The Future of Local Taxation in Scotland: Principles & Evidence Kenneth Gibb & Chris Leishman June 2008.

The Future of Local Taxation in Scotland: Principles & Evidence

Kenneth Gibb & Chris Leishman

June 2008

Overview

• Local tax principles• Reflections on the Government position and the

Consultation Paper• Revisiting the Rubik’s cube: the need to reform

structure, finance and function together• Single and multiple taxes• In defence of property taxes• New evidence on house price capitalisation

effects• New evidence on the consequences of a council

tax revaluation• Tentative conclusions

The Government Case

• Replace the council tax with an income tax based on 3p in the £ across all taxable income

• Significant financial shortfall in revenue raised to be met in large part by a claim to the council tax benefit savings

• HMRC are expected to administer/collect the tax

• This assumes that other legal issues are overcome as to whether this is a national or a local tax

• Let’s turn to the multiple criteria used to evaluate alternative taxes

Principles of Local Taxation

• Fiscal Federalism literature and various green papers and committees of inquiry since Layfield

• Feasibility• Fairness• Local accountability• Economic impacts/unintended

consequences

Feasibility

• Administrative efficiency• A predictable & secure tax base• Collectable?• Buoyancy• Property taxes and revaluation• Collection of local income tax• Administration of means-tested benefits

Fairness

• Fairness as progressivity- measurement issues- one tax or the tax net of benefit ?- fit with the entire tax/benefit system

• Fairness as horizontal equity- equal treatment of different groups

• Fairness as benefits received- consumption or user price argument- tax/benefits capitalisation

Accountability

• Transparency between spending, taxing and voting

• ‘User benefits and pays more’ principle link to fairness arguments

• Households versus individual tax liabilities• 100% low income rebates and other non tax

payers• The role of the national tax payer and local

tax ‘gearing’

Economic Impacts

• Minimise distortions to economic activity and its location (tax-induced inefficiencies)

• Marginal tax rate implications on supply of labour, savings and investment decisions

• Inter-authority domestic property tax capitalisation

• Business location decisions (tax capitalisation again)

• House price effects of tax changes and evidence from rates abolition

Grant funding and income distribution

• Little discussed aspect of the proposals concerns how the income raised from the local income tax is distributed

• It will not be kept where it raised but rather collected centrally and then allocated out according to a new but not yet constructed national needs assessment for local authority funding,

• A hugely complex and controversial topic in its own right

• And then there are the central v local accountability arguments….

• Is this all a tactical way of continuing the constitutional debate by other means?

Revisiting the Rubik’s Cube

• Gallagher et al paper (2007)• Back to Layfield – central or localised

systems of local government – structure and finance (grant v tax and choice of tax follow)

• Living with the poll tax system in 2008 – gearing and the local tax element

• Nationalising education and care?• Building a case for a hybrid tax and a

localised business tax

Single and Multiple Local Taxes

• Connecting income source to service type• Need, redistributive, amenity and facility services• Income and property domestic taxes for amenity and

facility services• Business taxes split between national and local

services?• Multiple taxes and the national benefits system• Optimal tax literature arguments for multiple taxes• We need more evidence on distributional impacts

In Defence of Property Taxes

• Old view and the new view of property taxes• Domestic property and the UK tax system• Feasibility• Fairness• Accountability• Wider economic effects• Exposing the shortcomings of the council tax

should not undermine the broader case for some kind of property tax

• Options include national and land taxes as well as local property taxes

The logic of capitalisation effects

• Council tax payments come from a household’s budget so the following measures are inflationary– reduction in regressivity– reduction in “hidden” local discounts

• For example, consider spending £200k in the housing market. What CT liability would you be buying in Edinburgh compared with Argyll & Bute or Shetland Isles?

• CT liabilities are based on 1991 prices

Variation in local house price growth

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Aberdeenshire

Dumfries & Galloway

East Renfrewshire

Argyll & Bute

Orkney Islands

Shetland Islands

East Lothian

Midlothian

Sharing the council tax cake

• Local government finance is complex!• Central grant based partly on:

– general need (formula based assessment)– LA ability to fund (% share of Scotland band D

equivalents)– + other (ring fenced) grant aided needs

• Consider two LAs (high and low price growth) and a system of tax fixed at 1991 prices

• Over time, households in the high price growth LA benefit

• This might cause additional inflation (circularity)

Returning to capitalisation…

• House price model based on 8 Scottish sub-regions 1994-2006

• Panel model using “long run” price specification

• change in Price = f(disposable income, gross income, hh:stock, UCC, price level)

• User cost (cost of owner vs renting):• = MR + T.P + d + rp - g

Effects of replacing council tax with something else

• Depends on price elasticity with respect to:– income (gross / disposable)

– property tax rate

– expected price growth

Coefficient

log diff real net hh income 0.038

log real net hh income 0.025

log gross real hh income -0.065

ratio of HH to Dwellings 0.083

UCC -0.896

Log real house price 0.036

Within sample forecasts

Aberdeen

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

LDRP(F) LDRP

Edinburgh

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

LDRP(F) LDRP

Dundee

-0.1

-0.05

0

0.05

0.1

0.15

0.2

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

LDRP(F) LDRP

Glasgow

-0.1

-0.05

0

0.05

0.1

0.15

0.2

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

LDRP(F) LDRP

50% CT and 1% local income tax

Simulation nominal price effect 2007 2008 2009 2010 2011

Aberdeen 0.37% 0.87% 1.74% 2.72% 4.10%

Ayrshire 0.45% 1.08% 2.37% 3.83% 6.18%

Borders and Dumfries 0.39% 0.93% 2.02% 3.27% 5.27%

Dundee 0.35% 0.88% 1.93% 3.19% 5.20%

Edinburgh 0.46% 1.16% 2.52% 4.21% 6.81%

Glasgow 0.41% 1.01% 2.06% 3.37% 5.18%

Highland 0.45% 1.11% 2.43% 4.00% 6.53%

Stirling 0.41% 0.98% 2.04% 3.26% 5.08%

0% CT and 3% local income tax

Simulation nominal price effect 2007 2008 2009 2010 2011

Aberdeen 0.68% 1.20% 1.41% 1.45% 1.11%

Ayrshire 0.83% 1.54% 2.10% 2.45% 2.54%

Borders and Dumfries 0.71% 1.29% 1.70% 1.91% 1.84%

Dundee 0.64% 1.19% 1.59% 1.82% 1.77%

Edinburgh 0.85% 1.64% 2.26% 2.75% 2.97%

Glasgow 0.74% 1.40% 1.77% 2.00% 1.86%

Highland 0.83% 1.56% 2.15% 2.57% 2.74%

Stirling 0.76% 1.37% 1.74% 1.92% 1.76%

Simulated revaluation (new band limits)

Tax Existing New

Band Upper bounds Upper bounds Multiple

A 27,000 89,999 3.33

B 35,000 129,999 3.71

C 45,000 169,999 3.78

D 58,000 209,999 3.62

E 80,000 299,999 3.75

F 106,000 429,999 4.06

G 212,000 599,999 2.83

H - - -

Big changers (LAs) – Band D equivalents

1996

Eilean Siar

Inverclyde

Shetland

West Dunbartonshire

Midlothian

Dumfries & Galloway

City of Edinburgh

Orkney

East Renfrewshire

Stirling

2004

Eilean Siar

Inverclyde

Shetland

West Dunbartonshire

Midlothian

Dumfries & Galloway

City of Edinburgh

Orkney

East Renfrewshire

Stirling

Predicted key movers in Band D equivalents

UA d9604

Eilean Siar -69.5%

Inverclyde 50.8%

Shetland -43.3%

West Dunbartonshire -35.8%

Midlothian -35.1%

Dumfries & Galloway -34.8%

City of Edinburgh 33.8%

Orkney -32.7%

East Renfrewshire 25.7%

Stirling 20.7%

Individual households – significant band movers

Households Band change Fiscal position

City of Edinburgh 10.69% B to C 33.8% gain in BDEs

6.67% C to D

Eilean Siar 8.67% C to B 69.5% reduction in BDEs

5.59% D to C

Highland 8.13% C to B 20.4% reduction in BDEs

7.76% D to C

Inverclyde 2.37% A to B 50.8% gain in BDEs

2.04% C to B

2.16% D to C

South Lanarkshire 5.65% C to B 5.3% gain in BDEs

4.94% D to C

West Dunbartonshire 5.69% A to B 35.8% loss in BDEs

4.05% B to C

Tentative Conclusions

• Government proposals are problematic across different dimensions and principles of taxation

• Good local and national arguments in favour of a well-designed property tax

• The structure of local taxation interacts with the grant system: revaluation essential to the credibility of a property tax may at the same time undermine the robustness of the finance system

• Abolition of council tax has small house price effects where disaggregated analysis suggests offsetting income effects reduce the impact of relative price change

• Revisit property taxes and hybrid/multiple local taxes in a wider context of reforming the system of local-central government relations

• In the shorter run:- a hybrid domestic tax- an element of local control over business rates- further debate on needs assessment