We need to talk about fiscal devolution.
Fiscal devolution is an issue that national politicians won’t touch even with someone else’s bargepole. So scared are they of the electorate getting a whiff of the prospect of a tax increase, that unless they’re freezing it or cutting it, they’re not talking about it. And local taxation is even more of a policy area non grata. To the extent that politicians, not just generals, operate to Clausewitz’s military dictum that they always “fight the last war”, Westminster folk memory of the poll tax debacle still looms large even though times have changed since 1990. In addition, it is a measure that next to no-one outside an expert policy community is calling for.
So why on earth would self-respecting policy bods like us call for fiscal devolution to be on the manifesto agenda? The times we live in seem to contain more unknowns than knowns, but we do know that the country is currently not working for too many people. So, here are three ways in which devolving tax powers to local areas could potentially help.
Firstly, fiscal devolution should mean better tax, not more tax per se. The primary purpose of tax is to generate revenue which is then allocated for investment in shared public goods, such as public services and infrastructure. But there is a second, less appreciated purpose to taxation, which is to create certain behavioural incentives. So, for example, the tax on cigarettes might yield returns, but it is set at a level which is designed to discourage smoking. For this and other public health related taxation, the long term aim isn’t to maximise revenue but to shift away from unhealthy behaviours.
In light of this role of taxation as an incentive, we need to consider how the current system of largely national revenue works to create or discourage incentives that are good for our economy. The UK only allows two locally-raised taxes: council tax, linked to 1991 property values, and business rates, calculated on the floorspace of premises – the latter of which isn’t fully retained locally (yet). They are both increasingly decoupled from the reality of actual wealth and value creation in our economy, and face declining popular legitimacy as a result. Taxes based on consumption and economic activity such as VAT, income tax, national insurance and corporation tax all go straight to the Exchequer.
This means that local authorities have no stake in activity or investment to support productive economic activity. For any local investments to support people to increase their income (such as by finding employment) or businesses to increase their profits (for example using business support to upskill management), the extra revenue generated goes into the general national pot. None of the rewards are retained locally, which makes it impossible to create a virtuous cycle of reinvestment in future wealth creation.This is increasingly untenable while we have a deep and long term productivity challenge nationally, with very poor productivity compared to our international peers.
At worst, the incentives on local authorities if business rates alone take up an increasing proportion of local budgets, could increasingly favour floorspace-hungry growth. This might involve out of town retail or warehouse units at scale which create largely low-skill, minimum wage jobs. Fiscal devolution could be used to ensure local governments have sharper incentives to promote productive and wealth creating growth which will boost local economies and contribute overall to national productivity.
Secondly, fiscal devolution puts local people in control. In addition to a greater share of nationally-levied taxes retained locally, devolved fiscal powers should also include giving local areas more freedom to levy bespoke taxes according to local circumstances. One option is a tourist tax, which could be in the form of a hotel occupancy tax and which many areas of the country stand to gain from. This would be win-win for local people – no new tax burden for them but instead those who visit the area generating lasting investment. Those who would argue this would discourage tourism forget that most advanced Western countries have such levies, which we experience when we ourselves travel, which they combine with healthy tourism. There may be other opportunities for discrete local taxation, for example related to property development or the proliferation of unhealthy food outlets, from which local people can benefit.
Finally, fiscal devolution should create greater local resilience. The goal of devolving proportions of existing national taxes and enabling the levying of specific new local taxes is to create a more varied local tax base that supports sustained investment in local services and growth. At the moment, over-reliance on business rates creates too much vulnerability to a single large factory or retail unit locating in a local area – a wider tax base would increase the ability of local areas to weather economic shocks like a large company relocating.
So, NLGN would like to see fiscal devolution in two ways:
- Devolve a share of nationally-levied taxes including VAT, corporation tax and income tax to be retained locally.
- Give local authorities the freedom to levy bespoke taxes from a menu of options including relating to tourism, property development and public health, for which they would remain accountable at the ballot box.
There would also be fears that the ability to vary tax rates between different areas would result in too much differentiation and competition between local areas. But again, decentralised fiscal powers are the norm in other advanced Western countries such as Germany, Norway and Denmark, where municipal level taxation plays a much greater role.
So, a plea to manifesto-writers – please consider how the centralised nature of our fiscal system is or isn’t underpinning the type of economy that works for everyone, and all parts of our country.