The background. From the beginning of the seventeenth century down to the 1980s, local government finance turned largely on “rates”, which were usually levied on the basis of the notional value of landed property, site and “improvements” together. This system was later modified by various statutory exemptions, by grants from central government, by systems of rate equalisation in favour of authorities with low rateable value and by revenue from local services, such as transport undertakings, etc. In 1989-1990 a new system for collecting local revenue was introduced, including the Uniform Business Rate (UBR) applied to commercial property, and the Community Charge (“poll tax”) applied to domestic property. The Community Charge proved unpopular and difficult to collect and was replaced hurriedly by the present Council Tax. To meet the temporary deficit, there was also a 2.5% increase in VAT – which is still with us.
The way we fund local councils today is certainly not perfect. There are various objections to UBR, but these lie outside the field of the present Paper. The banding of house values for purposes of the Council Tax does not accurately reflect the difference between the highest and lowest value houses, and poor people therefore pay a disproportionate share of this tax. People who have built property to high standards are penalised by comparison with people who have allowed property to decay. In any event, the valuation basis of the Council Tax is more than a decade and a half old, and outdated.
Some people have suggested that the Council Tax should be abolished and replaced by a Local Income Tax (LIT), under which Income Tax payers would receive a supplementary demand to pay for local services. In this Paper, that proposal will be examined, and we will consider whether there is a better alternative.
Why a Local Income Tax?
Supporters of LIT argue that it would be fair. Unlike Council Tax, it is claimed, IncomeTax is based on ability to pay, and its application to local government needs would ensure that the wealthy paid most and those with least to spare paid least. We need to consider, therefore, whether LIT is based on the right principle and whether, assuming that it is based on the right principle, matters are likely to work out in the way intended.
The principle of Council Tax is that similar properties should deliver amounts of tax (subject to some modifications according to the number of residents) because they receive similar services. Clearly this would not happen with LIT because one property might have one occupant with a low income and another similar property might have several occupants with much higher incomes.
The argument that ability to pay should be the exclusive, or at least the principal, criterion for determining how much a taxpayer should pay is by no means self-evident. for there is much to be said for the view that his payment should be based, at least in part, on the benefit he receives from Council activities. Payment for refuse collection, for example, consists mainly of fixed costs. On the other hand payment for education services is very different, for many people do not benefit directly at all, but it is almost universally agreed that the service should be provided.
Income Tax today.
Assuming that taxation should be based, at Ieast partly, on ability to pay, does Income Tax for central government purposes achieve this objective? Income Tax is so hedged about with allowances, conditions and exceptions that opportunities for avoidance and evasion have multiplied. These enable people who can afford to pay for the necessary expert advice to reduce their liabilities.
Income Tax is often deducted by employers at source, through the PAYE system. Employees whose tax is collected through PAYE have no way of under-stating their income, or moving it to a tax haven, or hiding it in cyberspace. But not all taxpayers come under PAYE in the first place, while not all taxpayers on PAYE are required to make returns to HMRC. A tax which does not operate impartially and oblige all citizens to accept their liabilities in full is not a fair one.
On top of all this, the cost of collecting Income Tax is enormous, so that a large part of the cost which the taxpayer must bear goes to administration rather than the purposes for which the money is required. There are also huge “compliance costs” carried by taxpayers themselves and their employers in providing the information required.
Can Income Tax be applied to local taxation?
For the moment, let us assume that all the various objections to national Income Tax can somehow be met satisfactorily, or even that Income Tax is the “least worst” way of raising revenue for the purposes of national government. Can Income Tax be satisfactorily applied to meet the needs of local government? There are various difficulties. Some of these could probably be overcome, though at considerable cost. Others appear insuperable.
1. It would be necessary to maintain an accurate register of taxpayers’ addresses and to establish a definition of what constitutes residence.
2. The total amount of tax payable will vary substantially between local authority areas. This would provide an incentive to avoid, and would give rise to problems of ensuring compliance. On top of the instances of avoidance and evasion currently incurred in collecting Income Tax for national purposes, LlT would be vulnerable to avoidance through use of addresses of convenience and registration where the rate of LIT is lower.
3. LIT would be particularly vulnerable to the movements of transitory populations. The costs of pursuing defaulters are likely to prove unacceptably high. In practice, evasion would be rewarded and the shortfall transferred to the more honest citizens.
4. Complications would arise when taxpayers live in one tax area and work in another, especially if the place of work is outside the UK.
5. Unincorporated businesses would contribute. but incorporated businesses would not. As the tax would not provide for contributions from companies to local revenue (other than through UBR, which is also payable by unincorporated businesses), this would discriminate against sole traders, partnerships and small businesses not registered as companies, whose profits are distributed as wage income.
6. The yield would be unpredictable. Incomes within a local authority area cannot be forecast accurately, and would presumably need to be estimated by reference to the past year’s income. The failure of a major local employer could lead to a large shortfall in revenue.
7. LIT would be “lumpy”: small variations in the national tax rate would produce relatively large variations in yield, causing problems for local authority treasurers when setting budgets.
8. Because earnings per head in many local authority areas are low, the yield would inevitably be restricted. The authorities concerned would need some form of grant or equalisation payment to boost their revenue. How is this to be achieved – by a uniform LIT akin to the UBR (which would effectively destroy the incentive for a local authority to be watchful of its finances), or by central government hand-outs from general taxation?
9. There is ample evidence that removal of taxes on real property result in higher property rents and prices. In other words, the main financial benefit from a switch from a property-based tax to a tax on the person is captured by the property-owner, or by the occupier’s landowner, who can then charge more in rent or in the selling price of what has become a tax-free asset
A better way.
It is easy to criticise LIT; but is it nevertheless better than any available alternative? What is needed is a tax which is cheap and simple to administer; which is impossible to avoid or evade; which does not hinder useful activity and which is fair for everybody. A tax on land values fulfils all these conditions.
“Land” as here understood, means the site alone, and does not include anything which present or past occupiers have put on it, such as buildings, machinery or crops. The qualities – and the value – of a plot of land derive partly from nature (such as fertility, presence of minerals or a fine view) and partly from human activity (such as proximity to roads, railways, shops and schools).
Such a tax, when designed for the special needs of local government, is known as Site Value Rating, or SVR. To apply SVR, the value of all sites in the local authority area would first be assessed. Professional valuers assure us that this would be a simple and cheap operation. A tax, or rate, would then be levied on the basis of that valuation, just as the old rating system used to levy a tax, or rate, on the basis of the total value of a property (i.e., site plus “improvements”). As site values vary over time, periodic (perhaps annual) reassessment would be necessary. The principle behind SVR is that each occupier will pay for the benefit he receives from what he has not created, but will not be penalised for what he has done to make the property he owns more valuable. One of the arguments in favour of LIT (which, as we have seen. is really flawed) is that it will fall most heavily on the people most able to bear it. As wealthy people usually live on valuable sites, while poor people live on less valuable sites, SVR will do exactly that.
But will there be hard cases, such as elderly people on small incomes, whose site values are high? Yes, indeed, SVR, like any other kind of taxation, may involve hard cases, unless Parliament makes careful provision to avoid those hard cases. But the possibility of such hard cases arising provides a challenge to the legislators to avoid them. It does not provide an excuse for failing to deal with the general problem.