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Is a local income tax the best way to sustainability for local government?

Neil Amin Smith, Tom Harris and David Phillips
Press release

Years of cuts and rising demands for services like social care mean that council funding in England looks increasingly unsustainable. In this context, the idea of devolving additional tax revenues and powers has been gaining traction among English councils, as they seek both more funding and greater control over their funding.

A new report by researchers at the Institute for Fiscal Studies assesses the options for devolving further tax revenues and powers to English councils, and reviews what’s devolved in other countries. It suggests that if the government wanted to devolve a significant new source of revenues to councils, a local income tax would be the best option. But such a move would inevitably come with challenges – not least to ensure equity between richer and poorer parts of the country.

Advantages of a ‘local income tax’

A local income tax could provide substantial sums of money. Each 1% of local income tax on all tax bands would yield around £6 billion, equivalent to almost 15% of councils’ core budgets. Such sums would help councils meet rising costs and demands for services like adult social care and could allow for further devolution of public spending to local areas too. Devolution of a portion of income tax would also:

  • Provide broad financial incentives to councils to grow their local economies, and, in particular, to raise incomes and employment among residents.
  • Give councils a buoyant revenue stream that automatically keeps pace with inflation and economic growth. Both council tax and business rates need to be increased manually each year just to keep pace with inflation, which can be politically difficult.

But implementation would mean overcoming some important challenges

  • A local income tax would raise significantly more in some areas than others. We estimate that revenues per person from a flat-rate tax across all tax bands would be more than six times higher in many richer parts of west London than in areas like Hull and Leicester. A system to redistribute revenues between councils would be required in order to avoid this translating into huge disparities in funding for local services.
  • Income tax rates that varied across areas would be more complex for employers, taxpayers, and HMRC to deal with. Up-to-date records on where taxpayers live – which, at present, employers and HMRC don’t always have – would be needed.

Other options for tax devolution come with more significant drawbacks though

  • Local corporation and value added or sales taxes would be much more difficult to administer and comply with. Moreover, differences in tax rates across councils would be more likely to distort taxpayers’ behaviour than they would for income tax.
  • Stamp duty land tax is much more unequally distributed – varying by a factor of more than twenty between richer parts of West London and places like Hartlepool and Blackpool. It is also a bad tax that should be abolished rather than entrenched via devolution.
  • Substantial new powers over council tax, such as the ability to carry out local revaluations, could pose problems for the system of redistributing funding between councils. It would be better to revalue and reform council tax at a national level – something which is overdue.

David Phillips, an associate director at the IFS and an author of the report said:

“A local income tax looks to be the best option if the government wanted to pursue significant tax devolution. However, there would still be a trade-off between the stronger financial incentives and greater local control that tax devolution brings, and the risk of bigger divergences in funding and public services that go alongside this.“

Tom Harris, a researcher at the IFS and another author of the report added:

“While tax devolution could give councils more options and discretion over how to raise funding, it is not a panacea for their funding issues. Addressing these ultimately requires either tax increases (whether via local or national taxes) or lower expectations of what councils can provide in future.”

Neil Amin-Smith, a researcher at the IFS and another author of the report said:

“Local income taxes have been talked about rather less in recent years than ideas like local tourist accommodation taxes. And it’s easy to see why such tourism taxes are attractive to councils – they could use them to raise revenues without directly levying a tax on their own voters. However, tourism taxes could raise useful amounts only in some heavily-visited parts of the country and even set at a relatively high rate of £5 per night, would raise just £2 billion across England – less than 5% of councils’ core budgets.”