Local tax reforms begin to impact

Behind the cloud of austerity that obscures so much, a quiet revolution is happening in local government finance in England. 

Authorities are currently setting their budgets for 2013/14 and they are only at the start of the formal process, but anecdotally the abolition (after eighty years or so) of a needs based general funding formula and its replacement with a system of partial retention of business rates income is having a more immediate impact than many thought it would.

Over time it is fully expected that authorities in areas where the economy is growing will do better than those areas where it is contracting or stagnant. The assumption up until now has been that the first year of the new system will see relatively little effect, because funding in year one is supposed to be the same as the funding each authority would have received had the Formula Grant still been in place.

But some authorities are already planning to collect more business rates next year than the Government ‘baseline’ predicts, while others are indicating that they will struggle to meet the baseline figure.  This is because the baseline is calculated on an average of several years past performance, and the business rates system is surprisingly volatile in the amount of cash it generates. 

This is interesting because it increases the prospect that rates retention will make a noticeable difference to local government spending decisions quite quickly – probably before the next round of Council elections, and what is more, before the next General Election.  

For authorities that see their futures are residential rather than commercial, rates retention is mirrored by the New Homes Bonus, which provides extra income on a temporary basis to authorities that grow their council tax base and again is intended to act as an incentive to authorities to allow and encourage the tax base to grow.

What is completely unknown, of course, is how the new system will change things in the longer term.  The mechanics of the new arrangements will alter the distribution of funding, but the impact of this will be watered down by periodic ‘resets’ which on the face of it are intended redress some of the balance in favour of authorities in greatest need.  This avoids the ‘Detroit’ effect in which economically moribund areas gradually lose their capacity to generate tax income.  But if the new system is kicking in more quickly than many expected, more change can be expected between resets than might previously have been assumed. 

Not that the old system ever adequately provided for need. The introduction of damping arrangements over recent years had already broken any last link between the analysis of need and the amount of money authorities actually received.  When resets take place they are also likely to be hedged round with arrangements that stop the funding of individual authorities changing too much in any one year. 

So in one sense the new system could be the worst of all worlds. It will have provide an imperfect relationship between funding and spending need but also an imperfect relationship between funding and economic growth.  Over time it is hard to see how a ‘postcode lottery’ of local authority provision can be avoided.

At least under the new system it should be clearer to local authorities what they need to do to get more money.  The Government hopes for a sea change in the way local authorities see their local economies and engage with the Government.  The old system of needs related grants was seen as a disincentive for authorities actively to manage economic development but also encouraged authorities constantly to approach the Government with the begging bowl.   In future, the Government  expects local authorities to look closer to home to meet their income needs.   That should be a considerable shot in the arm for local government.  

It would be nice to think that the changes will encourage local authorities to take a harder look at how their activities can create wealth.  Unfortunately, even in areas where the local economy is growing strongly,  the effect of austerity will mean that all authorities will still be making cuts, but some authorities will have to cut further, deeper and more quickly than others.  This probably means the begging bowl will not be consigned to the attic just yet.

Another consequence is that local government finance has suddenly become a whole lot more complicated, which will make it harder for everyone, including governments and voters to understand what is going on.

The old system was supposed to work in such a way that differences in spending choices were reflected in the relative levels of Council Tax.  Under the new system,  authorities will still differ from each other according to how they manage costs, but they will also now differ more strongly than in the past in the way they manage tax income.  This means that if my authority now sets a higher Council Tax or makes bigger spending cuts than  its neighbours, it might be because they are profligate and inefficient, or it might be because the Council next door is the one with the new estate and the out-of-town shopping centre.

Rates retention will change the way we all think about local government finance in England in unpredictable ways, and the indications are that it may have a more immediate impact than expected.