The Budget 2024 should commit to fiscal devolution
Three promises the Chancellor can make to boost growth and fix local finances without using any fiscal headroom.
Three promises the Chancellor can make to boost growth and fix local finances without using any fiscal headroom.
Ahead of Budget 2024, the public debate on tax and growth is heating up, and the hunt for rabbits is on. While “how much”, “from who” and “what taxes” are important parts of this debate, the question of “which part of the state” is not getting nearly the attention it should. With a poor growth outlook, the local finance system in a mess, and very limited fiscal headroom, there is a strong case for the Chancellor to pursue an idea that addresses each of these problems – beginning the process of fiscal devolution in England.
Internationally, the UK is an outlier in the developed world not for its level of tax, but for its centralisation of tax. Only five per cent of taxation in the UK in 2021 was collected by local government; below the 11 per cent average for non-federal OECD countries, and lower than other large non-federal states, such as 12 per cent in Poland; 14 per cent in France; 18 per cent in South Korea; and 23 per cent in Japan.
The UK’s exceptional level of fiscal centralisation is also relatively recent. Before 1988, the UK’s share of taxation collected by local government was no different from the OECD non-federal average. The UK only falls behind after the legislation that introduced the poll tax (before its replacement by council tax) and nationalised business rates.
A low share of taxes collected by local government may not seem like an issue, but it creates two problems for the economy and for the funding of local government. First, councils’ reliance on grants reduces their incentive to pursue local economic growth, and thereby national economic growth. Second, there is no solution to the crisis in local government funding without either reform of local taxation or large increases in central government grants (and thereby increases in national taxation).
The first problem arises because a low share of taxes collected by local government means, to finance local services, councils rely on grants from central government instead of taxing their local economy, particularly those that are more deprived.
This is not necessarily a big problem for an individual council’s finances or services. But across the entire country, a reliance on grants means that councils are disconnected from their local economies. In fact, allocating more money to councils that are poorer means that if councils make their economy more prosperous and grow their tax base, councils are penalised with less grant funding. They therefore have weak incentives to use their powers over housing, transport, commercial space, and other policy areas to grow their local economy and, by extension, the national economy.
The second problem is that councils across England, and of all colours, face a severe funding crisis. Councils are right to point out that, in the short-term, they need more grant to fulfil their statutory responsibilities. But there are two distinct issues here –the amount of resource in the local funding system, and the design of the local funding system.
Unless the centralised design of the funding system is reformed, councils will always be forced to fund local services by either increasing local taxes (council tax) or asking for more grant from central government (financed by national taxes), rather than growing their own local tax base.
Fiscal devolution is an answer to both the first and second problems as it would reconnect local government funding to the local tax base. If local governments supported their local economies (and thereby the national economy) to grow, then they would raise more revenues for services without increasing local tax rates.
Delivering fiscal devolution is complicated. The Government will need to take time and care to ensure that neither local authorities nor large numbers of voters are made worse off.
Yet, while it may be plainly unreasonable to expect the Chancellor to deliver fiscal devolution in the next Budget, the Chancellor can set into motion his stated aspiration from January 2023 to “move decisively towards fiscal devolution” by including three things in his speech on Wednesday:
Together, these three statements would move fiscal devolution to the top of the political agenda, without consuming any of the Chancellor’s fiscal headroom. These measures could be combined with emergency support for local government to meet its statutory needs in the short-term.
We are already seeing policy move in this direction without the political focus it deserves. The Single Settlements agreed in the Trailblazer Devolution Deals with Greater Manchester and the West Midlands are a big step towards this, and other metro mayors are likely to get achieve this autonomy by the next Spending Review too.
But the big challenge is local taxation. Different parts of England have different tax bases, and a common worry is that greater local autonomy over taxation would see poorer areas face higher council tax bills.
The key principles for fiscal devolution to address this worry are, first, that less national redistribution must be paired with more local redistribution, and second, that fiscal devolution should be delivered to local government structures that align with local economies.
Local finance under this model would be a fairer system where the fruits of higher local growth are shared between a local economy’s affluent and poorer neighbourhoods, instead of being sent off to Whitehall. For example, instead of how today’s funding system treats Leicester and the rest of Leicestershire as distinct entities, fiscal devolution could only work if their growth, risks, and governance were shared.
Furthermore, devolving taxes in this way could result in lower tax bills for many people, particularly those on low incomes. Centre for Cities has shown several times that this approach – including a ‘triple deal’ for the three biggest city-regions in England, and a proposal for local fiscal devolution to councils in Wales – could cut council tax bills for between two thirds and three quarters of people, without affecting the council tax receipts of any local authority.
By combining this with more autonomy over business rates, income tax retention, and possibly even a local income tax, future reforms could give councils a solid financial base that can guarantee quality services without large tax increases by rewarding them for growth.
It is too much to expect Budget 2024 to unwind England’s exceptional fiscal centralisation all in one go but, if the Chancellor is looking for a rabbit that is good for growth and doesn’t use any fiscal headroom, he will find that announcing a commitment to fiscal devolution is a perfect fit for his hat.
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