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 Rubiks 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 Lets 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 Rubiks 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 households 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

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 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 income0.038 log real net hh income0.025 log gross real hh income ratio of HH to Dwellings0.083 UCC Log real house price0.036

Within sample forecasts

50% CT and 1% local income tax Simulation nominal price effect Aberdeen0.37%0.87%1.74%2.72%4.10% Ayrshire0.45%1.08%2.37%3.83%6.18% Borders and Dumfries0.39%0.93%2.02%3.27%5.27% Dundee0.35%0.88%1.93%3.19%5.20% Edinburgh0.46%1.16%2.52%4.21%6.81% Glasgow0.41%1.01%2.06%3.37%5.18% Highland0.45%1.11%2.43%4.00%6.53% Stirling0.41%0.98%2.04%3.26%5.08%

0% CT and 3% local income tax Simulation nominal price effect Aberdeen0.68%1.20%1.41%1.45%1.11% Ayrshire0.83%1.54%2.10%2.45%2.54% Borders and Dumfries0.71%1.29%1.70%1.91%1.84% Dundee0.64%1.19%1.59%1.82%1.77% Edinburgh0.85%1.64%2.26%2.75%2.97% Glasgow0.74%1.40%1.77%2.00%1.86% Highland0.83%1.56%2.15%2.57%2.74% Stirling0.76%1.37%1.74%1.92%1.76%

Simulated revaluation (new band limits) TaxExistingNew BandUpper bounds Multiple A27,00089, B35,000129, C45,000169, D58,000209, E80,000299, F106,000429, G212,000599, H---

Big changers (LAs) – Band D equivalents

Predicted key movers in Band D equivalents UAd9604 Eilean Siar-69.5% Inverclyde50.8% Shetland-43.3% West Dunbartonshire-35.8% Midlothian-35.1% Dumfries & Galloway-34.8% City of Edinburgh33.8% Orkney-32.7% East Renfrewshire25.7% Stirling20.7%

Individual households – significant band movers HouseholdsBand changeFiscal position City of Edinburgh10.69%B to C33.8% gain in BDEs 6.67%C to D Eilean Siar8.67%C to B69.5% reduction in BDEs 5.59%D to C Highland8.13%C to B20.4% reduction in BDEs 7.76%D to C Inverclyde2.37%A to B50.8% gain in BDEs 2.04%C to B 2.16%D to C South Lanarkshire5.65%C to B5.3% gain in BDEs 4.94%D to C West Dunbartonshire5.69%A to B35.8% 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