28 February 2009

What if we Switched Local and National Taxation?

You don't have to read many of my blog posts to discover that my ideal tax system is one where all public revenue is raised from taxes on land values and fees charged for using state provided services, with income and general sales being completely untaxed. I favour that approach for various reasons, one of the major ones being that if the government invests money heavily in infrastructure in one area, the corresponding increase in land values in that area will increase the tax levied in that area, effectively increasing the extent to which the beneficiary pays and reducing cross subsidy between regions.

I was involved in a discussion recently about how Business Rates create that effect to some extent already, by taxing rental values nationally and then distributing the funds to local authorities. That got me thinking - what would happen if we reversed the current tax system so that central government was funded by a national equivalent of Council Tax and local authorities were funded by a locally set Income Tax. Having weighed it up, I think it would be a major improvement.

Council Tax seems better suited to the national level for the same reason as Business Rates, it ensures the beneficiary shoulders more of the cost of investment. This effect already exists within local authorities to some extent; for example, if a local authority area has one particularly good school, the houses around it will tend to be more expensive (and therefore potentially in a higher Council Tax band) because of the benefit it is confering. Those kinds of geographical disparities tend to be even more pronounced when looked at nationwide, where central government investment in infrastructure, such as transport networks, tends to be quite heavily concentrated. Making the areas which benefit most from those projects pay a greater proportion of the cost would make a more even spread of investment more likely and could actually reduce the extent to which regions seek central government funds.

On the other hand Income Tax seems better suited to the local than national level. The main argument made in favour of income tax is that it reflects affordability, but the a major flaw in that argument is that, when applied on a national level, it doesn't allow for differences in the cost of living across the country; an income which allows a comfortable lifestyle in a cheap area might only allow a Spartan existence in a more expensive area. If set across a local authority area, income tax would more accurately reflect affordability, as the cost of living would be fairly level across the tax base.

This is part of the reason our tax system is such a mess. Not only do we have a poor set of taxes, but the taxes which seem best suited to the national level are being levied locally and vice versa.

6 comments:

Mark Wadsworth said...

I have mulled this in the past and it's too complicated.

National flat rate LVT (the higher the better) and national flat rate income tax (the lower the better) is the way forward, and precious little else (except specific user charges or 'sin taxes').

If councils want to spend more than a redistributed flat rate (say) £1,500 per inhabitant, then they can have a local LVT surcharge.

Anton Howes said...

The problem is that although there's an incentive for councils to have infrastructure improvements in order to increase their tax receipts, the poorer areas will initially end up paying more.

We see this already with Council tax - poorer or less developed areas require more expenditure in order to address these problems, but that means that the residents must be taxed higher, thus deepening the problem. For example, residents of Kensington (one of the richest areas) would pay more in local income tax, but the council does not need all this extra money. That revenue would be better spent on helping Burnley (one of the poorest) to invest in infrastructure in order to improve the area.

I think a balance between the two is better for local taxation - having a large proportion redistributed nationally so as to prevent even the poorest areas from having their residents pay more in order to foot a bigger infrastructure bill, but also keeping an element of the incentive for councils to invest in infrastructure in order to improve the value of land in their area.

Mark Wadsworth said...

Re what Anton says, yes, there is a tension here.

But LVT would serve as a hurdle rate for deciding whether infrastructure is worth doing. It is worthwhile spending £1 on infrastructure in Burnley if that increases LVT receipts by more than £1, else not.

I'm not sure it needs go any deeper than this.

Let's assume that Burnley is so poor because of high unemployment. On day one, LVT would be so low in that area, initially, that more people and businesses are likely to move there, it would be like a tax free zone, so that fills the empty houses and creates more jobs.

Similarly, what attracts businesses and people to an area? Let's say transport infrastructure, good schools, safe streets - it's up to Burnley council to gamble on new roads or railways to kick start things, it will be local landowners who benefit so they should pay the tax to finance it.

Or Burnley Council has to persuade other councils to lend them a bit extra out of the national LVT pot - if £1 of spend in Burnley will result in £2 extra LVT in future, but £1 of extra spend in Kensington will only increase LVT by £1.50, then other councils can collectively decide to lend Burnley the money at ten per cent interest until Burnley has got things moving and tell Kensington to fund its own spend out of a local surcharge.

Look at it as if the nation's local councils are collectively running a chain of hotels (each borough being a hotel) they have to decide whether to do up the tattiest hotels or to spend more on making the nice hotels even nicer.

Anton Howes said...

Yes, I agree. It's fine as long as Burnley isn't allowed to drop below a certain level. Although it may be good to be a sort of tax-free zone, they still need a level of expenditure that's probably higher than the other councils due to crime, etc.

That's an interesting way of doing it.
So would there be a sort of Uber-Council with a representative from each council in order to decide how funding is distributed? Sounds better than Whitehall doing it.
I'm not sure lending is the right way to go about it, as those returns are still hard to calculate - who know by how much it will really appreciate in value!

And I'm not sure a system where some councils are indebted to others is a good one - as with developing countries, there's the potential to increase the divide, meaning that less well-off councils would have to increase taxation despite their being less well-off! Perhaps it's better for this Uber-Council to just decide how to allocate the pot raised through local taxation (probably a certain percentage of it from each council) for redistribution.

Mark Wadsworth said...

Anton, I'm sticking with my hotel-chain analogy for now, bearing in mind, it's a mutually-owned hotel-chain that provides services to, and pays dividends to, its true owners, the taxpayer/citizen/voter.

"Perhaps it's better for this Uber-Council to just decide how to allocate the pot raised through local taxation (probably a certain percentage of it from each council) for redistribution."

Nope, the first point of reference is the voter, who decides how much per capita each council gets (£1,500 seems like a good starting point, maybe more maybe less), with the rest redistributed via cuts in income tax or Citizen's Income (same thing, really).

If the Über-council, on behalf of its owners, decides that the tattier hotels need an extra bit of money short term to boost revenues long term, then provided they can justify that to their owners, then land owners in richer areas should be happy to make that small sacrifice (i.e. reducing their own Citizen's Income or tax cut by a few quid) in return for a higher CI or bigger income tax cut in future.

Paul Lockett said...

Thanks for the comments gents. Rather than try to join a discussion part way through, I'll respond to your original points.

Mark

In the main I agree; my preference would be for resource taxes collected at the national level, with the government taking what is need for expenditure and passing the remainder onto the local authorities per capita, which would then deduct their expenditure and pay the remainder out as a dividend.

I wrote this piece as a bit of an exercise to show that, in an either/or situation, having property tax at the national level and income tax at the local level, rather than vice versa, seems to make more sense.

Anton

These points raise enough to warrant a separate post, but I'll try to be brief.

the poorer areas will initially end up paying more.

In terms of local income tax, they undoubtedly would pay more there per pound earned, but if introduced alongside a nationally banded property tax, they would be paying far less in national tax, so the differences in disposable income after national tax would be much less pronounced.

We see this already with Council tax - poorer or less developed areas require more expenditure in order to address these problems, but that means that the residents must be taxed higher, thus deepening the problem.

However, with the current system, national expenditure on infrastructure can often get focused in wealthier areas, which is a major part of the reason for higher house prices in those areas. The system encourages an excessive concentration of investment.

For example, residents of Kensington (one of the richest areas) would pay more in local income tax, but the council does not need all this extra money. That revenue would be better spent on helping Burnley (one of the poorest) to invest in infrastructure in order to improve the area.

This is where I see one of the major issues, because with the current system, national infrastructure investment tends to be London-centric. While areas like Burnley may be further behind in terms of investment in infrastructure, expenditure on, for example, transport infrastructure, will always tend to gravitate towards the capital. Introducing a nationally banded property tax would ensure that, if an area enjoys a disproportionately high level of central government investment, it would pay more national tax as a result of the increase in property values, ensuring geographical fairness.