Local Tax Reform: God and the Devil in the Details

Ian Britton

By Professor Ken Gibb, Director, Policy Scotland

The media covered Reform Scotland‘s contribution to the local tax debate yesterday. This was a welcome contribution to the aims of tax reform situated much more squarely in thinking about the wider role of local government in modern Scotland. Central to their case is the localisation of financial powers – increasing the autonomy of local government in Scotland by ending the council tax freeze, returning local control of non domestic rates to councils and, most radically, offering local government the right to decide on their own type of local taxes.

In a sense Reform Scotland have correctly identified the fundamental questions of the relative autonomy and the funding balance between Holyrood and town hall as the irreducible decision for the future – and that local tax choices could be essentially a local or a Scottish level decision. They could have gone further in terms of aims to consider the appropriate distribution of powers and functions between local and central government and, indeed, further still to address the geography of local government itself and the optimal number of councils.

Reform Scotland want decentralisation and devolution to councils and what they say chimes with Strengthening Local Democracy. However, for the Commission on Local tax Reform there is a sense that they may feel Reform Scotland is looking at this with the wrong end of the telescope. The remit of the Commission is clear – it is about domestic local taxes only (including the freeze) and implicitly the balance of funding and non domestic rates are ‘on hold’. We may support the overarching aim but it has to be translated into this narrower focus on the local tax question for the time being. It is therefore critical that any subsequent reform proposals, if enacted, do not impede further goals regarding the other parts of this agenda – but these may not come to pass for quite a while after local taxes change (and with good reason, there is a lot to think about, see below).

Let’s talk more about their specific proposals – which admittedly are a little light on detail. Some might argue that what Reform Scotland offer is an aim or set of goals for local government reform but the design implications of what they propose for thinking about tax reform have many consequences, and I do not think that they are all thought through.

The main proposals are:

  • Give tax setting powers back to local government (end the freeze).
  • Return non domestic rates to local government (not part of the Commission remit).
  • Propose giving local authorities powers to establish the local taxes that work for them and of course that this should be accountable to local electorates and tax paying citizens. Reform Scotland say that this might include land value taxes or indeed sales taxes

Ending the freeze would be welcome and would of course allow councils to set their own rates of council tax allowing them to spend more or indeed to cut taxes. Almost inevitably this would not be a complete freedom and one would imagine some form of incentives and penalties for excessive annual increases. One question is whether or not this is sufficient for visible transparent local democratic functioning or whether it is necessary to give the power to change the basis of the tax too, as Reform Scotland would argue?

I was struck in the recent review of international evidence we did just how many countries have multiple local taxes (usually a combination of property and income taxes) and also that many of our major cities, outside of the UK, have many local taxes (one study of big OECD global cities averaged five local taxes). Except in the UK where we only have the council tax. So, my reflections here are couched in terms of seeing the case for multiple local taxes raising broadly the same revenue as at present with perhaps a supplementary local income tax augmenting a better form of property tax (Burt thought this unworkable but I am not so convinced).

I am not convinced about the localising of the form of local taxation for two principal reasons. The first is that a range of local tax systems operating across Scotland will play merry hell with the grant system which will have to compensate local authorities on a different basis depending on the system in operation. This may act to make the system much less transparent as well as increasing the transactions costs of setting up and running the system. Taxpayers making decisions across the cost of service between authorities or even mobility decisions will need to understand the differences n respective local tax systems.

Second, we would need to have a range of supports for low income households that vary by local tax system e.g. you might need a rebate system for a property tax or reformed council tax but not for a local income tax. The experience in England of localising council tax benefit has been to create a patchwork of local means-testing systems. Do we really want that in Scotland? Isn’t tax rate variation powers at the local level with a good defensible local tax solution for all of Scotland sufficient? I also doubt that many councils have the resources, staff and confidence to go their own way – tax systems are important pooled resources across a country for a reason. Economies of scale and scope are important.

I am an in-principle supporter of land value taxation but recognise it would have some challenges to be introduced and transitional phasing in and compensation will probably be necessary until it is established. I also think there is a case for thinking of it as a national tax for all Scotland – but that is another story. I do think, however, that Reform Scotland’s other potential proposal – a sales tax – does need to be seriously questioned. We have extensive VAT in the UK set at a high standard rate. Indirect taxes on consumption are notoriously regressive and impact hardest on low income groups. Local sales taxes cause all manner of border hopping and cross border shopping investments which are inefficient and cause wasteful displacement of economic activity. The EU would almost certainly preclude new sales taxes – so it is probably not a starter even if it did not have these detrimental effects.

What about returning non domestic rates (NDR) to local councils? There are several issues here (which is probably part of the reason why it did not feature in the Commission’s remit). First, the current system imposes a national tax rate which generates NDR income that goes to Holyrood. This is then distributed back to councils on a per capita basis. The original reasoning during the development of the poll tax system was both to placate the business lobby but also to enhance the population driven nature of the grant system envisaged (although there is also a significant needs-based redistributive element). It is important to stress that we still operate this poll tax simplified grant system. Actually returning the NDR to local level implies two decisions: first, giving the income raised locally back to local government (the urban argument made by for example Glasgow and Edinburgh who are big losers under the current system), which is distinct from, second, allowing councils to set the NDR tax rate.

In principle, I also favour returning income and tax raising powers over NDR to local government (again with reasonable controls over excessive tax rates) but we need to recognise that if it was just about giving the income raised back to local governments there would be big losers as well as winners. We need to know what that pattern would be and whether we intend to compensate for it, perhaps by reintroducing resources element to grants so that those councils with smaller tax bases receive extra central funding. But to be clear that would drive a coach and horses through the current funding system and would require a fundamental remaking of the system and a redistribution of grant overall. This is equally true of reinstating local tax rate powers over NDR. It may be a worthwhile goal (I think it is) but it will not be an easy fix.

The aims set out by Reform Scotland are worthwhile and supportable but the devil is in the details and cannot be lightly dismissed as such. There is sense in doing local government finance reform one step at a time, if only because doing it all together can be disastrous (as we saw in 1989-90) and there may be too many spinning plates to manage if we wish to compensate losers and transition to a new more rational and fair system.