At a CEPR lunchtime meeting on 19 April, Gordon Hughes considered the lessons to be drawn from the European and American experience of local government finance for the design of a new system for the UK. Gordon Hughes is Professor of Political Economy at the University of Edinburgh and a Research Fellow in the International Trade programme of the Centre for Economic Policy Research. His remarks were based in part on his paper on `Local Government Finance', written jointly with Stephen Smith of the Institute for Fiscal Studies, forthcoming in issue no. 13 of Economic Policy, October 1991. Financial support for the meeting was provided by the UK Economic and Social Research Council as part of its support for the Centre's dissemination programme. The views expressed by Professor Hughes were his own, however, and not those of the ESRC nor of CEPR, which takes no institutional policy positions.

Hughes stated that the political unrest experienced in the UK since the early 1970s in the form of tax revolts had focused principally on local taxation. This led initially to the abolition of domestic rates and more recently to the transfer of part of the burden of local taxation to the Exchequer and proposals to replace the poll tax with a modified form of property taxation. Participants in the debates surrounding these gyrations of policy have paid little attention, however, to the lessons to be learned from the experience of local government taxation and finance in other countries, especially in Europe. It therefore seems likely that any system that eventually emerges will retain the structural defects of the present system, which will soon lead to renewed problems.

There have been a number of local tax revolts in other industrial countries, most notably in the US during the early 1980s, but also in Scandinavia and in Spain. Such unrest arises when there are both a sharp rise in the average level of taxes collected by local government and also a heavy reliance upon a single source of revenue for local government finance, i.e. a high degree of `tax concentration'. The critical elements in the recent experience of the UK were the reduction in the share of local government spending that is financed by grants from central government combined with bureaucratic incentives to expand local government spending when the blame for its fiscal impact could be shifted elsewhere.

Hughes noted that the poll tax provides a convenient scapegoat for the current revolt. He maintained, however, that in reality it is little better or worse than a property tax, since it is neither particularly expensive to administer nor much more regressive than domestic rates. Its introduction has been badly mismanaged in some parts of the country, however, where it has caused large and essentially random shifts in the tax burden within income groups, because both the poll tax and the domestic rates that it replaced are poorly correlated with income. If the burden of rates had risen to reflect the revenue currently being collected from the poll tax, the resulting tax revolt would have been just as strong as the one that has actually occurred.

Until the changes to local government finance in the 1991 Budget, when the government raised (centrally collected) Value Added Tax from 15% to 17.5%, the local authorities were seeking to raise a far higher proportion of revenue through the poll tax than any country elsewhere in the industrialized world collects from any single local tax not based on income. Even countries that rely upon separate local taxation of income rather than revenue- sharing arrangements with a uniform national rate experience difficulties, unless the revenue raised locally is used to finance general expenditure on health care and social security which are not the responsibilities of local government in the UK.

Hughes argued that the reforms currently proposed are most unlikely to provide a stable and satisfactory basis for local government finance. As a fraction of capital values, the proposed levels of the new property tax exceed the tax rates that provoked the property tax revolt in the US. The next significant increase in the burden of local taxation will return the pattern of UK local government finance full circle to its starting-point of 20 years ago. The only alternative is to finance an increasing proportion of local spending from central grants, i.e. to adopt the pattern that prevailed in France, Italy and Spain until quite recently. All of these countries are now trying to move away from this pattern although it is still accepted in small countries such as Ireland and the Netherlands.

Given the objections of the Treasury and the Inland Revenue to a separate local income tax, Hughes argued that other countries' experience suggests that the only sustainable basis for the finance of local government that can preserve a genuine element of local independence is revenue-sharing of a uniform national tax base probably the income tax of the type operated in Germany. Local governments would lose the power to set tax rates independently, but they would retain control over spending decisions. High local tax rates are associated with (and indeed almost certainly cause) high local unemployment; so local control of tax rates may be a dubious privilege. The arguments for allowing local authorities to determine the combination of local public goods they supply are much stronger.