Local Income Tax Would Be Holyrood’s Biggest Mistake

20 Sep 2007

A LOCAL income tax would be the Scottish Parliament’s biggest mistake, damaging local government, undermining the property market and forcing high earners to leave Scotland, Tom Miers of the Policy Institute warned today.

The think tank has written to the main party leaders in Scotland spelling out the dangers of the policy and urging Holyrood to abandon the idea.

Tom Miers, executive director of the Policy Institute, said: “A local income tax would leave the accountability and efficiency of local government fatally undermined. Councils would no longer be able to set rates of taxation and a crucial link between voters and government would disappear.

“Even if a council succeeded in cutting costs it would have no way of returning the savings to taxpayers. We would be stuck with the current high levels of spending forever.”

He added: “A local income tax would result would hit high earners for thousands of pounds but high earners are also highly mobile. Increasing income tax by 3p in the pound is simply inviting these people to leave Scotland, or avoid it in the first place. UK companies with a presence on both sides of the border will recruit senior staff to offices outside Scotland. The tax could therefore damage the economy twice over - by driving wealth creators away and diverting business to other parts of the UK.”

Mr Miers said the tax would also damage the property market, adding: “The council tax provides some incentive to live in as small a house as is practicable. In particular, retired people are encouraged to move to smaller homes, to the benefit of working families. This currently helps to alleviate pressure on the housing market.”

Mr Miers stressed that the council tax was in need of reform. But he said: “Any reform must reinforce not weaken accountability and the activities and finances of local councils must be clearly ring-fenced from those of government at the Scottish level.”

The letter to party leaders follows:

19th September 2007

Amid continued reports of proposals to introduce a ‘local income tax’, I write to express some serious concerns with the concept. I hope this letter will be of some help in your deliberations on this subject.

These concerns are quite apart from the practical issues of implementation that have already been widely discussed, such as the question of whether the Treasury would withhold council tax rebate, or charge for collecting the new tax.

Replacing the Council Tax with a fixed 3p in the pound income tax increase would create three major additional problems:

1. The accountability and efficiency of local government would be fatally undermined.

Under the proposal, local councils would no longer set rates of local taxation to fund the services they provide. This surely goes against all sound constitutional principle, because it removes any incentive to fiscal rectitude and efficient government. The crucial financial link between voters and government would disappear at the local level.

In practical terms we would be stuck forever with the current high levels of local spending forever. Even if a local council succeeded in cutting costs it would have no way of returning the savings to taxpayers. There would therefore be little prospect of productivity increases or innovation in the delivery of local services.

Let me give one small example of how damaging this might be. There are currently innovative ideas emerging to incentivise householders to generate less rubbish by charging them according to the amount they produce. This might have considerable environmental and efficiency benefits. But such a scheme would be impossible to justify without an equivalent reduction in local taxes – something that could never happen with a fixed local income tax.

A variable local income tax would in theory avoid these problems. But a sufficiently flexible scheme is difficult to envisage in practice. Can we really expect the PAYE system to levy, for example, 23.84% on residents of Dundee but 23.87% on those of Angus?

2. The Scottish economy could experience a flight of high earners.

Assuming that the yield of the proposed local income tax was roughly the same as the current council tax, the main financial difference to taxpayers would be a small gain to large numbers of low earners, and a big loss of thousands of pounds to small numbers of high earners.

The problem here is that high earners are typically also highly mobile. Not only do they have more control over their terms and location of work, but are often socially at ease with moving around the UK. They are also adept at arranging their tax affairs to maximum advantage.

Increasing income tax by 3p in the pound is simply inviting these people to leave Scotland, or avoid it in the first place. I have already spoken to numerous individuals, typically entrepreneurs or owners of small businesses, who are planning to move their main domicile out of Scotland if this tax is imposed.

Furthermore, large UK companies with a presence on both sides of the border may recruit senior staff to offices outside Scotland if the local income tax becomes a reality.

The tax could therefore damage the economy twice over – by driving wealth creators away and diverting business to other parts of the UK. If this happened to any great extent it would of course undermine the very tax base that sustained local government.

3. The wrong signal would be sent to an inflated and volatile housing market.

One of the major political and economic concerns of recent times has been the big rise in house prices. This has put pressure on the built and natural environment by fuelling demand for more development. It has also put housing out of the financial reach of many first-time buyers and those on low incomes.

The Council Tax provides some incentive to live in as small a house as is practicable. In particular, retired people are encouraged to move to smaller homes, to the benefit of working families.

This effect, which alleviates pressure on the housing market to some degree, would be removed by a local income tax. The government would be sending a signal that encouraged profligate use of land and housing – hardly ideal given our increasing environmental concerns.

Reforming Local Government Finance

Having said all this, I do not pretend that the Council Tax is perfect. It is in clear need of reform or replacement

It may be that government could make a case for introducing more targeted relief for groups hardest hit by the tax. Another pressing problem is that the tax is based on valuations that took place in 1991. Regular, independent revaluations (perhaps at the beginning of every other Parliament) would ensure the burden fell on those most advantaged by rises in the value of their homes.

There are also more radical alternatives to be considered such as a local sales tax or a property tax.

But whatever reforms were undertaken, the most essential must be to reinforce - not weaken - the accountability function of local taxation. The main reason for the big recent rises in council tax, and its failure to act as an effective break on council spending, is that the finances of local and national government have become hopelessly entangled.

Indeed, since devolution, central government has routinely controlled its own expenditure by passing unfunded obligations to local government, resulting in the latter being forced to raise council tax.

It is this fundamental problem that must be tackled to arrive at a sensible settlement for local government finances. The activities and finances of local councils must be clearly separated from those of government at the Scottish level.

I’m sorry to write to you at such length on this matter. But it is my belief that to introduce a local income tax, as it is currently being proposed, would be the greatest policy blunder since devolution. It would be bad for government, bad for the economy, and bad for the environment.

I wish you all the best as you tackle this and other dilemmas in your demanding role.

Tom Miers
Executive Director