TP26. Taxation and Local Government

How is local government financed today, and how could the system be improved for the benefit of all concerned?

The financing system

Money for local government comes from several sources. A little comes from what might be called “trading” – items like entry fees from swimming baths, and library fines. Much comes from grants from central government. A lot is raised by two local taxes: the Council Tax, which is paid by householders, and the Uniform Business Rate, which is paid by commercial firms. There is an equalisation scheme, under which local authorities with exceptionally big revenues subsidise those with small revenues. In this Topic Paper we will concentrate on the two local taxes.

From the 16^th Century to the late 1980s, the local tax was “the rates”, which were eventually assessed on the value of a “hereditament” – that is, the land and the buildings on it. Exemptions were later made for certain kinds of property, particularly land used for agriculture.

In 1989-90, there was a major change. Business property became liable to a Uniform Business Rate – much like the old rating system, except that the rate was the same everywhere in the country, and did not vary according to the requirements of the local authority in which the property was located. Residential property became liable to the “Community Charge”, which soon became widely known as the “poll tax”. This was related to the number of adults living in the property, and varied according to the needs of the local authority where it was located.

The “poll tax” was widely resented, and in many places proved uncollectable. A different system had to be devised in a hurry. In 1992 the present Council Tax emerged as a compromise between conflicting ideas. The value of domestic property was assessed according to eight broad “bands”. The amount payable was determined partly by the “band” into which the property fell and partly on whether just one person, or more than one persons, was resident there.

Objections to the system.

There are various objections to the present system. Here are a few:

1. It was drawn up many years ago on the basis of property values which have since changed greatly.

2. Both UBR and Council Tax operate largely on the basis of a sort of “rating” system which taxes people heavily when they make good use of their land, and much less heavily when they make poor use of their land. This discourages optimum use.

3. Council Tax is charged partly on the “poll tax” basis of the number of occupants. This bears little relation to need, to use of local resources, or to ability to pay.

4. The present “bands” are very broad, and include properties of very different values within the same band.

How can this be improved?

Several suggestions have been made.

1. Local Income Tax

It has been suggested that the Council Tax for domestic property should be replaced by a Local Income Tax (LIT). This would require everyone who now pays income tax to central government to pay income tax to the authority of the local area in which he lives. This has serious disadvantages.

1. Income tax is often deducted at source by employers through PAYE, but some taxpayers do not pay in that way. There are also people with property here who are resident in other countries and do not pay UK income tax.

2. Some people have property in more than one local authority area, and these areas have different financial requirements.

3. LIT would impose considerable compliance costs on employers.

4. LIT taxes both buildings and the site on which they rest. For reasons which will be considered shortly, there is a good case for keeping those things separate.

2. Return to the old Rating System

There is a serious objection to the old rating system, which also applies both to the Council Tax and UBR today. The assessed value of a property was, and is, based on the total value of the site, plus any “improvements” put on it. Yet the value of the site and the value of improvements arise in very different ways. The value of improvements derives from public demand for the site, which is sometimes conditioned by nature: its fertility, for example; or the presence of minerals; or a good view. Alternatively, the value may be conditioned by the activities of other people: the presence of good roads or transport services; the proximity of schools, shops and other amenities and so on. In either case, the value of the site has nothing to do with what the owner has done.

To lump together benefits which the ratepayer or predecessor created and benefits which he didn’t create, produced all kinds of anomalies and absurdities. Thus, the owner of a site with no “improvements” on it was exempted from rates, and is still exempted from both Council Tax and UBR. This rule applied, and still applies, even if the site is of great and rising market value. The owner of such a site could, and can, hold on to it as prices rise, hoping eventually to make a killing. Not only does this mean that the local authority receives no revenue, but also the value of nearby property suffers.

3. Site Value Rating.

This meets all the difficulties presented by the present system, by LIT and by the old rating system.  SVR is a rating system which would assess not the total value of a piece of property but the value of the site alone, discounting all improvements which people have put upon it. As with any other tax, the value of the subject of taxation will vary from time to time, and should be re-assessed periodically – perhaps annually. Here are some of the advantages of SVR:

1. SVR charges only for unearned benefits which the occupier received, and not for benefits which he or his predecessors have created.

2. SVR cannot be avoided or evaded. Nobody can hide land, or hide its value.

3. SVR provides a positive incentive to the owner to make best use of his land, within the rules of planning law. He pays the same tax whether he leaves the land idle, under-uses it, or uses it to best advantage.

4. SVR would therefore discourage the derelict eyesores which are often found when owners hold property out of us in anticipation of selling when land values have risen. It would also discourage “land banks” which builders and developers often hold in anticipation of future changes in planning rules.

5. Local authorities would have a stronger incentive to develop improved local services, in order to generate higher site values, which they would be able to collect.

Wider applications

SVR is a local tax, but many people who support the idea are also supporters of a wider system applied to the revenue of central government, which is called Land Value Taxation (LVT). In other Topic Papers of this series, we explain how LVT would work, and how it would produce a great many benefits, not all of which are immediately obvious. When a general system of Land Value Taxation is in operation, it will be necessary to revise the system in the light of that measure.