House of Commons - The Balance of Power: Central and Local Government - Communities and Local Government Committee

The Balance of Power: Central and Local Government - Communities and Local Government Committee Contents

5 The finance question

105. As we have previously noted, England is at one extreme of the European spectrum in the high degree (75%) to which local government is dependent upon central government grant for its revenue. In this chapter, we consider whether local government's dependency on central government funding matters and, if so, what can be done to change the balance of funding.

Local government accountability

106. The balance of funding was one area where Frank Layfield and Sir Michael Lyons parted company, over sequencing if not on the ultimate destination—with Sir Michael Lyons emphasising to us that "the flexibility to use the money that it had" was a more pressing problem for local government, and that "the last thing that local government needed was the ability to raise more money that it did not have the freedom to explain how it was going to spend".[145] By contrast, Professor George Jones, who sat on the Layfield committee, has stated that

There can be no responsible local government responsive and accountable to its local voters, if a local authority simply spends money given to it by central government. It will always want more: like a drug addict it will always seek its fix of grant.[146]

107. There is, it seems to us, force in the argument that local government's dependency on central government grant forces it to look upwards to central government, and how it is designing its funding formula, rather than outwards towards its own community. By contrast, local authorities in Denmark and Sweden, who raise some 70% of their own revenue, appeared much less fixated with their relationship with central government. Moreover, the extent to which local government revenue is determined by central government also provides local government with an obvious scapegoat. As Chris Leslie, Director of New Local Government Network (NLGN), observed to us, "it can be quite convenient for councils to blame Ministers and Ministers blame councils, and it goes round and round and has done for generations."[147] Where local government has greater revenue raising powers, it brings greater transparency—and hence accountability—in terms of which body, local or central, is responsible for increasing financial burdens on local people, and whether that increased tax translates into better services.

108. We remain convinced by the conclusion contained in our predecessors' report on Local Government Revenue that "local authorities should have control over a much greater proportion of their income, at least 50%", and that "a shift in the balance of funding of the order of our recommendation would make the system significantly more acceptable and transparent."[148]. The Government should consider options to increase local government's revenue raising powers, in order to promote local accountability and encourage local government autonomy. This would encourage local government both to be more proactive and to be more proactive quickly—so that local authorities are able to respond immediately to rapid changes on the local scene, for example to high levels of migration. As Sir Richard Leese, leader of Manchester City Council, told us "[…] money means power, power is money, and I think if we were able to have far greater control over the money we raise, then I think that would deal in a very straightforward way with a lot of the devolution issues".[149] In light of this conclusion, we look in the next section at the scope for financial reform.

The scope for financial reform

109. The current system of council tax was hurriedly introduced to replace the disastrous community charge—the poll tax. It is based on a series of bands, A to H, each with a mathematical relationship to the central band D, ranging from two thirds for band A, to double for the highest valued properties of band H. It is therefore a regressive tax, in particular for some relatively poor households who do not receive council tax benefit, and does not bear significantly enough on the most affluent for whom council tax will be a low share of their income. This unfairness has become more and more manifest as council tax has risen, and led to a growing realisation amongst the public that it is not an acceptable way of financing local government. This strengthens the case for change.

110. However, we recognise the political reality that financial reform is particularly problematic in the English context. Lord Heseltine, who speaks with particular authority given his long practical experience, advised us that "personally I would not touch the financial arrangements because it would take too long and it will not actually improve the situation significantly."[150] Nick Raynsford MP, another former local government Minister, observed in recommending only incremental change that "I think the evidence of the poll tax gives a very clear warning against trying to do big bang changes in local government finances."[151] Nonetheless, the potential for radical financial reform to deliver substantial benefits in terms of greater local accountability and innovation should not be underestimated.

111. The first step is to identify the guiding principles for a new system of local government finance that better supports an autonomous, empowered local government. Our earlier report identified five guiding principles from the evidence that it received, which remain valid:

equity: it must be fair and be seen to be fair: as between different authorities, within individual authorities, and in its impact on individuals;

simplicity: it must be relatively easy to collect, and as easy for a taxpayer to understand as is compatible with equity and accountability;

flexibility: it must be adaptable to changing economic and constitutional circumstances [the buoyancy argument];

transparency: it must provide for a visible link to local levels of expenditure.

accountability: it must allow for authorities who raise and spend money to be, and be seen to be, accountable to the people they serve.[152]

Potential reforms to the local government financial system should also be assessed for compliance with the European Charter of Local Self-government. With regard to local government financial arrangements, article 9 of the Charter states that the resources available to local authorities should be of a "sufficiently diversified and buoyant nature to enable them to keep pace as far as practically possible with the real evolution of carrying out their tasks." The next step is to consider potential options against these principles.

The business rate

112. One option several witnesses proposed, and which has been constantly proposed ever since it was nationalised, was the re-localisation of the National Non-Domestic Rate (NNDR)—the business rate. The business rate is a national tax that is used to pay for local government services. It is chargeable on all non-domestic properties, except land or buildings used in agriculture. A uniform national rate is determined by central government, but the business rate is collected by local authorities. It is the means by which businesses and others who occupy non-domestic property make a contribution towards the cost of local services. Since 1990-91 business rate receipts have been paid into a national 'pool' and then redistributed to local authorities according to the number of people living in the area. It makes up around 30% of the total government grant to local government.

113. There appears to be a general consensus within the local government community that re-localising business rates would greatly increase their flexibility—it would, for instance, increase the percentage of locally raised revenue from 25% to nearer 45% in total. Gateshead Council wrote that the re-localisation would "help in restoring the balance of funding, reducing the effects of gearing and taking some pressures off local authorities",[153] and Oxfordshire County and District Councils jointly submitted that, although "it is not an easy process to change the balance of funding between local and national, […] business rates are the obvious power to devolve to local government."[154] Paul Carter, Leader of Kent Council explained to us what he would do with re-localised business rates:

it would be lovely to be able to have your own way of supporting small and medium-sized enterprises by having a different differential between what large businesses are paying and what smaller businesses are paying.[155]

And Buckinghamshire County Council observed that "giving local authorities the power to reinvest such revenue into the local area could result in tangible benefits by enhancing economic sustainability."[156]

114. Other witnesses were more sceptical of the impact of re-localised business rates. Sir Michael Lyons was sceptical because the need to reallocate some of the business rate to local authorities with a smaller business base would lead to complexity and diminish local accountability. He also, in what might perhaps be regarded as a somewhat self-negating argument, saw a risk of alienating business—who would fear "an inexorable increase in taxation" without empowering local government who would, in practice, have "no appetite, frankly, to consider anything other than a reduction in the business rate".[157] Lord Heseltine acknowledged the potential for re-localisation of the business rate to increase flexibility, but questioned whether, given current economic circumstances, there would be much potential "in the next couple of years."[158] The Secretary of State felt that it was "difficult to make decisions in this area", given the risk of "destabilising the system", and suggested that equalisation would be a big issue.[159]

115. During the recession, re-localisation would give local government an additional tool to pursue local recession-proofing policies. In the longer term, it would give local government an additional tool to promote economic growth and regeneration. Clearly, the concern about equalisation would have to be transparently addressed, in order to reassure local authorities with a smaller business tax base that re-localisation would not result in them losing out. Nevertheless, on balance, the arguments in favour of relocalising the business rate made in our predecessors' report remain valid, and we repeat, therefore, the recommendation made in our predecessors' report that the Government return business rates to local authority control as soon as possible.

Capping

116. One existing mechanism that local authorities can use to increase the proportion of revenue raised locally is to raise council tax above the limit set by central government. However, successive governments, both Conservative and Labour, have used capping—the power they have to restrict the revenue raising capacity of local government—to prevent councils from raising council tax above certain levels. Local government evidence to this inquiry echoed that to our predecessors' inquiry into Local Government Revenue opposing capping because it denies local accountability. Knowsley Borough Council's observation that "the cap on council tax is a draconian measure which undermines local accountability and reduces the flexibility that local authorities require to respond to the needs of local residents"[160] was typical of the submissions we received. By contrast, again as before, the Secretary of State for Communities and Local Government felt compelled to defend capping, on the grounds that "the national government has a responsibility to protect taxpayers".[161] The Government is clearly acutely aware of the extent to which the public and media in England blame it as well as, or even instead of, local government when local taxes increase.

117. We see no reason to demur from our predecessors' conclusion that "it is much more appropriate for local authorities to be held to account for local decisions, including the level of local taxation, through the ballot box."[162] Local councils should have the opportunity to make the case for council tax increases to their electorate, and the electorate, rather than central government by decree, should have the final verdict on whether the tax increases proposed are excessive. The continued use, and threat, of capping are emblematic of the Government's ultra-cautious approach to devolution.

Alternative forms of grant allocation

118. In evidence to this inquiry, the Government has used the need for equalisation as a defence of current financial arrangements, and to justify a cautious approach to any reform. In an earlier chapter, however, we have quoted evidence to the effect that the current level of government grant is significantly higher than required for equalisation purposes. Furthermore, during our inquiry, a number of witnesses expressed concern at the lack of transparency in the grant allocation process currently undertaken by central government. One main concern was that the lack of transparency allowed both local and central government to blame the other for increased taxation and delivery failures. The Lyons report concluded that:

[…] an independent and authoritative voice is needed to provide better information on funding to inform the public and Parliament about the impact of new burdens on local government and the evidence of future pressures. This could build on the Audit Commission's existing role but other options considered should include an independent commission.[163]

119. The idea that an independent commission should take on responsibility for grant distribution, the equalisation mechanism and possibly other areas too, such as assessing the impact of new burdens and how they should be funded, certainly has its supporters within the local government community. Councillor Sharon Taylor, Deputy Leader of the Labour Group, Local Government Association (LGA), giving evidence as part of the LGA delegation, explained to us that

I think there is a good case for the issue around having, as Lyons reported, some kind of independent commission into the equalisation in the grant distribution because there are some real anomalies. Anybody who has been anywhere near local government knows about the anomalies which come out of the grant formula and so on, and it has got so complicated now. In all honesty, I cannot explain to my residents how we end up with the amount of grant formula we end up with. It really needs to be much more transparent […][164]

120. We, however, are not completely convinced of the case for a commission. The concept of equalisation is at its heart a political one, requiring a political judgement. As Lord Heseltine pointed out during his oral evidence,

It [the proposal for an independent commission] is not politics. I spent hours looking at the printouts of grant mechanism distribution. Every government has its own idea of what makes sense by way of a distribution pattern, but none of us ever found a way of getting a uniform consistency into the distribution pattern. You thought you had got it; you damped here and you levered there and you put in this and that and then up popped one of your safest, most loyal constituencies that was hammered to hell by this new process whereupon the official said, "I'm very sorry, Secretary of State, we have done 45 different printouts and it has to go the printers tomorrow". That ends your political career in ignominy.[165]

Creating an unelected body to play such a crucial role in local government finance runs counter to the increase in local responsibility and local accountability that we are seeking to foster. Equally, however, we accept that the current system is too opaque, and leaves central government in control of too high a proportion of local government funding. The advice and evidence given to the Department to inform changes to the grant formula—and exemplifications of the effects of different options considered—should be available on the CLG website. This would ensure that changes based on extraneous considerations would be minimised, and a formula based on real needs and true resources arrived at.

121. Initially we were attracted to a variant of the system used in Denmark which would work to increase transparency and loosen central government's grip on the equalisation and grant allocation processes. Broadly, in Denmark, first the Danish local government association and central government negotiate a total figure for local government spending during the year consistent with the national government's macro economic policies. Then the Danish local government association works with local authorities to determine each local authority budget within this overall total, including appropriate equalisation arrangements. Whilst we have concluded that our more adversarial political system—at both national and local level—militates against a 'Danish' consensual solution of this sort, we still see scope for greater transparency and dialogue between Central Government and the Local Government Association (LGA). Accordingly, we recommend that the Government increase the transparency of the existing grant allocation process, and that the LGA take on more responsibility for engaging with the Government on grant allocation decisions.

Changing the local government tax

122. Were central government to implement our financial recommendations above, then the balance of funding would shift significantly in favour of local government, underpinning a wider shift in the balance of power between them. One further radical measure would be to change the form of the local tax to facilitate an increase in the proportion of its own revenue raised by local government. There would also have to be a corresponding adjustment of central government taxation if the overall burden on tax payers was not to increase. As our predecessor committee noted, there are advantages and disadvantages to retaining council tax as the main local tax. The main advantages are that the tax is simple to calculate and easy to collect. The main disadvantages are that it is not sufficiently progressive, not buoyant (i.e. revenues do not automatically increase with economic growth) and an inadequate income provider on its own. In a previous report we have called on the Government to "take action as a matter of urgency to address the restrictive nature of the rules governing council tax benefit as well as to increase take-up among all eligible low-income households."[166]

123. A number of witnesses to both inquiries have argued that it would be possible to make council tax fairer and increase its revenue-raising properties by expanding the banding at either side of the scale. A further solution would be to either replace or supplement council tax with a different local tax, such as a local income tax. This proposal has a long pedigree: it was recommended by the Layfield committee as the best means of changing the balance of funding from central to local government. As our predecessors noted in their report, a local income tax could not be introduced without detailed research assessing the practical implications.[167] There are also disadvantages to a local income tax, for example revenue would go down during a recession. Pragmatically, it would also be necessary to ensure that the first year of implementation had a net zero impact on tax payers to avoid a backlash against central government. In principle, though, a supplementary local income tax, introduced alongside council tax but with a corresponding reduction in central taxation so that the overall tax burden remained the same, is a potential longer-term solution to the balance of funding problem, and one that Government should seriously consider. It would be possible to replace central funding with such an income tax without any change to the total collected in taxation overall. Councils would then decide at what level to set their local tax.

145 Q 24 Back

146 University of Birmingham, Local Government - Past, Present and Future: A celebration of the 25 year writing partnership of George Jones and John Stewart, (Birmingham 2004) Page 9. Back

147 Q 63 Back

148 ODPM Committee, Local Government Revenue, para 50. Back

149 Q 161 Back

150 Q 443 Back

151 Q 473 Back

152 ODPM Committee, Local Government Revenue, para 12. Back

153 Ev 154 Back

154 Ev 176 Back

155 Q 202 Back

156 Ev 211 Back