Finance that’s fit for the future

By Jessica Studdert | 10 August 2020

We Brits are infamously eccentric. One peculiar quirk of ours – unlike most comparator countries – is the narrow frame we allow ourselves for thinking about local finance. So while austerity years have reduced local government grant, there has been no concurrent expansion of fiscal powers. Council tax and business rates are subject to strict central controls, while income from commercial ventures is limited and often criticised as risky.

As a result, councils have extremely limited room for financial manoeuvre and are highly vulnerable to the twin vagaries of a volatile national economy and inconsistent government policy.

The discussion about resourcing our municipal tier is reduced to squabbles over allocation formula – textbook divide and rule from Whitehall. The more fragile local government finance becomes, the more national policy-makers seem to presume this is an inherent quality of the sector itself, rather than a direct consequence of their own limited imagination. And so. radical reform of the scale required is not even close to being on the table.

This simply isn’t the case in many other countries where decentralised finance is standard practice. In Denmark, municipalities receive the majority of their funds from income tax. German Länder issue their own equivalent of VAT. In contrast to these two types of tax linked to productive economic activity – wages and transactions – UK local taxation is linked only to residential and commercial property values, which are outdated and distorted by an unbalanced economy.

The more councils are forced to rely only on council tax and business rates, the greater their incentives to build high value property and floor-hungry commercial spaces like warehouses which attract low-wage jobs, risking further skewing local economies.

What if councils were given a direct stake in more productive economic activity through revenue raising powers? The productivity gains could be significant. But this suggestion isn’t a serious starter in the UK and in policy terms our ‘productivity puzzle’ is seen as entirely separate to how we resource local government.

Instead, our regional inequality is used as a reason not to think big. Some areas are less able to raise revenue, so how can we possibly allow more fiscal freedoms? Most countries run perfectly effective decentralised financial systems which combine local autonomy with strong equalisation to balance out different starting points.

Take Japan, which also has a large capital city dominated by the financial sector: a proportion tax levied in Tokyo is redistributed to the rest of the country. But crucially, Japan’s prefectures have wide-ranging powers to levy local sales, income and tourism taxes, in addition to the ability to raise bond finance, so local areas access diverse revenue streams and invest in their own local growth.

The core challenge for localism is that it is seen as a policy issue rather than a more fundamental question of governance. So it sits under the remit of the Ministry of Housing, Communities and Local Government (MHCLG), subject to the whims of different secretaries of state and the disinterest of the Treasury.

If we had a more mature central and local governance relationship, underpinned by constitutional recognition of the latter’s autonomy, we could consider a more enduring settlement that enshrines the diversity and sustainability of local government finance. Responsive annual equalisation measures could plug gaps in the short-term, but enable shifts over the longer term as local economies grow and become more self-sufficient.

This should not be beyond us. Other countries manage it. We just need to recognise and rid ourselves of the narrow terms of the present debate and be more ambitious for a local financial system that is fit for future purpose.

Jessica Studdert is deputy director of the NLGN

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Whitehall Finance MHCLG Treasury

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