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.