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29 January 2001

Let local councils vary income tax

NS/Fabian Society Second-Term Agenda - Let local councils vary income tax

By Michael Jacobs

Local government has a crisis of credibility. Under 18 years of Tory rule, councils were stripped of powers and funding. In a whole range of fields – housing, social services, education, urban regeneration – the role of local government has been diminished, and could yet be eliminated altogether. Ministers complain that the performance standard of local authorities is not high enough. But taking away their functions can only make the idea of becoming a local councillor even less attractive to the talented aspiring politician. Where are the 21st-century Joseph Chamberlains now?

Local authorities in the UK now raise only around a quarter of their own income, against 55 per cent a decade ago. (This is a lower proportion than in all our major partners except the Netherlands.) The rest comes from central government, leaving local authorities not just financially but politically dependent. So far from being autonomous units of democratic government at local level, it is almost impossible now for councils to determine either what they do or how much they can spend doing it. Is it any wonder that the average turnout in local elections is less than 30 per cent?

If local authorities were able to raise taxes in order to fund improved services, participation rates in elections would surely rise. They can already raise council tax, but politically this is a hopeless option. Because the tax raises such a small proportion of total local authority funding, it must be increased by much more in percentage terms than the rise in spending that it is financing. A 5 per cent rise in council spending, for example, requires a 20 per cent increase in council tax, and the disproportion is even greater for poorer councils.

The Local Government Association’s solution is to restore business rates to local control. But since businesses do not have votes, this would not bring councils closer to their electorates; rather the contrary. And all the arguments that led to the nationalisation of business rates a decade ago still hold good. As local authorities in poorer areas increased their rates to secure income, while those in richer areas were able to reduce theirs, the effect on economic development would be exactly the reverse of what is needed.

A second option sometimes canvassed – it was recommended by the Layfield Committee on Local Government Finance in 1976 – is to introduce a local income tax. The principle is highly attractive: a progressive, buoyant and easily understood local tax that would give local authorities financial and democratic autonomy. (Local income tax operates successfully in most of Scandinavia.) But the administrative cost of introducing a whole new tax has led to its consistent rejection.

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There is, however, another option, and a model already exists. It is the Scottish Variable Rate (SVR). Under the Scotland Act, the Scottish Parliament has the power to vary the basic rate of income tax levied in Scotland by plus or minus 3p in the pound. Local authorities could be given a Local Variable Rate (LVR) power on exactly the same basis, with the power, in their case, to levy perhaps up to 2p in the pound.

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Administratively, this would be relatively simple. If a local authority wished to use the tax power, it would notify the Inland Revenue of its proposed rates and the Revenue would then issue new PAYE tax tables to employers and the self-employed in that area. Payslips would have a separate line for local income tax to ensure that the tax was politically visible, thereby increasing local accountability. The Inland Revenue would collect the tax as normal and remit it to the local authority.

A tax power of this kind has all the advantages of a general local income tax: autonomy, democratic accountability, simplicity, buoyancy and progressivity. But whereas under a general local tax a major administrative burden would be borne even when there was no change in the actual tax rates paid, under this scheme the administrative costs would be incurred only when a local authority decided that it wished to use the power. There would be no administrative “dead weight”.

Moreover, local authorities could be required, or advised, to hold local referendums when they wanted to exercise the power. In this way, they could ensure that the power was properly tied to the democratic process – and thereby to a genuine voter choice over local services. You may think that such a referendum would never be won. But when, two years ago, Milton Keynes council asked its local citizens if they wanted to pay higher council tax for better public services, the voters gave a thumping yes. When many people are worried about underfunding in schools, for example, it is quite likely that, in some areas, voters would wish to pay more.

A local power to vary income tax would give them the chance. And it would give back to local authorities the democratic autonomy that should be their constitutional right.

Michael Jacobs is the general secretary of the Fabian Society. This article – the eighth in a series on ideas for a second Labour term – is based on a chapter in the report of the Commission on Taxation and Citizenship, “Paying for Progress: a new politics of tax for public spending”, published by the Fabian Society, 11 Dartmouth St, London SW1H 9BN (£9.95 +£2 p&p)