Tax devolution: overdue or over-rated?
November 27, 2018
The tax system raises funds for public services and redistributes the nation’s wealth. However, with a growing gap between demand for local public services and the funding available, attention is turning to the role of local taxes. Could devolved taxes help address the revenue shortfall for councils while, at the same time, strengthening accountability between local communities and their councils? This was the topic of discussion at our recent roundtable with the IFS in Birmingham which brought together attendees from local government, research and business.
The IFS presented their forthcoming research into the potential benefits of tax devolution in England. They have landed on five criteria for assessing which taxes could potentially be devolved: accountability, distortions, incentives, inequality and volatility, and the administrative burden. If a devolved tax is to address the current funding gap, it also needs to generate the scale of revenues needed to have a measurable impact.
Using these criteria, according to the IFS, there are two existing taxes that may appear as suitable candidates: stamp duty and income tax. Income tax could either be assigned from the national tax take or be variable and determined at a local level. A local income tax was presented by IFS as a preferred option because it has a broader base but also has, they argued, less of the negative effects of stamp duty (which is very volatile year to year and increases the cost of mobility). That said, devolving income tax would come with its own challenges, including testing the capacity and capability of local government finance teams, difficulties in aligning tax take to current local government structures, and added complexity for business - and that’s before considering just how much decision-making would be devolved, the degree of equalisation needed or the potential impact of tax competition between places if areas are given the ability to determine the rate locally.
In our Local State We’re In survey of local authority chief executives and leaders, only 58% of respondents supported being assigned a proportion of income tax while 54% supported having control over a locally variable income tax. More popular options our survey highlighted were having greater freedom over the structure and level of council tax (96%) and greater freedom over the structure and level of business rates (90%).
This chimed with some of the attendees in the roundtable, who felt that flexibility over current local taxes might be a more useful focus for attention, and, together with the smaller taxes and charges being considered such tourist taxes and parking levies, might provide the cultural shift needed to empower communities and move towards more radical options for tax devolution. In terms of council tax, however, increased flexibility ranges from the relatively straightforward (e.g. remove the referendum requirement),to the more complex (changing the structure of bands or local revaluations - areas that the IFS will be looking at in further detail in 2019.
In recent years, as headline tax rises have been avoided by both national governments and councils, the interest in hypothecated taxation has increased. The social care precept, effectively a form of hypothecation, was cited by attendees as a good example where there was popular acceptance of the need for increased care funding and so an acceptance of the increased revenue which could be funded by more tax. Indeed, our work on health and social care recommended the extension of the social care precept in the short term as part of a broader move toward giving local leaders more power and accountability over local services.
However, there are drawbacks to a ‘ring fenced’ approach - it creates inflexibility in funding because revenues can only be spent on the purpose for which they were collected, limiting how much they can be tailored for the needs of each area, and it may contribute to a more transactional relationship between councils and communities, and as a result potentially disrupt the social contract whereby services are provided to those in need. As our recent report with Covi highlighted, for hypothecation to provide a viable answer, we need to work harder to improve the level of understanding we all have of the tax system and an ability to better assess the success of any new objectives.
While we wait for a clearer picture of the future of local government, the roundtable considered whether increasing flexibility over council tax and business rates, even with their complexities, alongside the introduction of smaller local taxes, might be the way forward. The unanswered question remains whether devolving taxes would actually promote growth or productivity and hence increase the overall funds available.
The IFS report on tax devolution will be published in early 2019.