In an interview published on the Sunday Post website on 14 November 2015, Nicola Sturgeon was asked about the future of local taxation. The interview was conducted by Andrew Picken and the relevant extract is quoted below.

A cross-party review of the council tax was meant to report back last month but is now not expected before the end of the year with all sides struggling to agree on a conclusion.

The council tax bands have now not been altered since 1991 and are now significantly out of kilter with modern house prices.

However, a revaluation would be highly controversial and electorally unpopular as a similar exercise in Wales put about a third of homes in a higher band.

Much more palatable in an election year would be to shake-up the bands without a revaluation, with the possibility of also introducing new bands at the top end of the market.

This would allow the SNP to follow the approach it took with stamp duty, maintaining the freeze or cutting bills for the lower council tax bands, which affect the majority of Scots and squeezing more money out of those in the higher bands who own more expensive homes.

Grilled about this scenario, Miss Sturgeon said her party had not taken a decision yet over whether the council tax freeze will appear in its 2016 manifesto.

Taking her time to formulate her sentence, she continued: “We will see what the cross-party commission says.

“I am not saying this is going to be our policy, but you could change the bands for council tax without doing a revaluation.

“You could change the proportions between the bands that doesn’t depend on a revaluation.”

Asked if her party’s approach to revamping the council tax will match that taken on the stamp duty changes introduced earlier this year, she said: “The progressive principle will run through all of the decisions we take on tax.

“That is true of stamp duty, it will be true or of council tax or any future proposal on local government finance and it will be true of any decisions we take on income tax.


by Mark Stephens (I_SPHERE, Heriot-Watt University
and Kenneth Gibb (Policy Scotland, University of Glasgow)

Briefing No. 5 pdf available here.


The Council Tax was designed to be unfair.

The cost of freezing the Council Tax grows each year and this year will cost £560 million.

Ending the freeze would allow us to build the social housing we need, reverse the Housing Benefit cuts and have money left over.

Local income tax would drive up house prices and could be avoided by the rich and mobile.

A fair system of property tax is essential to combat poverty and austerity – as well as putting local government finance on a secure footing.


The Council Tax was introduced in 1993 as a replacement for the Poll Tax. Properties are divided into one of eight bands, based on their 1991 value. It raises £2 billion every year, and funds about 12% of councils’ total gross revenue income.(1) The Council Tax has been frozen since 2008-09 and in Autumn 2014 the Scottish Government announced the establishment of a Commission on Local Tax Reform to find a fairer system.

The Council Tax is designed to be unfair

The bands are designed to tax more valuable properties less heavily than cheaper ones. Because people who live in more expensive and higher banded houses generally have higher incomes, this also means that people on higher incomes are taxed proportionately less heavily than people on low incomes. Introducing more bands can reduce this unfairness. But they cannot remove it.

The Council Tax freeze is expensive

The Council Tax has been frozen for eight years. Every year the Scottish Government has to set aside more money to pay for the freeze. Each year the freeze requires the cumulative sum of previous years’ freeze plus another £70 million per annum. This year, in total, the annual cost of maintaining the freeze is £560 million (8 times £70m), bringing the cumulative cost to £2.5 billion.(2)

Unfreezing the Council Tax could pay for the social housing we need….

Just one quarter of the £560 million that it costs to pay for the Council Tax freeze this year could help to increase the output of new social rented homes by more than 3,000 units a year – bringing the total to the 7,000 the Commission on Housing and Wellbeing3 says we need.

… and reverse all of the Housing Benefit cuts… 

A further £40 million of the freeze would be enough to reverse the main cuts to Housing Benefit since 2010 (4) … and still leave £375 million left over. That’s £375 million which could be used to reduce the impacts of austerity arising from cuts in the block grant from Westminster.

We can’t afford the freeze, but we need a fairer local tax

However, the Scottish Government does not want to increase the Council Tax because it is
unfair. So we need to find a new tax for local government which is fair.

Wouldn’t a local income tax be fairer?

Local income tax sounds like a fairer option because it is based on the ability to pay. But there are compelling reasons why abolishing the Council Tax in favour of an income tax would be a poor decision.

Abolishing the Council Tax would make buying or privately renting a house more expensive…

The Council Tax taxes property values – albeit imperfectly. If the Council Tax were abolished and not replaced with a fair property tax, it would lead to higher house prices and higher private rents. This is because property taxes reduce the price of property due to the liability to make ongoing annual payments. If this liability is removed potential owners and investors will be able to bid more for property, and house prices will increase.(5) Higher house prices would hit first time buyers and private renters, and would make the housing crisis worse.

What’s more, income tax revenues would have to rise by 17% to make up for the loss of current Council Tax revenues and by 22% to bring back revenues to their 2008-09 value.(6) In 2006, the Burt Review estimated that a revenue neutral local income tax would require an additional tax rate of between 5.7 and 7.9 pence in the pound (depending how broadly it was applied and at different tax rates) on top of the prevailing rate of general income tax.(7)

Income tax has other disadvantages

Income tax has other disadvantages. One of the most important of these is that unlike properties, people can move, so if income tax is higher in one council area compared to another, people can move to avoid it. Self-employed people could convert their income into dividends to avoid it. People with more than one home can juggle where they live. There is a growing international consensus that broadening the income-based tax base and increasing our reliance for revenue on it can have negative economic consequences such as ‘fiscal flight’, compared to widening and diversifying the tax base to other less productive sectors such as property.(8)

This is why we need a reformed property tax

Property has been used as a basis for taxation across the world for centuries because it is a fair and reliable way to raise revenue. A fair property tax is one which reflects the value of the property, and is revalued automatically and frequently.

What about the ‘asset rich but income poor’?

There are many ways that people with low current incomes, but who live in relatively expensive properties, can be protected. In Scotland, rebate systems have operated since the 1960s. Other options include allowing owners to defer payments, combining property tax with income tax, or even introducing a hybrid property and income tax.


A fair system of property taxation is essential – not only to replace the unfair Council Tax, but to combat poverty and austerity.


(1) Commission on Local Tax Reform, Council Tax Facts
(2) Don Peebles (Head of CIPFA Scotland) Council Tax in the Context of Local Government Finance
(3) Commission on Housing and Wellbeing (2015) A Blueprint for Scotland’s Future
4) Based on Scottish Government impact assessments.
)5 The last time property tax was abolished – when the rates were replaced by the poll tax – four separate studies found that long run house prices would rise by 5% (Department of the Environment, 1986, Paying for Local Government, Cmnd 9714), between 13-23% (Hughes, G, 1987 Rates Reform and the Housing Market. University of Edinburgh Discussion Paper – medium run figures), by 7-30% (Spencer, P, 1988 The Community Charge and its Likely Effects on the UK Economy, CSFB Economics. London: First Boston) or 10-17% (Rosenthal, L, 1999, ‘House prices and local taxes in the UK’, Fiscal Studies, 20(1)). In the event these effects were outweighed by the collapse in the housing market caused by the doubling of interest rates.
6) Calculated from GERS, Table 3.1
7) Sir Peter Burt (chair) (2006) A Fairer Way: Report of the Local Government Finance Review Committee, p. 98
(8) See Burt (2006); Steven Smith (2015) Taxation: A Very Short Introduction (OUP); also raised by Gibb, K and Christie, L (2015) International Literature Review for the Commission on Local Taxation.

By Dr David Comerford, University of Stirling

Recent figures released by Scottish Government and ONS have shown that the distribution of property wealth (GINI = 0.64) is more unequal than the, already skewed, distribution of income (post tax and transfer GINI = 0.31). Therefore, a revenue neutral shift from the really-not-very-proportional-at-all council tax, to a tax levied in proportion to property wealth would, all else equal, have more winners than losers. The broad outlines of the distributional effects are clear. However, as outlined in the Scottish Property Tax Reform principles, the case for taxing property wealth (and land in particular) is also expected to have beneficial effects on average and so the balance of winners relative to losers is even more favourable than a simple zero-sum distributional analysis would suggest. In this post I outline some of the mechanisms by which such a system of taxation could promote economic efficiency.

What is economic efficiency? Inputs are used efficiently if the maximum possible output is produced with these inputs. Economic efficiency is enhanced when labour, capital and land are used in their most appropriate ways; frictions or interventions (such as taxes or subsidies) which prevent their appropriate use (perhaps by shifting the incentives towards an alternative, less productive, use) will damage economic efficiency, though there may be cases where interventions are efficiency enhancing when they mitigate against some market failure.

The case for a shift towards property and land taxation being efficiency enhancing rests upon three main mechanisms which will be considered in turn: (1) the fixed (inelastic) supply of land means that its taxation is not distortionary, and these revenues could be used to reduce other distortionary taxes; (2) the impact of land as an asset class upon the macro-economy; and (3) the impact of home ownership upon labour mobility. The final section then considers the political economy that mitigates against a policy which should be a positive sum game, and which should be supported by the median voter even if it were a zero sum game.

The fixed supply of land

Suppose land is untaxed, you own £100,000 worth of land, and you deem that the best use of your land is to rent it out for £4,000 per year. Sometime later, a land tax is introduced and you are liable for some amount of tax, say £2,000 per year. Whatcha gonna do?

The best use of the land is unchanged so there’s only really two options: continue to rent the land out for £4,000 per year, and receive only £2,000 net of tax, or sell up (the sale price would likely have fallen to around £50,000). The land owner cannot increase the rent to recover the tax as the rental level is set via supply and demand in the rental market – the only way the rent would go up in response to this tax increase is if some (other) land owners decided to take their land off the market and so reduce supply. But if they did this then they’d still be liable for the land tax and they’d now be getting zero rental income – so it is unlikely that the supply of land would be greatly affected by the introduction of the land tax, which means that rental rates would be fairly unaffected, which means that the incidence of the tax would fall almost entirely upon the land owners rather than the land users.

This is clearly a large loss to the land-owners but notice that the level of economic activity is unchanged – the land will likely continue to be used by those who can best use it, and in the case of our example, they are likely to continue to pay around £4,000 per year for the privilege. The loss of spending power by the land owner is a gain in spending power by the government without any direct impact upon the supply of the factors of production being taxed (here land). This is non-distortionary tax: its implementation has not damaged economic efficiency. Other non-distortionary taxes exist e.g. the poll tax is also not associated with any withdrawal of factors of production from productive use – but few would argue that a land tax falls as heavily as a poll tax upon those least able to pay.

In contrast to a properly implemented land tax being non-distortionary, the current system of property taxation is distortionary in a way that is damaging to economic activity. Currently second homes or unlet business premises pay less tax (council tax or business rates) than main homes or let premises. This is effectively a tax subsidy to remove land from the market i.e. the current system says to the owners of a valuable and potentially productive asset, that one of the most privately profitable uses of this asset might be to simply not use it. Given that society as a whole could be made better off if this asset was used in production, or if the empty house was used by a family who needed a house, this framework is clearly crazy from an efficiency viewpoint.

Other taxes can be distortionary, for example the combination of income tax, national insurance, and benefit withdrawal, on top of the extra costs incurred when working like commuting, child care, etc, may cause potential low earners not to seek employment because they are no better off with a job compared with no job. To the extent that a shift in the tax burden towards land is used to reduce distortionary taxes levied in situations like this, we could see an increase in labour supply and so an increase in economic output from a revenue neutral but efficiency enhancing shift towards land taxes.

Land as an asset class

The current system of property taxation subsidises home ownership relative to renting a home. There are various ways in which the system does this including a capital gains tax exemption on your main residence, and no liability to pay tax on the income that you pay as rent from yourself as tenant, to yourself as owner. To see that these constitute a subsidy, consider the same property either owned by the occupants or rented to different occupants. It could be that ownership relative to renting just changed the timing of paying for the housing services that the property provides (e.g. perhaps ownership is more expensive initially but cheaper later on) – in which case there is no subsidy. However, in reality, the government earns more if the property is rented out: receipts of capital gains tax when the non-occupying owner eventually sells; and income tax on some of the rental income that this owner receives whilst in receipt of these rents. A situation in which government income is higher when the property is rented out, can equivalently be viewed as a situation in which government expenditure is higher when the property is owner occupied i.e. the government is paying a subsidy to home owners.

This is a regressive subsidy as it is disproportionately paid to the wealthy who are more likely to own their property. But does it also distort the market in ways that damage efficiency? One way in which it might is by shifting the portfolio choices of individuals: suppose you have savings of £20,000; in the absence of this subsidy you might choose to rent your home and hold these savings in a diversified portfolio of assets; when home ownership is subsidised, you instead use the money as the down payment to obtain a mortgage. This distortion in asset allocation decisions has two obvious costs.

The first is that you are more likely to put yourself into a leveraged position by taking out a large debt that is fixed in nominal terms and secured against a volatile asset (the value of the property). The gross value of the debt is likely many times the net asset position (e.g. 20 times for a 95% mortgage). This has macroeconomic consequences by encouraging individuals to behave in a pro-cyclical manner i.e. it increases the correlation between individual behaviour (we all experience similar house price movements) such that everyone feels wealthier at the same time (when house prices rise but mortgage debt stays constant) or poorer at the same time (when house prices fall but mortgage debt stays constant). To the extent that consumer spending is related to net wealth, this means that economic activity becomes much more cyclical, with all the costs that come with boom and bust cycles. The government should not be subsidising home ownership and encouraging these cycles, and should perhaps be taxing home ownership and discouraging these cycles. To the extent that we are talking about land values overall, and not just land used for residential property, the cyclical movement of real estate values also affects business solvency, and business investment via its use as collateral, all of which adds to the pro-cyclical impact of land values.

The second cost is also related to risk and diversification, but at a less coordinated macroeconomic level. Suppose you live in a town in which your employer is the largest employer. The present value of your future wages constitutes a large component of your implicit “net worth”. An optimal portfolio choice for your savings would be to invest in assets which were not correlated with your own future wages – so that when one asset performs badly, the other performs well to provide some compensation. But if your employer were to go out of business, not only would this damage your future earnings, it would also likely have a strong negative effect on local property values. Therefore, investing in local property is a particularly bad investment decision in this case. Again, it is irresponsible and malign that government policy at present subsidises and encourages individuals to make such sub-optimal choices. (A similar argument pertains against government subsidy of schemes which encourage investment in your own employer’s shares.)

It is not clear that this government subsidy of home ownership raises investment in housing (we do not have an over-supply in the housing stock) but it does likely raise land values overall and therefore shift the proportional composition of wealth holdings towards land, which is an extremely long duration asset, and away from productive investment which has shorter durations. The consequences of this shift in duration is that a greater proportion of wealth is left as inheritances, with consequences for the intergenerational transmission of inequality, if not economic efficiency.

It may also be the case that a policy framework which subsidies home ownership and hence shifts the composition of household savings towards land, crowds out the absolute level of investment in productive capacity for the economy. This needn’t be the case (if you buy land from me, I have to do something with the proceeds – perhaps I’ll start a business or build a factory), but it could be the case if those in receipt of funds from the sale of land are disproportionately likely to consume rather than to invest. This could be the case if it were the old selling to the young and using the proceeds to fund consumption in retirement. This is the mechanism underlying the argument in Weale (2007) in which rising house prices reduce the need to save for retirement, which reduces overall savings, which lowers the rate of investment in productive capital.

Labour mobility

High levels of home ownership, and high land values, damage labour mobility. This is a circular process: suppose I have a potential move – a job offer in another location; if we are in a state of low labour mobility then it is likely that the number of potential homes near this new job are relatively low (low mobility means that their current occupants are also less likely to move); but this lack of availability means that I am less likely to take up this opportunity, rather I’ll stay where I am; and this decision to stay itself contributes to a lack of mobility. Low mobility means that people are less likely to do the jobs for which they are most suited because they are more constrained by location. To the extent that they are less productive in the jobs in which they are constrained to stay, this has an economic efficiency cost. A particularly egregious example of such an efficiency loss is where your present state is unemployment, and low mobility means you stay in a location where no jobs are available.

How does home ownership and high land values damage mobility? One way is in differential land values. If the entire land value were taxed away, then a home of equivalent build specification and quality would cost approximately the same, independently of its location. This means that if you have certain expectations and requirements based on your current home, a better job offer in a new location (such that the new wage net of land tax was greater than the old wage net of land tax) needn’t mean much of a change in your housing costs: the sale of your current house should fund the purchase of your new house if they are to approximately the same specification. Without the land component of the property price being taxed away however, property values in productive locations are likely much higher. It is highly likely that the better job offer received will be in a more productive location which means the sale of your current house does not fund the acquisition of a new house. It may be that a higher wage makes up the difference, but this is not necessarily the case. If it is not then you face a trade-off: move to the better job but take an effective pay cut because you cannot replicate the current housing amenity you enjoy; or stay put. Many will stay put – labour mobility has been lowered by differential land values.

Home ownership also damages labour mobility via higher transaction costs. The costs of buying and selling a property (including crazy additional policy measures like transactions taxes e.g. the Land and Buildings Transaction Tax in Scotland), whether measured in monetary, time or stress terms, are greater than the costs of exiting and entering rental lease agreements. The benefits of moving therefore don’t have to simply be greater than zero, they have to be bigger than some positive value that represents all the moving costs. This can be seen in commuting patterns: according to Oswald (1999) home owners commute more and further than renters, which could contribute to transport congestion.

Sounds good – let’s go

In this post I’ve outlined some of the mechanisms whereby a shift in the incidence of tax towards land raises economic efficiency. This means that we would expect average incomes to be higher as the tax burden is shifted towards land relative to the status quo. This is on top of the fact that a revenue neutral shift in the incidence of tax from income to land would benefit more than 50% of the population because of the concentrated nature of land ownership. Therefore there should be a large constituency in favour of this, and its implementation in a democracy should be straightforward, no?

In steady state, the only people who should prefer the status quo over an alternative with greater taxation of land, are children of the very wealthy for whom the inheritances outweigh any efficiency losses. But we cannot jump from one steady state to another, and the transition from the status quo to a policy regime with higher land taxes, mitigates against its implementation. In particular, a majority of the population (65%) are from households who own their own home, and these households will be adversely affected if property values fall. They may benefit on net, but the losses will be immediate and the benefits will accrue over time. There may also be adverse macro-economic consequences if households see their gross asset position hit, without any relief on their mortgages. Funding mortgage relief would add a large cost to the implementation of a shift to land taxes, and may prevent this shift being used initially to reduce other taxes (instead the land tax revenue would be needed to repay the bonds that were issued to fund the mortgage relief).

Although property ownership is concentrated in value terms among the wealthy (with a GINI coefficient of 64%), home ownership itself is widespread, which makes the political economy of the implementation of a shift towards land taxes difficult. However, if wealth inequality continues to increase (as hypothesised by Piketty (2014)) then the political economy of a shift towards land taxes, in terms of whether or not 50% of the population would be better off implementing the policy, transition and all, becomes more favourable over time.

Professor Jim Gallagher argues that reformed local taxation will only be sustainable if it fits into reformed local finance, so that there is a clearer link between local taxes and local services.

The Council Tax is broken, and the Commission on Local Tax Reform has been asked to fix it. But they won’t succeed unless they consider the system as a whole.

Every government since the 1970s has struggled with the question of local taxation. The two commonest government responses have been to do the wrong thing, or do nothing. The Conservative government of the 1980s did the catastrophically wrong thing: the poll tax. Scottish governments have followed plan B: do nothing, postpone decisions, and freeze taxes meantime. That stokes up trouble for the future. So the Commission on Local Tax Reform is to be welcomed. Let’s hope that space on the shelf is not already being dusted for it.

The key thing about local taxation is that it is indeed local. Two consequences follow. First, the tax base should be something that doesn’t move around if tax rates change. That’s why taxes on real property, ie land and buildings, are the obvious and the main, if not the only, basis of local taxation. Second, local taxation has to be seen in the context of the system of local government and local government finance as a whole. Simply playing about with the structure of local tax on its own won’t do: you end up being drawn into changing other elements of the system in an unmanaged way.

So it would be a mistake for the Commission on Local Tax Reform to think it could discharge its responsibilities simply by polishing the council tax at the edges, though there are certainly some rough edges to be smoothed off.

 The big question

The first and biggest question is the one put very plainly by the Layfield Committee in 1976. (No analysis of local government finance since this committee has added much, so real anoraks should read that voluminous report. Go to an actual Library, with real paper books.) Should local government have the power to make its own spending and taxing decisions, or is it agent of central government? Government responded then by refusing to answer the question. Governments still won’t. But today in Scotland local government spending and taxation are decided in St Andrews House, and local authorities are routinely referred to as “delivery agents”.

We need to face up to that question more honestly than our politicians have been willing to do. My own view is that the reality is that for some local government services the public appetite for genuine local variation is small, and we should accept that reality, making councils explicitly agents; but for others, government should get off their backs.  For a fuller argument about this, see this report.

The Ladybird Guide to local government finance

But even that radical shift does not solve all the problems. We still have to fit local taxation into the wider system of local government finance. Each local area has different needs for whatever local services there are, and each has different taxable resources. Unless we are willing to accept that local services will depend on the accident of where taxable capacity falls (“full fiscal autonomy” for local government, if you like) we need a central system, mediated almost certainly through government grants, to equalise needs and resources. This takes us into deeply technical territory.

History gives us a few lessons, and I’m going to oversimplify them here. If you have a single local tax base (let’s call it “rates”) it’s reasonably straightforward to equalise for different local taxable resources. You simply give extra grant to those areas with weak taxable capacity; or if you’re feeling bullish take money away from those with lots. With more than one local tax base, this gets more complicated to do. (To equalise you have to make an assumption about the different tax rates each council might apply to get a single measure of taxable capacity; I will spare you the algebra.). That’s one reason why, when the poll tax was introduced, the government took the chance to nationalise the remaining property tax, non-domestic rates. It was a centralisation, but it also made the equalisation of resources much simpler.

If you want to equalise for different relative needs (say different numbers of old people, children, or levels of deprivation) as well as for different levels of resources, you can only do that if you set an expected level of spend. That’s why under the council tax, grant was calculated in such a way that if a local council spent what the government thought what was its fair share, based on relative need, of what the government thought should be spent in total, it would levy the government recommended rate of tax. Of course no council ever did, as each always thought the government total level spending was too low. But the result was that the differentials in council tax could be magnified: a council with low taxable capacity which went over the government spending level would find its council tax shooting up.

Now the technicians in government should understand all this, though for the last 8 years or more, since the council tax freeze, little account has been taken of present- day needs or resources in local government finance: last year’s budget has been the starting point for this year’s cuts.

The challenge for the Commission

But the challenge for the Commission on Local Tax Reform is not to do the sums but to craft a solution which is based on some understanding of the following interconnected questions:

  • How much spending and taxing discretion should local government have, and over what services?
  • how much equalisation is desirable for different taxable capacity and different spending need for those services.

What might this mean in practice?

First, we have to look at the local tax base in total: and that means not just the council tax, but also rates on non-domestic properties. We should compare the yield from these with the budget of those services which remain genuinely local, rather than run by councils as an agent of central government. (For the latter, government should simply pay 100% of the cost, as they are making the decisions.) We should find a rough and ready way of combining the two local tax bases into a single measure of taxable capacity to enable equalisation. We might well find that this revenue was more or less enough to cover local services. Then we should look at the degree of equalisation that was necessary and desirable for that mix of services, and devise a simple and robust grant equalisation formula to deliver that. Don’t try and make it perfect.

Don’t break the next local tax as well

Of course this doesn’t tell you how to change council tax itself: but it might create a system into which a reformed council tax could fit.

Council tax is not a perfect tax, but it’s not all that bad. It’s broken because it was asked to bear too much of the increase in cost of local spending for too long: it was carrying weight of these unanswered questions. Let’s try avoid breaking a reformed council tax in the way we broke the council tax.