Why the UK must embrace tax devolution

Britain has the most centralised tax-setting arrangements of any major democracy. In England, all revenues except council tax are the responsibility of the Exchequer. Until Scotland and Wales are given new tax powers, their governments will still be almost entirely funded by a block grant from the Treasury. There is a fundamental belief at the centre of British democracy that the chancellor should set all taxes and that central government should allocate resources to every sub-national institution. Indeed, the degree of centralisation suggests that Britain’s national politicians have little confidence that our democracy can work effectively other than when in the hands of grandees in Westminster and Whitehall.

Even council tax is capped and frozen within both England and, under a slightly different regime, Scotland. We are in a position where the budgets of all councils are set by Whitehall. Furthermore, because the government has decided to achieve its deficit reduction policy by cutting the expenditure of a sub-set of public services, there can be no room to lessen control: council spending will have to be cut substantially further by 2019 if George Osborne’s zero deficit target is to be achieved.

In fairness to the chancellor, the policy of central control over sub-national government long pre-dates his arrival at No 11. It has evolved over seven decades since the nationalisations of the immediate post-war period. As the welfare state grew, more and more of the resources to pay for it were derived from buoyant and progressive sources such as income tax. Despite efforts to widen the local tax base, notably the Layfield Committee’s proposals in 1976, successive governments left the system of local property taxation largely unchanged. In 1990, Mrs Thatcher’s government nationalised business rates as part of its disastrous poll tax reform. Thereafter, councils had access only to the remaining domestic property tax. It is that which has been capped and, indeed, its base has not been revalued since 1991.

Countries as diverse as Sweden, the United States, Germany, Canada, Spain and Switzerland run democratic systems which allow a dispersal of fiscal power. These nations operate successfully with taxation set at national and local levels, whether they are within ‘federal’ or ‘unitary’ arrangements. In some countries, there are three levels of tax-setting government. Germany’s multi-level constitutional arrangements were put in place after 1945 and were explicitly designed to create a system of government with multiple centres of power. France achieved substantial devolution during the 1980s, while Spain has moved from being highly-centralised to a far more devolved country during the last 40 years. Britain is an outlier by any standards.

The Scots, armed with no more than ballot boxes, have forced the Treasury into an ignominious retreat over their ‘total control’ policy. Once Edinburgh has been given power to determine not only stamp duty but also a proportion of income tax, while also retaining a share of VAT, Scotland will have fiscal power similar to states and regions in many federal countries. Wales will follow. This will leave England as a residual, hyper-centralised nation within the quasi-federal UK. Having said this, within Scotland and Wales, their own systems of local government are themselves relatively centralised.

How has Britain ended up with such an odd system of government and so little sub-national fiscal power? Some elements of national control can be traced back to the Fabians. Sidney and Beatrice Webb were strong proponents of centrally-imposed standards and the equalisation of resources. The refusal of George Lansbury to hand over Poplar’s rates to the London County Council remains a pivotal political act, in the sense that it encouraged the introduction of grants which have had the effect of transferring resources from rich to poor areas. Even today, as a consequence of needs-equalisation grants paid to councils over many decades, spending on schools and social care tends to be highest in deprived areas.

But the decision to have inter-authority equalisation grants, which are now common in many countries, did not inevitably have to lead to centralisation of all tax-setting powers. The growth of parts of the welfare state within local government may have required centrally-funded grant support, but it did not necessarily demand the demise of local tax autonomy. What appears to have happened is that, decade after decade, Westminster and Whitehall have used a series of opportunities to justify more and more central encroachment on local power.

The Attlee government removed health and some utilities provision from local authority control in the late 1940s. Subsequently, the expanding scale of compulsory schooling, social services, housing and other ‘welfare’ provision required additional central grant funding. Such growth in subventions inevitably led to a ‘he who pays the piper calls the tune’ attitude at the centre. De-industrialisation in the 1960s and 1970s meant the government found itself under pressure to assist declining areas with new, specific, grants. Over time, these urban interventions came more and more to be streams of ‘challenge’ funding: councils only received the money if they spent it in ways of which Whitehall approved.

Then there was the 1980s. The rise of radical Labour councils which pushed up local taxation in opposition to the Thatcher government’s policies triggered the introduction of rate-capping. In the ensuing war-of-all-against-all, there was a move from ‘selective’ to ‘universal’ capping. The Greater London Council and metropolitan county councils were abolished, removing a city-regional tier of government. The introduction of poll tax in 1990 led to the central determination of business rates. Capital spending was also subjected to a belt-and-braces control regime.

Education, much of which local government had originally developed, became politicised. As far back as 1976, James Callaghan started the process of pushing for a national system of schools in England. In a speech at Ruskin College he argued there was a “strong case for the so-called ‘core curriculum’ of basic knowledge…[and]…to maintain a proper national standard of performance…[and an]… inspectorate in relation to national standards”. The Thatcher and Major governments then moved to school-based governance which, over time, has led to today’s policy of removing local government responsibility for schools wherever possible. Further education colleges were removed from councils during the 1990s.

So, not only was there a gradual transfer of provision away from elected local government, its tax base was capped and eroded. While other major democracies, for example France and Spain, decentralised powers, Britain did the opposite. In Spain, reform started to take place following the death of Franco in 1975, while in France the Mitterrand government decentralised power during the 1980s. In Britain, the Treasury, over time, came to operate a public spending control system in which local authority activity counted pound for pound towards a national figure of ‘total managed expenditure’. The 2010 decision, discussed above, to shrink the UK’s budget deficit by expenditure reductions made disproportionately by local government, has created an additional justification for 100 per cent control of council budgets.

Against this unique policy background, the UK government now faces twin challenges. First, the requirement to deliver devolved fiscal power to Scotland and Wales has created pressure to ‘do something’ for England. Second, the commitment to reduce public expenditure to 36 per cent of GDP while ring-fencing health, pensions, schools’ and international development spending will create alarming consequences for the ‘unprotected’ services, including local government. Looking ahead, might the government find itself under pressure to devolve spending to local areas in an attempt to cope with these twin challenges?

George Osborne has been working with the ten Greater Manchester authorities on a city-regional devolution package which would give them additional powers over skills, transport, housing, planning and economic development. It is likely that the NHS will be devolved to Greater Manchester. Such reforms are, potentially, the building-blocks for wider devolution of public expenditure both to Manchester and other city regions. Legislation has been introduced to give the government powers to transfer responsibilities to groups of councils, be they in cities or counties. It is hard to know how radical this reform will turn out to be, but the growing pressures on public spending suggest there may be no option for the government but to consider a more radical package of devolution to city or county regions.

Ministers have not yet proved willing to consider fiscal devolution for England. Treasury orthodoxy holds that any form of tax differentiation will lead to competition and therefore be inefficient. However, other social democratic countries survive well with different tax levels and powers from place to place, but in Britain this is seen (particularly on the left) as risking postcode lotteries and uneven provision. There is, therefore, a strange alliance between Treasury officials and social democrats to sustain a centralised system of taxation and spending allocation.

Of course, Scotland will soon be able to set its own income tax rates, with similar powers potentially available for Wales. These radical changes will occur, we must assume, with grave misgivings among the chancellor’s advisers. However, there is nothing they can do about it because Scotland has used its democratic leverage to get what it wants from the UK government.

The longer-term question of whether sub-national areas of England will be given their own, wider, tax powers depends on the future of the union. Candidates in the 2016 London mayoral contest will doubtless demand greater tax powers for the capital. Greater Manchester’s leadership is also arguing for fiscal devolution. Once the Scots and the Welsh have been given their new freedoms, English councils and MPs are inevitably going to demand something more than an arcane form of England-only voting rights affecting a minority of parliamentary bills.

There is a major challenge for the Labour party in all of this. The Blair government offered the north east a minimal and under-powered form of regional government in 2004. This was rejected. There is no appetite for regional government within most of England, though the north east has latterly developed its own combined authority model of governance. City-region and county areas appear likely to be the basis of future reform in England. George Osborne has dominated national policy-making in relation to city-regions, leaving the Labour frontbench with nothing to say.

Labour leaders and mayors in cities such as Manchester, Newcastle, Liverpool, Leeds, Sheffield, Birmingham and Nottingham are closer to Osborne’s mildly devolutionary view of the world than Labour’s cautious centralism. Traditionally, the centre-left has taken a Fabian view about the need for equalisation, national standards and regulation. While it would not be necessary to abandon all inter-area transfers or, indeed, to remove nationally-imposed service standards, policies to devolve powers or taxation have hitherto proved hard for Labour shadow ministers to accept.

As the Labour leadership reforms itself for another five years in opposition, it will have to decide if it wants to support its own city leaders in transferring power away from Whitehall or, alternatively, attempt to slow down even the modest pace of Osborne’s city-regional devolution. The failure of hyper-centralisation to produce balanced GDP per head in different nations and regions of the UK suggests that it is time to give devolution a chance. Labour could, tentatively, attempt to be radical.