Executive Summary

UK cities currently lack the ability and incentives to prioritise spending and overcome barriers to local economic growth. Compared to their international counterparts, they have too few financial incentives to take the often difficult decisions required to boost growth, or innovate to deliver more effective and efficient public services.

But the funding landscape is changing. The move away from centrally redistributed grants to local government, towards places being more dependent for funding on the business rate revenues they collect locally, provides an opportunity to improve how the system works.

Often referred to as ‘fiscal devolution’, this process of giving places more responsibility to raise and retain their own funding will provide UK cities with sharper incentives to back investment in the things that can really make a difference to their local economy – building new homes, investing in the local skills base, or delivering new infrastructure to better connect people to jobs, and businesses to customers.

The devolution of business rates is a step in the right direction, giving cities more control over a growing tax base and more incentives to support and attract new businesses to the area, as well as the expansion of existing firms. But there remains a risk that the devolution of business rates alone – particularly in its current form – will not provide a strong enough growth incentive to generate significant additional funding for UK cities. To provide the financial incentives that cities need, policymakers should:

  1. Address weaknesses within the current business rates system, and ensure growth incentives are prioritised when devolution takes place in 2020. Reforms should include: extending reset periods, encouraging pooling between authorities in city-regions, conducting more frequent valuations and replacing the fixed yield with a fixed rate. This would reduce volatility in the system and improve responsiveness to local economic conditions.
  2. Devolve control over the £10 billion generated in stamp duty in England alongside the full £23 billion in business rates to provide far stronger incentives for places to grow. Doing so would mitigate the risk of cities being dependent upon just one devolved tax stream, by giving them control over the equivalent of 37 per cent of local spend, compared to just 19 per cent in the current system of funding (2014-15 figures). While this would still represent a relatively small proportion of local government revenue being drawn from local taxes compared to other countries – the figure is 48 per cent across municipalities in France, and 64 per cent in New York – it could make a big difference locally by incentivising authorities to permit more development. If the authorities of the Oxfordshire LEP, for example, delivered on existing housebuilding targets between now and 2031, between £707 million and £805 million would be generated in stamp duty on local new build sales alone, or between £44 million and £50 million per year. This would work out at between £66 and £75 per resident – much more than the current £14 equivalent in New Homes Bonus.
  3. Provide more freedoms regarding the setting of council tax to encourage revenue pooling between authorities. Around half of all workers in Britain live in one local authority but work in another, meaning that these workers generate tax in one authority, but consume public services in another. This means that within a city-region the tax base of more residential authorities is reliant on council tax, while in the core urban authority business rates make up a larger share of the tax take. Authorities across city-regions should not be encouraged to compete on these tax revenues. For example, in the context of Greater Manchester, Stockport should not be penalised for being a largely residential area (which therefore generates less in business rates), nor should it be incentivised to try and attract jobs away from Manchester city centre (in order to generate more business tax). This example also illustrates the need for authorities like Stockport to have more freedom and flexibility over council tax revenues, including the ability to raise rates without requiring a referendum, to spend the revenue generated as they see fit, and to introduce extra bands as appropriate.
  4. Ensure that the additional responsibilities passed down to cities alongside new tax streams are ones that local government can have a positive impact upon. Devolving control over the right taxes together with responsibility for the right lines of expenditure can create ‘virtuous cycles’ and incentivise behaviour that can both reduce expenditure and increase tax revenues. For example, if both stamp duty and the housing benefit bill were devolved together, there would be both a greater incentive for supporting the delivery of new homes – due to increased stamp duty and council tax revenues, and the prospect of driving reductions in local expenditure on housing benefit.

Greater fiscal devolution will also bring big benefits for the national finances. Incentivising places to generate more tax revenue generated by business rates and stamp duty by allowing them to keep a larger share will also generate more in other taxes that go direct to the Exchequer, such as income and corporation tax. If land and property taxes were devolved, resulting in behaviours by local government that increased revenues by 1 per cent above trend, this would generate an associated net additional £1.05 billion in income tax (or 1 per cent of the total income tax bill based on 2014-15 figures).

Finally, there are concerns that giving places more responsibility to raise and retain their own funding could mean that disparities between cities grow. But if we want to support struggling places in the new system of local government funding, then we need to incentivise growing places to generate more revenues than they do now and redistribute some of the additional funds generated.