Prospects for codifying the relationship between central and local government - Political and Constitutional Reform Contents


5  Financing greater local autonomy

TAX TRANSPARENCY

80. Local government could have all the flowery declarations about its liberties, but without proper finance they will not be worth the paper they are written on. We see the precedents currently being set within the devolved parts of the Union, who are taking responsibility for their own budgets, and we believe the Government should give serious consideration to implementing such a relationship for England too. We are not proposing more central government funding. However, removing ringfencing completely would give local government greater autonomy over how it allocated its funding. Allowing English local government to keep its fair share of income tax is in keeping with the general thrust of the devolution settlements in the rest of the UK.

81. In 2008, Spain's autonomous communities raised approximately 34% of their expenditure from local taxes on property and business, and 21% from sharing revenues on income tax and VAT (split equally between the autonomous communities and central government), with the remaining expenditure funded through equalisation or conditional grants from central government.[58] Clive Betts MP, Chair of the Communities and Local Government Committee, told us in 2011:

You have a list of powers for the regions in Spain—I know it's not quite the same as local government but it's an interesting example—and the regions negotiate with central Government the powers that they are competent to perform...It can't simply be undone by a simple legislative change in Parliament in the future.[59]

82. It is important that English local government is not hamstrung in competing with its continental counterparts. Bristol City Council told us that the current system of funding local government disincentivised local councils from investing in their area:

Bristol is competing on a global stage with the likes of Barcelona, Frankfurt and Boston. These are all cities with municipal authorities that retain a much greater share of the local tax base. This creates a major incentive for local authorities to invest in the local economy. English cities are not incentivised this way and are disadvantaged by the fact that the majority of the taxation generated by our relatively successful economy in Bristol is returned to London.[60]

Under the Local Government Finance Act, local councils can now keep a greater share of business rates than previously. However, much still remains to be done to allow Bristol to compete on a global stage with cities such as Barcelona, Frankfurt and Boston, hence the need for the code.

83. It is in looking at devolution in the UK that the most instructive precedents are being set and the most interesting lessons can be learnt. The Scotland Act 1998 introduced the Scottish Variable Rate (SVR) which gave the Scottish Parliament the power to raise or lower the basic rate of income tax by up to 3 pence in the pound. This power has never been used. The Scotland Act 2012 gives the Scottish Parliament the power to set a rate of income tax for Scottish taxpayers, and will come into force from April 2016.[61]

84. In Wales too, the concept of retaining a proportion of existing income tax has been proposed. The Commission on Devolution in Wales, also known as the Silk Commission, is looking into the further devolution of powers to Wales. Part 1 of the Commission's report, published in November 2012, recommended that the UK and Welsh Governments share the income tax take in Wales by 2020.[62] It stated:

there should be new Welsh rates of income tax, collected by HMRC, which should apply to the basic and higher and additional rates of income tax;

the basic, higher and additional rates of income tax levied by the UK Government in Wales should be reduced initially by 10 pence in the pound. Over time the Welsh Government's share could increase if there is political consensus.[63]

The Silk Commission report also recommended the full devolution of business rates to Wales.[64] The BBC noted that these proposals, if implemented would "make the Welsh government responsible for raising around 25% of its budget".[65] The proposals would give Wales greater power to raise its own finances and involve no new central government funding.

85. According to recent BBC reports, the UK Government is also considering Northern Ireland's call for a reduction in corporation tax in order to compete with the Republic of Ireland's 12.5% corporation tax rate.[66] On 21 February 2012, the Treasury announced that they would soon be devolving the power to set Air Passenger Duty rates for long-haul flights departing from Northern Ireland.[67] The Northern Ireland Assembly's Air Passenger Duty (Setting of Rate) Bill passed in the Assembly on 6 November 2012. Finance Minister Sammy Wilson MP MLA stated "The Executive committed in the Programme for Government to reduce the Air Passenger Duty for direct long haul flights to zero. The legislation passed today delivers on this commitment and is good news for our economy in these challenging financial times".[68]

86. Three of the four parts of the Union are exploring the retention of tax as their devolution settlements evolve. The fourth, England, needs to do likewise if it is to fund its own devolved settlement. Devolved power in many countries has been given financial life by the apportionment and retention of an agreed element of income tax. How could this work in England? We discuss possible options below.

87. In looking at the traditionally complex area of local government finance, simplicity was our watchword. We have therefore proposed no change in income tax rates, no change in the method of income tax collection, and no change in the equalisation formula. The change we propose is that of 'tax transparency'. Every taxpayer should know exactly how much of their taxes are spent on local government. We also propose, for added clarity, that the fraction of existing income tax that funds local government is clearly printed on every salary and wage slip.

88. Article 7.3 of the draft code states that local government, as a whole, should receive a guaranteed share of the existing income tax received by central government. The total income tax receipts in England for 2011-12 were estimated—by taking the total income tax take for the UK, and working out 83%, the percentage of the UK that currently reside in England—to be approximately £126,000 million.[69] The table below shows that total local government expenditure in England in 2011-12 was £127,114 million, with approximately £84,689 million, two thirds of local government expenditure, provided by central government. In other words, central government expenditure on local government in England equates to about two thirds of the income tax take for England.
Sources of Local Government Finance, England, 2011/12 and 2012/13      
             
   
2011/12
 
2012/13
    £ million %   £ million %
Council tax, balances & other income   23,407 18%   22,677 18%
of which:          
Council tax   22,31118%   22,52618%
Other Items   1260%   1310%
Reserves   9711%   210%
           
National Non-Domestic Rates   19,017 15%   23,129 19%
             
Central Government   84,689 67%   78,436 63%
of which:          
Gross Expenditure on Council Tax Benefits   4,1413%   4,1893%
Specific Grants   69,87755%   69,36556%
Local Services Support Grant   1890%   1600%
Police Grant   4,5464%   4,2243%
Revenue Support Grant   5,8735%   4480%
General Greater London Authority Grant   630%   500%
             
Total expenditure   127,114 100%   124,243 100%

Source: CIPFA. Finance and general statistics, 2012-13

89. There are many options which we feel central and local government could examine without prior commitment. One option, the most radical, would be complete transparency: where one third of income tax collected in England was distributed by HM Revenue and Customs to central government and the remaining two thirds to local government. Such a move could give financial reality to the general power of competence. There are other options, which would involve smaller proportions of the income tax take going to local government. A second option would be to adopt a proposal similar to the Silk Commission proposal on income tax for Wales. A third option would be to separate out local authority spending on education in England, and then to have the remainder of local government funding provided by a proportion of the income tax take for England.

90. We do not endorse any of these options at this point. We intend to seek further evidence on what approach would be best. We do however put forward the concept of tax transparency for Government, the LGA, and all those concerned with building a less dependent local government, to investigate, consider and discuss.

91. In his oral evidence Tony Travers suggested that the UK could implement a regional transfer system similar to Germany's:

...for many parts of England—if you put it this way—the total amount of the taxes paid by the city or county will be equivalent to the amount the Government spend on them. The only thing that is happening is all the money is going up to the Treasury and distributing power round Whitehall so that those people make the decisions about how the money is spent in Epping Forest, not people in Epping Forest.[70]

92. The concept of tax transparency would allow local people to see more clearly what their taxes pay for locally and encourage them to hold local councils to account for their expenditure. We recommend that central and local government seriously consider the concept of local authorities receiving a share of existing income tax, to see if a viable figure can, after careful consideration, be arrived at.

OTHER LOCAL REVENUE

93. If one of our three options were implemented, every council's budget would largely then be made up from the relevant income tax take. Any shortfall would be made up by a council's freedom to raise other local revenue. Most councils would doubtless choose to continue with council tax and business rates. Councils would be wholly free under the terms of the draft code to raise additional new revenue, providing local electors expressed their consent. With the ability to raise new local revenue, real financial accountability will be brought back to local government.

94. Financially autonomous councils would mean that the centre could no longer cap or control councils' ability to vary taxes, including council tax. In a mature democracy, the local electorate, not Whitehall, would become the democratic check on the council's tax-raising ability, and this alone would be a significant step towards financial autonomy for the localities. Most councils could be self-financing in due course.

95. Durham County Council felt that the code could go further and explicitly offer a menu of powers, similar to those given to the Devolved Assemblies and Legislatures, that local councils could draw down.[71] This could allow prospective councillors to campaign locally on what additional powers or taxes would be most appropriate for the local area. However, we feel that a code encompassing the broad principles of autonomy for local government is the most important step.

96. In his oral evidence, Stephen Hughes, then Chief Executive of Birmingham City Council, told us that if local government were given tax-raising powers, it would use them in a considered manner. He stated that he would be interested in local government being able to set a hotel room levy, which was commonly used in much of Europe:

I would probably do something very similar, which is copy the continental system of charging a pound a bed per night for anybody who comes to the area; no one would notice it on their bill, probably, but it would make a significant difference. What I don't think we would do is say, "Oh, great, let's double the business rates now," because we know the impact that that would have. That would drive businesses out of the area.[72]

97. However, Councillor Ruth Dombey, Leader of London Borough of Sutton Council, was concerned that referendums to approve taxes were a crude tool:

Under the model envisaged by the draft code, local authorities would be free to raise additional local taxes in order to support public health initiatives, perhaps through a tax on takeaways. Assuming that ministers would resist the urge to defend Britons' 'right to a kebab on a Friday night', any such tax would have to run the gauntlet of a local referendum.[73]

98. We believe that councils looking after their own financial affairs in this way would deliver a massive stimulus to local interest, participation and activity. Revealing that a guaranteed share of income tax goes to the localities would stimulate many more individuals to take an interest in council matters and indeed to join political parties and take part in the local debates that would take place about local taxation and spending decisions. John Newman wrote:

I ask, what is the point of local election when local councils are so hamstrung and wonder if this is a significant factor in the consistently low turnout in local elections which I have observed from fifty years of watching politics. If local councils were seen to have genuine power, perhaps more people would think it worthwhile being involved, if only voting![74]

99. A far healthier local democracy could emerge from local councils ceasing to be agents of central government, with electors being the passive recipients of decisions. Genuine activity and local decision-making could be generated, which could also stimulate greater interest and involvement in politics. This would ultimately assist Westminster.

100. From Victorian times onwards, local government has shown it is perfectly capable of running its own affairs in this way, innovating, and meeting local needs. Councillor JR Knight, Leader of Ashfield Council, asked:

Is British regional politics currently able to produce politicians of the type that fashioned the Chamberlains in Birmingham, the Lever brothers in Liverpool or the Firths in Sheffield? These individuals took mundane cities and paved, parked, assized, marketed, gas, watered and improved them, producing public works that are revered even today.[75]

101. It is currently a legal requirement on councils to balance their budgets. That requirement is safeguarded by section 114 of the Local Government Finance Act 1988[76], and section 25 of the Local Government Act 2003, which requires the Chief Financial Officer to report on the robustness of the budget and on the adequacy of proposed financial reserves.[77] If the requirement were given a higher profile, that could reassure the public that the safeguard of ensuring financial rectitude and discipline in local government is already in place. In the United States, for example, 38 states have laws which require them to operate an annual or biennial balanced budget, which in most cases must also be passed in the state legislature.[78]

102. The ability to raise additional local income, in whatever form was approved by the local electorate, would also extend to local electors consenting to the raising of bonds on the back of the local council's own hard-earned credit rating. Bond-raising by councils is commonplace in the United States which has a Municipal Bond Market with an estimated value of $3.7 trillion, made up of over 44,000 state and local bond issuers.[79] The bond market could be used to raise funds for specific projects such as building bridges, opening schools or establishing an early intervention fund. Councils that had autonomy in terms of powers and finances could begin to make a dramatic contribution to economic performance and political participation nationally and put behind them years of underachievement and risk aversion. Moreover, councils would have the democratic and constitutional legitimacy to play a full role in national life and in stimulating the local and the national economy. Tony Travers thought that giving local authorities the freedom to raise bonds could be successful:

If you think in the current, literally today's world of savings and international financial problems, were a city in Britain to be able to issue bonds to rebuild its infrastructure, local people could buy the bonds and get a decent rate of return over time. The issuance of the bond would put pressure on the city council or the PTA to make this project work properly. This would be an extremely good solution.[80]

Although default rates on the Municipal Bond Market have historically been low, we would wish to take more evidence on how to reduce any risk of default in bond financing. Consideration would also need to be given to the long-term impact of giving councils access to bond finance.

103. We believe that the power to raise revenue is fundamental to greater independence for local government. The Deputy Prime Minister, giving evidence to the Committee on 13 December seemed to concur when he told us "I personally believe that the momentum is towards ever greater fiscal tax devolution."[81] Under the code, it would be up to local councils, with the consent of their local communities, to decide what additional revenue-raising measures, if any, would be appropriate for their areas. We recommend that the Government considers how it can take its devolution of financial powers further and looks closely at the merits of freeing local councils in England to raise additional revenue, but only with the consent of their electorates.

LOCAL GOVERNMENT SHARE OF TAX IN OTHER MATURE DEMOCRACIES

104. As the table shows, local government in the UK raises much less of its own revenue— only 12.7%— through taxation, and is more reliant on central government funding than the other OECD countries. This is in part because local government in the UK is restricted in what taxes it can use to raise revenue, and its only discretionary tax, the council tax, can only be raised by more than 3.5% a year if councils win a local referendum. Writing in the Local Government Chronicle, Tony Travers stated: "local taxation has been made so perceptible and unpopular that it will surely remain capped for the foreseeable future. The tax base is impossible to revalue. In short, council tax is dying".[82]

105. Many other OECD countries rely on a mixture of locally raised direct and indirect taxes to raise approximately 50% of their revenue. Directly applied taxes in other countries can include revenue raised from either a municipal or local income tax. A sales tax would be a source of local indirect taxation.

106. For example, in municipalities in Finland, which raise 46% of their revenue from direct taxation, each municipality is responsible for annually determining their respective tax rates. In 2012, the municipal tax rates range between 16.25% and 21.75%, with an average of 19.25%.[83] In Norwegian municipalities, which raise 38.5% of their revenue from direct taxation, a proportion of tax is paid to the municipality and county, as well as to the state. Quebec, a Canadian province, has operated its own income tax since 1954, with its own definition of taxable income, and the other Canadian provinces operate provincial income tax rates which are collected and then redistributed by the federal government.[84]

107. If local government in England had a guaranteed share of national income tax, including the ability to raise additional taxes, agreed by local electors, it would be better placed to safeguard its autonomy and its local services in times of austerity. The Government should look carefully at the tax revenue mix in other countries and give serious consideration to looking at how similar schemes might work in England.

EQUALISATION SAFEGUARDED

108. While many respondents were broadly in favour of the provisions in article 7, which covers local government financial integrity, there was some confusion surrounding what the earlier draft of the code was proposing regarding equalisation. Sir Robin Wales, Mayor of Newham,[85] Councillor Roderick Bluh, Leader of Swindon Council,[86] and Hartlepool Borough Council raised these concerns in their written evidence.[87]

109. In response to this, it is important that we clarify that the code seeks to keep in place the existing formula for equalisation and does not change it at all. Currently local government finance equalisation is carried out in Whitehall, using a formula known as 'the four block model', which has been described by the journal Local Government Studies as an "extraordinarily complex formula-based funding mechanism [which] aims to ensure that all local authorities are able to provide individuals with a broadly comparable level of public service".[88] We do not feel that at the same time as introducing tax transparency we should tamper with the existing equalisation formula. The new line of accountability should be allowed to bed in. On equalisation, we propose that the very same civil servants will continue to apply the equalisation formula. The only change we suggest is that in future they should be answerable to a joint board of representatives of central and local government. We urge that for the foreseeable future little or no change should be made to the equalisation formula.


58   C Colino, "The Spanish model of devolution and regional governance: evolution, motivations, and effects on policy making", Policy and Politics, vol 36 (2008), no 4 Back

59   Q 273 Back

60   Ev w55 Back

61   HM Revenue and Customs, "Devolved taxation in Scotland", http://www.hmrc.gov.uk/news/news-calman.htm  Back

62   Commission on Devolution in Wales, Empowerment and Responsibility: Financial Powers to Strengthen Wales, November 2012, E38  Back

63   Empowerment and Responsibility, recommendation 16  Back

64   Empowerment and Responsibility, recommendation 2 Back

65   "Commission calls for Welsh government income tax powers", BBC News, 19 November 2012 http://www.bbc.co.uk/news/uk-wales-politics-20346118  Back

66   "Cameron urged to cut Northern Ireland's corporation tax rate" The Guardian website, 20 November 2012 http://www.guardian.co.uk/uk/2012/nov/20/cameron-urged-cut-northern-ireland-corporation-tax  Back

67   HC Deb, 21 February 2012 col 71WS  Back

68   Northern Ireland Executive website, "Finance Minister Sammy Wilson has welcomed the abolishment of Air Passenger Duty on long haul flights from Northern Ireland", 6 November 2012 http://www.northernireland.gov.uk/news-dfp-061112-air-passenger-duty  Back

69   Figures provided by the House of Commons Library Social and General Statistics Section. Figures are an estimate.  Back

70   Q 88 Back

71   Ev w78 Back

72   Q 187 Back

73   Ev w63 Back

74   Ev w121 Back

75   Ev w99 Back

76   Local Government Finance Act 1988 Back

77   Local Government Act 2003  Back

78   Table 1, National Conference of State Legislatures, NCSL fiscal brief state balanced budget provisions, October 2010 Back

79   "Could municipal bonds be the next financial titanic?" , Forbes Magazine, 20 September 2012 Back

80   Q 115 Back

81   Uncorrected transcript of oral evidence taken before the Political and Constitutional Reform Committee, The coalition's programme of political and constitutional reform, 13 December 2012, Q 57 Back

82   "Local Government's sole tax is withering away", Local Government Chronicle, 11 October 2012 Back

83   Earned Income Taxation Finland, Ministry of Finance, http://www.vm.fi/vm/en/10_taxation/01_personal_taxation/01_earned_income/index.jsp  Back

84   Statistics Canada, Section H: Government Finance, http://www.statcan.gc.ca/pub/11-516-x/sectionh/4057752-eng.htm  Back

85   Ev w107 Back

86   Ev w16 Back

87   Ev w39 Back

88   A Gibson and S Asthana, "A Tangled Web: Complexity and Inequality in the English Local Government Finance Settlement", Local Government Studies, Volume 38, Number 3, 1 June 2012 , pp 301-319(19)  Back


 
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Prepared 29 January 2013