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Section 19: Equalisation
Equalisation of Resources
1. A central feature of the present local government finance system is the equalisation of each local authority's financial resources. There are wide variations in the size, demography and topography of the 32 authorities, ranging from, at one extreme, the 4 Cities and, at the other, small, sparsely populated rural areas such as the 3 Islands Councils. Without the equalisation of financial resources, many authorities would find it impossible to provide even a very basic level of services without putting an intolerable burden on local taxpayers.
2. The general principle of equalising public funding in the UK is long established and, so far as local government is concerned, now enshrined in Article 9.5 of the European Charter of Local Self-Government. Support for the principle was strongly endorsed by all of those - especially local authorities and other local government bodies - who commented on the matter in response to our Consultation Paper. We have, therefore, proceeded during the Review on the basis that equalisation of resources to protect financially weaker local authorities is a "given".
Process of Equalising Resources
3. The equalisation of local authorities' financial resources is a 2 stage process which forms part of the procedure for distributing the total level of Aggregate External Finance ( AEF) amongst the 32 local authorities. The first is to equalise differences in local authorities' assessed spending needs. This is done through the Grant Aided Expenditure ( GAE) distribution system.
Grant Aided Expenditure ( GAE)
4. The relative spending needs of local authorities have for many years been assessed by what is known as the "client group approach". This allocates to each of the 32 authorities a share of Grant Aided Expenditure ( GAE), the total of which, as well as its split between local services, is determined by Scottish Ministers as part of the overall local government finance settlement. The total of GAE represents Ministers' view of what authorities need to spend to provide services.
5. The "client group approach" is an objective method of calculating a relative GAE figure for local authorities which takes account of variations in the demand for services and the costs of providing them to a similar standard and with a similar degree of efficiency. The approach uses primary and, where appropriate, secondary indicators to assess demand and cost. Key to the validity of the process is the availability of objective data outwith the control of local authorities and which offer plausible explanations for inter-authority variations in the demand for and costs of providing services. In a small minority of cases, in the absence of any other data, budgeted or actual expenditure figures are used as indicators.
6. A range of indicators is used to assess relative demand for and costs of services. For example, the primary indicator for the Primary School Teachers GAE assessment is the number of primary school pupils in each local authority area, with a secondary indicator of the percentage of pupils in small rural schools. The sum of each authority's share of each of the service and sub-service GAEs determines an overall GAE figure for that authority that is then used in the equalisation process. Because it is distributing an aggregate level of GAE which has been pre-determined by Scottish Ministers, the system is self-financing. This means that there are "winners" and "losers" amongst authorities whenever any changes to the distribution formulae are made.
7. Any changes to the GAE distribution system are, in the first instance, considered by sub-groups of the joint Scottish Executive/Local Government Three Year Settlement Group, the membership of which comprises officials from the Scottish Executive, COSLA and individual local authorities. Changes to the system are subject to the approval of Scottish Ministers.
8. All the local authorities and local government organisations that responded to our consultation paper had something to say about the GAE distribution system. Many expressed more concern about ensuring that the overall size of the cake was adequate, that new burdens placed on local government were properly funded and that funds were not "ring fenced" than they did about how the cake was sliced up. Most of the responses referred in general terms to strengths and weaknesses of the distribution system. A number of local authorities expressed concern about particular aspects of it. For example, it was felt that insufficient account was taken of deprivation in both urban and rural areas. Two authorities - Aberdeenshire Council and Orkney Islands Council - made more detailed submissions about the system.
9. In its evidence to us, COSLA stated that there was a broad consensus amongst local authorities that the present formulae should be retained for the distribution of "core" Scottish Executive funding and emphasised the importance of maintaining stability in each authority's share of the cake. We were further told the Convention accepts that the present distribution formulae may not take full account of the impact on demand for and costs of services of deprivation and poverty, super-sparsity and diseconomies of scale, but argued that those issues could be addressed only once new monies to deal with them had been provided by the Executive.
10. Aberdeenshire Council raised both general concerns about the distribution system and a number of detailed points regarding particular GAE assessments. Orkney Islands Council expressed concern that its per capita level of funding was badly out of line with that of the other two Islands Councils. The Islands Council further argued that the whole distribution system increasingly lacks fairness and transparency, that it is in "serious need of overhaul" and that the process of distribution should be made independent of both the Scottish Executive and local government. When questioned about them, COSLA did not accept Orkney's general arguments. In particular, COSLA rejected the idea of making the distribution system independent of the Scottish Executive and local government, arguing that there was no need for a quango to undertake this function.
11. We note 275 that there is international precedent for decisions on the distribution of central government support for local government being made by independent bodies. Examples are the Inter-Government Commissions in Australia, Canada and the United States. In those countries, determination of the aggregate level of transfers from central to local government remains the responsibility of the central government. But the task of determining the formulae used for the allocation of the funds-concerned amongst local authorities is delegated to the Commission.
12. "The mechanism for distributing grant between authorities" is an "associated issue" in our remit and, as we think COSLA and individual local authorities - including Aberdeenshire and Orkney Islands Councils - appreciate, we have not been in a position to conduct a fundamental review of the GAE distribution system. Nonetheless, the fact that at least two councils have serious reservations about the present distribution suggest to us that the system as a whole needs to be kept under regular review. We recognise fully the desirability of stability in the distribution arrangements, especially now that three year budgeting has been introduced, but believe that a balance needs to be struck between, on one hand, stability in levels of funding and, on the other hand, ensuring that the system is kept under regular review to ensure that it remains as fair and objective as possible.
13. To assist this process and, on the basis of the international experience referred to above, we think that there might be a case for introducing an independent element into the GAE distribution system. One option could be a wholly independent body on the lines of those in Australia, Canada and the United States. Such a body would clearly have to consult local government on its proposals, especially having regard to the terms of Article 9.6 of the European Charter of Local Self Government. An alternative could be the appointment of some independent members to the existing Scottish Executive/Local Government Groups. We recommend that, in consultation with COSLA, Ministers should consider those possibilities.
Equalisation of Tax Base
14. The second stage of the process is to equalise differences in each authority's non-business tax base and consequently the ability to raise income from, at present, the council tax (the business tax base is now equalised through the pooling of non-domestic rate income and its distribution to authorities on a per capita basis). There are large differences in the number of properties subject to the council tax in each local authority area. For example, in 2004-05, 276 there were over 274,200 properties in Glasgow City and only 9,380 in the Orkney Islands. Properties in each area are spread across the 8 council tax bands, but, for ease of comparison, the numbers are converted mathematically to Band D equivalents.
Implications for Equalisation of Tax Base of any Change in Local Domestic Taxation System
15. We recognise that any change in the local domestic taxation system would have implications for the equalisation of each local authority's tax base. In purely arithmetic terms, this would be straight-forward in the case of our recommended local property tax. Instead of equalising differences in the number of Band D equivalents, tax bases would be equalised on the basis of differences in the total value of domestic properties - perhaps expressed as the product of a standard percentage tax rate - in each council area.
16. We further recognise that this could affect the stability of three year local government finance settlements. There are a number of possible ways of dealing with this. For example, local authorities might have to accept that updated tax bases would not be applied during the course of any three year settlement period. Alternatively, figures for years 2 and 3 could be less certain than at present or levels of support could be re-determined subsequently. How this is dealt with is something the Scottish Executive and local government would have to consider.
17. In the case of local income tax, equalisation of each authority's tax base would raise problems which could be difficult to overcome. Those problems would arise whether the local income tax rate was set nationally by Scottish Ministers or locally by each council.
18. The number of taxpayers in each area (even if information on this for the 32 Scottish councils could be supplied by HMRC) would not provide an appropriate basis for equalisation because of inter-local authority population movement and the fact that levels of taxable income can vary significantly from one taxpayer to another and from one tax year to another.
19. We consider that the basis for equalisation would have to be the local income tax yield in each council area. The use of historical tax yield data would have limitations because of the above factors. In any event, while HMRC issue historical tax yield data for a number of English local authority areas, they do not publish such data for Scottish (or Welsh) local authority areas because of the small sample size in many cases. 277
20. It would therefore be necessary to devise arrangements that allowed local income tax yield in each local authority area to be compared. Ideally this should be the actual yield for the year to which the equalisation relates. Because the self-employed do not have to submit their self-assessment returns to HMRC until 31 January following the end of the tax year in question, it could be year 3 before actual local income tax yield information for year 1 was available. The only way actual yield figures could be used to equalise each council's local income tax base would be to distribute AEF for year 1 initially using some sort of broad-brush proxy for tax yield (perhaps a standard percentage of the adult population), and in year 3, when actual tax yield information was available, to re-determine the distribution of AEF for year 1. Any such re-determination would produce "winners" and "losers" as compared with the original distribution. It would consequently introduce even more uncertainty and instability into the local government finance system as compared with the difficulty relating to regular revaluations under LPT which is discussed above and not only undermine but negate the benefits of three year settlements. Re-determinations of AEF would have to become a regular feature of the local government finance system if actual local income tax yield was to be the basis for equalising tax bases.
21. A possible alternative approach would be to operate a local income tax system in "shadow" form in years 1 and 2 - in other words, on a notional rather than actual basis - and then to use the tax yield figures for year 1 as the basis for equalising each councils tax base in year 3. Thereafter the local income tax system could actually be introduced and each council's tax base could be equalised using actual tax yield information for the most recent tax year for which it was available. But this possible alternative would involve placing a responsibility on employers operating the PAYE system and those subject to self-assessment to assess local income tax liability for years 1 and 2 on a purely notional basis. It might be difficult for them to accept that this burden was necessary simply to aid the distribution of AEF. And, of course, the notional local income tax yield figures would be historical data and subject to the limitations already outlined. Regular re-determinations of AEF could be avoided only if local authorities were prepared to accept a swings and roundabouts approach to the use of historical local income tax yield data for the purpose of equalising tax bases.
22. We think that, if a local income tax were introduced, a good deal of thought would have to be given to how the tax base of each local authority could be equalised for the purpose of distributing AEF. Another aspect of the difficulty of determining local income tax yield at an individual local authority level, is the problem authorities could face in preparing budgets and this is considered in Section10.
23. In the case of any hybrid local taxation system, it would be necessary to take each of the component taxes into account in equalising authorities' tax bases. Any hybrid which had a local income tax component would give rise to the same difficulties which are discussed above.
Possible Departures from "Full" Equalisation of Financial Resources
24. As indicated above, we believe that any departures from "full" equalisation of financial resources should be very much at the margin. But we consider that there might be a case for excluding any income raised from a tourist tax (which is considered in Section17), especially if that income was used exclusively for tourism developments. We also believe that, if a Local Authority Business Growth Incentive ( LAGBI) scheme (which is considered in section17) was introduced in Scotland, there would be a case for excluding from the non-domestic rates income pooling arrangements any growth in rates income covered by such a scheme.
Conclusions
25. We believe that equalisation of financial resources must remain a central feature of the local government finance system, both to protect financially weaker local authorities and to avoid "post code lotteries" in the provision of essential services.
26. We further believe that any departures from "full" equalisation should be very much at the margin.
27. As regards GAE distribution, we believe that a balance needs to struck between stability and ensuring that the system is kept under regular review.
28. We recognise that any change in the local non-business taxation system would have implications for the equalisation of each council's tax base. In the case of our recommended LPT, equalisation should be relatively straight forward. But in the case of local income tax it could raise considerable problems.
Recommendation 16: We recommend that equalisation of financial resources remains as a central feature of the local government finance system. Any departures from "full" equalisation should be very much at the margin.
Recommendation 17: We recommend that, in consultation with COSLA, Ministers should consider the possibility of passing responsibility for the distribution system to an independent body or, alternatively, appointing independent members to the existing Scottish Executive/Local Government Committee which oversees the system.
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