Walking a fine line

Fiscal geography and local taxation are controversial issues in UK politics. Successful reform goes unnoticed, while failures and botches are punished hard. The most extreme manifestation is the case of Margaret Thatcher, who lost power over the poll tax in 1990. And just last year Theresa May was seriously wounded in the 2017 election campaign by controversial school funding reforms.

As a result, inaction often wins the day even when reform seems ripe. Tony Blair bottled a routine revaluation of council tax in England, leaving our main local tax still today based on 1990 valuations. The Barnett formula for allocating money between the nations of the UK has been untouchable for 40 years to the huge benefit of Scotland and detriment of Wales. And there are still unwarranted differences in local NHS allocations even though ministers have been trying to address the problem since 1970.

With this backdrop it would be no surprise if a future Labour government were to choose the path of indecision or incremental revision over radical reform. Nevertheless, the party has hinted that it wants to think from scratch about fiscal geography and localism. In its 2017 manifesto Labour called for long-term reform of the allocation of public spending to ensure that ‘no nation or region of the UK is unfairly disadvantaged’. It promised a constitutional convention to extend democracy at every level and to consider the option of a more federalised country. In England it pledged to devolve more power – along with more funding – and to initiate a review to ensure sustainable long-term funding for local government looking at council tax, business rates and options such as land value tax. So what are the main issues Labour will need to consider?

Geographic variations in spending

Public spending per capita varies widely by English region in ways that are, on the face of it, hard to justify. Figure 1 presents spending on most public services (this is the total that excludes social protection, which is mainly social security). The data reveals that expenditure per capita is almost 50 per cent higher in London than in South West England and although the capital is the clear outlier there is wide variation across the rest of England too.

The key question is how much of these variations are warranted and what criteria for determining fairness should be used. For example, London’s high spending is mainly linked to the higher costs of delivering services (property is more expensive and earnings are higher). But are there unjustified historic differences too? And elsewhere are differences in need sufficiently driving spending variations? Figure 1 shows that differences in spending levels are linked to differences in economic output but the relationship is quite weak. The East Midlands fairs worst as it is both economically disadvantaged and a low recipient of spending.

The greatest geographic variety is found within the relatively small spending areas of public order and transport (this is true whether London is included or excluded). But health spending also varies significantly. Education spending is more uniformly distributed, even before the new school funding reforms, and is less related to economic disadvantage than health expenditure. Meanwhile social security spending is allocated by demand-led national rules so variations directly reflect differences in the population – e.g. the number of pensioners, disabled people and people receiving means-tested benefits.

Figure 1: Regional variation in public spending per capita and other indicators
(England =100%, ranked by spending excluding social protection)

Sources: HM Treasury, ONS

It is no doubt possible to explain many of these disparities by examining the data in more granular detail – at the level of individual budgets or localities. But the differences at least demand investigation and a future Labour government should seek to review all the national formula used to allocate funding. For example, when the Conservatives came into power they reduced the extent to which social deprivation is used to allocate NHS budgets. Labour should also examine the extent to which allocations vary from those determined by formulae because of protections for ‘losers’ and caps on growth for ‘winners’. In recent years there has been little scope to close historic inequalities because spending has been stagnant or falling permitting little convergence each year. But in the context of rising budgets after austerity, there will be scope to align designated and actual allocations more quickly without cash losers emerging.

Geographic variations in tax

Regional levels of taxation per capita vary a great deal, reflecting differences in economic output and average earnings. Figure 1 shows that these gaps are far larger than comparable variations in spending. This is what we should expect from a well-functioning fiscal union: tax raised is skewed to reflect ability to pay while spending is broadly uniform, with only a degree of variation to reflect levels of need and cost. However, figure 2 shows how this process of geographic redistribution leads to very different fiscal economies in each region. For example, public spending accounts for well over half of the North East economy and the fiscal transfer the region receives is around one fifth of its economic output.

These tax and transfer numbers are important, particularly in the context of the ‘London question’. We’ve seen that public service spending per capita in the capital is high. But figure 2 shows that relative to the size of London’s economy the city actually has low levels of spending: if London were a nation state it would have public spending similar to Singapore.* Even with its high spending per capita, London now makes a fiscal transfer to the rest of the UK that is equivalent to 7 per cent of its economic output. This is the ‘London nationalist’ case against reducing spending per capita and increasing the city’s transfers to the rest of the country.

However, figure 2 also shows that London pays far less tax than anywhere else, relative to the size of its economy. A large fraction of this gap can be explained by wealthy commuters who work in the city but live elsewhere. But additionally, the tax system is not sufficiently effective at taxing high incomes, wealth and profits which is something the Labour party is keen to address. Any incoming government wishing to transfer more from the capital and other wealthy areas should therefore focus first on better revenue raising. The alternative of seeking to suppress spending in London is politically controversial and will not necessarily be viewed as fair in relation to population need and delivery costs.

Figure 2: Regional expenditure, revenue and fiscal transfer (ranked by transfer as a percentage of regional GVA)*

Source: ONS

Localising spending

The Conservative government’s view on local spending autonomy has been contradictory. When David Cameron came to power he preached localism, scrapping hundreds of targets and pooling dozens of grants into fewer, more flexible budgets. New responsibilities have also been devolved – both to councils and new city-regions. But often this has been without sufficient money, as in the case of council tax benefit; and the new city-region mayors have been created with very limited budgets and revenue powers. But in other ways the Conservatives have been centralisers. The government has driven through the nationalisation of schools funding with the mass roll-out of academies and now the introduction of direct funding of all schools from 2020. In the case of social care, new national requirements were introduced along with a new grant fund to partially compensate for insufficient council money.

A future Labour government should think afresh about which tier of government should make what sort of fiscal decision. The heart of the tax and social security system, which secures revenue for government and equalises living standards for citizens, should remain a national government responsibility. With the partial exception of Scotland, we remain a single political community where people expect government to raise taxes and provide support to people consistently. For this reason, benefits such as attendance allowance and housing benefit should not be localised, as some have suggested.

A national allocation system is also required for achieving equitable spending power for public services between areas. The various departmental spending formulae for distributing resources should either stay in the hands of government or be devolved to expert commissions made up of representatives from localities. This is particularly important when the state imposes minimum national standards or requirements on local public services. Local areas cannot be expected to deliver national policy without fair national funding. For example, there is a case for a designated budget for adult social care now that all councils must meet high basic requirements (as I argue in my contribution to the new Fabian Society report Take Good Care).

On the other hand, there could be far more local autonomy in the deployment as opposed to the allocation of funding. Where localities have sufficient governance and accountability, they should ideally be able to operate on the basis of a single public service budget designed to meet all national standards and requirements. This implies pooling budgets between all local public agencies, including local government, NHS, probation, skills, employment and transport. It also means localising school funding and making local areas the commissioners of school places again, albeit with a fairer schools funding formula. Single local public service budgets coordinated by local government may be particularly important for the financial sustainability of councils, because otherwise their finances will become totally lopsided as social care absorbs an ever-rising share of their spending. Careful thought will also need to be given to the allocation of powers and money between local authorities and city-regions; responsibilities could be exercised by different tiers in different parts of the country to reflect local political and economic geography.

Localising revenue raising

There is a growing interest in enhancing local revenue raising powers as well as spending autonomy. The government is rolling out its policy of localising business rates although the pace of change has recently slowed. New revenue raising powers have recently been handed to Scotland and other parts of the UK are watching with interest. Independent reviews like the London Finance Commission have proposed devolving a significant range of taxes within England.

Compared with other countries, revenue raising in the UK is highly centralised, so there is a prima facie case for localising some taxes. However, a 2015 Fabian Society report found significant public scepticism and hostility to transferring tax raising powers to local areas. In a series of focus groups participants raised concerns about inequality, inefficiency and the limitations of local democracy. Moreover, significant challenges are created by the UK’s very large geographic inequalities and the variations in tax bases that this creates.

Initial differences in tax bases can be corrected by grants based on appropriate equalisation formulae designed to take into account different local revenue raising capacities. But such systems do not necessarily stay fair, because over time richer areas can raise more new income than poorer areas with the same percentage tax rises (this is why councils in poorer areas have been more heavily hit by recent grant cuts and why the new council tax social care precept favours richer areas). Low income areas are also less likely to be able to grow the size of their tax base through economic development. When a tax base starts small, impressive percentage growth will translate into less extra cash, compared to when a tax base was larger to begin with (this explains why more affluent areas are more likely to benefit from the retention of business rates). Additionally, a growing tax base is not necessarily linked to economic or employment growth that is within a locality’s control as research on business rate retention has uncovered.

Taking all this into account a future Labour government that places a high priority on geographic fairness should proceed with caution on tax devolution. In particular, the present model of business rates localisation (introduced for the sake of creating economic incentives for councils) is unequal, complex and empirically unsound. There is a good case for ending it in its current form. In the long term, if politicians want to move beyond a national system, they could consider much more radical devolution of tax raising powers but with an equalising formula that assumes each region will raise a constant share of its local economic output using its own mix of tax measures. Such a federal solution would be a huge step in the UK context but it might have more chance of securing equality between areas than the patchy and piecemeal devolution of individual tax powers.

This discussion takes us to the question of reforming council tax. There is significant interest on the left in wholesale reform of our main local tax either to make charges fully proportionate to property prices or to replace council tax with a land value tax. New technologies also open the prospect of regular revaluations, based on real home sales data. From a national perspective there is much to commend in these ideas, as the new tax would be much more progressive and would create a fiscal dampner on house price rises. A tax of around 0.4 per cent a year on the value of a home (a little more if it were just the value of the land) could yield roughly the same revenue as council tax and leave a clear majority paying less than they do now. There is also a good for absorbing stamp duty into any new system to remove a barrier to moving home. However, from a local perspective such a move would exacerbate the equalisation challenges that already exist because poorer areas would end up with still smaller tax bases than at present. If Labour proceeds with reform it may need to take a wholly novel approach to local government finance. Perhaps we need a local/national hybrid tax where the money councils raise in relation to property prices is centrally pooled and then redistributed on the basis of a uniform national payment per property.

* ADDED FOLLOWING PUBLICATION (29/7/2018): Comparing spending and revenue collection to regional GVA is however problematic due to high levels of inter-regional commuting. London’s spending is less out of line with other regions when compared to the total incomes of residents rather than the city’s value added. Londoners also pay a higher share of their incomes than average (because they are more prosperous). The complex question of rival measures and concepts of geographic fairness will be explored further in the final report of this project.