When the poor pay twice

To hire voluntary bodies to run public services is to risk a form of regressive taxation. Mathew Lit

The perception of new Labour's public service reform agenda has been more Balfour Beatty than Barnardo's, but Britain's third sector of charities and voluntary organisations has been assigned a crucial, if neglected and barely investigated, role within it.

Last year's government spending review concluded that the voluntary sector could make a special contribution in delivering health, crime reduction, education, and services for children and young people.

In July, the Treasury announced a review of how the sector can make that contribution and it has already launched a £125m fund, called "futurebuilders", to give non-profit organisations some of the necessary expertise.

In fact, the voluntary sector already provides a significant proportion of Britain's public services, particularly in areas such as residential care, training and education for the disabled and the homeless, social care, housing and regeneration.

A public service run by the voluntary sector is not the same thing as straight privatisation. Directors of the thin-cat variety, unpaid trustees rather than hordes of rapacious shareholders, a service ethos and a widely acknowledged ability to reach marginalised groups - all these distinguish non-profit organisations from their commercial counterparts.

The problem is the funding. To encourage charities to take over more and more of the public services is to enshrine what amounts to a double tax on the poor. The government develops a collective nervous tic at the merest suggestion that the rich should pay a tiny bit more tax. Yet it seems quite unperturbed at the prospect of the poor paying more.

But charitable donations are inherently regressive - the percentage of income given by donors drops the further up the income scale you go. It has been called "Robin Hood in reverse". Research by Professor Adrian Sargeant of Henley Management College shows that UK donors with incomes of between £5,000 and £10,000 a year give on average close to 4.5 per cent of their income to charity, while those earning between £40,000 and £50,000 contribute just 2 per cent. This is corroborated by the Institute for Fiscal Studies, which found in 1997 that the poorest 10 per cent of donors give nearly 3 per cent of their earnings to charity, while the richest tenth give just over 1 per cent.

In theory, this shouldn't matter - a charity contracted to provide a public service should simply be reimbursed by the state, so that its own donated income can be used to fund additional services. But the reality is different for most charities that have entered the "contract culture". While private companies can make a profit out of public services, voluntary organisations struggle to receive back anything close to the cost of the resources they provide. The result is a large subsidy of the public sector drawn from charities' donated income.

For example, Leonard Cheshire, which runs 200 homes and training centres for disabled people, estimates its "subsidy" to local authorities for 2002-2003 at £1.2m. And it is only through careful renegotiation of contracts that it has got the figure down from £6.7m two years ago. The Jewish charity Norwood, which provides residential and daycare services to people with learning disabilities, recorded a shortfall of £800,000 in its local authority contract funding last year. It was forced to use a ninth of its donated income of £7.5m to plug the gap. "Local authorities are tightening their budgets and, at the same time, demand for our services increased considerably," said the charity's annual report in January.

A subsidy figure for the voluntary sector as a whole is difficult to come by, as many charities are reluctant to admit that they fund the state at all, for fear of planting the dispiriting knowledge in donors' minds that they are paying twice for their public services. But several major charities have recently calculated that they are undervaluing the real costs of their services to statutory bodies by 3-5 per cent. Given that the National Council for Voluntary Organisations estimates the sector earns £2.5bn a year from government, the subsidy could be between £75m and £125m at the very least. And this is before the Treasury-funded expansion of the voluntary sector's role has begun.

To be fair, the government, under pressure from the voluntary sector, has committed itself to "full cost recovery" for all public sector contracts. Each government department now has a senior civil servant to act as a voluntary sector "champion". But most public service contracts that involve charities are with local councils, which have their own budgetary constraints. Guidance for councils on outsourcing services, published last month by John Prescott's office, does not even mention full cost recovery for charities.

In any case, it is doubtful that the Treasury is willing to provide the means to achieve the end. This year, the Legal Services Commission - its funding cut by the Treasury - withdrew an annual cost-of-living increase from contracts with 400 voluntary sector advice centres which run the Community Legal Service, the new version of legal aid. The centres are contractually obliged to meet a local government pay settlement of around 8 per cent. So either they make redundancies or they close - or use their own donated income to make up the shortfall.

The danger, therefore, remains: that the government's plans for a new kind of public service will be based on a funding system so regressive it would make an ultra-right US Republican blush.

The New Statesman/Co-operative Bank Upstarts Awards 2004, rewarding social enterprise, are taking nominations now at www.upstarts.org.uk