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Section 7: The Balance of Funding

Introduction

1. On the assumption that there is a place for local taxation in the local government finance system, a question arises as to what size of contribution a locally-set tax should make to funding for local authorities. In this section we discuss that question. We also consider how important a question this is as part of the overall debate about local taxation in Scotland.

2. At its simplest level, the balance of funding is the balance between Scottish Executive funding towards the revenue budgets that councils have to deliver local services and local funding. This is most frequently expressed as the ratio between:

• a combination of what councils receive from local businesses (Non-Domestic Rates) and the Scottish Executive (Revenue Support Grant and specific grants); and
• the income councils receive from local residents (at present this is the income councils receive as council tax, either directly from local residents or, in respect of those who are in receipt of Council Tax Benefit, from the Department of Work and Pensions).

3. For the purposes of this section, we use this definition of the balance of funding unless otherwise stated. However, this ratio does not take account of all local authority revenues. Fees and charges which councils receive for meeting the costs of various services ( e.g. the use of leisure facilities) are excluded, as are rents and other income from housing services.

4. As indicated in section 3, as recently as 1988-89 the balance of funding was almost 50:50 between Scottish Office and local funding. This balance shifted by 1996-97 to 87:13. More recently, the proportion of local funding has increased and, in 2004-05, the balance of funding was 80:20. ⁸¹

5. The balance of funding is generally discussed as a single aggregate figure for Scotland as a whole. This average figure masks some extensive differences between authorities. Local authorities with a lower tax base and/or which face greater levels of need or higher costs to deliver services receive more grant from the Scottish Executive than other areas. The two extremes are City of Edinburgh, with a balance of funding of 75:25, and Comhairle nan Eilean Siar where the balance is 92:8. ⁸²

6. For the purposes of the following discussion, references to particular balances of funding should be read as Scotland-wide average ratios, which would not necessarily apply in every local authority area.

Public Understanding About the Balance of Funding

7. The two pieces of public research conducted for us both tested people's understanding about the balance of funding in Scotland. The results show that, while the public tend to believe that council tax contributes a larger share of local government funding than in fact it does, people do appreciate that councils receive more of their income from other sources.

8. The representative sample survey conducted by MORI Scotland found that people's estimate of the balance of funding was that it was skewed towards local government, with the mean figure for the proportion raised through council tax being 44%. A large number (42%) said they did not know.

9.GfKNOP's deliberative research for our Committee found that participants were able to recall various key sources of local government finance, notably council tax; charges and "fines", and central government grants - with council tax typically being mentioned first. Furthermore, most participants had a reasonable awareness of the balance of funding - most assumed that over 65% of funds for local services came from central government.

10. In contrast, in equivalent work conducted by NOP for the ODPM Balance of Funding Review in England, most people thought that most funding for local services was raised by local authorities. ⁸²GfKNOP suggests that people in Scotland may feel closer to their local authorities than people in England.

11. It has been argued that strong public awareness of how local services are paid for is an important element of public accountability. In this respect, there remains considerable room for improvement.

Stakeholders' Views About the Balance of Funding

12. There is strong support from the local government sector for a change in the balance of funding with many arguing for a 50:50 balance, or something approaching that. This echoes the Scottish Parliament's former Local Government Committee (since replaced by the Local Government and Transport Committee) which in 2002 recommended a change in the balance of funding "to 50:50, or as close to 50:50 as possible". ⁸³

13. The Scottish Green Party and Scottish Conservative Party argue in favour of local authorities raising a greater proportion of their own income. The Scottish Labour Party support what they describe in their submission as "a balance".

14. However, the general public appears to be less enthused about changes to the balance of funding. The MORI Scotland poll conducted for us found that, once respondents were told of the actual balance of funding, 48% said they were happy with the present situation, while 37% felt that local authorities should have more revenue raising powers. Most participants in the GfKNOP focus groups were happy about the sources of funding. Generally, GfKNOP found that people did not want to see the current balance of funding changed.

15. Our consultation revealed quite strong demand (around 90 responses or some 30% of individuals who responded to the Consultation Paper) for a change in the balance of funding in the opposite direction. This was seen as being achieved through either 100% funding from the Scottish Executive or a nationally set local income tax.

How Important is a Particular Balance of Funding?

16. The arguments made to us in evidence about the importance of weighting the balance of funding more in favour of local government can be categorised as follows:

• The relationship between the balance of funding and balance of powers between local and central government;
• The relationship between the balance of funding and levels of public engagement in local affairs;
• Public attitudes towards the balance of funding;
• The "gearing effect";
• The concept of "parity of esteem" between central and local government;
• Scottish Executive's funding levels; and
• Whether or not we can learn anything from practice in other countries.

Relationship between balance of funding and balance of powers

17. It was argued that the balance of funding should reflect the ratio between local government's statutory responsibilities and its discretionary powers.

Relationship between balance of funding and public engagement in local affairs

18. A number of local authorities felt that local accountability would be increased by having a greater proportion of their income that was seen to be raised locally.

19. The Committee sought evidence about whether the balance of funding played a significant role in stimulating public engagement in local affairs. We looked at the level of voter turnout as a test for public engagement. There is some evidence both ways.

20. John Gibson of EFG Research provided the Scottish Parliament's former Local Government Committee with some evidence that people are more likely to vote in local elections when local domestic tax makes up a larger proportion of local government spending. ⁸⁴ This was based on research on the relationship between the balance of funding and the turnout in local elections in England between 1975 and 1991. However, research for the ODPM Balance of Funding Inquiry found that there was no available evidence demonstrating any direct connection between the balance of funding and election turnout. ⁸⁵

21. As discussed in section5, MORI Scotland reported that respondents to our survey said that, of the factors that were most important in determining voting intentions at local elections, what candidates say or do on issues and policies affecting the local area ranked first (50%); if they are likely to spend public money carefully (46%); what candidates say or do on policies affecting Scotland or the UK (34%) and what candidates say about levels of council tax (33%). Mention of council tax was significantly more likely to be made by those who were dissatisfied with council tax than among those who were satisfied (43%, or 16% of the total respondents).

22. In the Scottish context, the Committee could find no objective research to support the argument that changing the balance of funding to, say, 50:50 would increase local accountability through increased electorate turn-out. As previously mentioned, City of Edinburgh and Comhairle nan Eilean Siar are at opposite ends of the present balance of funding spectrum with the balance being 75:25 in the former and 92:8 in the latter. At the 2003 local elections, the turn-out figures were 51.8% in Edinburgh and 64.1% in Eilean Siar (although it should be noted that both Holyrood and local elections were held on the same day). The latter figure was the highest in Scotland. Edinburgh's turn-out was only marginally higher than the Scottish average of 49.8%.

23. Overall, the evidence from research conducted for our Committee tends to agree with that of the ODPM Balance of Funding Inquiry. GfKNOP reported from the deliberative focus group work that there was no evidence that a shift in the balance of funding weighted to local government either would affect levels of public engagement with local government or that it would have any effect on local accountability.

Public attitudes

24. Whether or not a change in the balance of funding would enhance public engagement in local politics, we received contradictory evidence about the public's broader attitudes to changes in the balance of funding.

25. A strong message came from members of the public who responded to the written consultation that the balance of funding is too skewed towards local taxation. The key reason for this appeared to lie in respondents' dissatisfaction with the fairness of local taxation. Other significant reasons were that a stronger focus towards central government would better reflect the reality of who actually manages local services, and in some cases distrust in the ability of local government to be responsible in their use of tax-raising powers.

26.GfKNOP reported that participants in the deliberative focus groups they undertook generally did not want to see the current balance of funding changed. The principal reasons given related to distrust of council tax; lack of faith in councils to raise and spend money appropriately and efficiently; and concern about the impact on deprived areas in Scotland. Furthermore many felt that central government should regulate and monitor local authorities in their tax-raising function.

Effect on gearing

27. Local authorities argue that a change in the balance of funding is required to deal with the "gearing effect". Gearing in this context is the result of the situation where, when only a small proportion of local government funding comes from local taxes, even modest increases in overall council spending require large percentage rises in local taxes For example, in cases where council tax makes up 20% of council revenue (or £1 in every £5), a 1% growth in total spending with no commensurate increase in central funding requires a 5% increase in the council tax.

28. We received insufficient evidence to assess how important the gearing effect is to the public in Scotland. However, in their 2003 Report, the ODPM Balance of Funding Review group argued that, while the public in England has little interest in the balance of funding itself, they are concerned about rates of increase in council tax that might arise from the gearing effect. ⁸⁶

29. For local authorities, the gearing effect exaggerates the public's perceptions about the size of the year-on-year increases in the council tax and leads to the conclusion that councils are responsible for these rises due to their inefficiencies and profligate spending. The argument is particularly important to local authorities because of their claim that the Scottish Executive is not providing the additional funds needed each year to fulfil their current and new responsibilities. A high gearing effect might be seen both by the Executive and by the electorate as being desirable in helping to curb council tax increases and to drive out efficiency savings.

30. Most recently, Sir Michael Lyons has expressed concern that the gearing effect in England "can lead to a distorted focus on the marginal pound rather than the total budget of an authority". However, he was quick to add that changing the balance of funding alone will not, in his view, address the pressures on local services. ⁸⁷

31. We believe this is an important point. The key issue is about overall levels of funding and overall spending, not about marginal changes in funding. The gearing effect is not by itself the inevitable consequence of a balance of funding weighted heavily to the Scottish Executive. What the gearing effect does is exacerbate tensions that already exist in the funding system. Whether these tensions are due to inadequate levels of central funding for local services, or whether they reflect a failure on the part of local government to deliver services as efficiently as they might is difficult to decide. There is presently no objective and measurable basis upon which to assess either the sufficiency of Executive funding for local government or the efficiency of councils in delivering services. ⁸⁸ As a result, the gearing effect creates considerable acrimony in the annual debate between the two sides.

Parity of esteem

32. Several councils highlighted the importance they attach to the "parity of esteem" between central and local government. They highlighted the ability to set a sizeable proportion of their income locally as being a litmus test of this parity of esteem.

33. Other than arguing for "parity of esteem" with central government, no local authority explained why a 50:50 ratio in particular is important. Indeed, some councils argued that the principle of a robust local tax and funding system is more important than the precise ratio.

34. The Committee do not accept that the balance of funding should be an important measure by which the power, influence and beneficial impact of local government is judged. The primary role of local government is to develop and deliver high quality services for local residents and businesses. We believe the more appropriate debate is for local government to demonstrate why it should be given greater authority and freedom to shape and deliver services for their local populations with less intervention from the Scottish Executive. The balance of funding should not be treated as a proxy for the balance of power.

Scottish Executive funding levels

35. In their written evidence, SOLACE argued that greater responsibility should be given to local government to raise funds, because of what they described as "structural faults" in the current funding system.

36. The Committee recognises the importance of adequate levels of Scottish Executive funding for local government. However, the significance of adequate funding is so great that any shortcomings require to be resolved in their own right, rather than through changes to the balance of funding.

Practice in other countries

37.UNISON argued that the balance of funding is too centralised and more centralised than most of the rest of Europe. Certainly the UK appears to have a greater degree of central funding than most other European countries.

Figure 7.1: Taxes, grants and other revenues as a percentage of total subnational revenues⁸⁹

38. The UK, Eire and the Netherlands fund local government in a broadly similar way, in terms of the split between grant income, local tax revenue and non-tax revenue. As a percentage of total tax revenue, local tax revenue, is very low in the UK. In most other countries, a significantly larger proportion of funding comes from local/sub-national tax revenue, as Figure 7.1 shows. However, some countries with a higher proportion of local tax revenue appear to have even less discretion over how the level of tax is set.

39. Research by John Loughlin of Cardiff University on international comparisons ⁹⁰ found a general trend towards increasing the proportion of funds that local authorities receive as transfers from central government, with local revenues falling as result. Transfers were increasingly block, rather than ring-fenced, grants. He also found that, in most cases, local authorities had little influence in determining the size or rate of revenue sources, some of which was effectively assigned revenue.

How to Change the Balance of Funding

40. There appear to be three ways through which the balance of funding could be weighted more to local government:

• By removing from local government any funding responsibility in relation to certain services for which the Scottish Executive has lead policy responsibility. These services would be paid for directly by the Executive;
• By allowing local authorities to set non-domestic rates; or
• By increasing the share of local government income that is funded directly by local residents.

Direct funding from Scottish Executive for certain services

41. This option would transfer control of funding from local authorities for those services where councils have little or no scope in practice to determine or influence how the services are delivered. The overall local government budget would fall but, within that total, the amount of money that councils receive from local taxes would stay the same. As a result, the amount of funds that councils received from local taxes would increase as a share of their total budget.

42. For example, education accounts for some 40% of the local government budget at present. If the cost of providing education were funded separately and directly by the Executive, the total local government budget would fall to around 60% of its current levels. If council tax levels remained the same, council tax would provide around one-third of that remaining 60%.

43. A number of suggestions were made as to which services might be most suitable for transfer from local to central government control (see, for example, the suggestion made by Arthur Midwinter for transferring responsibility for education to the Scottish Executive, discussed in section 5).

44. It may be appropriate for certain services to be funded directly by the Executive. However, it is not for us to advocate such a course of action, particularly as it is not clear, on a service-by-service basis, what the extent of local discretion is. What is clear to us is that such decisions should be taken because they most effectively ensure quality in the delivery of these services, not simply to secure a change in the balance of funding.

Relocalisation of non-domestic rates

45. This was of considerable interest to both local government and those business interests that responded to our public consultation.

46. Many of the local government sector argued for councils to be given the power to set non-domestic rate levels, as well as council tax. Were this to happen, the Scotland-average balance of funding would change from around 80:20 to approximately 60:40.

47. This change would only affect the balance of funding as it relates to the gearing ratio. It would do nothing to change the balance of funding, in terms of the proportion of local government spending that local residents pay through local taxation. The Committee are not convinced that there is a meaningful link between local funding and local accountability but even if there were, there is nothing in this proposal that would enhance local accountability.

48. The pertinent issue is the effect that such a change might have on the future relationship between local government and the business community. Supporters of re-localisation argue that it would foster a better relationship between local authorities and business in their areas. It has been claimed that this relationship was undermined by the decision of the then UK Government in 1989 to nationalise the setting of Scottish poundages as part of the move to a Uniform Business Rate.

49. In the eyes of Scottish business representatives, however, the relationship between local authorities and local businesses has improved, not deteriorated, since 1989 and they have claimed that the reason for this was the nationalisation of non-domestic rates. The Scottish business community also argue that a local tax would be less predictable than nationally-set tax; that there would be little incentive for a council not to increase a locally-set tax; and that councils are not democratically accountable to businesses. For all those reasons, business appears to be strongly against re-localisation of non-domestic rates.

50. The Committee question how many of the arguments about the likely effects of re-localisation on local government's relationship with the business community are intrinsically correct in principle. The arguments' validity appears to depend on how relocalisation was re-introduced. For instance, if a relocalised non-domestic rate was introduced, subject to a cap equal to the rate of any increase in local domestic taxes, this might address the concerns of the business community both about the predictability of a locally-set rate and whether councils could be trusted to keep non-domestic rate increases down.

51. We note from recent reviews in England that a more pragmatic relationship between local government and the business community appears to operate there. In their evidence to the ODPM Balance of Funding Review, CBI expressed support for the idea of allowing some local retention of business rates. ⁹¹ Furthermore, in an attempt to reassure business interests, virtually all local authorities and local government organisations argued that the annual increase in NDRs should be linked to the increase in council tax.

52. The question of whether local authorities should have any role in setting business rates also appears to have had a high profile in Sir Michael Lyon's evidence gathering. His Interim Report from December 2005 ⁹² suggested a stronger willingness within the business community to give local authorities a role in tax-setting than their counterparts in Scotland evinced in evidence to us. ⁹³ But there was greater opposition from the CBI in England to the proposal following the publication of Sir Michael's subsequent paper National Prosperity, Local Choice and Civic Engagement. ⁹⁴

53. Overall, we do not believe the potential economic effects of re-localisation are significant enough of themselves to make a substantial contribution to the debate either in favour of or against re-localisation.

54. One factor concerns how much of any increase in non-domestic rates actually would be paid in net terms by local businesses. There may be a trade-off between rent and other property costs, so that an increase in rates would dampen the ability of landlords to secure large increases in rents. A 1995 article by the Institute for Fiscal Studies ⁹⁵ states the empirical evidence seems rather mixed overall. In the short term, it seems that businesses tend to bear the bulk of the burden of increased local tax rates. However, in the long run businesses may be able to pass on much of the burden of high local tax rates to their landlords in the form of lower property rents.

55. Arthur Midwinter argued to the Scottish Parliament's Local Government Committee that non-domestic rates should not be re-localised, in order to provide Scottish Parliament with one of the very few sources of income it has power to determine. ⁹⁶

56. In oral evidence to us, Councillor Pat Watters, President of COSLA told us he believed that having a uniform business rate is a sensible approach, to provide a clearly level playing field throughout Scotland.

57. We note that Scottish Ministers have announced their intention to bring the Scottish business rate into line with the rate that applies in England, and possibly even below. This could only be achieved if non-domestic rates remained nationally-set.

Increasing the share of income received from local residents

58. The third way to change the balance of funding would be by increasing the share of the cost of local services that residents pay through local taxes. We do not think that any meaningful link exists between the proportion of the cost of local services that people pay through local taxes and local accountability but this option could be used to test whether or not such a link exists.

59. Not all forms of local tax that are suitable for raising 20% of council income will remain suitable for raising, 40% or 50% of the total. Shortcomings in any tax may have limited impact where the level of that tax is modest but can become unacceptable as the tax level grows. It also becomes more important that a tax does not result in any perverse or unintended behavioural effects that might hinder local economies.

60. One way of reducing the risk of unfairness or unintended consequences is by having more than one type of local tax. A cocktail of local taxes may alleviate any unwanted effects of a disproportionate burden being carried by one tax.

61. A major difficulty with a "cocktail of taxes" approach is that the public might well assume that more types of tax means actually having to pay more tax. Indeed, the GfKNOP report indicated likely public opposition to a hybrid system with more than one form of local taxation, because it could provide an opportunity to increase tax take by stealth. How well this risk was managed would depend on how responsibly a hybrid tax was introduced and on how clearly it could be demonstrated to the public that either national taxes would be reduced as a result or that the additional tax revenue was necessary. A degree of proportionality must be adopted for local taxation. Mirroring the national basket of taxes at a local level might be justifiable in terms of creating fairness, but it would be a complex and costly way of doing so.

Conclusions

62. We question many of the arguments that have been made in relation to the balance of funding. Change to the balance is often regarded as an important end in itself, with demand for more weighting towards local government being seen as synonymous with local government having greater powers, thus reducing the extent of (in)appropriate central controls upon local authorities. Change to the balance is also considered
by some as a more important goal than how it is achieved. For instance, many local authorities argued for non-domestic rates to be re-localised in order to weight the balance of funding more towards local authorities. In many such cases we were surprised that other effects of such a change (such as the effect on councils' relationships with the business community) were considered as being incidental to this primary goal.

63. Our overall conclusion about the importance of the balance of funding is that in itself it is tangential to the main problem. The right level of funding, the relationship between central and local government and the extent of discretion for local government are the crux of the problem.

64. Where there exists a disagreement between the Scottish Executive and local government about either the adequacy of funding for local services or how efficiently councils deliver these services, the gearing effect does exaggerate the extent of difference between the two sides. However, the gearing effect does not create these differences of view between local and central government. Nor would these differences disappear were the balance of funding to change.

65. We have seen no evidence to suggest, nor do we accept the argument, that simply shifting the balance of funding towards local government in itself will improve accountability or the degree of public engagement. Nor do we believe the balance of funding rather than local authorities' ability to develop and deliver high quality local services is the real measure of esteem in the eyes of the public.

66. We have identified three ways in which the balance of funding could be weighted more towards local government. We are satisfied that any of these methods could be used to bring about such a change. However, we do not accept that these methods of themselves offer any justification for a change in the balance of funding.

67. We argue that any change to the balance of funding should be treated as part of the fundamental strategic change we advocate in sections 5 and 6.

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