The government’s latest thinking on the Local Government Finance Bill has prompted lots of reflections and commentary – much of it demonstrating little understanding of economics or the basic trade-offs that the new local government system has to consider.
While we would welcome a Bill that had stronger incentives for growth including enabling local authorities to keep more than 50% of their business rate, we also recognise that legislation is devised in the context of a whole system and trade-offs have to be made.
It would be nice to be able to devise a local government funding system that maximises the incentive to pursue growth for some places whilst simultaneously providing an equitable system of redistribution and security for others. But with no additional funding on the table, this simply is not possible.
Local authorities, pressure groups and other commentators could make a more useful contribution to the debate if they weighed up the pros and cons a bit more and evaluated their position in the context of the balance the whole system is trying to strike. My reflections on the trade-offs involved within the proposed system are set out below.
Growing the size of the pie vs redistributing the existing pie
Much of the debate has been about winners and losers and who will get what under the new local government funding system. This downplays the real issue which is how to structure the new system in order to maximise growth and thus increase the total amount of money within the system so that everyone can get potentially get more. For example, if the incentive is sufficiently large so that Reading is encouraged to increase its business rates growth, then it will get to keep 50% of its resulting larger business rates pot. But Reading will also send 50% of this larger pot back to the centre to be reallocated to less successful places such as Burnley. The opposite is therefore also true.
Our research suggests that allowing authorities to retain a greater share of their business rate growth will create net economic benefits for the UK. If this plays out then there will be more money available via the central pot to redistribute to those places that are less able to grow their business bases. So what’s good for Reading should also be good for Burnley.
Safety nets vs growth incentives
For an incentive to work most effectively there must be a downside. In fact avoidance of the downside may provide a more effective incentive than the benefits of the upside. Therefore any safety net acts as a disincentive. If it is overly large or kicks-in very early it will reduce the effects of any growth incentive, particularly for those authorities that sit around the line between being top-up and tariff authorities. The system must work so that it always makes more sense for a city to go for growth than to rely on redistributive handouts.
Pooling vs competition
While much of the discussion has focused on the 50% retention rate, the government has also missed an opportunity in not providing incentives for pooling at the level of the functional economy. One of the likely effects of this will be increased tax competition between authorities as they vie to retain their existing businesses and attract new ones to their area. In some places this could result in a ‘race to the bottom’. If you’re in any doubt that this increased competition could happen, have a look at how authorities in the USA use their variable tax-system to do just this. If we want less competition, then we need to encourage more pooling. The new local government finance system should do more to encourage this – even if this is simply through explaining the benefits more clearly.
Because of the competing interests within this Bill — cities with stronger and weaker economies, central and local government, growth incentives and equitable redistribution — it was never going to make everyone happy. Understanding and respecting the notion of trade-offs is the framework in which discussion of the most effective local government system should be placed.