Why a local income tax would prove disastrous for Scotland

25 Sep 2007

This article by Tom Miers appeared in The Scotsman on 25th September

The SNP and Liberal Democrats are considering whether to replace Council Tax with a fixed 3p in the pound income tax increase. What might seem a neat way to get rid of a hated impost would in fact, I believe, rank as the biggest blunder since devolution.

A ‘local income tax’ would be bad for democracy, bad for the environment, and bad for the Scottish economy. Here’s why.

Quite apart from the practical questions of implementation, such as whether the Treasury would withhold council tax rebate or charge for collecting the new tax, it is a deeply flawed concept for three reasons.

Firstly, 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 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 with the current high levels of local spending forever. Even if a 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.

To give an example of how damaging this might be, the Accounts Commission on Wednesday suggested that we could persuade 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 the proposed fixed levy.

A variable local income tax would in theory avoid these problems. But a sufficiently flexible scheme is hard to imagine in practice. Can we really expect companies to levy PAYE at, say, 23.84% on their employees who live in Dundee but 23.87% on those from Angus?

Second, the Scottish economy could experience a flight of high earners.

The art of taxation is to take the golden egg without killing the goose that lays it. Hiking income tax in Scotland by 3p would be a reckless gamble with the economy.

The main financial difference to taxpayers would be a small gain to large numbers of low earners, and a loss of thousands of pounds to small numbers of high earners.

The problem 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 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. This would of course undermine the very tax base that sustained local government.

Third, 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

No one pretends that the Council Tax is perfect. No tax is popular, but this one 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. However not all taxes can or should be based solely on ability to pay, or else we would scrap VAT, corporation tax, and cigarette taxes, and levy income tax at 98%.

A more pressing problem is that the council tax is based on 1991 house valuations. Regular, independent revaluations 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.

If we are to arrive at a sensible settlement for local government finances, the activities and finances of local councils must be clearly separated from those of central government.

It is often too easy for idealists to criticise politicians, who must marry principle with the practical need to win votes. Nevertheless it seems extraordinary that two parties whose purpose is founded in improving democratic accountability should seek to destroy it at the local level. They should reconsider.