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Associate Director Anthony Breach explores how Wales could tackle unfairness in the council tax system and set the agenda for other nations and regions of the UK to follow with its council tax reforms.
Fiscal devolution is the only way out of the local funding crisis – revaluation alone won’t be enough
Local finance has shot up the political agenda since the New Year. Multiple councils are now warning of the possibility of financial failure as systemic issues have started to come to a head. In response, MPs are not just calling for emergency support for English local authorities, but also beginning to suggest wider changes to the local finance system.
Amid all of this, commentators in England have been pointing to the Welsh Government’s coincidentally-simultaneous proposals for council tax revaluation and changes to council tax banding as a solution. Yet while the Welsh Government is to be commended for taking on this thorny issue, the current proposals are not enough to fix the problems with local finance in either England or Wales.
There are two separate issues facing local finance – the amount of resource in the funding system, and the design of the funding system. The Welsh Government’s proposals aren’t directly related to the first issue, but by addressing the second issue, they could be argued to make it easier for local government to raise more revenue from council tax.
Council tax is widely recognised to be an unfair and regressive tax. The more expensive your house is, the lower your tax rate.
Unfairness is not the only problem with the design of council tax, however. Council tax also presents a barrier to local and national economic growth that in turn creates a funding problem in local government. This is for two reasons.
The first is that council tax is not ‘buoyant’, in that receipts do not rise along with economic activity. Unlike most taxes which are set as a percentage of activity or wealth, council tax is set as a fixed, nominal bill. Making the local economy more prosperous does nothing to increase receipts – meaning councils are not rewarded if they pursue economic growth, and they have to vote to increase bills just to keep pace with inflation.
The second is that council tax’s interactions with the grant system also penalise growth. As council tax is set nationally (every bill is ‘anchored’ around the local bill for Band D), different councils raise different amounts of money from the same tax rates as differences in house prices cause the local tax base to vary. The funding gaps that appear – especially after a revaluation or changes to ‘anchoring’ as the Welsh Government is proposing – are filled by central government grants, with those councils with smaller tax bases getting more grants and vice versa.
Sending more grant to poorer councils and less to affluent councils does sound very fair. But the effect on incentives is pernicious. If a poor council area becomes more prosperous, then the next time the local finance system is reset, the council is penalised with less grant. Conversely, an affluent local council that rejected economic growth would be rewarded with more grant. The grant system therefore discourages councils from taking tough decisions that would grow their tax base. Under the current system, councils have no incentive to fund services by growing their tax base or by extension the national economy.
These economic problems with council tax are not resolved by the proposals developed by the Welsh Government and the IFS. They do tackle other problems: the proposals make council tax fairer at a national level, with the revaluation and the various changes to ‘anchoring’ of bills around Band D. But they don’t fix the lack of buoyancy or address the impact of grant on incentives.
It is therefore difficult to see how the Welsh Government’s council tax ideas could sustainably address the local finance crisis in England. The economic problems with council tax mean that currently the only ways to increase resource for local services is either higher council tax bills on households or more grants from central government.
It may seem that there is a trade-off between fairness and economic incentives. This concern is often raised when fiscal devolution ideas are floated,, especially with the local finance crisis putting councils under huge pressure. Either less affluent areas fear losing funding, or affluent areas fear disproportionate council tax increases due to their high house prices.
However, this concern is mistaken. As our report In Place of Centralisation on devolution to England’s three biggest cities and our briefing on council tax in Wales both show, it is possible to improve the growth incentive of council tax and make it more fair, if there is a shift from national redistribution to local redistribution.
This can be done in a revenue-neutral way by:
Together, these changes would give local authorities the flexibility to turn council tax from a regressive tax into a flat or progressive tax, broadening the tax base and allowing most households to benefit from a tax cut even as council tax raises the same amount of money as today. Centre for Cities’ briefing on council tax reforms in Wales estimates that, with this change, up to 66 per cent of Wales could benefit from an average £393 tax cut, paid for by the residents of the 34 per cent most expensive houses in each council area seeing an average council tax increase of £696.
Crucially, under fiscal devolution, a large majority of people in every council area would benefit from a tax cut, as council tax would be adapted to local conditions and deliver local redistribution.
Fiscal devolution in this way would also reconnect council tax to the local economy. As council tax would become much more buoyant and grants would not need to adjust due to revenue-neutrality, councils would be able to raise revenue by growing their local tax base through a larger and more productive local economy.
Places would no longer be penalised if they grew their local economy. And if every council is better incentivised to grow their local economy, this will scale up to improve national economic performance.
The proposal set out in the briefing is modelled for Wales, as a response to the Welsh Government’s consultation on reform. But while the Welsh Government’s proposals alone aren’t enough to fix England’s local finance problems, fiscal devolution of council tax in the manner set above can provide a boost to growth, fairness and resources – with the following extra steps.
First, local finance needs to be structured around growth. Unless councils get to keep much more of what they grow from their own tax base, the only two tools councils have to increase funding for services are higher council tax bills or higher grant.
Second, England needs to reorganise local government to unlock fiscal devolution. Wales can deliver fiscal devolution easily because its map of councils is already reorganised and simple. But England’s current local government map is a mess that makes it exceptionally challenging to consistently devolve responsibilities across the country, including taxation. A simple map in England, with local governments matching local economies, would make it much easier to fix local finances.
Third, England needs to add income tax to the local funding mix. Business rates and grants are an important part of the local finance system, and both England and Wales can go further on this. But the regional divides across England are so stark that an additional source of funding is probably needed to give services in poorer parts of the country extra support. Income tax is by far the most appropriate tax for this, either by sharing local revenues with national government, some autonomy over rates, or some combination of the two.
Centre for Cities has already set out how this could work in the three biggest cities in England with a ‘triple deal’ with In Place of Centralisation, but the underlying principles are relevant for the entire country.
Associate Director Anthony Breach explores how Wales could tackle unfairness in the council tax system and set the agenda for other nations and regions of the UK to follow with its council tax reforms.
Join us at this online event to discuss what the next phase of devolution looks like and how it connects to the wider question of the UK’s economic strategy.
This latest research from Centre for Cities and Resolution Foundation as part of the Economy 2030 Inquiry sets out recommendations for the next phase of devolution, proposing a triple devolution deal for England’s three biggest city-regions with fiscal devolution at its core.
A new report from the Resolution Foundation and Centre for Cities finds that if the national economy is to escape stagnation by 2030, the current system of subnational government will need to change.
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