on the Horizon?

The Welsh government recently commissioned an independent report looking at the future of income tax devolution in Wales — specifically, whether the current system should stay as it is or whether a move towards full devolution would make more sense.

The report was put together by the Fraser of Allander Institute at the University of Strathclyde and Bangor University, and it examines four possible approaches, each with different implications for how much tax revenue the Welsh government ends up with after the block grant adjustment (BGA) is factored in.

How Does Welsh Income Tax Devolution Currently Work?

At the moment, the UK government reduces each of its income tax rates — basic, higher, and additional — by 10 percentage points for Welsh taxpayers. The Welsh government then sets its own rates at 10% to fill that gap. The net effect is that Welsh taxpayers pay the same overall amount of income tax as those in England and Northern Ireland.

It's a partially devolved system. Wales controls its own rates, but the thresholds and bands are still set by Westminster.

What Is the Block Grant Adjustment?

The BGA is essentially a reduction to the funding the UK government provides to the devolved administrations in Wales and Scotland. It's designed to reflect the tax revenue Westminster would have collected if devolution hadn't happened.

How the BGA is calculated matters quite a bit, because the devolved governments effectively gain or lose based on the difference between the tax they actually collect and the BGA deducted from their grant. The bigger that gap in their favour, the better off they are.

Currently, Wales and Scotland handle this differently. In Wales, the BGA is calculated separately for each tax band (a "by-band" approach). In Scotland, there's a single adjustment applied across the board.

The Four Options

The report looks at four possible models:

Option 1 — Partial devolution of income tax rates with a by-band BGA. This is how Wales currently operates.

Option 2 — Partial devolution of income tax rates with a single BGA.

Option 3 — Full devolution of income tax rates and thresholds with a single BGA. This is how Scotland currently operates.

Option 4 — Full devolution of income tax rates and thresholds with a by-band BGA.

The report assesses how sensitive the Welsh government's net tax position would be under each of these models — essentially, how much the outcome could swing depending on factors outside Welsh government control.

What Does the Report Conclude?

Perhaps unsurprisingly, there's no clear winner. Each option comes with trade-offs.

The partially devolved models (Options 1 and 2) give the Welsh government less control over the tax system, but they also limit its exposure to unpredictable changes — movements in UK tax policy, shifts in the income distribution of Welsh taxpayers, and so on.

Full devolution (Options 3 and 4) would hand the Welsh government significantly more control over rates and thresholds. But as the report points out, income tax rates can't be set in isolation. Any changes would need to account for how Welsh income tax interacts with the wider UK system, and the potential knock-on effects of future UK government policy decisions.

The report's recommendation is that any move towards changing the devolution model would need to carefully weigh the Welsh government's appetite for risk against a realistic assessment of what could go wrong. It's a question of control versus exposure, and there's no easy answer.

You can read the full report on the Welsh government website.