The VAT opportunity
This article by Alison Payne first appeared in issue 25 of Scottish Policy Now.
In one of her final moves as Prime Minister, Theresa May has announced a review into devolution. The review is to be chaired by Lord Dunlop, the former Scotland Office minister, and is expected to look at ensuring that UK government structures and departments are co-operating to make sure devolution works, particularly following the UK’s likely departure from the European Union. I hope that VAT is one of the issues that the review considers.
The link between VAT and the performance of the economy has been a talking point for successive commissions into Scottish devolution.
The Calman Commission said devolution of VAT had the “potential to deliver accountability given its significant yield and the transparency to the population.” but “devolution of VAT to Scotland is precluded by EU law.”
The post-independence referendum Smith Commission recommended (and the Scotland Act 2016 delivered) the assignation of 50% of VAT revenues to the Scottish Parliament, again acknowledging the link with growth but the illegality of devolving the tax.
The Scottish Conservatives’ submission to the Smith Commission went as far as saying “…VAT – like income tax – is in principle suitable for devolution. Sales taxes are commonly decentralised – even down to local level – in countries such as Canada and the US. Further, VAT is a growth tax, which supports the sorts of services devolved governments provide. Were it not illegal under EU law, we would have been inclined to recommend that VAT be devolved to the Scottish Parliament”.
Furthermore, then Chief Secretary to the Treasury David Gauke told the House of Commons that “control over setting VAT rates is not being devolved to Scotland, because EU VAT law does not allow for differential VAT rates within a member state”.
In other words, there has been an appreciation across political parties that devolving VAT to Holyrood makes sense, but that due to the UK’s membership of the EU, this could not be delivered.
Within the European Union the VAT Directive limits the abilities of member states with regard to the use of the tax. The aim of the directive is to move toward harmonizing VAT across member states. As a result of this directive, the ability of both the UK Government to devolve the tax, or the Scottish Government to change the regime is hampered.
However, the UK’s decision to leave the EU, should it be implemented, means that the issue of devolving VAT can be returned to. Indeed, the First Minister commented at a recent Reform Scotland event that in the event of Brexit, she believed VAT should be devolved. Therefore, it makes sense for this to be considered as part of Lord Dunlop’s review.
The Scotland Act 2016 allows for the first 10p of the standard rate of VAT receipts and the first 2.5p of the reduced rate of VAT receipts in Scotland to be assigned to the Scottish Government from 2019-20. Assigning revenue does not pass any additional control to Scotland, the ability to change the rate remains at Westminster. The latest edition of Government Expenditure and Revenue Scotland estimates that assigned revenue to be around £5bn.
VAT in full is estimated to have raised just over £10bn in Scotland in 2017/18 and is the third largest source of tax revenue behind income tax and national insurance.
Devolution of VAT would also solve Holyrood’s problem of being so heavily dependent on one tax. In 2017/18, 66% of all devolved tax revenue came from non-savings & non-dividend income tax. Non-Domestic Rates accounted for 17% and Council tax for 15%. (The rest was made up LBTT and Scottish Landfill Tax)
To put that over-reliance in context, across the UK as a whole, revenue from income tax accounted for 24% of tax revenue.
Scotland’s taxation powers are currently so heavily skewed towards income tax, which means that changes in the rates and bands can cause potential significant risk to the Scottish Budget without the remaining “basket” of taxes to offset that risk.
The Calman Commission highlighted that “governments seek to operate a broad tax base in order to mitigate variations in one particular component of that tax base”. However, the current devolution settlement has left Scotland without the basket it requires and devolving VAT could be a set in the right direction.
Currently the Scottish Parliament is responsible for raising, through devolved taxes, about 37% of what it spends.
Despite being responsible for roughly 60% of all public expenditure in Scotland, Holyrood is responsible for only about 30% of taxation. That imbalance is not good for transparency or accountability.
If VAT was devolved it would lead to a re-balancing with Holyrood gaining a similar responsibility for revenue raising as it did for expenditure – 46% and 60% respectively; and would be responsible for raising nearly 60% of its own revenue. This would mean that for the first time since devolution, the Scottish Parliament would be responsible for raising the majority of what it spends.
This is a far more stable settlement.
Ultimately, the ability to devolve VAT is dependent on the UK leaving the EU, something which may still not happen. However, both contenders for the Tory leadership have set out their commitment to ensuring the UK leaves the EU. Therefore, there is nothing stopping either giving the commitment now to devolve VAT once Brexit occurs. The review into devolution also offers another opportunity for the devolution of VAT.
Although the politics of this issue are critical, so are the economics. Devolving VAT would rapidly focus minds at Holyrood on promoting economic growth because of its direct link to tax revenue, and it would also give the Finance Secretary an important extra tool to change outcomes through tax policy.