Stripping Whitehall of the bulk of its powers through a process of sweeping devolution would raise living standards in the UK by 6%, a leading free-market thinktank has said.

The Institute for Economic Affairs said Britain would be richer with a fully federal system in which central government would have control over defence, foreign affairs and border control and all other responsibilities would be passed down to local authorities.

A report from the thinktank said the UK was one of the most centralised countries in the world, with local government currently collecting 5% of all tax revenues, compared to 50% in Canada, 29% in Germany and 13% in France.

The IEA said devolution of tax-raising powers would encourage local authorities to experiment, would match spending with the wishes of local people and would lead to greater competition between providers of services currently provided by central government.

“Handing responsibility to the local level would help ensure that services and regulation were better matched to people’s preferences and circumstances,” the IEA said. “Moreover, it would lead to competition between local authorities as voters could move from one local authority to another if their own was ineffective. The erosion of the tax base that would result from such decisions would provide the right incentives for local government to be effective and efficient.”

The UK's approach to devolution is incoherent and unstable Prof Philip Booth, IEA

The author of the report, Professor Philip Booth, said there was evidence that lifting the amount of tax raised locally to 20% – a level still below the average for the G7 industrial nations – would increase per capita incomes by 6%.

He said the government’s proposal to have English votes for English laws was unworkable, because it would lead to some MPs have responsibilities for two sets of issues and some for only one. Booth said that apart from the core functions retained at a UK level, everything else should be the responsibility of devolved parliaments.

The government has called for more powers to be devolved to city regions, but Booth said there was a need to be radical, with much more extensive decentralisation of regulation, tax and spending to a local level.

“The UK’s approach to devolution is incoherent and unstable,” Booth said. “It’s clear that the only long-term stable solution is to create a proper federal state with a very small number of powers held at UK level. All other issues should be the responsibility of separate governments in Scotland and the rest of the UK (or England, Wales and Northern Ireland). There should then be a sweeping decentralisation of regulation, tax and spending powers to local government. With very few exceptions, each layer of government must raise what it spends.”