Three monkeys on the back of English fiscal devolution

The fiscal powers of English local authorities are extremely limited. In recent years there have been many proposals for significant fiscal devolution to take place, but little progress has been made on this agenda. In this post Mark Sandford argues that there are three fundamental reasons for this: the nature of the UK state, the complexity involved and equity considerations.

The mid-2010s have seen an unprecedented number of proposals for devolution of fiscal powers to local authorities in England. The coalition government’s ‘devolution deal’ policy, together with the substantial fiscal devolution granted to Scotland in the wake of the 2014 independence referendum, have encouraged many stakeholders to believe that English local government is on the cusp of a breakthrough in the balance of revenue-raising power between local and central government (Morrin and Blond 2015; Centre for Cities 2015). Some have produced reports containing substantial proposals for fiscal devolution to English local authorities (Centre for Cities 2015; ICLGF 2015; ICLGFW 2016; London Finance Commission 2017; EEF 2017). Associated concepts such as place-based budgets, raising borrowing caps, commercial councils and local government restructuring have also attracted attention as potential solutions to English local government’s financial challenges.

I suggest that these hopes and plans arise from an over-optimistic reading of the political landscape. Most of the key drivers of the apparent ‘devolutionary turn’ in England are ephemeral and highly dependent on ‘constitutional entrepreneurs’ and windows of opportunity. Developments in Scotland, Northern Ireland and Wales are matters of high politics. English devolution deals and the retention of business rates by local authorities were largely driven by former Chancellor George Osborne. Inertia and Brexit will drag hugely on all policy innovations in the 2017–22 parliament. The confusion of local administrative boundaries, public bodies and contested local identities have long frustrated strategic approaches to local governance in England.

But this type of political headwind is priced in by commentators. There are three more fundamental reasons why fiscal devolution in England was always likely to face insurmountable obstacles, which relate to the nature of the UK state, the complexity of the change implied, and to local equity. These have been largely lost in the warm glow of consensual causes such as inclusive growth and regional prosperity. They run beneath the day-to-day debate on policy solutions, and offer a more cultural account of the critical relationships at issue.

First is the nature of parliamentary sovereignty and public accountability. In the British constitutional worldview, public servants are responsible for safeguarding public money, ensuring that the principles of ‘economy, efficiency and effectiveness’ are maintained in its spending. Parliament votes in favour of taxation for given purposes, and its intentions must be honoured. It may be tempting for sceptical commentators to dismiss this as a cover for a centralist instinct, but this would be misplaced. Parliamentary sovereignty is a foundation stone of British constitutional practice, and adherence to it runs deep in the clay of the UK Civil Service. This is evident at every turn: from the detailed departmental ‘accountability system statements’, to the struggle with multi-level governance in Accountability: Adapting to Decentralisation, to the detailed requirements for local accountability for transferred money in devolution deals.

This worldview underlies proposals in 2013 for parliamentary investigations of individual councils’ finances from the then chair of the Public Accounts Committee, in the wake of the abolition of the Audit Commission. Although nothing came of this, the mere fact of its being suggested highlights the centrality of parliamentary accountability to UK political life. The National Audit Office expressed unease in reports in 2014 and 2016 at the hands-off approach to local accountability adopted by the Department for Communities and Local Government on the basis that they saw threats to the safeguarding of public money – even though the Department for Communities and Local Government itself argued that it was taking this approach because it viewed local electoral accountability as paramount.

Approaches to fiscal devolution that appear to play fast and loose with accountability – parliamentary or otherwise – will trigger red flags in Whitehall. There is a related strand of thinking, perhaps more inchoate, that parliament alone has the power to tax in the UK: Midwinter and Mair’s 1987 study Business Rates Reform notes historical debate over whether the local rate (the only ‘tax’ available to UK local government) truly constituted a ‘tax’. Fiscal devolution to Scotland and Wales has eroded this narrative somewhat, but the idea of entrusting broad revenue-raising powers to local institutions remains strongly counter-cultural in the UK. Traditions of parliamentary sovereignty and accountability are not moved by the fact that local and regional governments in other states frequently have access to several sources of own revenue, which helps to maximise their financial stability and reduce risk.

A second issue is the importance of variations in tax incidence across England. England’s economy, and hence its taxbase, is geographically unequal. More tax, and more tax per capita, is raised in some localities or regions (however defined) than in others: recently documented in the Centre for Cities’ admirable work on tax incidence. It follows that any system of fiscal devolution that allowed local areas to retain the revenue from such taxes would result in very different levels of revenue (both in absolute and per capita terms) for different areas – unless mitigating action is taken.

In practice, equity considerations have long mandated the spending of public money more equally across the UK, so that some areas receive more spending than they raise in taxation and vice versa (this underlies Greater Manchester’s advertising of its ‘£5bn deficit’, the estimated difference between public spending and taxes raised in its area). Even if they are sometimes honoured in the breach, there is no sign that central government is willing to abandon equity considerations entirely.

Because of England’s variations in tax incidence, local retention of revenue via fiscal devolution, and equity considerations requiring redistribution between local areas, work directly against one another, both in theory and in practice. There is simply no way around this: any fiscal devolution system for English local government must find a balance between these two principles (or abandon one of them). This fact has tended to be glossed over by advocates of fiscal devolution: the 2015 Independent Commission on Local Government Finance is one of the few publications to recognise this issue. Many commentators make no reference to the revenue outcomes arising from proposals to localise, for instance, stamp duty or a portion of income tax. If revenues from such taxes were purely retained locally then, compared to now, wealthy areas would win and less wealthy areas would lose – often substantially. This issue has not bitten as hard on fiscal devolution to Scotland, Wales and Northern Ireland, because in those countries fiscal devolution’s starting point is generous in per capita terms compared to England.

The Business Rate Retention Scheme provides an example of this clash. The ‘tariffs’ and ‘top ups’, politically essential to guarantee equity, mean that individual local authorities may retain as little as 15% of their rate revenue, compared to the 50% retained collectively. This is because a slice of their revenue is transferred to authorities with lower taxbases. This has obvious implications for another of the drivers behind fiscal devolution proposals: calls for increased local discretion or ‘autonomy’. A similar dilemma would arise with many of the taxes proposed for devolution in the literature – income tax, stamp duty, capital gains tax, corporation tax. Ironically, it is rarely noted that council tax, despite its universally bad press, is more muted in this regard because of its relatively regressive nature. Because the variation between tax rates on the highest and lowest council tax bands is only 1 to 3, council tax does not produce huge per capita differences in locally available revenue.

An alternative approach is to devolve the power to collect certain taxes to local authorities and then transfer responsibilities matching the value of the revenues gained. This is roughly the approach used in the 2017-18 business rate retention pilots (though this uses grant funding rather than devolved taxes). This goes counter to most recent proposals, and could bring its own problems. Wealthy areas might receive more devolved tax revenue per capita and therefore be able to access greater devolved powers than their less wealthy counterparts. This would not directly exacerbate inequity, but it would increase the capacity for autonomous action in the wealthier areas in the long term. The implication that greater powers will come to those who can ‘afford’ them could raise political tensions in the long term.

Any scheme for local fiscal devolution in England would need to acknowledge that designing a system to balance equity and fiscal devolution could be politically challenging, and potentially fiendishly complex. This is amply demonstrated by the debates around business rate retention and the Fair Funding Review in 2016-17. Commentators are well aware of this clash and have largely shied away from it to date, but fiscal devolution cannot be implemented without confronting it; and it is inevitable that some stakeholders would not be happy with whatever ‘solution’ transpired. One partial solution is to pool revenue across larger geographical areas: this may lie behind the encouragement of business rate pooling by the government and other commentators.

A third obstacle is administrative and practice-related. The UK’s tax system is not set up to collect tax revenue, or provide disaggregated revenue figures, on a geographical basis. There is no way of accurately identifying how much income tax, corporation tax or VAT (for instance) is paid in a particular location. The Centre for Cities work mentioned above used a variety of statistical sources to arrive at good approximations; but the HMRC’s system itself does not code tax paid by area. The seriousness of this obstacle varies. For income tax, data is not currently held, but additional tax codes could be introduced according to residence (or indeed place of work). This and other administrative matters have contributed to a start date for the new Scottish income tax system of 2018-19, three years after the original policy commitment. Stamp duty revenue is recorded by postcode, the boundaries of which do not match local administrative geographies. For taxes such as corporation tax and VAT, the difficulties are more fundamental. It is challenging to attribute the incidence of liability for either tax to a specific geographical location within a state. Scottish VAT receipts are to be assigned from 2019-20, four years after the original policy commitment. According to the 2017-18 Scottish government budget, they are to be ‘based on a methodology that will estimate expenditure in Scotland on goods and services that are liable for VAT’ – in order to avoid an extra administrative burden on business.  The government has produced a guide to the Northern Ireland devolved corporation tax regime that runs to 123 pages.

These administrative challenges act as a drag on change. Whatever form of fiscal devolution were to be introduced, it is likely that a stable policy commitment, probably lasting for a full five-year parliament, would be required to make the system work; even assuming that the political obstacles noted above could be overcome. Fiscal devolution is sufficiently novel to the UK that the initial outcomes are likely to be unpredictable, possibly leading to close early supervision and tweaks to the system to keep it on the road. To the political eye, these are costly commitments to deliver a constitutional reform initiative the benefits of which are relatively intangible to the electorate. This is not to mention the burning awareness within Whitehall of what happened the last time a UK government pursued a full-scale reform of local government finance, in the form of the community charge.

It is no accident that the forms of fiscal devolution that are under active consideration in some quarters of the UK government relate to taxes that do not yet exist. These focus on land value capture (LVC), including discussions of a pilot in London of a Development Rights Auction Model (DRAM). These aim to tax rises in private asset values resulting from publicly-funded infrastructure development. There is clearly an appetite within government to find effective ways of doing this. The advantage of ‘greenfield sites’ for fiscal devolution is that they avoid the difficulties associated with existing tax systems: the need to retrofit existing administrative systems; changes to patterns of winners and losers; and confronting constitutional preconceptions.

In conclusion, there is no shortage of ideas for fiscal devolution in England. But they run up against cultural, administrative and political difficulties that are rarely acknowledged in their full complexity. For a viable policy to develop, these need to be tackled in detail. English fiscal devolution, like English devolution per se, will not be successfully introduced on the sly. In the medium term, local authorities could be forgiven for concluding that it is easier and quicker to negotiate grants or ‘investment funds’ from central government. The strings invariably attached to such money may be smaller obstacles to their mission than a lengthy reordering of central-local relations and the uncertainties thereof.

Thanks to Kevin Muldoon Smith and Guy Ware for comments on an earlier version of this piece.

About the author

Dr Mark Sandford is a Senior Researcher at the House of Commons Library, specialising in local government and devolution. He is a member of honorary staff at the Constitution Unit.

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