The Commission on Local Tax Reform: Volume 1 – Just Change: A New Approach to Local Taxation
07 How Can Alternative Taxes be Administered?
- Existing local tax collection staff and administrative infrastructures provide a basis for the collection of a future alternative local property tax.
- The administration of a locally determined income tax would require radical changes to existing practices.
- Existing HMRC income tax collection systems might provide a basis for collecting a locally set income tax, but this would be a major undertaking, could not extend to income from savings and dividends, and would need the support of the UK Parliament.
- The alternatives to using HMRC income tax collection systems include a Scottish collection body or individual local collection arrangements, both of which create significant administrative and compliance challenges.
7.1 Our analysis so far has focused on the amounts of tax people would be required to pay and the impacts this would have. Yet some taxes can cost more to collect than others, and indeed, some taxes place a greater bureaucratic burden on those who pay the tax – sometimes called the compliance cost.
7.2 By requiring us to consider “The administrative and collection arrangements that apply”, our remit means we must understand what would be involved in the collection and administration of alternative tax systems.
The Current Council Tax Collection Arrangements
7.3 Under the present arrangements, each local authority bills each household for the Council Tax due on their home, based on the tax rates set by that council, the information it has about who lives there and which valuation band the property falls into. Councils also administer the Council Tax Reduction scheme, which requires details of the income, benefits received and wider circumstances of the household.
7.4 There is an established administrative infrastructure to deliver these functions. Professional standards for such staff are supported by the Institute for Revenues, Rating and Valuation (IRRV). Local authorities’ business processes are enabled using specialist software provided by a small number of suppliers familiar with the local authorities’ requirements and the policy environment. The creation and maintenance of property valuations is a statutory role – the Assessor – distinct from other Local Government officers. Most councils delegate the duties of the Assessor to Valuation Joint Boards covering a number of local authority areas. Valuation Appeal Committees, comprising independent lay people appointed by the Sheriff Principal, provide an important function, determining appeals in relation to the valuation of property or the calculation of Council Tax liabilities. Appeals regarding a local authority’s assessment of an individual’s entitlement to a Council Tax Reduction are dealt with differently by panels comprising tribunal judges and convened by the Scottish Tribunals Service.
7.5 Councils also presently administer the Scottish Welfare Fund for the Scottish Government and Housing Benefit on behalf of the DWP. This latter function will be increasingly removed from local authorities as the DWP rolls out the Universal Credit programme.
7.6 The administration of the Council Tax Reduction scheme is complex, although eligibility criteria are very similar to those for Housing Benefit. This reflects the intention that both attempt to target assistance by accounting for wider household circumstances beyond a simple estimate of income. Entitlement criteria often replicate those used elsewhere in the benefits system (for example, entitlement to particular disability benefits is used as a proxy to describe a degree of need associated with a particular level of disability) and many cases are “passported”. This term is used to describe a situation where the entitlement to a particular benefit (for example Jobseekers’ Allowance) of itself provides sufficient information about need and income to bypass a more detailed needs assessment. These interdependencies contribute to a perception that the legislation and the entitlement criteria for Council Tax Reduction can appear to be overwhelmingly complex. However, we recognise that administration is facilitated by the sharing of data between Her Majesty’s Revenue & Customs (HMRC), DWP and local authorities and, because the Council Tax Reduction scheme “piggy backs” on particular criteria used in the benefits system, alternative ways of assessing individual need would entail duplication of effort.
7.7 Local authorities are required by statute to collect Scottish Water charges which, for domestic properties, are based on their Council Tax band with a system of discounts applying. Local authorities bill and collect these charges alongside Council Tax, receiving around £18 million per year from Scottish Water to meet administrative costs.
7.8 In their evidence to us, the Chartered Institute of Public Finance and Accountancy (CIPFA) and their local authorities’ Directors of Finance Section estimated that Council Tax collection costs by local authorities in 2014-15 were £25.980 million with valuation costs a further £10.768 million. Together, these amount to around 1.9% of the tax collected. Administration costs for the Council Tax Reduction scheme are hard to isolate from the total costs of administering Housing Benefit and the Council Tax Reduction scheme combined. Around 80% of Housing Benefit claims have an associated application for a Council Tax Reduction. For 2015-16, the DWP and Scottish Government combined made payments totalling around £34.5 million to cover the estimated costs of local authorities administering the two systems.
The Current Income Tax Collection Arrangements
7.9 Presently, income tax is a UK-wide tax, set by the UK Government and Parliament, administered by HMRC and with receipts accruing to the UK Exchequer. It is collected in one of three ways:
- under the Pay as You Earn (PAYE) system, it is withheld from salaries and pensions by employers and pension providers – those administering the very thing that is taxed;
- it is withheld (at the basic tax rate only) from interest and returns on some other types of investments by banks, funds and other financial institutions – again those administering the very thing that is taxed; and
- it is collected under the self-assessment regime for those whose full income tax liability cannot be collected by employers or pension providers. This includes people who are self-employed, those who have significant investment income or those whose income comes from more than one source.
7.10 After April 2016, HMRC will collect the SRIT, using the existing PAYE and self-assessment systems. Special PAYE “S” codes will be issued to Scottish taxpayers and payroll systems will use these to collect Scottish income tax. SRIT will not apply to income from savings and dividends which will continue to be taxed at the UK basic rate.
7.11 Establishing the systems required to collect the SRIT required the identification of all Scottish taxpayers, the development of HMRC‘s own business processes and systems, and created compliance costs for employers whose payroll systems needed to be adapted to apply a different rate of income tax for employees identified as being Scottish taxpayers. Implementing the SRIT is estimated to cost £30 million to £35 million in HMRC start-up costs with no estimate available for the compliance costs to business. Indications from HMRC are that the subsequent annual running costs for the SRIT would be £2 million to £2.5 million if the rate was the same as elsewhere in the UK or £5.5 million and £6 million if a different rate was to be set. These higher costs reflect the likely additional compliance work that would be needed.
7.12 Ensuring compliance with a tax system is an important element of maintaining fairness as it ensures that those who are liable to a tax pay what is owed. Local authorities and HMRC both have substantive and rapidly enforceable powers to recover outstanding debt, including arresting earnings, freezing bank accounts and the confiscation of property.
7.13 We heard evidence that local authorities’ collection of water charges was a complicating factor in the understanding of Council Tax debts. This is especially the case as maximum relief from water charges still leaves a liability of 75%, even if the household is entitled to a full Council Tax reduction. We also heard evidence that some households’ prioritisation of debt repayment can be based on the scale of the penalties for late payment. Late payment of Council Tax initially means the loss of entitlement to pay in instalments, but continuing non-payment results in the council obtaining a summary warrant from a Sheriff Court and the taxpayer automatically incurring a penalty of 10% of the debt. To some, this is preferable to the late or non-payment of other debts that can incur a higher penalty.
Administering Alternative Property Taxes
7.14 Depending on the scale of the change, alternative property taxes might reasonably be expected to be implemented by adapting the existing revenue collection arrangements within local authorities and the associated bodies described above. In the next chapter we identify some of the issues that transition would raise, including the revaluation of properties. Business processes and IT systems, as well as the role of the Assessors, Valuation Joint Boards and Valuation Appeals Committees may need to be adapted, depending on the nature of the tax that was implemented, and so there would be some cost. But overall, existing staff and structures could provide the basis for the administration and collection of a new or revised local property tax in the longer term, including, potentially, a local tax on land values. This would also afford an opportunity to integrate land value and ownership data on the Registers of Scotland’s Land Register.
7.15 The administration of a system of income based and needs-assessed relief to a local property tax can be expected to continue to be complex. It is not clear how this might be impacted by the roll out of Universal Credit or the expected increased devolution of support for housing costs.
Administering a Local Income Tax
7.16 In some countries, Local Government is assigned a fixed proportion of receipts from the national income tax. This gives Local Government a material stake in the national economy and makes the origin of its funding more evident. But since this does not allow for local variation, this is not a locally controlled tax. A more sophisticated assignment system might involve estimating the amount of national income tax paid in each local authority area and making that a transparent part of the funding from central government. This, again, would not be a locally controlled tax, but could connect the funding for Local Government with local economic performance.
7.17 Although income tax is a fundamental part of the existing tax system, the administration of a locally determined income tax would require radical changes to existing practices. In theory, there are three potential means of collecting a locally determined income tax – collection by HMRC, collection by local authorities, or the establishment of a separate income tax collection system on a Scotland-wide basis.
7.18 We therefore considered how a locally determined income tax might be administered, firstly by examining collection by HMRC. The establishment of the SRIT will demonstrate the capacity of the existing income tax system, administered by HMRC, to apply a different tax rate on earned income based on where the taxpayer lives. Indeed, liability (or otherwise) for SRIT is based on a distinction between those who are chiefly resident in Scotland and those who are chiefly resident elsewhere. Our understanding of the processes undertaken by HMRC to identify Scottish taxpayers suggests that for most circumstances, this was not a major issue, although there were some types of case that proved more difficult to resolve. These included students starting work, offshore workers, members of the armed services, anybody who moves to or from Scotland during the year, people who live in Scotland and work elsewhere or vice versa and people who have two houses – one of which is in Scotland – for any other reason. We therefore consider that determining residence would be a significant factor for a locally variable tax.
7.19 Having identified which taxpayers reside in which local authority area, mechanisms would need to be established to enable a locally determined rate of income tax to apply to residents in each of Scotland’s 32 local authority areas. Hence, the capability of the existing PAYE and self-assessment systems to support this would need to be ascertained and explored with HMRC and payroll and pension providers.
7.20 Importantly, as HMRC is a department of the UK Government, accountable to the UK Parliament through a UK Government Minister, using HMRC to collect a locally variable income tax across Scotland’s 32 local authority areas would need the support of the UK Government and Parliament. If UK legislation was required, this support would need to extend to creating space in a legislative programme.
7.21 One consequence of the PAYE system being used to collect a locally determined income tax would potentially be that two employees of the same organisation, in the same roles with the same salaries, would pay different rates of tax as a consequence of their home addresses. Although this presently happens with Council Tax, this would require a strong level of public understanding to work, as well as robust administrative procedures to ensure the correct rate of tax was collected and to deal with changes such as people moving house.
7.22 The SRIT, and the proposed Scotland Bill 2015 income tax provisions do not apply to income from savings and dividends as this was not considered to be administratively practicable. However, if UK Government consent was received for HMRC to collect a locally determined income tax, we think the scope for that to apply to income from savings and dividends should be re-examined, both with HMRC and with industry representative bodies such as the Association of British Insurers and the wider tax profession.
7.23 The collection of a locally determined income tax by HMRC would also mean that local authorities’ revenues would be subject to HMRC‘s collection performance. HMRC estimate the difference between the amount of tax that should be collected and what is actually collected as being 1.6% of liabilities under PAYE and 15.4% of liabilities under self-assessment. We did not take evidence on whether these differences may derive in part from HMRC‘s operational practices. By comparison, Council Tax in-year collection rates are around 96%. However, other evidence clearly suggests that income tax deducted at source by employers’ payroll systems will inherently collect more of the tax due and at lower cost than if collected after salaries have been paid. The Institute for Fiscal Studies “Mirrlees” review of “Tax by Design” states that “withholding (such as under PAYE) is an extremely effective way of collecting income tax because it reduces the risk of non-compliance and takes advantage of the economies of scale in tax remittance”. Consequently, using HMRC to collect a local income tax would suggest that the income of a local authority would depend on the proportions of taxpayers in that area paying tax by self-assessment and by PAYE. This may also introduce a revenue risk into the future given that the proportion of income tax paid under the self-assessment scheme may be increasing.
7.24 The collection of a locally varied income tax by HMRC alongside the SRIT (and the proposed Scotland Bill 2015 income tax provisions) would also mean that the tax base of local authorities would have some dependence on the decisions of other levels of government – for example in defining income itself, what the personal allowance is and any interactions with the benefits system, including the present system of tax credits. In more extreme circumstances, the tax rate determined by one level of government could influence the scope for other jurisdictions sharing the same tax base to apply the tax rates they wish. Mechanisms for managing these interactions and dependencies, which are being developed for the SRIT, would therefore be needed.
7.25 The alternative approaches of collecting locally determined income tax by local authorities themselves, or by a Scotland-wide tax authority (Revenue Scotland would be the obvious institution for this, although presently has no role in income tax collection) would make such a locally determined income tax less dependent on the national tax policy decisions of the UK and Scottish Governments. However, there would be significant practical challenges in establishing a collection system for a locally variable income tax either by local authorities or through a Scotland wide authority for local taxes.
7.26 Replicating HMRC‘s PAYE system would necessitate establishing a system to deduct a locally determined income tax at source and require employers to administer employees’ income tax for not just HMRC, but also for either one Scotland-wide tax authority or up to 32 local tax authorities. Even in the case of one Scotland-wide body, there would be multiple new tax codes to reflect the different rates set by each local authority – as would be needed if HMRC were the collection agency.
7.27 We did not take evidence on the practicability of this specific approach, but we received evidence from employer representative organisations indicating likely opposition to employers being tasked with collecting local taxation in any form because of the additional costs likely to be created. Employers have, however, had to update systems to administer SRIT from April 2016, and may well have to update them again before any further tax powers are introduced, such as those set out in the Scotland Bill 2015.
7.28 Rather than seeking to replicate the PAYE system, an alternative way of collecting and administering a locally determined income tax separately from the national and SRIT would be to introduce the common overseas practice of requiring everybody to submit a tax return. Many countries we examined that operate some form of local income tax system do so on the basis that all citizens are required to submit tax returns – something akin to the HMRC self-assessment regime.
7.29 We have seen estimates suggesting that around three-quarters of Scottish taxpayers are in the PAYE system and do not have to submit tax returns. Therefore introducing a tax return system purely for a local income tax would represent a far-reaching change, raising likely issues of public acceptance. It is also the case that the administrative costs to government of withholding income tax at source are much less than under a tax return system – for PAYE they have been estimated at 0.7% of revenues compared to 4.5% under self-assessment. By comparison, Council Tax collection costs are estimated to be around 1.9% of total revenues.
7.30 This therefore presents a difficult choice if a locally determined income tax is to be implemented. A locally set income tax administered as part of the wider Scottish and UK tax system would maximise collection rates and minimise the associated compliance and administrative costs, but is unlikely to be able to include all types of income and would require the support of the UK Government and Parliament. In the absence of that support, the alternatives of either duplicating the HMRC systems at the Scottish or local levels, or collecting a locally determined income tax entirely by some form of self-assessment, introduce different costs and benefits. These options would be much less dependent on the decisions of the UK Government but acceptance from employers and/or the public may be difficult, they are likely to be more expensive to administer, and may collect a smaller proportion of the taxes due.
7.31 Whichever system was employed, a locally determined income tax would represent a significant administrative change to existing practices either within HMRC, local authorities, or any new or existing Scottish body.