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The prospect of devolving more financial powers to UK cities raises legitimate concerns about those places that are less able to generate their own revenues. As we have written before, often the fear is that a more devolved system will result in more unequal outcomes (the dreaded ‘postcode lottery’) where poorer cities will be left behind.
It doesn’t help that the debate tends to extremes. For example, it’s regularly argued that London should become a city-state and have full control of the income tax revenue generated within its boundaries – this would amount to 31 per cent of the national total.
Such an unconstructive debate means we fail to look overseas for examples of local government funding systems that sit between total centralisation on the one hand and full autonomy on the other. But in doing so, we would unearth a number of different funding models that manage to avoid the level of inequality feared for the UK.
For example, Sweden, France and Canada can provide plenty of lessons as we go about devising a new local government funding system.
In Sweden, more than a third of taxpayers’ money is retained by local government (the equivalent figure is 5 per cent in the UK). Income tax is the main source of local government funding and represents 70 per cent of local revenues. But alongside significant fiscal autonomy, there is also considerable redistribution between places. To smooth out disparities in income, local authorities with tax revenues below a set threshold receive an income redistribution grant. This is mainly funded by central government, but about 10 per cent of the amount comes from local authorities with above-average income tax revenues. A second redistribution grant which is aimed at correcting the differences in the cost of delivering services is completely funded by local government, at no cost to central government.
In France, about half of local government revenues come from local taxes, mostly from local property and business taxes. Local government also receives general grants from central government, as well as additional redistribution funds to account for specific wealth and population disparities. Although redistribution is mostly funded by central government, the contribution made by local authorities is increasing.
Canada is one of the most decentralised countries in the OECD, with about half of government revenues raised and retained locally (through both provinces and municipalities). As a comparison, a third of tax revenues are raised by US states and municipalities. But unlike the US, there is a formal redistribution mechanism between provinces. At the city level, municipalities rely on locally raised revenues, with only 20 per cent of their funding coming from grants. The bulk of cities’ money comes from property taxes, a relatively common characteristic among Commonwealth countries. But the dependence on this one tax stream is financially risky, and in Canada tends to result in urban sprawl. As the tax is based on the market value of the property, housebuilders and homeowners tend to invest in cheaper, low-density areas and municipalities are pushed to accept these new developments to increase their tax base.
These three examples show that it is possible to create systems with varying degrees of fiscal autonomy and redistribution. In the UK the new local government funding system should look to learn from the best of these other systems while avoiding the pitfalls. This means providing stronger incentives for local authorities to support economic growth; improving the existing system of local taxes by addressing issues in the current business rates and council tax system; and diversifying local tax streams by enabling local authorities to retain stamp duty land tax and other property tax revenues as well as business rates. Our report Beyond business rates explores these issues in greater detail.
Fiscal autonomy on its own is not a sufficient condition to ensure local authorities get the adequate flexibility to support economic growth. My next blog will look at the additional responsibilities that cities in more devolved countries hold compared to the UK.
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