Can local government cope with fiscal devolution?
A new report from the Northern Powerhouse Partnership (NPP) recommends that local government should be given a new land value tax to replace the sector’s existing taxes (council tax, business rates) and stamp duty (currently a Treasury tax). This is undoubtedly a good thing for local government but will require the sector to change its perceptions about the relationship between needs and tax incentives.
Different authorities have varying ability to raise taxation income but also a different ability to grow. Regardless of how much taxation is devolved, the sector needs a funding system that balances different needs and tax-raising ability. The funding system must use redistribution to fund differences in needs and resources – but balance this with incentivising growth. Beyond this, individual authorities should be able to make a choice made locally about the rates and scope of local taxes.
Fiscal rewards are not new in local government
Changes have been taking place in local government since 2010 that have given local government greater fiscal rewards for growth. There has been a move from an entirely redistribution-based system under the previous Labour government to one where a surprising proportion of local government funding is based on growth. Mostly rewards have come from the Business Rates Retention Scheme (BRRS), along with enterprise zones (EZ), 100% retention of renewable schemes, and then the business rates pilots and pools (allowing councils to keep even more of their business rates income). It could be argued that the rewards from council tax-base growth have been even greater.
Since then, proposals to reset or re-baseline this growth have been continually postponed. There has been no BRRS baseline reset (it is now 10 years since baselines were set), and combined above-baseline growth is worth about £1.2bn. Council tax has not been equalised since 2013-14 (even then, only about 80% of council tax income was equalised), allowing some councils to keep much more growth than others. Income from enterprise zones will not be equalized for 25 years. And the 100% business rates pilots in devo areas are now worth about £110mn annually. These pilots started in 2017-18 as a temporary scheme but have now effectively become permanent features that are likely to morph into the 100% retention scheme promised for the two “trailblazer” deals in GM and WM. Those who have had the highest BR and taxbase growth rates have gained considerably – although those gains are often hidden within an opaque local government funding system.
Overall, this growth-based income represents up to about 11% of local government resources. Incentives via the BRRS represent about 3% of total resources, with the remainder from non-equalised council tax income. So, it is nothing new for authorities with higher growth rates to benefit more from tax (and income) growth. It is unsatisfactory that equalisation is as random and unplanned as it is – but it seems right that authorities should be able to benefit from local tax and income growth. But it is better to do it in a planned and explicit way rather than through the current ad hoc improvisation.
Building a funding system with fiscal transfers
Moving towards a devolved taxation system, combined with redistribution for needs, will require explicit transfers of locally-raised taxation from areas with high tax yield to those with higher needs. Although this happens now, it is hidden beneath the bonnet of the local government finance system. Authorities (and ministers) seem not to mind the formal fiscal transfers in the business rates system (tariffs and top-ups), but have stopped short of similarly explicit transfers of council tax income. This is a psychological barrier rather than a practical one. And it is one that the sector must get used to if fiscal devolution is going to work.
Those with less ability to grow their local taxation should be asking for something else in return. One might be explicit pledges about how often baselines are reset and that these resets can take place without a specific decision by ministers. Over the past decade, the political turmoil of Brexit and then the pandemic, compounded by Whitehall’s natural dislike of changing funding distribution, has led to baselines going unchanged for over a decade. Another “ask” for low-growth authorities might be that their baselines are reset less frequently, so that any growth they do have gives them a scaled-up reward.
New taxes for local government
Local government has had less opportunity to raise new taxes, and this is where London has been a trailblazer: the business rates supplement (to fund roughly half of Crossrail/ Elizabeth Line, planned £6.1bn), a choice no longer available to other parts of England; then the Congestion Charge (which raises about £232mn annually), and now ULEZ (raising an expected c.£300mn annually over a short period of time).
Some councils have been exploring their own taxes, although without Whitehall’s sign-off they cannot go ahead. A tourist tax would raise about £21mn annually (at £1 per night) for Cornwall, for instance. Doubling council tax for second-homes would raise £26mn in Cornwall and Cumbria – but would also give Camden an additional £14mn. The proposals to add 3 new super-bands on to council tax or to give local government a share of national taxes (VAT, Stamp Duty) have been made to the Treasury before, but without success. Nottingham City Council is the only authority to make use of the workplace parking charge (about £9m annually).
Allowing councils to keep more of their own tax gains will be more acceptable if those councils are doing something with the proceeds of new taxes or increased tax revenues. They will fall into disrepute if councils with greater ability to generate local tax revenues simply use those revenues to cut tax rates for their residents. This is difficult to legislate for but local politicians will probably want to show that, say, a new tourist tax is used to reinvest in the local tourist industry rather than reducing Band D council tax.
Psychological change for local government
Localisation of more taxation will force local government to get used to the idea that not everything will be equalized all the time. This is a psychological more than a technical challenge for local government. Judgements will have to be made about how to compensate for differences in needs and tax-raising ability. But localizing taxes only makes sense if we accept that there will be differences between the amounts that local authorities generate and keep. There are differences at the moment, but they are only really acceptable because we don’t look too closely at how local government funding works. A clearer, more explicit plan about the balance between needs and incentives will help everyone in the sector get greater acceptance of localised taxation.