Now for the main course, by Steve Freer

9 Nov 06
The white paper is done and dusted. Now it's time for Sir Michael Lyons to put some financial meat on the bare bones of local government reform. He should focus on capping, council tax and the business rate, argues Steve Freer

10 November 2006

The white paper is done and dusted. Now it's time for Sir Michael Lyons to put some financial meat on the bare bones of local government reform. He should focus on capping, council tax and the business rate, argues Steve Freer

There was a very large elephant in the room when the local government white paper, 'Strong and prosperous communities', was launched a fortnight ago. 'A new relationship with local government based on a mature conversation about what is best for local people' – the prime minister's words – sounds appealing. But few would put hand on heart that it can be delivered without significant local government finance reforms, and on that subject the white paper was deafeningly silent.

Enter Sir Michael Lyons. He, of course, has the tricky challenge of supplying the missing content. His much anticipated review is due to report in December. After two years of careful analysis and research, he is expected to make significant recommendations to tackle the many well-documented concerns about local government funding and finance arrangements. Whether he can persuade the government to make sufficient changes to give real credibility to its own white paper remains to be seen.

So what will Lyons recommend? And, much more important, how will the government react to his proposals? Expect a comprehensive, closely argued report, a weighty tome that explores all the issues and options thoroughly. And for the non-anoraks who just want to cut to the chase, look out for three litmus test issues: capping, council tax and the business rate.

Capping is the place to start. The policy here will speak volumes about how government really views local councils. It is now clear that news of the demise of 'crude and universal' capping was seriously over-hyped in 1997. The depressing reality of the past two or three years is that capping is alive and well and actively shaping the budgets of every authority in the land. It continues to be applied universally to all councils and the method of its implementation – ministerial threats if a pre-selected council tax increase is breached – is even more indiscriminate than the authority-by-authority provisional spending limits that existed in the mid-1990s.

Lyons has already dropped very public hints that he is not a fan of capping. But if he recommends its abolition, will the government be willing to act on this most controversial of central controls?

In truth, it is a very difficult call. Nothing could be more in step with Tony Blair's 'new relationship based on a mature conversation' than abolition of capping. But without capping – or more accurately, without the threat of it – how will the government exert downward pressure on council tax bills?

For the government, capping is the Rubicon. To cross it, ministers must sign up to a fundamental tenet: that each local council is responsible and accountable for its own tax and spend decisions. And they must be ready to take some flak along the way as this nowadays rather radical proposition seeps into the public consciousness. Importantly, local authorities must believe it too. Indeed, they must live and breathe it, stepping up to the plate to accept responsibility for their own budget decisions. For if the government once gets a sniff that councils are ducking their proper accountability by shuffling the blame towards central government, all bets will rightly be off.

Significantly, there are no compromise options on capping. If ministers argue, for example, that it should be retained for a further period as a safety net to ensure that local government really has come of age, or to be used only in absolute extremis, we will know immediately that they have not crossed the river and that the white paper is what the government thinks it should say rather than what it really believes.

Lyons, of course, faces more complex challenges, too. He must also frame recommendations for a better system for funding local government. This is where he will need all his experience and skill and where we can expect a very carefully mixed cocktail.

On a variety of public platforms he has made it clear that he is interested in making recommendations that are likely to lead to real change. That is code for a willingness to stir in a dash of pragmatism – understanding where the political boundaries are; if necessary, having a go at extending them; but, ultimately, ensuring that he is dealing in the art of the politically possible.

But can he plot a course from where we are now to a better place without scaring too many horses?

Council tax is very clearly the first port of call. We are over the drama of three years ago when average increases of more than 12% whipped up a frenzied clamour for abolition. But there is still a very noisy lobby and a strong case for reform. So Lyons, and the government in its turn, can put together a very attractive package here, with strong elements of stability and continuity – the retention of a proven, if sometimes overstretched, tax – and strong elements of reform and improvement to address perceived unfairness.

Measures to modernise and open up access to council tax benefits are expected to feature particularly strongly, given that so much of the lobbying has focused on pensioners on fixed incomes. The New Policy Institute has also argued a very persuasive case for a redesign of council tax bands as a prerequisite for any future revaluation exercise ('Location, location', Public Finance, October 6–12). Whether the government has the stomach for a revaluation, now or later, is, of course, another matter.

In principle, the opportunity of refreshing and revitalising the council tax in this way should be attractive to government. There will be plenty of technically challenging details to fret over. And they will need to do so with great care because the Daily Mail will be holding the front page for the merest hint of a misjudgement that might trouble Middle England. But the fundamentals of the policy – especially the strong emphasis on improving fairness – are very positive and will play well with pensioners as well as the backbenches of the Parliamentary Labour Party.

In fact, this could be such a good story that it poses a real danger for local government. Put simply, the government might make reform of council tax the story. It might become the solution to reforming local government funding rather than one component of a bigger and more ambitious package.

There are two reasons why council tax reform, on its own, would be a poor result for local government. The first is that, do what it might, the government will not be able to transform the council tax to raise significantly more revenue. So councils will be handcuffed to a funding system that offers very little scope to meet the unrelenting pressures and challenges for increased investment.

The second is that the council tax alone is an unbalanced funding portfolio. It offers a means of raising funding and a mechanism for developing an accountability relationship with one key consistency – local homeowners/occupiers. But what about raising revenues from – and developing a powerful accountability relationship with – the local business community? This is where local government desperately needs further change, and, ironically, it is where the arguments for improvements in fairness are most compelling.

So this is the area in which local government must pray for Lyons to develop his most persuasive and passionate argument – stressing fairness and accountability – for bold change.

Since the early 1990s, the business rate has, of course, been a national tax, albeit collected locally and assigned to support local government spending. Distributed on a population basis, it is effectively part of the grant pool distributed to councils to reflect local differences in needs and resources. Uniquely – and this is part of the problem in engineering change – annual increases in the business rate have been capped to the prevailing rate of inflation. Viewed in isolation, it seems entirely reasonable to give business taxpayers the reassurance of such a protection. But viewed in the context of the wider system for funding local government, this really is an anomaly and an unfairness that should concern us all.

Its cumulative effect has been considerable. In 1993, business rate revenues funded 23% of local spending while council tax revenues funded 18%. Over the intervening years, spending pressures have caused budgets to rise ahead of inflation. The council tax has increased accordingly by an average of 4.8% ahead of inflation. The business rate has, by design, tracked inflation.

By 2006, business rate funding had therefore plummeted to 17% of the total funding requirements of local government whereas council tax revenues now meet 21%. No wonder pensioners on fixed incomes are feeling the pain.

The solution to this difficulty is administratively simple but politically high risk. Unlike other options to engineer a major shift in the balance of funding between central and local sources – most obviously local income tax – localising the business rate is familiar 'can do' territory. But is it also political 'no go' territory?

The government will know that the business lobby is not at all keen to give up its current favoured position. But if ministers are serious about developing a fairer funding system, they should opt for a local business rate; if they are serious about a more accountable local government – including accountability to local businesses – they should opt for a local business rate; and if they are serious about 'place-shaping', they should opt for a local business rate.

Overridingly, if the government is serious about its own white paper, it should, with Lyons' help, abolish capping, make bold reforms to council tax and introduce a local business rate.

Now that really would deal with the elephant.

Steve Freer is the chief executive of CIPFA


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