When the cap fits, by Tony Travers

9 Mar 06
In 2003, angry pensioners were taking to the streets as council tax soared, unchecked by government. This year, ministers cracked the whip and councils meekly complied. Tony Travers explains what's behind the U-turn

10 March 2006

In 2003, angry pensioners were taking to the streets as council tax soared, unchecked by government. This year, ministers cracked the whip and councils meekly complied. Tony Travers explains what's behind the U-turn

Council tax isn't out of control. This startling conclusion has begun to percolate through Fleet Street, which means there will be fewer 'local tax horror' headlines this year than in previous ones. An average rise of about 4.5% (predicted recently by CIPFA) is, mercifully, well below the 13% level recorded in 2003. Few individual figures in the CIPFA survey are large enough to suggest that the government will resort to extensive capping in 2006/07.

The moderation of local government's tax increases can be seen in Figure 1. Following a number of years when the average was 6%–9%, topped by the 2003 spike, rises have fallen back to just over 4% a year in 2005 and 2006. The government was, apparently, willing to tolerate increases at three or more times the rate of inflation until the 2003/04 problems revealed a 'pain threshold'.

The main reason for the slowdown in increases is central government's changed priorities since 2003/04. In the years from 1997/98 to 2003/04, the focus was on being seen to be pushing up public expenditure, with only a modest concern for the impact on taxation. Council tax rose sharply in real terms, although not as a proportion of all income. Central support for local spending increased only slightly less rapidly than local taxation, implying the government was broadly comfortable with sharp increases in both.

But things have changed since the 2003 'crisis'. The over-riding concern has been to keep council tax rises down. Too many pensioners have volunteered to go to prison for non-payment. The Balance of Funding (now Lyons) inquiry had its focus shifted towards the short-term problem of how to defuse the council tax problem. But what has really changed the speed of local tax rises has been the threat and use of tax limitation. A government that took office committed to abolish 'crude and universal' capping has re-introduced limitation.

Although only a small number of authorities have had their local tax bills capped, the risk that more would suffer the same fate has provoked a display of mass compliance. Authorities throughout England have meekly accepted the need to trim services rather than risk having to send out two sets of council

tax bills.

The CIPFA council tax survey, published on March 2, illustrates the point. Only one billing authority, City of York Council, has so far dared to breach the government's informal cap of 5%, setting an increase of 5.49%. Just three precepting authorities, usually more willing to risk the wrath of ministers, have decided to try their luck this year. Buckinghamshire Fire Authority has increased its precept by 6.4%, while Essex and Norfolk police authorities have both set a 5.9% rise.

We have arrived at a world of self-limitation not dissimilar to the pre-signalled capping of John Major's government. If the government turned the screws further – by threatening capping at a figure of, say, 3% – there is little doubt that still lower council tax numbers would emerge.

The contrast with the current financial chaos in the National Health Service is instructive. The NHS has been given spending increases well ahead of those in local government, without the need to set an unpopular tax. Notwithstanding all the extra billions of pounds the trusts are receiving, they are still running deficits amounting to more than £500m.

It is easy to imagine the bile that would be pouring out of Whitehall if councils were heading for March 31 with budget overhangs on such a scale. But the NHS's sanctified status means it cannot be criticised directly, leaving Department of Health permanent secretary and NHS chief executive Sir Nigel Crisp to take the rap. This week it was announced that he would be retiring at the end of the month.

Back to council tax, however. Despite the more moderate increases in 2006 and 2005, local taxation continues to be a threat to Downing Street. It is a measure of how politically salient the subject remains that last autumn the government abandoned the 2007 revaluation. In subsequent months, Conservative local government shadow Caroline Spelman has nevertheless been able to keep the press filled with 'local tax snooper' and 'government to tax loft conversions'-style stories about the real or imagined antics of the Valuation Office.

Sir Michael Lyons has been given the longer-term problem of how to sort out local taxation, although the terms of reference of his inquiry have expanded significantly. Looking at the percentages in Figure 1, it is easy to see how council tax might have become a problem. In a low-inflation economy, this visible and highly regressive tax has been allowed to soar.

Figure 2 compares the total yield from council tax with that of other revenues in the years from 1997/98 to 2005/06. Overall government income increased by 58%. Public spending rose faster than this because the government moved from having a substantial budget surplus to running a large deficit. Over the same period, the yield of council tax jumped by 101%.

The political craziness of allowing such a large increase in local government's sole tax is implied by other data in Figure 2. Consider the rises in fuel duties and Vehicle Excise Duty. These are revenues levied on the all-seeing and all-powerful motorist. Lo and behold, the Treasury has been careful to hold down motoring taxes at well below the rate of rises in general taxation. Despite oft-repeated concerns for the environment, ministers have understood the power of the haulage and private car lobby. The treatment of tobacco and, indeed, alcohol duties has been even more careful, given the risks of cross-border smuggling.

Thus, the government proved brilliantly sensitive to the political and economic realities of driving, smoking and drinking. Yet at the same time it was happy to stoke up the council tax bonfire. Why? Perhaps it was seeking to increase the proportion of council spending funded by local taxation. Perhaps it was all a ghastly mistake, achieved incrementally over a number of years, with no view as to the longer-term impact.

The 2003 council tax hike was certainly an accident. Efforts to redistribute revenue support grant had the unexpected consequence of requiring massive council tax bills in areas that lost resources. The Audit Commission pointed its independent finger directly at the government over this one. Conspiracy theorists might argue that ministers were happy to see councillors put under political pressure, as this would make it easier to maintain the need for a full array of central controls over town halls. Lyons has been left to sort out this mess, although few now expect him to propose a radical change to the council tax or, for that matter, to suggest a wholly new local tax.

Who knows? But we have arrived at a point where things can only get worse. As the chancellor prepares his tenth Budget, the wider issue of how far Britain will tolerate tax rises has climbed up the political agenda. The tax burden is now rising to pay for earlier increases in public spending, and there is still disagreement between economists about whether Gordon Brown will need to put up tax rates to meet his self-imposed fiscal rules. Recent tax flows have been slightly above the levels predicted, marginally taking pressure off the Treasury.

But whatever happens to tax, the outline of future expenditure plans now seems clear. Institute for Fiscal Studies' figures published in previous issues of Public Finance, have shown how, from 2007/08 onwards, pressure will mount for year-on-year spending increases well below the levels of recent years. Even the favoured children such as health and education will have their pocket money cut. Other services will be lucky to see rises in their expenditure that match inflation. In short, we will return to a world not dissimilar to that of the period from 1993 to 1999.

Oddly, this change of gear will probably be more problematic for generously funded services than for the perennially squeezed. Managers dealing with highways, refuse collection, street management and the fire brigade have never enjoyed the luxury of year upon year of 6%–9% cash increases. The prospect of, say, 2% a year won't seem particularly threatening to them.

But for managers in the already troubled NHS, spending increases of around half those of recent years will surely lead to even worse financial difficulties. On top of this, many hospital trusts and schools will have to cope with the rising costs of Private Finance Initiative contracts.

At the root of the problem is public expectation. For a number of years, the government has encouraged us to believe that spending on hospitals, schools, the police, the arts and social services has increased as never before. The rhetoric of 'record levels of investment' has rarely been far from ministerial lips. Recently, the Conservatives have started to shift their collective attention away from tax cuts to service quality improvements. The electorate has made it clear that it wants to maintain high levels of spending, even if there is scant evidence of a desire to pay more tax.

Extra borrowing is not possible, because of the chancellor's famous 'golden rule'. So, the only way forward is tighter public expenditure settlements. This reality makes the 2007 Comprehensive Spending Review of the utmost importance to all parts of the public sector. Submissions will be arriving on ministerial doormats throughout the early summer this year.

Looking ahead, it is possible to see some of the earliest indications of where the biggest shocks are likely to be felt. The NHS, as stated above, is going to be the single biggest 'loser' in terms of the need to cut back on annual spending increases. There is also evidence of growing Treasury concern about the cost of new PFI hospital projects.

The press has recently been briefed about the inevitability of cutting back on little-used rail services. It is certain that rail fares will rise sharply in the years ahead, partly to plug spending gaps and partly to choke off demand. The Post Office's government subsidy to maintain rural sub-offices is under threat. Stamp prices are already planned to rise. Student fees are about to be introduced in England. These, too, will surely rise once in place. Across government, it is likely that charging for services will be increased wherever possible, be it by fares, stamps, student fees or even road pricing.

The Lyons inquiry, with little radical to suggest, might find itself under pressure to propose more charging and/or local add-ons to existing taxes. Indeed, the continuing post-Turner debate about pensions still seems most likely to lead Britain towards some form of compulsory personal provision – another form of charging. Having said that, the NHS and schools remain off-limits. These services must, it would appear, remain free at the point of delivery.

With little tax headroom and only limited room to charge for services, there will have to be further initiatives to improve value for money. Whether or not Gershon is anything beyond a smoke-and-mirrors illusion, the government will have to maintain pressure to deliver more services with the same money. The public sector can expect a series of further initiatives designed to improve efficiency. Public sector staff numbers are already starting to taper off, following several years of growth. The crossover year between the 'feast' period since 2000 and the 'famine' after 2008/09 is 2006/07. Council tax moderation this spring is a leading indicator of the very different world that lies ahead.

Tony Travers is the director of the Greater London Group at the London School of Economics


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