Fiscal devo: getting the tax assignment model right for regional growth

The Prime Minister Andy Burnham clearly relishes setting out a vision. A national care service. Greater public control over basic utilities. Growth in every postcode.

For all of these, the devil will be in the detail. Turning a vision into actionable policy.

That’s perhaps even more true for one of the government’s other policies that doesn’t so often get onto the 9 o’clock news, but which could in fact be very consequential. Tax revenue assignment.

This is the plan, initially announced by the former Chancellor Rachel Reeves in March to share a portion of national tax revenues with England’s regional mayors. Andy Burnham confirmed he would go ahead with this plan in July, and said which taxes. Business rates from next April. Income tax from April 2028. More detail is promised in a ‘fiscal devolution roadmap’ to be published alongside the Budget later this month.

In a new IFS report, supported by CIPFA and the Nuffield Foundation, myself and colleagues have assessed what we know so far, and analysed the options available to the government.

It’s a bit of a tome – just about readable on a journey from No 10 to No 10 North, perhaps. But the key message is simple. The government needs to think carefully about what it is trying to achieve with this policy and make sure the technical design of the system aligns with that. Fail to do that and a potentially beneficial reform could backfire.

First, it is clear the government hopes this will boost growth. But how?

One way is by providing a stronger financial incentive to mayors to grow their local economies. With a share of business rates and income tax revenues they would gain when more property is built and when local residents’ incomes rise – rewarding actions that boost growth. They could borrow against the proceeds of growth to help fund the investments to generate growth. But of course, growth isn’t guaranteed, and factors completely outside mayors’ control – like changes in technology or global demand for certain goods and services – could blow a hole in local revenues.

Mayors often emphasise another potential benefit: longer-term certainty over their funding than the current year-to-year grants from government they often rely on. But if revenues move up and down too much depending on the local economy, that can be a source of uncertainty too. Systems that insure mayors against the ups and downs in revenues can provide more certainty, but only by reducing the potential rewards from growing local revenues too.

So the design of the revenue assignment system – how much emphasis it places on incentives versus insurance – should depend on whether the government thinks stronger incentives or more certain long-term funding are the real prize.

Our analysis shows seemingly technical design choices will affect exactly what incentives mayors do face, and how funding is likely to be distributed between England’s mayors.

For example, by deciding exactly what portion of revenues to share with mayors, the government can incentivise them to do different things. A flat share (e.g. 10%) of all income tax revenue would align mayors’ financial incentives with efforts to grow overall income tax revenues. But this would also mean they’d have the strongest incentives to grow the incomes of the already-rich – who make the biggest contribution to overall income tax revenues. Instead, sharing only part of the income from the basic rate of tax would provide mayors with incentives to boost the incomes of their lower- and middle-income residents. But they wouldn’t gain from attracting more high income residents.

Another key choice is how to redistribute tax revenues. Income tax revenues per person are over 3 times higher in Greater London than some of the northern and midlands mayoral areas. Redistribution will be needed to stop the capital gaining and poorer regions losing overnight when the system is brought in.

But this redistribution is not a one-off exercise. If any redistributive transfers are held fixed or even increased in line with inflation, they will fall behind what (we hope) is a growing pot of tax revenues. Over time, Greater London’s funding would pull ahead of the north and midlands even if its underlying economy and local taxpayers’ incomes grew no more quickly. That wouldn’t be conducive to tackling regional inequality.

We show that this can be prevented by updating redistribution so it keeps pace with average tax revenue growth. In that case Greater London would only see its funding pull ahead if its economy grew faster.

Of course, the government may still have concerns about that. But you can’t have rewards without risks too.

And that’s back to the big choice. How comfortable is the government in seeing some places – whether that’s Greater London or Greater Manchester – seeing their funding pull ahead of other areas in order to reward growth?

An answer to that question is vital to make sure the fiscal devolution roadmap leads to a destination the government is happy with.

This article was first published by The Municipal Journal, and is reproduced here with kind permission.