Britain needs tax devolution, but beware of fiscal war
Britain is an outlier for tax centralisation, but devolution can go badly wrong, says Tim Sarson
Last week government front benchers and local leaders from across England got together at Number 10 North to discuss the details of a new Visitor Levy, or tourism tax.
Quite a momentous moment in its own way, because this is the first time a new taxing power has been granted to English regions in decades.
Devolution is on the march. At least the idea of it. If things shape out as the Prime Minister has suggested, the political and fiscal structure of this country is going to look very different in a few years’ time. For a tax policy specialist at a firm that’s highly regional with offices the length and breadth of the country, this is rather a fascinating development.
So far what’s on offer, beyond the visitor levy, seems to be largely about spending rather than taxing powers. Westminster continues to collect our taxes, but mayors of devolved cities and regions will get more of a say in how this central pot is spent. Those same mayors and many across the country are hopeful things eventually go further.
Britain is one of the developed world’s most centralised states. Consider how little of our national tax take is collected at local or regional level. In 2023, according to the OECD, it was 4.8 per cent. The remaining 95.2 goes into central Treasury coffers before being spread back out across the country. That’s very low, and it’s been so for a long time. Even before the parish level Poor Rate was absorbed into general taxation in the 1920s, it was only bringing in somewhere between three and 10 per cent of national revenue.
In the USA the comparable percentage is 34.8. In Canada a whopping 46.7. Is this just a function of continental-scale federations? No. Germany collects 32.6 percent of revenues at city and lander (federal state) level. Germany has rather less regional inequality than we do, even comparing the richest areas with the former East. So does Switzerland, a much smaller landmass than the UK. Even France, where all roads lead to Paris, manages 14.3 percent. So we’re an outlier.
There are two common arguments for devolving taxation to the sub-national level. One, that regional government is closer to the needs and priorities of its voters and can therefore better direct fiscal policy. The other is that devolution allows experimentation and healthy competition for investment.
Regional competition
The first argument is politically powerful, but economically hard to prove. But, on the other hand, there’s plenty of evidence that tax decentralisation drives inter-regional competition.
In 2014 in the US Nevada enacted a huge package of tax reforms specifically to attract a $5bn Tesla gigafactory. It worked. There are countless other examples at state level in recent years. The Swiss canton of Zug has the lowest effective tax rates in the confederation and its second highest GDP per capita. Both were historically low population rural regions, which were able to deploy tax incentives to drive investment and growth. Imagine what might happen in, say, Staffordshire or Ceredigion if they could offer a 15 per cent corporate tax rate, or 5p off income tax.
It’s not always like that. Rich regions can end up with higher tax receipts if their source of wealth is immovable natural resources or they’re already at a big competitive advantage over their neighbours. Canada’s Alberta, the second richest province in the country, gets to keep most of its oil and gas royalties, so it’s able to maintain very high levels of public spending. In Canada, as in Switzerland and Germany, robust redistribution shaves off the sharp edges of inequality, but when that’s not the case things can go badly wrong. Brazil saw decades of “fiscal war” between states trying to outcompete each other. The financially weaker states became unable to provide services and public works to attract investment, and inequality worsened. Brazil is now edging away from devolution to more centralised tax collection.
Britain isn’t Canada or the USA, or Switzerland for that matter. But we could certainly benefit from a dose of regional competition. Allowing mayors to spend central government money on local priorities is great, but the relationship with Westminster would be more symmetrical if it also involves the commercial discipline that comes with control over revenue. If we’re serious about returning power to our cities and regions, we surely need to get that 4.8 per cent up a bit.
Tim Sarson is head of tax policy at KPMG