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Section 9: Domestic Tax Options in Principle

Introduction

1. Scottish Ministers asked us to consider other possible domestic taxes ( i.e. taxes not levied on business) and other options also have been suggested to us. There are a large number of taxes that could be used to support the cost of local services. Essentially, all of them fall within one or more of the following categories:

• Taxes on income ( e.g. local income tax);
• Taxes on wealth, including land and property ( e.g. domestic rates, land value tax);
• Taxes on people, usually at a flat rate (poll taxes); and
• Taxes on transactions and products ( e.g. local sales tax; specific additional taxes on fuel, tourism, chewing gum, alcohol).

2. Some taxes operate as a hybrid of two or more of these types of tax. Indeed, the council tax could be described as a hybrid of 3 different kinds of tax. Council tax is most obviously a tax on property, as the council tax band into which each home in Scotland is placed is based on a value for the dwelling and the land on which it stands. Second, council tax has a large personal tax element to it, which makes it partially a tax on people. Council tax is based on the property occupied by a household that is assumed to contain two adults and properties occupied by only one person are eligible for a 25% discount. Finally, council tax has an income-related element to it, in that Council Tax Benefit provides some protection to households on low incomes (subject to certain conditions, such as savings limits).

3. A summary of the criteria we use in assessing the options before us and the ranking we gave in the previous Section to each of the criterion is shown in the following table. Where we think it relevant to do so, we link certain criteria as shown in the table and consider them together.

Taxing Income

4. Income tax is used as a major source of revenue in most developed countries.

5.OECD¹⁰⁶ figures suggest that the overall tax structure used in the United Kingdom is broadly consistent with the average for OECD countries. In relation to income-based taxes, the UK received 30.2% of its tax income in 2001 from personal income taxes (more than 26.5% for OECD countries as a whole). As referred to below, property taxes are more significant in the UK than other OECD countries. The further 17.0% of UK tax income received from National Insurance contributions, which shares many of the features of personal income tax, was less than the unweighted OECD average, where social contributions made up 25.1% of total tax income. Corporate/profits taxes amounted to 9.5% of total UK tax income, in line with the unweighted OECD average of 9.4%.

6. As far as local government tax revenues are concerned, most other OECD countries either rely predominantly on income/profit taxes ( e.g. the Scandinavian nations, Germany, Belgium) or levy them as a major element within a combination of at least three types of tax ( e.g. Austria, Japan, Spain). ¹⁰⁷

7.GfKNOP reported that a local income tax was the favoured method of local taxation from most participants in the deliberative focus groups they undertook (although they also reported strong indications that people who might pay more under a local income tax might oppose any change - especially working families). Expressions of support for a local income tax in some form also came from many members of the public who responded to the consultation paper - 96 individuals (33% of total), of whom 42 were clearly pensioners.

8. While the MORI Scotland survey did not seek views on a local income tax itself, it revealed significantly higher levels of satisfaction (37%) and lower levels of dissatisfaction (35%) with income tax than with council tax (21% and 60% respectively.

9. Local income tax is supported by the Scottish Liberal Democrats and Scottish National Party. The Scottish Socialist Party favour a nationally-set Scottish Service Tax, levied on income. The Scottish Labour Party and the Scottish Green Party do not favour a local income tax, while the Scottish Conservatives did not comment.

10. To a large extent, the views of local authorities reflect their particular political make-up. Aberdeenshire and Angus support a local income tax, provided councils can set the level. Perth and Kinross Council also appear to favour this option. However, Labour-run authorities generally oppose it. SRPBA, ¹⁰⁸CBI Scotland and UNISON¹⁰⁹ have also expressed opposition to local income tax.

11. In its 2002 report following its Inquiry into Local Government Finance, the Scottish Parliament's then Local Government Committee recommended that the Executive should examine the feasibility of a local income tax in the longer term, in order to supplement and reduce councils' dependence on Executive grants and council tax proceeds. ¹¹⁰

Macro-economic criterion

12. On the question of possible effects on the economy, obviously this will depend on the level and nature of the tax.

Fairness-related criteria

13. Overwhelmingly, the key reason for public expressions of support for local income tax - both from responses to the consultation paper and the outcome of the GfKNOP research - is the perceived fairness of the association between a local income tax and ability to pay. A particular feature mentioned is the perceived fairness for pensioners, although this also applies to low-income families.

14. However, some low paid people ( e.g. students, those living in houses of multiple occupation, those eligible for full/substantial Council Tax Benefit) might be worse off under a local income tax than under council tax. This argument was made by the Scottish Labour Party, among others. CIPFA also warn that interplay with other benefits could mean that, without protection, the very poorest might be worse off with a local income tax than under council tax.

15. However, the perspective of fairness may change when local income tax is considered as part of the basket of taxes. HMRC estimates that income tax generated almost one-third of its tax receipts in 2005-06. ¹¹¹

16. If a local income tax that applied only to earned income was introduced, consideration would have to be given to whether or not this would be seen as "fair". We consider this further in section10.

17. Theoretically, a local income tax running alongside national income tax should not require a stand-alone system of benefits to rebate any part of a liability for local tax. This was reported by GfKNOP as an advantage of local income tax identified by focus groups. However, CIPFA argued that, because of the effects of the benefits system, the very poorest might be worse off with a local income tax than under council tax. The principles of Working Tax Credit and Child Tax Credit show how such assistance could be provided if necessary.

18. The broad principles of income tax appear to be well understood and well accepted by the public. A local income tax, if modelled closely on UK income tax, should therefore prove easy to understand.

19.GfKNOP's focus groups recognised that local income tax would be less visible than council tax. They broadly seemed comfortable with this, remarking that it would be less controversial, but some fear was expressed that it might become easier for councils to increase the amount of tax people were paying covertly through "stealth" taxation.

Assessment and collection criteria

20. The debate over the collectability of local income tax appears to be influenced by people's particular impressions of the model that would be adopted. There appear to be two options: a tax with a nationally-set rate and a tax with a local council-set rate (as proposed by the Scottish Liberal Democrats and Scottish National Party). Opponents of a local income tax (such as the Scottish Labour Party and several councils) focus upon a locally-variable system, possibly with a different tax rate applied by each authority, which might be very complex and expensive to administer. Aside from the Scottish Socialist Party, nobody suggested a structure of allowances and tax bands for a local income tax that was not based on the UK income tax structure.

21. Supporters of a local income tax see it working in a very similar way to PAYE, with very little need for adjustment. Several members of the public who responded to the consultation paper were attracted by the prospect that local income tax might be collected via PAYE. PAYE was held in high regard by many respondents because it was seen as an effective means of collection from those taxpayers who currently pay income tax through PAYE. In contrast, they tend to perceive the collection rate of council tax as poor, particularly in local authorities where resistance to the Community Charge had been strongest.

22. We discuss in more detail the taxation of all forms of income (both earned and unearned), most but not all of which is paid through the PAYE system, in section10.

23. A more complex system of income tax could increase the opportunity among some taxpayers to evade payment of the tax. ¹¹²

24. How easy for the taxpayer a tax on income is to pay might be heavily dependant on the particular model adopted. However, the GfKNOP research reported comments from participants that income tax is much easier for them to pay (via PAYE) than is council tax, because it is deducted at source.

25. The cost of operating a local income tax would depend on the model introduced. Assessment and collection costs would fall upon HMRC, DWP and employers in relation to PAYE, and HMRC, DWP and taxpayers in respect of self-assessed income. We consider in greater detail the likely collection costs for certain local income tax models in section10. In doing so, we bear in mind that a balance might have to be struck between framing a model in a way that minimises costs and at the same time still meets other key objectives.

Yield-related criteria

26. The Scottish Labour Party and those Labour-run councils that submitted evidence criticised local income tax strongly on the basis that its volatility would undermine its stability and make its yield difficult to predict. The fact that a time lag tends to apply before a decline in the economic cycle affects tax revenue may allow limited scope for anticipated falls in tax income to be foreseen.

27. Available evidence demonstrates that income tax revenues are both buoyant and cyclical, as a result of which they tend to be less stable than a property tax. The most recent slump in incomes and tax revenue occurred in 1993-94. Since then, as Figure 9.1 below shows, income tax revenue has shown modest contractions in some years but little sign of more fundamental volatility. Based on the available evidence, it would be plausible to assume that a local income tax would be cyclical and, in comparison to council tax, relatively buoyant.

Figure 9.1: GDP, income and income tax revenue indices¹¹³

28. Because of the size of the local tax base, receipts from local income tax would be more volatile than UK income tax receipts. This could be significant for smaller communities.

29. The example of UK income tax shows that, where there exists a stable economic and public expenditure platform, income tax percentage rates can apply unchanged over a period of many years.

Accountability and balance of funding criteria

30. Figure 9.2 sets out the income tax base in Scotland, in terms of the number of income tax payers and their status.

Figure 9.2: Tax Status of Adults in Scotland In 2004-05¹¹⁴

31. This tax base is likely to change in the years ahead. The size of the working age population in Scotland will fall by 15% - more than half a million - by 2040. Scotland already has a high rate of participation in the labour market trends and past trends do not suggest that immigration is likely to offset this decline in those of working age. It will fall as a share of the total Scottish population from 67% to 58% over the same period (see Figure 9.3).

Figure 9.3: Projected Population Aged 15-64 and as Share of Scottish Population

32. Future changes to retirement law, working practices and in the costs of pensions may change the convention that those aged between 16 and 64 are of working age. Nevertheless, if council revenue is to be maintained and supported by a local income tax and unless positive buoyancy in income tax receipts throughout this period is assumed, these results suggest that rates will have to be increased to offset the decline in the number of workers.

33. In terms of its perception as a local tax, the Scottish Labour Party suggests that local income tax would not have a visible relationship to local services, in that it would be hidden by UK income tax. We agree with this concern for that tax that was collected via PAYE, where a local income tax might be hidden alongside not only UK income tax payments but also other pay or salary deductions such as National Insurance contributions, pension contributions, trade union levies and charitable deductions.

34. Local authorities and political parties in favour of a local income tax argue that it provides a relatively easy means to weight the balance of funding towards local government, if funding until now collected via national income tax was in future collected via a local income tax. Stephen Smith, in evidence to the Local Government Committee's Inquiry into Local Government Finance, also argued that a local income tax would be capable of raising large amounts of money, unlike most alternatives. ¹¹⁵ This is because taxpayers perceive income tax to have a closer association with ability to pay than other taxes.

35. We note that international comparisons indicate that countries whose local governments raise a large proportion of their own income (such as the Scandinavian nations, the Czech Republic and Slovakia) tend to rely heavily on local income taxes. ¹¹⁶ We also agree that, in principle at least, a local income tax could fit comfortably in a structure where the balance of funding in Scotland was weighted towards local government.

Implementation criterion

36. Detailed discussion on how a local income tax might be introduced is set out in section10.

Summary

37. It is clear from the public survey work undertaken for us that the most important criterion for a local tax in the minds of most people is that it should be fair and, in particular, that it should take account of a household's ability to pay. The results show that the ability to pay is associated with people's income and therefore a local income tax is the most "fair". However, when probed further, there was little support from those who would have to pay more under a local income tax.

38.UK income tax already accounts for around one-third of UK tax receipts. Adding a local income tax would add further pressure to the existing base of income tax payers, with the potential to hit two-earner households particularly hard. With this could come unwanted economic and behavioural effects.

39. A local income tax offers the prospect of buoyancy and it is well understood as a concept by the public.

40. This leaves other criteria, against which a local income tax might score either well or badly, depending on the precise features of the model adopted. It could potentially be difficult and expensive to administer, unstable and unpredictable and that its introduction could be time-consuming and turbulent. In developing detailed models for a local income tax, we have to consider carefully whether these risks could be managed, and if this could be done without tainting the essential perceived fairness of the tax.

Taxing Wealth (Including Land and Property)

41. Wealth includes both property and other household assets ( e.g. furniture, cars, electrical appliances, jewellery). The possession of wealth, as well as income, improves the owner's quality of life. In theory, the taxation of wealth can cover either the continued ownership of wealth or the transfer of ownership. In this section, when we refer to property we mean real estate, while we refer to other forms of wealth as moveable assets. For the purposes of this report, and given the level of home ownership in Scotland (now 65% ¹¹⁷), we assume that real estate is an acceptable proxy for overall wealth.

42. It would be possible to tax total net wealth, including moveable assets, after allowing for liabilities. Indeed, several countries do this, ¹¹⁸ but some have been considering its abolition. ¹¹⁹ The tax assessment process appears to be expensive and cumbersome, and there is an incentive for taxpayers to inflate their liabilities ( i.e. take out loans in order to invest in tax-favoured or under-assessed assets like property) in order to reduce their liability to the tax. Taxes used in the United Kingdom already used to reflect transfers of ownership of land, property and other assets include stamp duty, inheritance tax and capital gains tax.

43. Property tax is the classic local tax internationally, but is being used less (although Italy has quite recently introduced a new property tax). ¹²⁰ Australia, Eire and New Zealand principally rely on property taxes as a mechanism for raising tax locally. It is also extensively used in the United States, Netherlands and South Korea. ¹²¹

44. Many of the opinions referred to in this section were expressed in relation to council tax specifically. However, we have used those that appear to be valid in relation to property taxes generally for the purposes of this section.

45. Local taxes are an integral part of the overall basket of taxes in a country and should not be viewed as something entirely separate. The Organisation for Economic Co-operation and Development ( OECD) argues that property taxation should form part of the overall tax system: ¹²²

"Enhanced taxation of property would contribute to improving the neutrality of the tax system towards various forms of wealth (the main components of which are real estate, financial assets and human capital) and thus serve to rebalance the tax burden away from labour."

46. One of the messages emerging from reviews by OECD of tax systems in certain member countries that features in its Economic Survey series has been about the opportunities that exist in many member countries to increase the taxation of real estate. This includes a recommendation about the benefits of shifting from wealth transaction taxes to taxes on property, to facilitate land developments from which governments can capture rent. ¹²³

47. The breakdown of tax receipts is shown in figure 4.1. Some 11% of UK tax receipts could be considered to come from taxes on wealth, including council tax (which is treated as if it were purely a tax on property for these purposes) and taxes on the transfer of assets. This is twice the average for OECD countries, although consistent with figures from Japan and the United States. ¹²⁴ Other than council tax, the principal wealth taxes in the UK are national non-domestic rates (which obviously apply to businesses rather than individual taxpayers), stamp duty and inheritance tax (both of which are taxes on transactions rather than the ownership of wealth).

Macro-economic criterion

48. The inclusion of property taxes within the overall basket of taxes can have a positive effect on the economy. ODPM's Balance of Funding Review Group noted that property taxes are widely used in other countries and reported ¹²⁵ that a positive feature of council tax is that it is the only non-transactional tax on residential property values. This point was echoed by Stephen Smith in evidence to the Scottish Parliament's former Local Government Committee as part of its Inquiry into Local Government Finance. He said that housing would be largely untaxed, were it not for local property taxation (currently council tax) and added:

"Encouraging over-consumption of housing by leaving it as one of the few wholly untaxed items of consumption is probably not desirable". ¹²⁶

49. Stamp duty and inheritance tax provide taxes on property transactions, which apply where homes and valuable assets change ownership. However, the UK tax system does not target the continued ownership of residential property, other than through council tax.

50. Muellbauer and Murphy ¹²⁷ argue that several factors lay behind the boom and bust in the property market in the late 1980s and early 1990s. Amongst a range of other factors, they suggest that tax changes contributed towards the boom and bust. Analysis by Rosenthal ¹²⁸ of house-price inflation in the English regions between 1985 and 1990 indicates that local tax reform was responsible for rises in the real cost of housing in this period of 10-17%. These studies (alongside evidence from Meen ¹²⁹ about the sensitivity of house prices to disposable incomes and Mortgage Interest Relief at Source ( MIRAS), which existed at the time) indicate that the presence of property taxation can act as a stabilising influence on property prices.

51.ODPM's Balance of Funding Review Group added that another feature of council tax (and presumably property taxes more broadly) that could be perceived as a benefit is that it encourages efficient use of the housing stock by discouraging people from living in a home that is larger than they need. ¹³⁰ Some other stakeholders ¹³¹ have made a similar point to us, noting the demographic need for additional housing. It could address a number of perceived problems. These include the perceived inefficiency of the use of a large domestic property continuing to be occupied by parents after their children have moved out. Also, property taxes can reduce demand for second homes.

52. Help the Aged in Scotland oppose any such suggestion, in relation to elderly people. Their submission report to our consultation refers to research involving Help the Aged, which argues that:

"There are important links between an older person's home and their sense of well-being and sense of identity, particularly when they live in a place that has links to their own personal history." ¹³²

53. This research does not simply state that older people should be encouraged to stay in their long-time home. It also says that factors like security, accessibility and social contact are also important for an older person's quality of life. We address this issue more fully in section16.

54. We do not doubt the validity of these arguments or the emotional importance of a familiar home to many elderly people. Ultimately, the relative strength of these arguments to combat competing arguments about encouraging the most efficient use of housing stock will depend on several factors that lie outwith our remit - such as the nature of demographic change in Scotland, environment concerns and other issues that constrain the pace of housebuilding in Scotland.

Fairness-related criteria

55. Many respondents to our consultation argued that property taxes are not fair because they do not take account of ability to pay within a household. Households on lower incomes have to pay a greater proportion of their income on a property tax than other households on higher incomes, including households with multiple income earners. The Scottish Liberal Democrats, Scottish National Party and Scottish Socialist Party expressed similar views. Few people said they feel that council tax provides a close link with ability to pay. Nor did they suggest that people have the option of moving to a less valuable home if their existing home is too expensive.

56. Our survey showed that many members of the public do not consider the fairness of property tax in terms of its place in the tax system overall. They appear to look upon local tax as a specific and discrete entity. We received many representations from members of the public, local authorities, political parties and other interests about the extent to which council tax is not a fair tax.

57. Some respondents considered any property tax unjust, as it is a tax on one type of spending, rather than earnings, which penalises people for spending their money wisely (sic) and investing in a home (possibly at considerable sacrifice).

58. To quote Kenneth Gibb, ¹³³ and as supported in more recent commentary: ¹³⁴

"In total, owner occupied housing is very favourably taxed when compared to other investments, other forms of housing provision, and other forms of consumption."

59. Evidence from England, ¹³⁵ and anecdotal evidence in Scotland, suggest that the availability of good schools or public transport connections can make a difference to the value of otherwise similar properties from one area to another. As a generality, it is reasonable that private benefits from public investments are partially returned in tax to the community. In the case of an increase in the value of a property arising from such community benefits, this is best achieved by a property tax.

60. Local authorities and the Scottish Labour Party describe property values as a good proxy for ability to pay, especially if a supporting benefit scheme (such as Council Tax Benefit) is taken into account. In practice, a benefit system is an important component of a property-based tax.

61. How easy the tax is to understand and to calculate will depend on its particular features.

Assessment and collection criteria

62. A good local tax should be easy and reasonably inexpensive to collect, to offer a stable and predictable source of funding and to be identifiable as a local tax. A property tax stands up well against these criteria.

63. Property taxes are relatively difficult to evade, as land and buildings cannot be hidden. The Balance of Funding Review group for ODPM stated that a key benefit of council tax is that it is easy to assess and collect.

64. This criterion should reflect how easy a particular tax is for the public to pay, as well as how easily it can be collected.

65. Unlike, for example, income tax under PAYE which is assessed and collected routinely without much action by the domestic taxpayer, property taxes require positive action by the taxpayer in order to pay the tax, even if only to set up and monitor a series of direct debit payments. There is, however, no reason in principle nor in practice why they are awkward to pay, because local authorities can put in place user-friendly payment arrangements without putting their overall collection rates at risk.

66. The likely collection costs of a property tax will depend on its particular features.

Yield-related criteria

67. From the perspective of local authorities as recipients of tax income, property taxes are broadly stable taxes with predictable yield. They require a household to pay a pre-determined amount of tax each year (unlike income and transaction taxes, where the receipts are subject to the vagaries of whatever income or spending levels might be in any given year).

68. In section8, we concluded that the criterion of stability should be extended to consider stability from the perspective of the taxpayer, in terms of how flexibly a tax can respond to meet any changes in a household's ability to pay the local tax. In this respect, property taxes are very inflexible, as a tax level set for a year on the basis of property value will not change in cases where a household's income suddenly drops during the course of the year. However, an effective benefits system can compensate for such eventualities.

69. Property taxes are not inherently buoyant. Revenue obtained from income and transaction-based taxes increase automatically in line with growth on overall income and spending levels. For property taxes, however, some form of manual adjustment is necessary to achieve buoyancy - either by increasing the rate or level of tax, or by using revaluation to bring in buoyancy.

Accountability and balance of funding criteria

70. In terms of the size of tax base, there are around 2.26 million occupied properties in Scotland on which a property tax could be levied. ¹³⁷ The presence of a local property tax within the overall basket of taxation widens the overall taxbase, reducing the risk of the total burden of tax falling too heavily on one or two categories of taxpayer.

71. The property tax base has been increasing in recent years, due to changes in the demographic profile of Scotland. The number of households in Scotland is increasing, a trend that is likely to continue, from 2.25 million in 2004 to an estimated 2.46 million in 2017. This is due principally to a reduction in average household size (the mean size of households is expected to fall from 2.22 persons in 2004 to 2.04 persons in 2017 ¹³⁸ as the number of households containing only 1 adult increases).

72. There is nothing inherent in property taxes that make them necessarily either a local or a national tax. However, experiences from council tax and domestic rates over many years show that property taxes are identifiable as a local tax. The rates of these taxes have been set by local authorities and they require the taxpayer to take positive action to pay their tax liability directly to their local authority.

73. Turning to the balance of funding, we believe that, in the UK context, it would not be appropriate for a non-business property tax to make up the majority share of local government's overall funding. It has an important role to play, but within the context of the overall basket of taxes.

74. Among unitary countries, those nations that base local taxation on property taxes tend to be those with the balances of funding weighted towards central government (notably Eire, the Netherlands and the UK). ¹³⁹

Implementation criterion

75. The existing council tax system is primarily property-based. There is nothing inherent in a property tax that makes it particularly easy or difficult to introduce. The existing council tax system is property-based and so reforming it or introducing a different kind of council tax should be more straight-forward to introduce than if it were to be replaced by another form of tax.

Summary

76. We consider that a tax on wealth has many merits in principle. In the context of local government finance, we use property as a proxy for wealth.

77. When looked at as part of the overall tax system, the fairness of property taxes can be justified robustly. Taxing property can be an effective way to broaden the range of taxes within the basket of taxation. Relying too heavily on one kind of tax places a great onus upon those who are liable for that tax. A property tax can provide a valuable means of capturing many people with reasonable means who do not contribute much through other taxes, which reduces the burden upon other taxpayers.

78. Applying a tax to property offers a relevant and valuable means of broadening the range of taxes. A property tax offers potential benefits for the economy, not least in helping to stabilise the housing market

79. The property tax contains attractive features as a local tax. In administrative terms, it can be relatively simple and inexpensive to collect and offers a relatively stable and predictable yield year-on-year. We already have, in the council tax, a system that is largely founded on property values. This means that the process of achieving change should be more straight-forward than under certain other taxation options.

80. In overall terms, an effective and comprehensive system to cope with the problems of low-income households is an essential feature of a property tax, to provide the necessary fairness, based on a household's ability to pay. We examine this issue further in section15.

81. A property tax is a valuable element within a basket of local and UK taxes. As with any other tax, there is a limit to the contribution it can make to financing local government.

Taxing People at a Flat Rate

82. The concept of taxing people at a flat rate was the basis for the Community Charge, which operated in Scotland from 1989 to 1993. Similar taxes have been operated in the past in both the United Kingdom and other countries. We understand that such poll taxes, as they are often described, are no longer used as a significant source of revenue by any major countries. ¹⁴⁰

83. The suggestion of a poll tax in our consultation paper attracted many responses. However, the idea was not discussed in much detail by most respondents, not least because the prevailing view was that the very concept of such a tax had been deeply tarnished by the experience of the Community Charge.

84. A substantial majority of respondents strongly opposed a poll tax in principle. However, some individuals favoured the Poll Tax and others expressed support for the inclusion of this option in a hybrid system. This support was based on the argument that all adult residents of a local authority area should make a contribution towards the cost of local government services there. This aspect of the tax was seen as being fair and consistent with principles of local accountability.

85. Amongst local authorities, there was overwhelming opposition to the notion of a poll tax. It was also opposed by ICAS, SRPBA, CBI and UNISON.

Macro-economic criterion

86. In terms of its potential effects on the economy, there is evidence to suggest that replacing a tax based on property with a poll tax could result in property values rising, stimulating house-price inflation. ¹⁴¹

Fairness-related criteria

87. The large majority of comments about poll taxes from responses to our consultation, together with experience of the Community Charge, show that poll taxes are largely seen as being unfair, insofar as they apply at a flat rate and regardless of a taxpayer's ability to pay.

88. Unless a poll tax was set at a very low rate that was affordable to most people, it would be heavily dependent on the benefits system to ensure that some account could be taken of people's ability to pay.

89. The concept of a flat rate payment payable by every individual is very clear. As measures were brought in to take account of different people's varying ability to pay, so would this clarity and simplicity be clouded. A flat rate tax is also simple to calculate.

Assessment and collection criteria

90. A number of respondents considered a poll tax would be difficult to collect. Experience from the Community Charge showed that enforcement then was difficult, as it was a tax on individuals, who are mobile.

91. The cost of collecting a poll tax could potentially be extremely high. Furthermore, the fact that a person's liability bears no direct relationship to his or her ability to pay would mean that either the tax would have to be set at a low level or a complex and extensive benefit system would have to be developed. The costs of either scenario, when compared with the expected proceeds from the tax, would be high. This is on top of any further difficulties that might arise from the collection of taxes from mobile individuals.

Yield-related criteria

92. In theory, the proceeds from a poll tax should be very stable, as changes in population size tend to occur only slowly. As such, the proceeds of a poll tax should be predictable. Practice suggests otherwise, as such predictability could be impaired by the difficulties of collection.

93. Given the relatively stable - albeit slowly declining - size of the adult population, a poll tax would offer negligible buoyancy. Tax levels would have to be uprated annually.

Accountability and balance of funding criteria

94. Theoretically, a poll tax provides a very large tax base, in that every adult would be liable to pay it - potentially around 4.17 million people. ¹⁴² To raise the current yield of council tax (gross of revenue received from Council Tax Benefit) ¹⁴³ and excluding any further exemptions or discounts, a poll tax would require a payment of around £470 per person.

95. One of the main purposes of a poll tax is that it should be clearly identifiable as a local tax. In this respect, poll taxes fit the bill.

96. In terms of how it could adapt to a different balance of funding, it was suggested by some that a poll tax element could at least feature as part of a cocktail of taxes, alongside other elements that better reflected ability to pay. However, the perceived "unfairness" of the tax may ensure that it could only contribute a modest amount of local revenue.

Implementation criterion

97. Even though the present council tax has a personal tax component to it, most people tend to perceive it as a property tax. We believe that introducing a poll tax to a Scotland still burned by the experience of the Community Charge would be extremely difficult. Regardless of how it was developed and framed, such a tax would almost certainly face substantial criticism from the outset as to its fairness and costs of collection, which would almost certainly leave public confidence in it fatally weakened.

Summary

98. We see no justification for considering a poll tax further as a possible replacement for council tax. It may be a simple tax to understand and to associate with local services. If compliance levels were high, it should also be stable and predictable. However, history demonstrates that the absence of a direct link with ability to pay is such a fundamental shortcoming that it would not only be highly unpopular but potentially very difficult to enforce successfully.

99. In practice, we conclude that a poll tax could only survive if set at a very low level and supported by an extensive benefits system. The costs of this and of collecting the tax would almost certainly consume a very large proportion of the tax proceeds.

Taxing Transactions

100. A tax on transactions could apply as a general sales tax that applies to most or all goods and services as VAT presently does. Alternatively, it could be applied as a selective and incremental tax, on goods such as fuel, tobacco or alcohol. It could also be applied to particular services, such as tourism and hotel beds.

101. International comparison shows that sales taxes are used, although generally in combination with other taxes. ¹⁴⁴ In federal countries, such as Australia, Austria, Canada, Germany and the United States, they tend to form a significant share of tax revenues for state government, ¹⁴⁵ but considerably less for local government. ¹⁴⁶ Amongst unitary countries, sales taxes are not used in Scandinavia ¹⁴⁷ or Ireland. They make a small contribution to local tax revenues in France, Italy, Japan, Korea and New Zealand but substantially more in Spain and especially the Netherlands (at around 40%).

102. Bed taxes and other types of tourism tax ( e.g. airport departure fees and taxes) are often used in other cities and countries, and are used in particular to assist the promotion and development of tourism locally. ¹⁴⁸

103. The concept of a sales tax attracted a mixed response from members of the public. Some individuals expressed support for this option and others mentioned it as a possible component of a hybrid system. From the MORI Scotland survey, the current national VAT attracted a relatively favourable response from respondents.

104. However, other members of the public expressed criticism. So, too, did the local government sector, although SOLACE¹⁴⁹ suggested that the idea of a local sales tax in place of a portion of RSG may be worthy of further investigation. It was also opposed by SRPBA, ¹⁵⁰SRC¹⁵¹ and CBI Scotland. ¹⁵²

105. Many of the expressions of support for a local sales tax were conditional. Key amongst these conditions were that the rate should be set nationally to avoid encouraging cross-local authority boundary shopping, that basic goods should be exempted from the tax, as with VAT, and that it should only be used to supplement other taxes.

106. The option of a local vehicle fuel tax was very unpopular among respondents. This opposition was echoed in the MORI Scotland survey, where fuel duty attracted the least favourable response of any of the current types of tax listed and 69% of respondents expressed dissatisfaction with it. ¹⁵³ A local fuel tax was equally unpopular among local authorities.

107. Responses to the consultation paper suggest a local tourist tax would be very unpopular among the public. Most comment from local authorities was also critical, although there was some interest in this option from UNISON, West Lothian Council and, particularly, City of Edinburgh Council. In oral evidence, Edinburgh pointed to the possibility of local authorities being given an enabling power to set a local tourism tax if they so wished (including, for instance, for a limited period of the year).

108. Only one tourism industry body - the British Hospitality Association (Scotland) - made a submission in relation to a tourism tax. They strongly opposed the option.

109. The question was raised as to whether a sales tax in addition to VAT would comply with EU law. Legal advice that we received indicates that the answer to the question of whether a local sales tax would breach the Sixth EUVAT Directive ¹⁵⁴ would depend to a great extent on the structure of the tax. The more distinctive it appears to VAT then the greater the chance of compatibility.

110. It appears likely that a separate rate of VAT for Scotland or for local authorities would be incompatible with this Directive, as it does not permit differential tax rates within states. However, a tax that applied only to goods (not services), was not multi-stage (as VAT is, for example) and applied only at the point of retail sale to the ultimate customer may be compatible with EU law.

Macro-economic criterion

111. One possible effect on the economy of a locally-set sales tax in Scotland would be a shift in shopping patterns from high-tax to low-tax areas. This is because sales tax income would be paid to the council in which money is spent, even if the person spending lives in another council area. The introduction of a local sales tax or any specific taxes might have an inflationary effect in Scotland.

112. A study by the IFS refers to evidence from the United States, where many local authorities already operate local sales taxes. This suggests that the extent of cross-border shopping is far more severe where a tax is set at city-level than at state level. ¹⁵⁵

113. Much of Scotland's population lives within easy travelling distance of shops in neighbouring local authority areas. Those councils that stood to gain from such a tax would tend to be those with the most attractive and accessible shopping facilities and, potentially, those that could afford to keep their tax rates low. In this case, it appears the incentive for local authorities to keep rates low would be commercial (in order to optimise tax yield from taxpayers across their broader region).

114. The risk of "tax-shopping" might be particularly great for businesses in the South of Scotland, who would face competition from counterparts in the North of England that may not have to apply such a tax. Again, the general principle would appear to apply whereby people are more likely to shop across authority borders where it is relatively easy for them to do so and where the potential savings make this worthwhile.

115. Given the potential for cross-local authority boundary shopping, there may be reason either to apply a local sales tax at a national rate or to encourage local authorities to set similar tax rates.

116. The growth of internet shopping gives rise to increasing concern insofar as transactions are concerned, because remote and mobile sellers are difficult to tax. Experience from the United States is that many internet sellers do not have to collect sales tax if they have no physical presence in the State. Although the ultimate buyer may be required to pay tax on internet sales, substantial amounts of revenue are lost because the compliance rate is low. ¹⁵⁶

117. We are also conscious of broader economic consequences that could arise from the application of a dual layer of sales taxes at national and local levels, including inflationary pressures, market distortion and interference with macro-fiscal tools.

118. Submissions suggest the introduction of a tourism tax could have a stifling effect on the tourism industry in Scotland. The extent of this effect would depend on the size and nature of any levy that was introduced, and on the uses to which the receipts were put. However, tourism taxes work successfully in other countries.

119. The most frequently raised concern from respondents about a tourism tax relates to its potential effect on Scotland's tourism industry. Support tended to be predicated on the expectation that proceeds would go direct to the local authority in question with no consequences upon their entitlement to AEF. As a result, tourism tax is perceived as a modest supplementary tax for those authorities that could stand to benefit from it.

120. The fact that a tourism tax is perceived as an optional supplementary tax should mean that concerns about impact of the tax on the tourism industry (and also the cost of its collection) could be addressed as part of the decision by each authority in deciding whether or not to introduce it (and if so, how).

Fairness-related criteria

121. There is a clear relationship between transaction taxes and ability to pay. However, such taxes have a regressive nature which undermine their fairness. This is because lower income households are likely to consume more and save less than higher income counterparts. Furthermore, a greater proportion of this spending will be on goods and services that are essential for basic living.

122. Presumably, it is partly to address this regressive element that the UK Government does not apply VAT to "essential" products like many foodstuffs, children's clothes, books and newspapers, while energy is subject to a reduced rate. However, it remains regressive because those people on low incomes, who may be on full Council Tax Benefit or below the starting rate threshold for income tax, would still have to pay tax for any non-exempt purchase that they made. Exemptions from VAT and sales taxes are less effective in addressing fairness because they apply to everyone.

123.NERA refer to evidence differentiating between levels of regressiveness in the short-term and long-term. ¹⁵⁷ Taking account of "whole-of-life" scenarios, many people will tend to spend all of their income in their youth and old age and then save in their "prime earning" middle years. Nevertheless, sales taxes are regressive for elderly people on low incomes, whose consumption is high relative to their income.

124. Some respondents described a tax on fuel as being unfair, and particularly prejudicial to rural populations, people with limited mobility and those on low incomes who need to drive.

125. We believe a local sales tax could be able to operate independently of the benefits system, if it were used as a supplementary tax or was responsible for collecting a relatively small share of local government revenue. However, we would question its introduction as a full replacement for council tax without measures being set up to counteract its regressive potential.

126. The concept of a local sales tax could be confused with that of VAT. However, a tax based on final retail price is probably easier to understand than VAT, which is applied at every stage of production and development of a product or service. On a transaction-by-transaction basis, a tax based as a percentage of final retail price would be straight-forward to calculate.

Assessment and collection criteria

127. Well-established arrangements already exist for the payment of VAT to HMRC. To this extent, a sturdy possible basis for collecting and ensuring payment of a local sales tax already exists, at least in relation to VAT-registered businesses located in Scotland.

128. Additional compliance arrangements would have to be considered if a local sales tax were to apply to businesses in Scotland that are not VAT-registered. Given the likely difficulties under EU law of introducing a local sales tax in a way that mimicked VAT, the collection system adopted would have to address how the tax payable was both calculated and verified in order to minimise avoidance.

129. Consideration would also have to be given to how such a tax might apply to businesses based outwith Scotland. A drift from local retailers towards internet-based businesses based elsewhere would create difficulties in collecting the tax.

130. From the perspective of the taxpayer, paying a local sales tax should be simple, as it would be automatically charged as part of their transactions.

131. The cost of collecting local sales tax could be high. A local sales tax would have to be introduced on a different basis to that which applies to VAT, as indicated above and new arrangements would have to be introduced for capturing the local sales tax proceeds from all businesses, both those that are currently and those that are not currently VAT-registered.

132. Compliance with a local sales tax regime could be expensive for business in Scotland which would have to calculate liability for both VAT and local sales tax. National companies might also encounter difficulties in applying a multitude of different tax rates. NERA reports that, in the United States, around half of all State governments allow retailers to deduct a specified percentage from the sales taxes they pass on to the State, in recognition of their role as 'tax collector'. ¹⁵⁸

Yield-related criteria

133. A local sales tax would be naturally buoyant, with some volatility given its association with income levels and based on the nature of VAT receipts. Therefore, we have concerns about its stability and predictability. Figure 9.4 below provides a proxy for the possible yield of a sales tax. As Figure 9.4 shows, evidence of Scotland's net VAT receipts shows receipts have consistently exceeded GDP growth with some volatility since 1993. The estimates should be treated with extreme caution. ¹⁵⁹

134. From these data, it appears that the real terms revenue generated by a local sales tax would be buoyant, as its index exceeds that of GVA (Gross Value Added), and also cyclical due to a degree of volatility displayed over time. While we cannot infer too much from that in the context of a local sales tax that had a different basis from that which applies to VAT, it offers a degree of comfort about the ability of a sales tax to provide a degree of stability if the broader economy is managed in a controlled and sustained way. Stability could be further enhanced by subjecting essential items, which would be purchased regardless of the state of the economy, to the tax. However, this would clearly be a regressive measure.

Figure 9.4: Scottish percentage share of VAT receipts and GVA¹⁶⁰

135. Any future changes in shopping practices, such as increased internet shopping, could severely affect income raised from the tax. There could be a drift of revenue collected from councils that set higher taxes to those that set lower taxes.

Accountability and balance of funding criteria

136. Sales taxes offer a potentially large tax base. In practice, the application of exemptions on products like many foodstuffs, children's clothes, books and newspapers, that are exempt from VAT, reduces the taxbase.

137. Scotland's share of the United Kingdom's VAT revenue for 2003-04 was estimated to be £5.68 billion (or 8.2% of total UKVAT receipts). ¹⁶¹ That year, council tax income (including Council Tax Benefit) amounted to £1.84 billion, ¹⁶² or around 32% of the value of VAT revenue.

138. The tax base of specific taxes is much smaller than for VAT. At a UK level, HM Treasury has estimated it would receive £24.6 billion in fuel duties in 2005-06, compared with £76.3 billion in VAT. If we assume that around 10% (or £2.5 billion) of these fuel duty receipts are attributable to Scotland, the rate of fuel duties would have to increase by 60-70%, everything else remaining equal, in order to replace council tax proceeds.

139. One of the arguments for a tourism tax is that it would extend the tax base, to include overseas visitors to Scotland. Visitors benefit from infrastructure and public services but would not otherwise contribute directly towards the cost of this were it not for a tourism tax.

140. On a transaction-by-transaction basis, local sales tax charges should be clearly identifiable, particularly if taxes were not included in price tickets. Over the course of a year, however, it is likely that few taxpayers would be aware of how much they were paying in total in local tax, especially to their own local authority. It is also our view that, given the opportunities that exist for cross-border shopping, particularly in Central Scotland, there would be little evidence of any association between taxation to residents' own local authority and the provision of local services.

141. Turning to the balance of funding, transaction taxes are typically used in other countries (particularly in unitary countries or at local level in federal countries) as a supplementary tax. Their potentially regressive nature and the risk of adverse economic effects appear to leave them not well suited to financing a large share of local government expenditure.

Implementation criterion

142. A local sales tax could require considerable time to introduce, not least to allow business with the time it would need to prepare for collecting the new tax.

143. A separate issue arises over how product prices are referred to in national or regional advertisements, when varying local sales tax rates might result in different prices being payable in two different branches of the same chain in neighbouring local authority areas. In the United States, prices shown tend to exclude sales taxes, which allows for account to be taken of local differences in tax rates payable towards the same product or service. However, NERA suggest that it might be difficult for retailers to include references to pricing in national advertising in the EU, as existing consumer laws require retailers to advertise tax-inclusive prices. ¹⁶³

Summary

144. It is difficult to make a local sales tax a true local tax in essence, because the proceeds of residents' tax payments would not necessarily go to their own local authority. A sales tax could change people's shopping behaviours, with one possibility being the leaking of the taxbase itself if internet shopping based outwith Scotland were to develop much further, undermining the stability and predictability of the tax in so doing.

145. The fact that a local sales tax could not be administered easily alongside VAT (as the two taxes would probably have to be quite different in form to satisfy EU law) would make the collection of the tax more difficult and expensive than might be expected at first sight.

146. The suggestion of a local motor vehicle fuel duty attracted strong opposition and has little to commend it.

147. We therefore rule out sales taxes and motor vehicle fuel duties as a core feature of a local tax system.

148. There may be more merit to the suggestion of a local tourism tax, but only a modest and supplementary feature of a local taxation system.

Conclusions

149. Of the options considered in this section, we have concluded that only taxes on property or income justify detailed further examination. These are assessed more fully in the following sections.

150. The only exception might be a local tourism tax which is considered further in section17.

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