A sensible start to fiscal devolution

Should England’s regional mayors be rewarded when their local economies grow? Most would probably say yes. But what if that means richer areas pulling further ahead of poorer ones? Or mayors facing funding cuts because of economic developments completely outside their control?

These are the difficult questions at the heart of the government’s plans to share income tax revenues with England’s mayors from April 2028. And the answers matter. The way the system is designed could shape both the financial incentives facing mayors and the funding available for their priorities for years to come.

The fiscal devolution roadmap, published alongside the Budget, provides some welcome clarity. The government has opted for what I’d call a balanced approach: mayors will be rewarded when their tax revenues grow, but with protections against large losses and widening funding inequalities.

That’s a reasonable. Indeed, several elements are in line with recommendations made in our recent IFS report, co-funded by the Chartered Institute of Public Finance & Accountancy. But there are a couple of details I’d urge the government to reconsider.

Slicing the income tax pie

First, exactly which income tax revenues should mayors share?

The government plans to assign a portion of revenues from the basic rate of income tax, based on where taxpayers live.

There is logic to this. The highest earners are particularly concentrated in places like London. Focusing on basic-rate revenues therefore reduces differences in tax bases between mayoral areas. It also focuses mayors’ financial incentives on boosting employment and the incomes of low- and middle-income residents.

But it comes with a downside. Mayors won’t benefit from increasing the earnings of residents already paying higher-rate income tax – broadly those earning over £50,000. And the plans exclude income from property, savings and dividends altogether.

That last exclusion is particularly questionable. Imagine a mayoral area successfully supporting small business growth. If more residents set up incorporated businesses and take income as dividends rather than through traditional self-employment, the mayor could miss out on the resulting tax revenues.

Why create such a distinction? Mayors should have a stake in growing all forms of taxable income in their areas, even if the government wants to concentrate the incentives on lower and middle earners.

Balancing risks and rewards

Second, how should the government protect mayors against revenue risks?

There is much to welcome here. The government plans to update assessments of mayors’ spending needs before the system starts, rather than simply perpetuating a patchwork of historical grant allocations.

It will then use redistributive payments to ensure mayors’ initial funding reflects those assessments, rather than how rich their local tax bases happen to be.

Crucially, those payments will grow in line with average income tax revenue growth across mayoral areas. This avoids a major pitfall: richer areas seeing their funding pull ahead simply because redistribution fails to keep pace with national revenue growth.

Mayors will instead gain if their revenues grow faster than average, and lose if they grow more slowly. Redistribution and incentives can work together.

The government also plans a safety net against particularly large revenue falls, funded by levies on the strongest revenue growth. Again, sensible in principle.

But the roadmap hints that the thresholds determining when these protections and levies apply may be fixed in real terms. As revenues grow, that would mean the safety net becoming less generous relative to average revenues, while more mayors find their growth subject to levies.

Why allow the system to change in this way simply through the passage of time? Indexing these thresholds to average revenue growth, as with the main redistributive payments, deserves serious consideration.

There is another, more welcome decision. Rather than periodically wiping out all accumulated growth through abrupt resets, mayors will retain the benefits of growth for perhaps 10 or 15 years before those gains are gradually redistributed. This provides a reasonable compromise between rewarding growth and preventing permanent funding divergence. But the rules should be confirmed well in advance.

Where next?

The roadmap is therefore a promising first step – at least for England’s regional mayors. It offers meaningful incentives for growth without abandoning protection against financial risks and regional inequalities.

Much of the detail remains to be settled by next year’s Spending Review. The government has made some sensible choices so far. A little more thought about which income is included, and how the safety net and levies evolve, could further improve things.

The roadmap does relatively less to address councils’ devolution asks. They will swap some more of their grant funding for the remaining central share of business rates – probably in 2029–30. Like mayors they’ll gain or lose more based on the performance of their local economies.

But the biggest issue facing councils is not a lack of financial incentives. It’s a lack of funding. And with the government’s message to the public focused on a set of policies to slightly ease the cost of living, giving councils significant new revenue-raising powers seems off the table.

This article was first published by Local Government Chronicle, and is reproduced here with kind permission.