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In a letter to the Financial Times in January 2023, Chris Smith, editor of Public Finance, suggested local government finance in the UK was in need of “courageous conversations” as a prelude to reform, principally between the sector and the Treasury – but that ministers “won’t like what they would hear”.
The conventional expectation of this conversation is that the sector would make scattergun demands for more money, and more tax-raising powers. The Treasury would ask what those new powers would be used for, and express doubt that local authorities would be able to make robust spending decisions with either grant funding or locally raised money.
These stances have deep roots in what political scientists have called “the British political tradition” and the “Westminster model”. Professor John Stewart identified the prevalence of “elite contempt” among civil servants in 1993; twenty years later, the Institute for Government noted the constant fear from ministers that local councils “will do something barmy”. There have been signs of this stance thawing in recent years, mostly in the context of devolution deals. Given this political inheritance, their significance should not be underestimated.
The fiscal gap
And yet, a growing openness to the devolution of power from central government has not yet been matched in fiscal matters. Local authority representatives and think-tanks often cite ‘fiscal devolution’ as an aspiration, but this is rarely fleshed out (the IFS’s 2019 report Taking Control, and Localis’s 2020 report Fiscal Devolution: adopting an international approach are rare exceptions).
Sources occasionally suggest interest in fiscal devolution from the government: ministers are said to be interested in it as a route to strengthen accountability, and there exists a ‘Fiscal Devolution Working Group’ within government.
But this interest has not translated into a comprehensive perspective on which fiscal powers could be made available to local authorities, and why.
By contrast, the fit between fiscal devolution and devolved responsibilities was absolutely central to the Calman Commission, the foundation of the current fiscal system in Scotland.
The Commons Library recently published a briefing paper entitled Local government taxation which explains various forms of fiscal devolution in detail.
Proposals for change would need to answer some fundamental questions. For instance, which tier(s) of government would administer a new tax? How would central grants take account of tax revenues? How would it interact with any new accountability framework for metro-mayors? Would it generate substantial or peripheral quantities of revenue, or would it focus on changing behaviour? Which areas would pay the most, and should any revenue be redistributed?
I suggest a framework to address these questions with regard to England. First, potential reforms to property taxes: these would have little effect on overall funding levels, but any reforms would likely set the tone for further changes.
Second, smaller taxes on specific sectors or behaviours: these raise peripheral amounts of revenue, vary by geography, and serve principally as policy tools.
Third, assigned shares of national taxes, binding sub-national governments into economic outcomes (and potentially rewarding them for effective local policy). All of these changes could be made while raising minimal additional amounts of revenue overall – reflecting the wariness of imposing ‘new taxes’ acknowledged by the Shadow Chancellor of the Exchequer in January 2023.
Property taxation
English local authorities raise most of their local income from council tax and business rates. Both taxes are unpopular: the tax rates are perceived to be high, unrelated to the ability to pay, and difficult to appeal against.
Both have seen recent proposals for reform, but this is one “courageous conversation” that few UK governments will want to have.
Council tax on second homes and long-term empty homes has risen in recent years, and there have been calls for it to be extended to vacant land (applying it to unused planning permissions). Retail groups have argued for business rates to be rebalanced away from high streets and towards larger companies on business parks.
Council tax in particular has seen multiple proposals for reform and revaluation. These have almost all sought to raise the same quantity of revenue overall, but in a more progressive way.
Greater localisation, or reform, of both of these taxes is normally linked to increasing local accountability and greater flexibility to react to local circumstances. But, more than 30 years after the poll tax, they remain hugely sensitive.
Their unpopularity means that there is no realistic prospect of using them to raise substantial extra revenue. Recent proposals for online sales taxes and vacant land taxes would contribute little in that regard.
This reminds us of the need to view tax systems as a whole. Most countries have local property taxes that are based on property values together with tax bands/rates or ‘multipliers’, such as council tax and business rates.
But property taxes elsewhere can often be lower than those in England, because local authorities can supplement them with income from other local sources. One benefit of additional sources of revenue for local authorities would be to relieve the pressure on council tax and business rates, which do not have the flexibility or room for manoeuvre to shore up council finances single-handedly.
Levies
Levies permit the payer to do something specific. For instance, drivers of certain vehicles must pay low emission zone or congestion charging levies to enter many city centres.
New commercial developments in many local authorities are charged a community infrastructure levy based on floorspace.
Additional proposals of this kind include the transient visitor levy or ‘tourist tax’, currently under consideration in Scotland and Wales, and various approaches to ‘land value capture’, with tax increases in property values attributable to public investment in infrastructure.
These types of tax are different from property taxes, in that they are focused on specific activities or relate to specific sectors of the economy.
For the most part they do not produce enough revenue to act as a core source of funding for public services.
Furthermore, there is often pressure to ensure that revenues from these taxes are spent on the sector that pays them. In the UK, transport levy revenues must be spent on transport, and tourism tax revenues in other states often must be spent on tourism-related activities.
Levies frequently produce peripheral amounts of revenue. London raises some £400m per year in transport levies, but this pales alongside spending of £60bn by the whole of English local government.
Or they may produce large sums in some locations but next to nothing elsewhere – a feature that they share with other sources of funding, such as parking charges or commercial revenue from airports. That characteristic makes this type of tax unsuitable as a core funding source.
Levies can strengthen the business case for specific large-scale projects.
Land value capture mechanisms paid a large part of the cost of the Northern Line extension to Nine Elms in south-west London, for instance.
In Manchester and Liverpool, a ‘tourism tax’ of sorts is shortly to be introduced via a tourism-specific Business Improvement District. The Liverpool one is expected to raise just under £1m per year, which will be spent within the BID area itself.
But this highlights that these types of tax act as a policy tool first and a source of revenue second. Transient visitor levies cannot raise revenue in areas with few visitors and land value capture cannot raise revenue where land has no potential to increase in value.
Shared taxes
In some countries in Europe and elsewhere, local authorities share in national tax revenues.
Tax sharing systems typically apply to taxes that bring in substantial revenue, such as income tax, corporation tax and VAT (or their equivalents).
These systems can work differently, and this has an effect on the outcomes and the incentives that local authorities face.
For instance, local authorities might receive a share of the income tax paid in their area or the revenue might go to the sector as a whole and then be redistributed according to a measure of need.
In a country like England, which has significant regional inequalities, it seems likely that some redistribution between areas of revenue from these sources would be necessary.
This could take the form of a needs assessment, or a system rewarding growth in revenue against a baseline could be used.
In some countries (such as Italy) regional and municipal councils can set a supplementary rate on shared taxes, within limits; in other countries (such as Germany) they cannot.
Interestingly – contrary to what might be expected – tax competition between areas frequently appears minimal in this type of system.
A guaranteed revenue stream, which is less easy to change than annual grants, may be the most valuable aspect of a shared tax system for a local authority.
Revenues from taxes such as income tax, corporation tax and VAT could be substantial enough to bolster the core finances of local authorities – taking the pressure off property taxation.
Shared taxes would also take some of the heat out of perpetual clashes over grant funding.
All local government funding systems include some form of central grants. Some grant funding is general, whilst some is ringfenced for specific purposes.
England has always seen tension between the two, with central politicians frequently tempted to ringfence grants for specific services; education, health, fire, police, and latterly certain aspects of transport (the Potholes Fund) and social care (the Adult Social Care grant).
However, ringfenced grant funding is less of a sore point for local authorities when it constitutes a smaller amount of spending.
The experience of fiscal devolution in Scotland and Wales suggests that a full parliamentary term would be required to establish shared tax systems.
This would be a change that would go beyond local government, requiring a cross-government commitment to reworking UK fiscal structures.
Conclusion
A critical part of how any fiscal devolution reforms function in practice will be how the different elements interact with one another.
Will local authorities gain substantial new revenue streams from new taxes? Will localities be able to retain tax revenues, or should funds be redistributed between areas? If the latter, how will local authorities be accountable for the funds that they raise? What effects will any future grant system have on the total funds available to local authorities?
These issues concern how the local government finance system works as a whole, and it is “courageous conversations” regarding the system as a whole that governments have long shied away from.
This essay is included in Moving Through the Gears: where will local government finance be in 2030?, published by Localis.
