IFS PRESS RELEASE THE INSTITUTE FOR FISCAL STUDIES 7 Ridgmount Street, London WC1E 7AE 020 7291 4800, mailbox@ifs.org.uk, www.ifs.org.uk For immediate release, Wednesday 14th March 2007 Contact: Emma Hyman on 020 7291 4800 Analysis of the SNP proposal for a capped local income tax The Scottish National Party today set out proposals for replacing council tax (and council tax benefit) with a local income tax in Scotland. The local income tax (LIT) would apply at the starting, basic and higher rates, to all taxable income except savings income, but would be capped so that local authorities would not be allowed to increase the rate above 3%. The SNP would continue to levy a property tax on second and empty homes. Stuart Adam, a senior research economist at the IFS, said: “The SNP is proposing to cut taxes and spending and virtually eliminate local councils’ ability to decide their levels. Whether voters would see the spending cuts as a price worth paying for the tax cuts remains to be seen – the effects would be very different for different families and in different areas – but the trade-off would no longer be at the discretion of local decision-makers.” Council tax in Scotland is forecast to raise £2,131 million in 2006–07, of which around £45 million comes from second and empty homes. Council tax benefit is forecast to cost £381 million. We estimate that, if the LIT were in place in 2006–07 and all Scottish local authorities set the rate at the maximum 3%, the LIT would raise around £1,250 million, assuming individuals’ behaviour did not change in response to the reform. The reform would therefore constitute a £450 million tax cut, but would leave a corresponding hole in local authorities’ finances. The size of this shortfall would depend on whether or not the savings from not having to pay council tax benefit after the reform – savings which would initially accrue to the UK Exchequer centrally since council tax benefit is centrally financed – were then returned to Scotland and made available to Scottish local authorities. If this saved money were returned to Scotland, local authorities’ funding shortfall for 2006–07 would be around £450 million, the same as the tax cut; if not, it would be around £840 million. Local authorities could only fill this hole by reducing spending or by raising revenue from other sources such as user charges. The SNP argue that a £450 million reduction in local authority spending could be absorbed with no loss of quality in public services, by councils’ making efficiency savings of 1½% a year for three years. Precedent suggests that such efficiency savings might be difficult to achieve, particularly since they would come on top of any efficiency savings implied by Gordon Brown’s plans for the UK as a whole. Local authorities’ reduced ability to raise revenue would constitute a significant reduction in the importance of local government within Scotland. First, local taxation and spending would fall; and second, the level of spending would be almost entirely determined by the level of grant received from the Scottish Executive, since local authorities would lose the ability to increase local taxes if they wanted to spend more. Local authorities would be virtually forced to limit their spending to the level of centrally-assessed needs, so those currently spending a lot relative to their centrally-assessed needs (and so setting above-average Band D council tax rates) would face the tightest spending squeeze. Whether individual families are better or worse off from the reform as a whole depends in part on the unknown impact of these cuts in local authority spending. Winners from the tax changes alone would be those with relatively low incomes who pay relatively high council tax (which includes many pensioners), while losers would be those with relatively high incomes who pay relatively low council tax (which includes many single working people without children). Hence the reform would redistribute from those who are relatively rich in terms of their current income but poor in terms of the value of their home towards those who are relatively rich in terms of the value of their home but poor in terms of their current income. Not everyone with a low income would gain: those who currently pay no net council tax – because they receive full council tax benefit, because they are students, or because liability for the tax falls on relatives living in the same household – have nothing to gain from the abolition of council tax, and those in such a position who also pay income tax would lose from the proposed reform. The overall £450 million tax cut corresponds to an average gain of £3.20 per family per week. Using the IFS tax and benefit model, TAXBEN, we have estimated the effect of this reform on family incomes (again assuming that families do not change their behaviour in response to the reform), and the distributional patterns are shown in the tables overleaf. However, note that top incomes are under-recorded in the survey data on which TAXBEN is based, so the policy as we model it looks slightly more generous that it would actually be: the true gains would be smaller than shown for groups containing high-income individuals. Thus different families would see different changes in their tax bill, and the average change would vary significantly between local authorities. Families in different areas would also see their local authority’s spending cut by different amounts. The net effect of these is that some areas would see a greater reduction in spending per family than in taxes per family, and vice versa. This reflects complicated but significant redistribution between local authorities. Grants from the Scottish Executive would change to support areas with a low income tax base rather than with a low council tax base. Areas that have relatively low incomes but a relatively high value of properties would gain from an increased grant from the Scottish Executive and their taxes would fall by more than their spending, while areas that have relatively high incomes but a relatively low value of properties would lose and their spending would fall by more than their taxes. Effect across the Scottish income distribution of replacing council tax with a 3% local income tax, 2006–07 Income decile group Poorest 2nd 3rd 4th 5th 6th 7th 8th 9th Richest Overall, modelled Overall, best estimate Average change in net weekly income £0.83 £4.18 £6.72 £6.84 £6.38 £6.83 £5.57 £4.97 £2.19 -£8.71 £3.58 £3.20 % change in net income 1.23% 2.48% 3.05% 2.82% 2.26% 2.07% 1.42% 1.04% 0.37% -0.95% 0.97% n/a Note: Policy as described in the text: council tax abolished for main homes only, savings income excluded from LIT. The “best estimate” overall change (£3.20) is below the “modelled” overall change (£3.58) because the data on which our model is based under-record top incomes and our model therefore understates the losses from a local income tax. The average change shown for each decile group is therefore overestimated by an average of 38p, but this is be concentrated in the higher income groups whose incomes are under-recorded. Income decile groups are derived by dividing all families in Scotland into 10 equal-sized groups according to income adjusted for family size using the McClements equivalence scale. Source: Authors’ calculations using the IFS tax and benefit model, TAXBEN, run on uprated data from the 2004–05 Family Resources Survey. Effect for different family types of replacing council tax with a 3% local income tax in Scotland, 2006–07 Family type Single, not working Single, working Lone parent, not working Lone parent, working Non-working couple without children Non-working couple with children One-earner couple without children One-earner couple with children Two-earner couple without children Two-earner couple with children Single pensioner Pensioner couple Overall, modelled Overall, best estimate Average change in net weekly income £1.07 £0.07 £0.50 £7.63 £7.54 £8.34 £7.31 £6.04 £1.63 £2.79 £5.87 £10.37 £3.58 £3.20 % change in net income 0.98% 0.03% 0.21% 2.16% 2.27% 2.55% 1.60% 1.11% 0.25% 0.40% 2.64% 2.61% 0.97% n/a Note: Policy as described in the text: council tax abolished for main homes only, savings income excluded from LIT. The “best estimate” overall change (£3.20) is below the “modelled” overall change (£3.58) because the data on which our model is based under-record top incomes and our model therefore understates the losses from a local income tax. The average change shown for each family type is therefore an overestimate, particularly for higher income groups. Source: Authors’ calculations using the IFS tax and benefit model, TAXBEN, run on uprated data from the 2004–05 Family Resources Survey. ENDS