The Commission on Local Tax Reform: Volume 1 – Just Change: A New Approach to Local Taxation
05 Can a Local Tax be Fair and Equitable for Everyone?
- International examples are diverse and show that there is not a universal understanding of a fair local taxation system.
- The predominant view of the Commission is that any reform of local tax has to include recurrent tax on domestic property, but that any such system needs to be more progressive than the current Council Tax system.
- The predominant view of the Commission is that Local Government’s tax base should, if it could be proved feasible, be broadened to include income as this is widely perceived to be a fairer basis on which to levy a tax.
- A system of land tax is promising, but gaining a full understanding of its impact would require further analysis.
5.1 The concepts of fairness and equity in a taxation system are not straightforward and are often subjective. Governments across the world today recognise their importance, but differ on the definition. “Fairness” is often interpreted as being substantially based on the “ability to pay”, though that term in itself can be understood in several ways. An “equitable” tax will apply equally to two people or households who are in similar circumstances. An “equitable” tax will also not have any disproportionate impacts on particular people or household types, localities or parts of the population, though again different observers will disagree over what is proportionate and what is disproportionate in any system.
5.2 A tax that is based on the ability to pay and treats all equitably is more likely to deliver stable revenues, not just because it will, by definition, be affordable, but also because it is likely to benefit from greater public acceptance.
5.3 Our remit requires us to assess “the impacts on individuals, households and inequalities in income and wealth” of alternative local tax systems, and we therefore consider in detail whether alternatives to the present Council Tax can be fair and equitable.
The Ability to Pay
5.4 There is strong, but not unanimous, initial public challenge to the idea that any tax based on property or land values is truly related to ability to pay. Some believe that a tax based on property and/or land values can never be fair. This is because they attach a strong importance to income in their definition of fairness, as they perceive it connects to ability to pay. Others maintain that property or land should be taxed, believing that ownership of a property or land indicates a degree of wealth that in turn indicates the ability to pay. However, this opens the question of whether ownership and occupation of property indicates the same ability to pay.
5.5 The review of international evidence conducted for us by Policy Scotland at the University of Glasgow very much confirms the difficulty in defining “ability to pay”, as well as the practical challenges of designing a local tax system conforming to this principle of fairness. Indeed, this research demonstrates that across the OECD, practices are diverse and that there is not a universal understanding of a fair local taxation system. The research also showed that most OECD countries operate more than one source of local taxation, and in most instances include property and often income within this mix.
5.6 Our analysis explores the different impacts on household incomes of different tax systems by modelling some illustrations of more progressive property taxes, as well as considering a flat rate local tax on income. We also considered the impact of these different tax systems on wealth, and looked at whether wealth is related to income. The available data did not support the same level of analysis for a land value tax, but if land could be valued accurately, we see it as being a variant of a property tax that separates the values of the land and the building from the overall value. As such, it would have similar impacts on income and wealth as a property tax, depending on the design.
FIGURE 5.1: PROGRESSIVE, PROPORTIONATE AND REGRESSIVE TAXES
Many people associate fairness with whether a tax is progressive or not. But what does that mean?
MEASURING FAIRNESS AGAINST INCOME
Sometimes, people use terms like regressiveness to describe how the tax rate changes as incomes change.
That is why VAT is often called regressive. It is a 20% flat rate on the value of goods and services, but because lower income households spend relatively more of their income, on average they spend more proportionately on VAT.
The same would be true of a proportionate, or flat rate, property tax because, on average, housing costs make up a larger proportion of a lower income household’s expenditure.
Some think that this interpretation of progressiveness and regressiveness is more important than how a tax relates to its tax base. That is why we look at both interpretations.
The present Council Tax is regressive whichever interpretation is used.
Can a Property or Land Tax be Fair and Equitable?
5.7 The present Council Tax is regressive. Tax on the highest value properties is exactly three times the tax on the very lowest value homes. But even when the Council Tax began, those highest value properties were worth around eight times, or more, than the lowest. This regressivity was built in from the start.
5.8 Our analysis confirms that the present Council Tax is also regressive when measured against household incomes. Although the tax rate is determined by the property value, this results, in most circumstances, in the share of household income going on Council Tax being greater at lower incomes than at higher incomes.
5.9 We looked at the impact of a property tax that is proportionate to property values. Our analysis is based on an estimate of the property tax base in 2013-14. The figures we have produced can only be viewed as an illustration of the scale of the changes if a proportionate property tax replaced the present Council Tax. The actual rates that each household would pay will depend primarily on the value of property in the valuation year and, importantly, the rate set by the council in that local authority area. However, it is clear that a proportionate system would lead to relative changes in the liability of lower value properties in relation to higher value properties.
5.10 Our analysis estimates that, in 2013-14, adapting the present Council Tax to achieve this proportionality would require the tax on the highest value homes to be 15 times the tax on the lowest value homes. In this example, the liability for Band A would halve, and the liability for Band H would be 2.5 times higher than at present. This system would still result in lower income households spending a greater share of their income on local tax than higher income households.
5.11 We looked at whether a property tax could be structured so that it is progressive with respect to both property values and to net household incomes. Our analysis suggests that even with substantially higher rates for the most expensive properties, a property tax cannot be progressive with respect to income for all households. By itself, a property tax cannot meet this test of fairness.
5.12 One other suggestion to improve fairness further was the reform of the present Council Tax to create an additional band above the current highest of Band H, as was implemented in Wales in 2005. While this would allow an increase in the difference between the charges applied to the properties at each end of the scale, Band H at present consists of less than 13,000 properties in Scotland out of the 2.4 million in total. The potential effect on overall progressivity of splitting a band that already includes relatively few properties is therefore extremely small.
FIGURE 5.2: WHAT COULD A REFORMED PROPORTIONATE COUNCIL TAX SYSTEM LOOK LIKE?
Discounts and Reductions
5.13 We recognise the importance of reduction (or relief) schemes to ensure those without the means to pay the tax are protected. Indeed, we heard much evidence pointing to the futility of taxing those who simply could not pay.
5.14 The present Council Tax Reduction scheme is such a system of income based relief that also takes account of need. It is highly targeted, providing different levels of support for different household circumstances. But our analysis shows this support is greater for pensioner households and those with children than for in-work households without children. This is confirmed in evidence we received that some households may not be receiving the support that they need. Even after factoring in Council Tax reduction, the present Council Tax system is largely regressive for those households with incomes above the lowest 20%.
5.15 We also heard that the Council Tax Reduction scheme’s complexity can make it hard to access. We do not have data describing how many of those entitled to a Council Tax reduction apply for this relief, but the Department of Work and Pensions (DWP) had estimated that of those entitled to the preceding Council Tax Benefit, 62% to 69% by caseload and 64% to 71% by expenditure actually claimed. Whilst entitlement criteria for the Council Tax Reduction scheme uses many of the criteria and thresholds from the present DWP benefits systems, we heard evidence that application is awkward and especially so for those whose working hours and/or income vary frequently. Overall, these difficulties reflect international experience – in their report to us, Policy Scotland at the University of Glasgow concluded that: “Finding the right way to compensate low income taxpayers remains a critical issue for property taxation”.
5.16 However, if it was more effective and accessible, a scheme that reduced liability according to income and need could allow a fairer property tax to be operated. Particular options for improving the Council Tax Reduction scheme (or a replacement system of relief) include increasing the allowances made for living expenses, or making the rate at which the discount is withdrawn as income rises much less sharp. This may mean greater amounts of revenue foregone by local authorities than at present, which would have to be replaced to maintain revenues and thus the same level of local service provision. One way this might be achieved could be by an increase in the revenue raised from other local taxpayers.
Property Taxes and Wealth
5.17 Our remit also requires us to consider the relationship between property taxes and wealth. Occupation of high value property could be indicative of relatively high levels of current income or high levels of wealth, or both. We heard views that, at present, wealth is undertaxed and has reviewed evidence that levels of wealth inequality are greater than income inequality.
5.18 The extent to which ownership of property is indicative of ability to pay has been questioned in evidence to the Commission. In oral evidence to us, the Institute for Fiscal Studies advanced a rationale that “housing should be taxed like other consumption” – in effect making such a tax almost a proxy for VAT. However, property is an asset that, for owner occupiers at least, does not produce a tangible revenue stream out of which to pay a property tax. There is some evidence of a link between net property wealth and income, but there are circumstances for which this does not hold. For example, retired owner occupiers are more likely to own their home outright but their income is likely to be lower than a working-age household who are more likely to have an outstanding mortgage.
5.19 Even where net property wealth is not a proxy for current income, we heard some express a view that net property wealth means there are substantial holdings of wealth that could be realised if the property was sold. For some, there may be reasons why selling a home is not practical, such as suitable alternatives not being available. For others, selling a property might represent a difficult and emotional choice because it has been a long-standing family home.
5.20 The present Council Tax is levied on occupiers and this proves easy to collect. The alternative, of taxing owners (generally a feature of land taxes) can be harder to enforce, especially in cases where the owner is a company or overseas. We have also heard mixed views as to whether a tax on owners would indeed be paid by landlords, or would instead be recovered by increasing the rents charged to occupiers.
5.21 For these reasons, we therefore considered the impact of property taxes on wealth where the tax is paid by the occupier. If applied in a proportionate or more progressive way, property taxes based on property value offer some, but not complete, connections to the wealth of owner occupiers (although those with mortgages will pay proportionately too much based on their actual wealth holdings).
5.22 Proportionate or more progressive property taxes paid by tenants may also link to other forms of wealth, such as in circumstances where renting a particular property is an elective choice, although this may be linked more closely to current income than accumulated wealth. However, many tenants, and in particular tenants of social housing, may not have a choice over where they live and in such circumstances, occupancy of a property has little or no relation to wealth.
5.23 The imperfect link between ability to pay and a property tax could be addressed by a system of reliefs as described earlier in this chapter, whilst enabling those links to wealth where it is an appropriate reflection of ability to pay to be maintained. Such reliefs could apply to land as well as property taxes.
5.24 We also considered if it was possible for a tax on property to be deferred until the property is sold. Whilst theoretically appealing, when such a scheme was implemented in Northern Ireland for pensioners, it was taken up by so few people that it was closed. We understand this was because the concept of bequeathing property with a claim of deferred local tax on the title was not attractive.
5.25 The present Council Tax system provides many exemptions and discounts which are not means tested. Some of these, in particular the single person discount, have been challenged in evidence on the grounds of fairness. Others have cautioned against removing any discount or exemption without fully understanding the consequences, some of which may be unintentional. For example, we have heard that the removal of single person discount could have a detrimental impact on single pensioner households. Any new system must therefore be based on a full consideration of all current discounts and exemptions. Within a new system, such reliefs should be kept under review to ensure they remain fit for purpose.
5.26 Our analysis therefore indicates that a more proportionate property tax, implemented alongside a more progressive system of income and need based reliefs, would be much fairer than the present Council Tax and connect better to both the income and the wealth interpretations of “ability to pay”. The public opinions we accessed, especially at the listening events, were often open to such a proportionate, mixed (or hybrid) system, whilst research conducted for us by the University of Stirling confirms the potential benefits of such arrangements.
Valuation of Property
5.27 The valuation of property is obviously fundamental to a tax based on property values. The evidence we received suggested that the continued use of the 1991 value of each property to calculate that property’s Council Tax bill today contributes to perceptions of unfairness among both experts and the public. Indeed, some cite this to further discredit the present arrangements.
5.28 We recognise that property tax liabilities should ideally be linked to up-to-date property values. The present Council Tax, based on 1991 values, means people living in properties that have increased in value by more than the Scottish average since 1991 are likely to be paying less than they should, whilst others in properties whose value has not kept pace with the Scottish average are paying more than they should. Only properties where values have grown in line with the Scottish average are paying what they should. The Scottish Assessors Association (SAA) provided convincing evidence that they are able to apply fair and accurate, but nevertheless hypothetical, 1991 valuations to new properties. However, the need to do so – especially as some types of property did not exist in 1991 – is a concern.
5.29 In collaboration with Heriot-Watt University, we have been able to analyse the impact of revaluing properties for a subset of around 700,000 properties in seven local authorities across Scotland whilst maintaining the other elements of the present Council Tax system. In this analysis, we adjusted the bands to keep the number of properties in each band the same. Although we recognise that computer models alone will never be able to accurately value every property, the findings from this analysis are instructive, suggesting that 57% of properties in Scotland would have changed Council Tax band if revaluation had taken place in 2014, with roughly an equal amount moving up as moving down. Around 44% of properties would have moved up or down by one band, 11% would have moved up or down by two bands, and around 2% would have moved up or down by three bands or more. 43% of properties would have remained in the same band.
5.30 Some evidence indicated that the longer the time taken between property valuations, the greater the potential change in relative values. Our analysis confirms this, and shows that if Council Tax was retained and properties were revalued, many would change bands. Although tax liabilities would also be driven by the locally determined rates, income based relief schemes, transitional arrangements (and a number of other factors), the scale of potential change indicates that whilst keeping valuations up-to-date is desirable, an initial revaluation of properties would be politically challenging to deliver. The research by Policy Scotland at the University of Glasgow indicates that the difficulties arising from deferring the revaluations within a property tax system are widely experienced in other countries and are not unique to Scotland. This challenge must be overcome and we believe that a well-designed transitional framework to enable taxpayers to adjust would help to improve public acceptance.
Can a Local Income Tax be Fair and Equitable?
5.31 A tax on income, by description, should relate directly to the ability to pay and thus be fair and equitable (as long as a regressive tax structure is not put in place). Our analysis confirms that connecting local income tax to ability to pay – as understood by income – is much easier than for taxes on property or land, as income and ability to pay are linked in a more obvious way. Furthermore, our analysis also shows that, even for income taxed at a flat rate, a household on a low income will pay proportionally less local income tax than an identical household with high income.
5.32 In contrast to a property tax, which must be adjusted for some households in order to relate to current income, the challenge for a local income tax is to ensure that it applies to all forms of income.
5.33 In Chapter 7, we set out ways in which a local income tax might be collected. This highlights that, in practical terms, it would be very difficult for savings, investment and dividend income to be subject to local tax. This in turn could mean that some individuals with potentially significant wealth providing substantial unearned income would pay little or no local tax. If this administrative constraint could not be overcome, a local income tax would have no direct impact on combating inequalities in wealth as it would tax current income rather than the wealth accumulated through income over time.
5.34 Although not a universally-held view, we encountered some public perceptions that a local income tax has an element of “unfairness”- it would not apply to the wealth implied by a person residing in a high value property but living on a modest income. Others, as highlighted earlier in this chapter, saw this relatively lower charge for the asset-rich cash-poor as a positive feature, especially in the case of pensioners. This division again reflects the conflicting opinions held on the ability to pay.
5.35 Income tax could also be challenged as not being adequately connected to income after necessary costs – such as those of a family or related to disability – are taken into account. This is in contrast to the approach taken by the Council Tax Reduction scheme, which gives different allowances to households of different types based on an estimation of the costs of living, taking into account factors like the number of children and additional support needs. Such targeting requires individual circumstances to be assessed and introduces administrative and compliance costs that are likely to be prohibitive if they were to apply to the entire working population. Furthermore, linking personal circumstances to the tax system is often the subject of challenge and significant dispute, as evidenced by the debate within the 2010-2015 UK Coalition Government about the introduction of a married couples’ allowance to the UK income tax system.
5.36 Figure 4.4 describes our analysis of a local income tax that was based on one scenario of a flat rate rather than different rates applying at the basic, higher and additional tax thresholds. We emphasise that the purpose of this modelling is to inform our understanding rather than to present a preferred system. Indeed, it is impossible to say exactly how much households would pay if a “revenue neutral” local income tax was introduced in future. This is because local income tax bases will change substantially every year as local populations and labour markets change, earnings grow (or fall), and the UK Government revises the definition of income and the level of the personal allowance. However, our analysis allows us to look at the relative impacts of a local income tax – irrespective of whether the rate is different from the one we have assumed, the relative impact across households with the same income should stay broadly the same.
5.37 One important finding, confirming the point made in paragraph 5.31, is that once income is adjusted to take account of the different costs of living, a household in the same income decile that has children is more likely to pay a higher proportion of their equivalised net household income under local income tax than households without children. In addition, because personal allowances are calculated for individuals, households with two earners will pay tax on a lower proportion of equivalised net household income than households with the same income but one earner. These factors challenge whether or not a local income tax is indeed equitable by our measure, though this must be considered alongside the parallel challenge that property taxes also depend on income and need-based relief schemes to ensure liabilities adapt where households of different circumstances live in similar properties.
5.38 The general approach to income taxation in the UK is to allow a certain amount of income to be earned before income tax applies (the personal allowance) with the benefit system providing some additional support to households with children and those with additional support needs. As new tax and social security powers are transferred to Scotland, there may be an opportunity to shape a local income tax to be more equitable across all households, although this would be a significant change to existing practice. This, along with the challenges of taxing dividends and investments, illustrates that it is difficult to achieve both fairness and administrative efficiency in any one single tax instrument.
1 Jackie Baillie MSP was not able to agree this recommendation