Future Local Part 4: A taxing issue
In the fourth part of the LGiU's series on the future of local government after the EU referendum, Lauren Lucas argues that the promise of devolution is hollow without a review of our centralised system of taxation. Other essays in this series may be found at Future Local: where next for devolution?
‘The parking charges are going up again – it’s ridiculous.’ The woman is middle-aged, well-dressed with immaculately manicured nails and with an over-excited toddler in tow. It’s a sunny day and we are in a Hertfordshire local authority car park. ‘The council must be making a fortune. Still, it’s a nice day for the splash park.’
How to respond? I could have told her how council budgets had been cut by 40 percent in the last six years; that fees and charges form an increasingly important source of funding; that parking charges pay for the upkeep of parking facilities; that the council also funded the construction of the free splash park she was about to visit. But I didn’t want to ruin her day, so I just tutted and moved on.
Every day there is a new news story about increased fees and charges: parking charges; parking fines; charges for waste collection; library fines and more. The local government funding base is at a low ebb. Dramatic reductions to the central government grants over the last six years have put increasing pressure on other forms of local government funding; namely council tax, business rates and fees and charges.
The negative headlines aren’t a surprise. Council tax and business rate increases are capped by central government, leaving fees and charges as the only funding mechanism left with any degree of flexibility.
According to Simon Jenkins writing in the Standard, the City of Westminster now gets almost twice as much revenue from parking meters (£80 million) as from its entire residential council tax (£50 million), leading him memorably to describe Westminster Council as “a car parking company with a sideline in municipal government.”
So how do we pay for local government?
The problem is a thorny one, with a long and painful history. In contrast with other European countries, taxation in Britain has become increasingly centralised since the middle of the twentieth century.
The introduction of new national welfare programmes called for redistributed national funding. De-industrialisation in the 1960s and 70s resulted in the growth of ring-fenced government grants.
In the 1980s, confrontation between the government and radical Labour authorities led to government rate capping and the search for another way of funding councils. The resulting Community Charge, or Poll Tax saw rioting and looting on the streets of the capital and its replacement in the form of council tax was always an uneasy compromise.
In recent years the majority of local government funding came from the Revenue Support Grant (RSG), distributed by central government according to a funding formula based on need. There were winners and losers, but the fundamental principle was that areas with less revenue raising potential would be supported by the redistributive aspects of the grant.
We are now in a place where 95 per cent of taxation in Britain is set and raised by central government, making it one of the most centralized tax setting arrangements of any democratic country.
This is no accident, but is the result of deliberate policy over many years which have moved towards a centrally controlled fiscal policy. Arguments used against increased local taxation have generally fallen into two categories. Treasury officials argue that regional tax differences will lead to competition, which will be inefficient. Critics on the left have tended to stress the danger of postcode lotteries and the need for national standards.
All this is beginning to change. In his 2015 party conference speech, the Chancellor George Osborne announced his ‘devolution revolution’, the complete phasing out of the Revenue Support Grant by 2020, to be replaced by the 100 per cent of revenue from business rates to spend on local government services. The move gave councils the ability to lower rates locally and to keep the entirety of the proceeds in a bid to incentivize them to promote local economic growth.
The political earthquake unleashed by the Brexit vote has thrown up serious questions about the future of the whole devolution project. But if the plans for business rate devolution do go ahead, locally raised revenue will form a far greater proportion of the council funding base than it has done for many years.
Why is local taxation important?
The main argument for councils raising their own revenue is one of democracy and local accountability. The Layfield Report of 1976 (the last UK government report to really address the issue of local taxation) argued that more local control of revenue raising would make councils accountable to their electorate, rather than to the State.
"If local authorities are to be accountable they should be responsible to their electorates for both the expenditure they incur and the revenue they raise to finance it, particularly for increases in both." (Layfield Report 1976)
In this analysis, general revenue raised by central government and transferred across to local government blurs the issue of local responsibility and accountability. This may be true. Certainly one of the most frequently cited reasons for citizens not voting in local elections is that it seems to make very little difference to the services they receive.
But there is another driver. It is a truth less than universally acknowledged that central government will always want to control anything it funds directly. Until local government has greater determination over its own budgets it is unlikely to avoid micro-management by central government for long, whatever the direction of the current administration.
With this in mind, the tentative steps towards business rate devolution are exciting news. They could mark the beginning of a new conversation about local government sovereignty and the way that its services are funded.
Are the devo deals delivering on devolution?
Whether the devolution deals are really giving us a properly devolved settlement is less certain. Despite progress on business rates, It is deeply questionable whether real fiscal devolution has ever been on the cards in the present devolution talks.
Even councils with relatively conservative plans for fiscal devolution in their bid documents were quickly disabused of the notion that devolution was intended to help them raise money. One council Leader commented:
‘We had all sorts of ambitions for fiscal devolution in our first devolution bid. But it was made immediately clear that this was a red line and not up for discussion.’
Mayors can raise a supplement on business rates to fund infrastructure projects up to a cap of 2p per pound of rateable value. But on the whole, what is on the negotiating table is the decentralisation of budgets, rather than the devolution of powers to raise funding.
This is a fundamental problem. Councils’ responsibilities are growing and the local taxation base needs to grow equivalently if services are to continue operating. In the LGiU's 2016 finance survey, 82 per cent of chief financial officers said they would be forced to dip into reserves to balance the books. 70 per cent thought the government’s proposals for fiscal devolution should go further.
If councils are to have more responsibility for services they must have more flexibility in funding them.
A more local system of taxation?
So what should a good local tax look like? As you might expect, there is considerable debate on the issue, but there appears to be a broad consensus among economists that any local tax should try to meet as many of the following criteria as possible.
1) Simple to administer. The smaller the organization, the higher the administrative costs per unit of revenue raised. This calls for relative simplicity in the tax system.
2) Economically efficient. Tax competition between local authorities is not popular among economists. They believe that taxes where possible should be 'neutral', ie. they don't affect decision making in the private sector. Massive regional variation in business rates would fall foul of this guidance.
3) Equitable. The fairness of a local tax has two dimensions. Firstly how progressive or regressive it is. A highly redistributive tax could (in theory) cause better off residents to relocate to another area with lower taxation. A very regressive taxation which falls equally on all, irrespective of their ability to pay, is likely to be perceived as unfair. Secondly there is a question of regional equity. Plans for business rate retention have been criticised by local authorities in areas with fewer businesses as giving an unfair advantage to councils with a strong existing business base.
4) Accountable. Local taxation should make councils more directly accountable to their residents by ensuring those who fund services also receive them - and vote on their performance. Arguably, funding by business rates could be a problem in some areas if it makes a council more accountable to local businesses than it is to local residents.
5) Stable - Local governments have to provide services on a continuous and reliable basis. Taxes that tend to fluctuate over a business cycle (such as personal income taxes) are consequently seen as undesirable at a local level.
There is no form of local taxation that meets all these criteria and there are trade-offs to be had. Despite this, there are obvious contenders for fiscal devolution - and others that would be inappropriate.
For example, corporate income taxes are not generally seen as sensible to devolve as they are complex to administer and businesses are very good at moving profits around to take advantage of different rates. However, property and land taxes are considered to be good taxes to devolve in that they are immovable and relatively simple to administer and enforce.
Personal income tax and sales taxes fall in between. Personal income taxes may be complicated to administer and are relatively unstable, but they are probably the most progressive form of taxation and could contribute to greater accountability at a local level. The Layfield Review of 1976 recommended a local income tax in its conclusions.
Sales taxes are commonly devolved in other parts of the world, particularly in the US where they are collected by both States and local governments. 34 per cent of the States' own source revenue was collected from sales tax in 2013 for example. They are seen by many as a regressive form of taxation and EU legislation prevents within-country variation of VAT, but Brexit may re-open conversations about how VAT operates.
Some taxes are more controversial than others...
Taxation is a complicated and often less than exciting policy issue, but it is absolutely integral to any further discussions about devolution. If devolution is to be meaningful, it must take place in the context of a national discussion about how public services are funded, as well as how they are delivered.
In reality there is always likely to be a need for a combination of central grant and local taxation and for some element of redistribution. However, this redistribution does not necessarily all have to take place at a national level. Inter-authority equalisation grants are common in many countries.
In an increasingly globalised world, local authorities are taking on many new responsibilities, from preventing radicalisation to dealing with the impacts of climate change: to play their part they need to be empowered as trusted partners of central government.
As we take our first steps towards a future outside the EU, we must use the opportunity to revisit the settlement between local and national government. This means reviewing our centralised fiscal policy and drawing on international best practice to produce a fairer and more efficient model for fiscal devolution.
Thanks to David Phillips, Senior Research Economist at the IFS
Cover image: Paying the Tax (The Tax Collector), by Pieter Brueghel the Younger