Evidence for fiscal devolution

Britain is highly centralised. Cities in England are funded through a combination of local taxes, grants from central government and local sales, fees and charges. The only localised tax stream is council tax which accounts for 18 per cent of local revenue funding – with restrictions on the ability of cities to set rates. Grants from central government, including ringfenced grants for education, non-ringfenced grants, and the Revenue Support Grant which funds local government activities, make up 67 per cent of local government revenues. Business rates are collected locally and redistributed by central government.

Figure 2: Primary source of local government funding in England

Sources of revenue for local government

Source: DCLG 2015: Local Government Financial Statistics England

Compared to their OECD counterparts, UK cities are more reliant on government transfers. For example, London receives 74 per cent of its revenues through transfers, in New York it is 31 per cent, in Paris 18 per cent and in Tokyo 8 per cent,5 But this does not mean that other countries abandon principles of redistribution between places in order to support those less able to generate tax revenues. Even within more fiscally decentralised countries, there are models of sub-national funding and local tax raising powers. These include some form of redistributive mechanism between localities, funded through a combination of central government funding and ‘horizontal’ transfers between authorities. See Box 1 for more detail.

Finland provides an example of how a more devolved system does not necessarily lead to worse or more diversified outcomes in public services. Here local government is primarily funded through a local income tax which represents 39 per cent of total local revenues.6 Local government also accounts for a higher share of total public spending than in Britain; 40 per cent of total public expenditure compared to 25 per cent. The Finnish education system, the second largest expenditure by local government, performs very well by international standards and and students achieve good outcomes, regardless of social background.7 School age education in Finland is financed and delivered by local authorities – including funding, curriculum and hiring teachers – according to priorities set out by the Finnish Government every four years.

Calls for local government in Britain to have more flexibility and control over its funding, including over tax streams, are not new. The Layfield Committee (1974-76), Lyons Enquiry (2004-2007), Mirlees Review (2011), London Finance Commission (2013) and Independent Commission on Local Government Finance (2015) all called for one or more of the following: reform of existing local council tax , re-localisation of business rates, devolution of other property taxes and access to new forms of taxation for local government.8

This is based on the broad consensus that giving cities and localities some control over tax raising powers and expenditure, where cities bear the responsibility for implementing policy,9 can improve both public services and economic growth.

  • Supporting economic growth. Giving cities more control over tax revenues and tax raising powers creates sharper incentives for them to support economic growth which in turn boosts revenues. There is evidence that in countries with low levels of fiscal decentralization, moderate devolution can have positive effects on economic development.10 Meanwhile, the reduction in the rate of floorspace growth in UK cities after nationalisation of business rates in 1990, suggests that centralisation acted as a disincentive for local authorities to permit more development and encourage business growth.11
  • Improving public services. There is evidence from across OECD countries that local government efficiency is improved through decentralisation.9 This is because decentralisation overcomes some of the dis-economies of scale that can occur in large administrations, as well as the improving the willingness and capacity of local government to innovate – the risks of innovating at large scale are bigger. Decentralisation coupled with greater funding certainty and control can also make it easier to deliver more integrated services across and within local authorities.13 Finally, greater responsibility over budgets tends to increase the efficient use of public funding.

The next section examines the recent proposal to fully devolve business rates to local government and its impact on the ability to support growth and deliver more effective services.

Box 1: International Comparisons

There is significant variation between countries as to how local government is organised, funded and what services it delivers.

France: Local government funded through local property tax

Like Britain, France is a relatively centralised country – despite successive waves of decentralisation over the past 30 years. Local government accounts for 20 per cent of local expenditure, compared to 25 per cent in the UK.14 However it has much more fiscal autonomy: local taxes make up 48 per cent of local revenues. Local revenues come from local property taxes (with rates set locally) and include a residential property tax (based on the rental value of the property), a separate tax on buildings and on land (paid by owners and based on the rental value of property) and a business property tax (based on commercial property rental values and on business value added).

Transfers from central government account for 22 per cent of local government revenues.15 Flat-rate grants are allocated to every local authority to fund public service delivery, while equalisation grants are used to support disadvantaged authorities.16 Most redistribution is from central to local government (88 per cent of equalisation funds) but there has been a recent shift to increase redistribution between local authorities, with several ‘horizontal’ redistribution funds created between 2010 and 2013.

Local government in France has similar functions than in Britain, with responsibilities for social action, economic development, transport, housing, education and environment shared between the three tiers of local government.

Public transport funding is particularly interesting. In the Paris city region, 39 per cent of transport companies’ revenues come from a local transport tax. This is matched with the revenues raised through tickets (39 per cent) and is significantly higher than public subsidies (19 per cent) that also fund transport in the capital.

Finland: Local government funded through a local income tax

In Finland, local government is primarily funded through a local income tax (with rates set by municipalities) which contributes up to 95 per cent of local tax revenues, which in turn account for 45 per cent of local revenues.17 Other taxes include a corporate and property tax, both of which can be set by local authorities, within limits. Local taxes account for 23 per cent of total tax revenues in Finland – the figure is 5 per cent in Britain.

Grant funding makes up 18 per cent of municipal revenues. Part of this is funded directly by central government, with allocations made on the basis of population and need (for instance, the number of students in a municipality partly determines the allocation for education). The rest is a compensation scheme based on municipal tax income, redistributing some revenues between municipalities.18

Finnish municipalities are in charge of broadly similar public services as in Britain – including planning and real estate, environment, culture and education – as well as social care and health. But municipalities provide most social services and directly fund primary health care, together they account for almost half of local spend.

Hospitals are also decentralised and are run by groups of municipalities combined into joint authorities.19 Education, which makes up the second largest element of local spend, is funded by a combination of municipalities’ own revenues and a central government grant.19

USA: Local government funded through a highly diversified portfolio of taxes

Government in the United States is significantly more decentralised than in Britain, split between Federal, State and local levels. Federal government accounts for just half of total public expenditures but federal taxes account for 65 per cent of tax revenues. Combined, state and local taxes represent 34 per cent of government revenues. Local taxes include real estate taxes, sales taxes, income taxes (on personal income and corporations) and other taxes, such as hotel room occupancy, commercial rent, beer and liquor excise, etc.

Federal grants are allocated to both states and local governments on a need or population basis (for education, for example) and on a competitive basis.21 Apart from a few programmes, there is little redistribution at the federal level between states. One such programme is Medicaid, where federal government transfers to states vary according to state income per capita – they cover between 50 and 77 per cent of the total state-level Medicaid bill.22 There is more significant redistribution within states.

New York City’s government is one of the largest city governments in the country and spends more than than most individual states.23 The city has significant political and fiscal autonomy, with local taxes accounting for 64 per cent of the city revenue.24 The New York City Department for Education funds principals, teachers, school buses, the cost of standardized tests and after-school programmes, as well as school facilities.25 The city also delivers a large number of social services, including child care, employment and training, food assistance, senior benefits and rent assistance programmes.26

Footnotes

  • 5 London Finance Commission (2013), International Comparison of Global City Financing
  • 6 Loughlin J & Martin S (2005), Options for reforming local government funding to increase local streams of funding: interational comparisons, Cardiff University
  • 7 OECD (2013), Education policy outlook – Finland http://www.oecd.org/edu/EDUCATION%20POLICY%20OUTLOOK%20FINLAND_EN.pdf
  • 8 cott A and Pitt J, (2015), Need to Know Review Number 6: Local Government Funding, Local Government Knowledge Navigator
  • 9 Porcelli F, (2009), Fiscal Decentralisation and efficiency of government. A brief literature review, University of Warwick
  • 10 Review of the London Finance Commission, (May 2013), Raising the Capital
  • 11 Larkin K, Wilcox, Z & Gailey C, (2011), Room for Improvement: Creating the financial incentives needed for economic growth, London: Centre for Cities
  • 12 Porcelli F, (2009), Fiscal Decentralisation and efficiency of government. A brief literature review, University of Warwick
  • 13 ndependent Commission on Local Government Finance, (2015), Financing English Devolution
  • 14 OECD (2013), Fiscal Decentralisation Database
  • 15 Bergès, P. et al. (2013), Enjeux et réformes de la péréquation financière des collectivités territoriales, Ministère de l’économie et des finances.
  • 16 French Government, Les principes régissant les dotations, Available from: http://www.collectivites-locales.gouv.fr/principes-regissant-dotations
  • 17 Loughlin, J., Martin, S. (2005), Options for reforming local government funding to increase local streams of funding: interational comparisons, Cardiff University
  • 18 The Association of Finnish Local and Regional Authorities (2012), letter to the European Commission: http://ec.europa.eu/economy_finance/articles/governance/pdf/finnish_regional_authorities.pdf
  • 19 The Association of Finnish Local and Regional Authorities: http://www.localfinland.fi/en/Pages/default.aspx
  • 20 The Association of Finnish Local and Regional Authorities: http://www.localfinland.fi/en/Pages/default.aspx
  • 21 Congressional Budget Office (2013), Federal Grants to State and Local Governments
  • 22 Laubach T, Fiscal Relations Across Levels of Government in the United States. OECD Economics Department Working Paper No. 462.
  • 23 Independent Budget Office (2013), Understanding New York City’s Budget: A guide
  • 24 City of New York Adopted budget 2016 http://www.nyc.gov/html/omb/downloads/pdf/erc6_15.pdf
  • 25 New York City Department of Education: http://schools.nyc.gov/AboutUs/funding/overview/default.htm
  • 26 New York City Access NYC: https://a069-access.nyc.gov/ACCESSNYC/application.do