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The Progress Essays

How do we makethe case fortaxation?

David Coats, Sonia Sodha, Howard Reed,Stephen Hale and Chris Leslie

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The Progress Essays

How do wemake the casefor taxation?David Coats, Sonia Sodha, Howard Reed,Stephen Hale and Chris Leslie

Contents

Introduction: defusing the tax bombshell 3David Coats

Paying for opportunity 9Sonia Sodha and Howard Reed

Is there more to life than trading? 18Stephen Hale

Taxation and progressive politics: the local dimension 25Chris Leslie


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Introduction:defusing the tax bombshellDavid Coats

Benjamin Franklin, in a letter of 1789 observed that:

‘In this world nothing can be said to be certain, except death and taxes.’

It is a tribute to Franklin’s talent for the well-made phrase that hiswords continue to resonate today. Indeed, they seem to speakdirectly to the most neuralgic issue in British politics. Deep in theconsciousness of many Labour ministers lies the belief that aninjudicious statement about tax can accelerate the inevitability of amessy political demise. The frenzy generated by inheritance tax(IHT) last autumn, the continuing controversy about the taxation ofnon-doms or the thorny problems arising from council tax reformall suggest that, for Labour, these are issues that continue to demandthe gentlest handling. This is surprising. A largely successfulgovernment, in power for over a decade, which has reshaped theideological landscape, seems to be displaying a remarkable lack ofintellectual self-confidence about the use of taxation as aninstrument of social justice.


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Of course, one might say that recent history offers plenty of reasonsfor caution. Those who experienced the electoral defeats of the 1980sand 90s inevitably find it hard to forget the time, effort and patiencerequired to restore the party’s reputation for economic competence.‘Labour’s tax bombshell’ was a compelling Conservative slogan in the1992 election campaign. Fiscal policy only became a negative for theTories following sterling’s unceremonious ejection from the exchangerate mechanism ERM. And even in these radically changedcircumstances Labour imposed significant constraints on its ownroom for manoeuvre.

Polling evidence continued to show that the party was not yetfully trusted to manage the economy well. Middle England

wanted reassurance and gotit in the form of a sustainedcommitment to leave the basicand top rates of income taxrates at their pre-1997 levels.Rhetorically, the repositioningwas even more radical, withPeter Mandelson explainingthat he was seriously relaxedabout people getting filthy richand the primeminister opining

that he had little or no interest in David Beckham’s salary. Leadingmembers of the government were absolutely determined to ensure thatnone of Labour’s actions could be presented as a ‘tax on aspiration’.

These statements may have been politically necessary, but theyleft many orthodox social democrats feeling a little queasy and theydid little to rebut the Conservative argument that tax cuts werealways, everywhere and invariably a good thing.

“Middle England wantedreassurance and got it in the formof a sustained commitment toleave the basic and top rates ofincome tax rates at theirpre-1997 levels”

The paradox, of course, is that Labour has sometimes found thecourage to be bold. A windfall tax on the privatised utilities was usedto fund the first phase of the New Deal and an increase in nationalinsurance was effectively hypothecated to fund the big growth inhealth spending. Of course, careful preparation was required – a ‘fatcat’ campaign aimed at utility bosses and the Wanless review’sforensic arguments for growth in the NHS budget – but theseinitiatives at least offered the hope for a more sophisticated debate.Most importantly, they showed that the party could advance apersuasive argument for a measured increase in taxation and thatthe public would respond, if not with enthusiasm, then with at leasta little more than grudging acquiescence.

Recent events suggest we run the risk of allowing our opponentsto define the terms of the public conversation. George Osborne andDavid Cameron have tried to appropriate some of Labour’s clothesby accepting projected levels of health and education spending tothe end of the current spending review period. But they also remaincommitted to a generally smaller state and to reductions in bothIHT (where they have made specific commitments) and income tax(still described as a long-term goal). And linked to this politicalcross-dressing is a rather conventional Conservative case: ‘marketsare smart and governments are dumb’. Individuals are the bestjudges of their own welfare and taxes should therefore be as low aspossible, which carries with it the implication that income inequalityis the price we pay for social progress.

While tactically astute, the Conservative approach looksstrategically weak. In the medium term it is hard to see how highlevels of health and education spending can be combined with taxcuts unless other budgets are reduced. The Tory healthspokesperson Andrew Lansley was honest enough to admit as much


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in March 2008, although he subsequently retracted his statementwith alacrity. And the Osborne IHT plan, while it wrong-footed thegovernment last autumn, is nothing more than a huge tax break forthe already wealthy.

One might gently suggest that widening wealth inequalities areincompatible with Cameron’s goal of ‘healing our broken society’,although it is reasonable to assume that the Conservative party willfind it difficult to accept that there is any link between risinginequality and declining social cohesion. These apparentcontradictions suggest some possibilities for an intelligent critiqueof the opposition’s proposals. But picking holes in our opponents’arguments is an inadequate strategy for Labour’s re-election – re-energising the electorate demands a positive prospectus and somepractical proposals for reform.

The three papers presented here are designed to do precisely that.Sonia Sodha and Howard Reed offer a lively defence of the case forwealth taxation, identify the weaknesses in the IHT regime andsuggest that in the long term government should move to thetaxation of land values – although they recognise too that thisapproach presents a thicket of policy complexity. Most importantly,perhaps, they urge us to understand that the public become lesshostile to IHT when a positive case is made.

Stephen Hale, while praising the Stern review’s elegantpresentation of the economic case for tackling climate change, iscritical of the reliance on emissions trading as the best route tocarbon reduction. He argues instead for a mix of emissions trading,tighter regulation, a reformed climate change levy and incentives forhouseholds to change their behaviour, reduce energy consumptionand invest in environmentally friendly products. His challenge toministers is clear, but so is his argument that a dispassionate


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presentation of the facts (particularly that these tax changes shouldbe revenue neutral) can win public support for some otherwiseunpalatable changes. Politicians of all parties have an irresistibleincentive to get these policies right. Uncontrolled climate changeleading to environmental catastrophe is an outcome that all politicalparties will wish to avoid – indeed, it is not too fanciful to suggestthat in the medium-term there is no alternative to a robust politicalconsensus that applies sustained downward pressure to the level ofcarbon emissions.

Chris Leslie dares to enter the dangerous territory of council taxreform. That politicians should approach the issue with trepidationis nothing more than common sense. Attempting to reform the ratesled to demonstrations in the streets and the defenestration of oneConservative prime minister. No Labour prime minister will want tofollow in Mrs Thatcher’s footsteps. At the heart of thiscomprehensive set of proposals is a national revaluation, combinedwith income tax changes so that the more affluent compensate thelosers. The political difficulties should be self-evident, but as Leslieargues, the current arrangements are unfair, unpopular and overtime probably unworkable. Once again, the challenge is to present adifficult political case with determination. Unless politicians can doso then the issue will fester and more serious problems arise in thefuture.

Simply put, the golden thread running through all thesecontributions is that ministers must escape from the ideological cul-de-sac of ‘taxes: bad; tax cuts: good’. Failure to do so represents anunnecessary surrender to a bad case.

Central to each of the papers is the belief that the electorate willrespond favourably to serious arguments about tax, presented bypoliticians with a clear set of values and a persuasive vision of the


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society they wish to create. But vision has to be tempered bypragmatism and practicality. Ministers must articulate the long-term challenges, the general direction of policy, the changes that willbe implemented tomorrow and a more ambitious prospectus for themedium term. Most importantly perhaps, these arguments must berooted in the notion of citizenship; it must be made clear that ourtaxes are used to fund public services, to secure insurance againstrisk and to equalise life chances. In other words, contrary to theThatcherite view, there is such a thing as society – or, to quoteBenjamin Franklin again:

‘We must all hang together, or most assuredly we will all hang separately.’

David Coats is associate director of policy atTheWork Foundation


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Paying for opportunitySonia Sodha and Howard Reed

Since the 1980s the UK’s system of estate taxation has remainedlargely unchanged, save for some minor tinkering with the thresholdfor inheritance tax (IHT) to take account of inflation. While therehave been occasional noises from across the political spectrumabout broader reform, or evenabolition, an uneasy consensusseemed to have emerged aroundthe status quo as the favouredoption, with the tax seen as toomuch of a political minefield tocontemplate wholesale reform.

But in the last few months thisconsensus has crumbled andIHT has become a key battleground for the two main parties todemonstrate their tax-cutting credentials. The Conservatives movedfirst, with shadow chancellor George Osborne pledging that, ifelected, the next Conservative government would raise the IHTthreshold from its present level of £350,000 to £1m. This commitmentcoincided with a revival of the Tories’ fortunes in the opinion polls,which put paid to rumours of an early election. A week later, Alistair


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“ IHT has become a keybattleground for the two mainparties to demonstrate theirtax-cutting credentials”

Darling’s first pre-budget report as chancellor announced that thegovernment planned to double the headline IHT threshold from£300,000 to £600,000 for married couples (with an increase to£700,000 by 2010). Although the Treasury claimed that this reformhad been in the pipeline for several months, it was hard to avoid theimpression that the government had made a U-turn on IHT inresponse to the popularity of the Conservative attack.

So do these developments spell the death of IHT? Or is there hopeyet for the progressive principle in wealth taxation? Here we set outsome of the problems with the current system and some potentialsolutions for the long-term. Perhaps most importantly, we look athow progressives can secure broader support for wealth taxation,which has come increasingly under threat in recent years. Our keycontention is that reform and support have to be linked. Defendingthe current, problem-ridden system will always be doomed to fail.

First, a look at how IHT currently operates. It is levied at a rate of40 per cent above the tax-free threshold of £300,000. There are anumber of important exemptions, including transfers to spouses orcharities, small gifts, and reliefs for agricultural property and familybusinesses. It is currently paid by only 6 per cent of estates eachyear.1

But significant problems exist with the system. First, IHT isnotoriously easy for the very wealthy to avoid via expensive taxadvice. So while the decision to double this threshold for marriedcouples and civil partners looks, on the face of it, like a huge taxbonus, in fact it was already possible for most married couples totake advantage of a doubled threshold using careful tax planning.

Many more loopholes exist. Although some, most notably ontrusts, have been closed, the biggest and most easily exploitedremains wide open. Because IHT is designed as a tax on the estates

1. Brown G (2006), BudgetStatement, available online athttp://www.hm-treasury.gov.uk/budget/budget_06/bud_bud06_ speech.cfm.


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of the deceased rather than the gifts of the living, people can alwaysavoid paying it by gifting their wealth to others as long as they livefor seven years after they have done so. It is easiest for the wealthiestto take advantage of this provision – for the moderately affluent,their wealth tends to be locked up in their homes. One report hassuggested that IHT receipts are only 16 per cent of what they wouldbe were it not for avoidance and exemptions.2

The second major oversight in the current system of wealthtaxation is the exemption of principal private residences from capitalgains tax, or any other tax except IHT. It seems unfair that windfallgains in housing value, which simply represent a transfer of wealthfrom non-owners to owners, and derive in the main from restraintson house-building, go untaxed altogether until death, whereasearned income and other forms of investment income are subject totax on an annual basis. This exclusion helps to justify an IHT rate ashigh as 40 per cent. The total value of the UK’s private housing stockrose by over £400bn in value in 2006,3 yet Treasury figures suggestthat IHT and stamp duty on house purchases raised only around£14bn – less than 4 per cent of the increase in value.4 Thus thecurrent IHT system captures only a tiny fraction of increases inhousing wealth.

However, the general public does not seem to see it that way,perhaps unsurprisingly given the lack of defence of wealth taxationby our politicians. On the face of it, IHT looks highly unpopular.The Conservative pledge to raise the threshold to £1m seemed toresonate strongly with ‘floating voters’ if opinion polls taken soonafter Osborne’s announcement were anything to go by.

That said, the findings of more systematic research on publicattitudes give somewhat greater grounds for optimism. A Fabian TaxCommission survey in 2000 found that a very slight majority of the

2. Wadsworth, M. (2006) Tax,Benefits, Pensions: Keep itSimple Part 2.Available atwww.bowgroup.org/harriercollectionitems/Tax+Simplification.doc

3. Halifax (2006), UK PrivateHousing StockWorth £3.8Trillion, Press release 15January 2007, availableonline at http://www.hbosplc.com/economy/includes/150107ukprivatehousingstock.doc

4. HMTreasury (2006),Budget 2006: A Strong andStrengthening Future,London: HMTreasury


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public – 51 per cent – were completely opposed to any tax oninheritance, demonstrating significant resistance, but certainly notunanimous opposition.5 Interestingly, attitudes were least hostileamong older groups and the most affluent social classes.

Yet misperceptions about IHT are widespread: an Ipsos/MORIpoll shows that people were most likely to say 25-49 per cent ofestates paid the tax, far higher than the actual figure of six per centeach year.6 Moreover, we should only read so much into polls, whichusually provide only a superficial snapshot of people’s attitudesabout inheritance tax, and do not always reveal the depth withwhich they hold their beliefs.

In contrast, deliberative workshops can enable policymakers to get asense of how fixed public views are and of the overall potential forchange.7 ippr conducted deliberative workshops on IHT in 2005 with abroadly representative sample of 32 people. At the start of theworkshops there were similar levels of hostility to IHT as those revealedby the Fabian commission survey. However, once people werepresented with balanced arguments for and against inheritance tax, andan informed debate ensued, therewas amodest shift in support for IHT.While half of participants were opposed outright both before and afterthe workshops, there was a clear increase in support among those whowere ambiguous or unsure about the idea. Hypothecation of IHTseemed to increase support further: a clear majority said they would bemore willing to support IHT if it were put aside to spend on a particulararea of public services.8

There is also some evidence of changing attitudes, with the middle-aged generation less concerned about leaving an inheritance. In theIpsos/MORI survey, only 15 per cent of potential bequeathers said itwas ‘very important’ to leave an inheritance, with most saying it was‘fairly important’ (50 per cent) or ‘not very important’ (28 per cent).

5. Fabian Society onTaxationand Citizenship (2000),Paying for Progress: A newpolitics of tax for publicspending, London:TheFabian Society.

6. Rowlingson, K and McKay,S (2005) Attitudes toInheritance in BritainYork:Joseph Rowntree Foundation

7. Lewis M andWhite S(2006), “InheritanceTax:What do the PeopleThink?”in PaxtonW andWhite Swith Maxwell D (eds),TheCitizen’s Stake, Bristol:ThePolicy Press.

8. Ibid.


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Older age groups (70 plus) were more likely than younger groups toagree with the statement ‘older people should be more careful withtheir money so they can leave an inheritance’. It’s hard to know whetherthe current middle-aged generation will change their mind as theymove into retirement, but this data certainly suggests that publicattitudes are not as intractable as might be assumed.

New research has also probed public attitudes into other forms ofwealth taxation.9 In broadly representative focus groups, it foundthat people were more positively disposed to a tax on land valuethan inheritance tax: some recognised that an increase in land valuecaused by social investment near their home should be taxed(although others maintained that any increase in the value of theirland was rightfully theirs).

All this suggests that it would be feasible for progressives to builda consensus in favour of wealth taxation, but this possibility iscontingent on three things. First, progressives need to start from aposition of realism. There will always be some people for whommaking bequests is important, and it would be futile, and indeedwrong, for politicians to try to argue against this. The goal ofprogressivism is not to eliminate all advantage that may be passeddown through a family in an attempt to level down – but instead toextend this advantage to all as far as possible. A tax on wealth shouldtherefore be understood as a way of funding the expansion ofopportunities for those who are not lucky enough to receive aninheritance. One way of doing so would be to link revenues from atax on wealth to expenditure on policies that explicitly expandopportunities such as education and childcare. Public supportshould be easier to build if citizens can see that this link exists.

Second, progressives need to defend wealth taxation from firstprinciples using the facts – so people are aware of the arguments in

9, Prabhakar R (2007),TaxingWealth: Public attitudestowards policies forovercoming wealth inequality,paper for presentation at2007 Political StudiesAssociation AnnualConference.


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10. McLean I (2006), “ThePolitics of LandTax –Thenand Now” in Maxwell D andVigor A (eds), Time for LandValue Tax, London: ippr.

favour as well as against wealth taxation, and the reality of how itoperates. But in order to make this case, wealth taxation needs to beclearly linked to the principles that lie behind wealth taxation. As wehave outlined above, the current structure of IHT and capital gainstax is not linked to the idea that windfall gains to wealth should betaxed just as income is, and that everyone making bequests or giftsshould be taxed, not just those who cannot afford expensive taxadvice or who have given away their wealth earlier in their lifetimes.It is difficult to defend IHT as a one-off tax on housing wealthbecause it taxes different kinds of wealth in exactly the same way. SoIHT in its current form is easily attacked and difficult to defend.

Third, making the case for wealth taxation will also be easier if thetax is perceived as fairer, and this gives further impetus for reform.Our long-term vision for wealth taxation is therefore a system thatis strongly linked to the progressive principles that justify it. Thereare two candidates that could potentially form the focus of the policydiscussions required to achieve long-term reform.

The first would be bringing housing wealth more fully into the taxsystem. There has recently been increasing interest in the idea of atax on land value, levied on owners. Such a tax could be an annuallevy at a set percentage of land value, say half to one per cent. Thiskind of tax would have a number of advantages. First, and mostimportantly, it would capture some of the huge gains in land valuethat simply represent a transfer of wealth from non-owners toowners, without some of the distortionary effects that would comewith a tax on transactions, such as bringing principal privateresidences under the auspices of capital gains tax.10 Second, unlikeinheritance tax, it would be difficult to avoid – land cannot be easilymoved or hidden. Third, it could have significant macroeconomicbenefits, helping to stabilise property prices in high-demand areas


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and to increase investment in low-demand ones.11 Slower houseprice growth in areas of high demand will help to bring homeownership within the reach of increasing numbers of people.

Of course, there would be many difficulties involved with suchfundamental reform of the tax system.12 It would create new losers aswell as winners, not least those who live in expensive houses butwith moderate incomes – which would make the introduction ofsuch a tax a political challenge. These impacts could partly besoftened by allowing those in low-income households to build uptax liability against the property tax-free until it is sold, and byincluding exemptions for low-income homeowners. There are alsomany unresolved questions about how such a tax might work13 –would it wholly or partly replace local taxation, and how muchwould go to the Exchequer? And how would land value itself beassessed?

This kind of fundamental reform to the system of wealth taxationin the UK seems a long way off. However, progressives need to startthinking about how we can realise the benefits of such a systemthrough short-term reforms to our current system of propertytaxation. The future revaluation of council tax (whenever it occurs)may offer an opportunity to make a strong case for property taxationbetter linked to property value.14 There are also numerousinternational examples which we can draw on – the fiscalframeworks in South Africa, western Canada and some Caribbeanstates all incorporate a form of land value tax.

The second candidate for reform is changing our system of taxingintergenerational transmissions of wealth so that the affluent cannotavoid tax by giving away their wealth seven years before they die.This loophole cannot be addressed through tinkering with the IHTlegislation. Rather, more fundamental reform is required. One

11. Muelbauer J (2006),“PropertyTaxation and theEconomy” in Maxwell D andVigor A (eds), Time for LandValue Tax, London: ippr.

12. Brookes R,“Commentary”, in Maxwell DandVigor A (eds), Time forLand Value Tax?, London: ippr.

13. McLean I (2006), “ThePolitics of LandTax –Thenand Now” in Maxwell D andVigor A (eds), Time for LandValue Tax, London: ippr.

14. Maxwell D andVigor A(2006), “Introduction” inMaxwell D andVigor A (eds),Time for Land Value Tax,London: ippr.


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option would be a tax on gifts rather than inheritance. Ifprogressives believe that the transmission of financial wealthbetween generations should be taxed, they should be brave enoughto advocate the tax of all forms of transmission between adultgenerations, not just those at death.

Such a tax could either take the form of a tax on the gifts thatdonors make, or a tax on the recipients of gifts as was proposed bythe Fabian Tax Commission in 2002.15 There would be certainadministrative complexities associated with a gift recipient tax thatcould increase compliance costs.16 But individuals already need tokeep a record of gifts that exceed the £3,000 annual exemption limitbecause these are liable for inheritance tax should they die withinseven years – so moving towards a tax on donor gifts does not seeminconceivable. To minimise the need for lengthy record-keeping,gifts could be assessed for tax purposes on an annual basis, with anannual tax-free allowance. Such a reform could potentially lead to asignificant increase in tax take, and might therefore allow a move toa banded system, with smaller annual gift amounts taxed at lowerrates than larger ones. There would, of course, need to be largerexemptions for gifts to children. Again, such reform would be along-term goal and would require further investigation andmodelling, but we believe it is an option progressives should explore.

Wealth taxation is currently a little-used method ofredistribution: IHT and capital gains tax between them raise only atiny proportion of total government revenue. But this is anargument for reform, not abolition. Research shows that publicopposition to wealth taxation is not as intractable as we might think,despite the warm response to the Conservatives’ proposals lastautumn. But it will be exceptionally difficult to win support forreform so long as IHT is perceived to be unfair and progressives fail

15. Patrick R and Jacobs M(2003), Wealth’s FairMeasure: The reform ofinheritance tax, London:TheFabian Society.

16. Maxwell D (2005),“Towards a Citizen’sInheritance”, in PaxtonWandWhite S with Maxwell D(eds), The Citizen’s Stake,Bristol:The Policy Press.


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to make the case for wealth taxation. Defence and reform of wealthtaxation must go hand in hand.

Sonia Sodha is a research fellow in the directors’ research team at ippr.

She is co-author of ‘Mind theWealth Gap:The politics of resource

inequality’ in Pearce N and Margo J (eds) (2007), Politics for a New

Generation, London: Palgrave Macmillan and ippr.

Howard Reed is chief economist at ippr and is currently leading work at

the institute on tax reform to promote encourage progressivity and

environmental effectiveness.


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Is there more to lifethan trading?Stephen Hale

Environmental taxes are out of political fashion. The new orthodoxysystematically prefers emissions trading to tax. The government hasintroduced a plethora of trading schemes on the grounds ofperceived efficiency and simplicity, and regards environmental taxesas less politically and empirically desirable. This is now a widespreadorthodoxy. It is also wrong. The result is rising UK emissions andfalling revenues from environmental taxation.

It is time for a rethink. As Sir Nicholas Stern argued, we need touse a much wider set of instruments to tackle climate change andother environmental concerns effectively. The political space existsto do so. Taxation can and should be used in many instances toestablish a predictable carbon price, and well-designed regulationsare a critical tool for establishing minimum standards and drivinginnovation in both energy and transport policy.

Labour’s recordLabour entered office with considerable enthusiasm forenvironmental taxation, as set out in an early statement of intent on


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environmental tax and demonstrated by the introduction ofLabour’s most high-profile green tax, the climate change levy. Thiswas introduced in the teeth of considerable opposition, and had a fargreater effect on emissions than the critics predicted. But it wasarguably the high point of Labour’s commitment, and has not beenenhanced over time to strengthen the price signal for bothgenerators and consumers of energy.

Hostility to the levy and to fuel duty, and the Treasury’sinstitutional hostility to domestic action on climate change, havesince combined to drasticallycurtail Labour’s approach. Thediminishing enthusiasm forenvironmental taxes is visiblepartly from the declining revenuearising from them. In 2006,revenue from environmentaltaxation had fallen to 7.3 per centof total taxation, by comparison to 9.1 per cent in 1993.1 Two-thirds ofthe total is accounted for by fuel duty, a tax which has failed to reversethe declining cost of motoring in real terms.

But the real test of environmental taxation should beeffectiveness, not revenue. Well-designed taxes can and do drivebehavioural change. In retrospect, Gordon Brown’s most successfulenvironmental tax will probably be seen as the 2007 landfill tax. Inhis final budget, he announced annual rises of £8 per tonne and along-term rate of £56 per tonne by 2011. Remarkably, this was thethird declaration of the final long-term rate for landfill tax. It shouldfinally make alternatives to landfill economically attractive and shiftnew investment to more environmentally and economicallyadvantageous patterns of waste management and resource use.

1. Andrew Leicester,November 2006, The UK taxsystem and the environment,Institute for Fiscal Studies.


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“Gordon Brown’s most successfulenvironmental tax will probably beseen as the 2007 landfill tax”

Other taxes have not had an equivalent impact on investmentpatterns. With the political space created by rising public concernand an opposition that has not been afraid to outflank Labour ongreen taxes on aviation, the challenge now is to develop an approachto environmental taxation that works with other policy levers toshift business and public behaviour and secure Labour’s goals onclimate change, waste and resources.

This is urgent. As all parties now acknowledge, runaway climatechange would bring with it a series of profound economic, social,security and environmental impacts that would do immensedamage to our planet and our wellbeing.

There is also a pressing political need for greater policycoherence. As a result of the climate change bill, an independentcommittee chaired by Adair Turner will make publicrecommendations to the government in November 2008 on thetargets and policies needed to secure emissions reductions from nowto 2020. The autumn pre-budget report is a critical opportunity forthe government to get its house in order in advance of that.

Tax in context – a Stern reminderThe Stern review of the economics of climate change, published bythe UK government in 2006 and named after its lead author SirNicholas Stern, is the definitive assessment of the policy frameworkneeded to tackle climate change.2 His report proposed threeelements in the global policy framework needed to tackle climatechange. The neglect of any one of these tools will significantlyincrease the costs of action.

The Stern report offered three possible means for pricing carbon:trading, taxation and regulation. Taxes deliver a certain carbon priceand a consistent market signal, benefits not yet exhibited by any

2. Sir Nicholas Stern, 2006,The Stern Review on theEconomics of ClimateChange, HMTreasury.


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emissions trading scheme. But, the critique goes, the effect onbehaviour and thus emissions is harder to predict. If the tax is set toolow, the tax is paid without achieving its environmental objective. Ifit is set too high, you have a revolt on your hands. By contrast,trading appears to be economically efficient and politically easier.

As a result trading has become the default policy of choice in the UKand the EU. The EU emissions trading scheme is seen as the key toreducing emissions from electricity generation and intensive industrialusers,3 and will soon also include aviation emissions. The new carbonreduction commitment will trade emissions from the smaller retail andpublic sectors’ electricity and gas use, and household energy emissionswill soon be traded by energy suppliers under the supplier obligation.

Beyond tradingHowever, trading is a necessary but wholly insufficient means ofsecuring emissions reductions. The design of trading schemes by

3. From 2008 the ETS will cap52% of projected UK carbondioxide emissions.


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Policy framework for climate change mitigation

Policy to reduce emissions should be based on three essential elements: carbon pricing, technology

policy, and removal of barriers to behavioural change.

1. Carbon pricing

Establishing a carbon price, through tax, trading or regulation, is an essential foundation for climate

change policy.

2.Technology

Policies are required to support the development of a range of low-carbon and high-efficiency

technologies on an urgent timescale.

3. Removal of barriers to behavioural change

The removal of these barriers is a third essential element, one that is particularly important in

encouraging the take-up of opportunities for energy efficiency.

governments creates a host of risks. The current trading scheme is notdelivering any significant emissions reductions due to a weak cap anda lack of market confidence of the long-term carbon price. Franticefforts are now underway to achieve this at EU level. Tax, like trading,is not a panacea. But it can provide a critical floor for the carbon priceand safeguard against market volatility and eliminate the windfallgains which are a common feature of trading schemes.

In the energy sector, tax can create the certainty needed to underpintrading for both energy generators and large consumers of energy. Areformed climate change levy could achieve this, as the Conservativeshave argued. At the household level, well-placed rebates and levies onstamp duty and council tax can drive behavioural change, and promotethe purchase of environmentally friendly products.

In transport, taxation is critical to securing the long-termemissions reductions that have so far proved so elusive. We need toinfluence consumers at the point of purchase, and to establishmeaningful differences in vehicle excise duty bands, to accelerate anemerging shift in car purchase patterns. Sales of low-emissions carsrose by 17 per cent last year, while those in the top road tax band fellby 15 per cent to the lowest level on record.4

But the critical weakness in the predominant orthodoxy is not thebalance between tax and trading. A clear market price of carbonmay be best secured, in different circumstances, by tax, trading or acombination of both. Rather, it is the tendency to downplay theother levers highlighted by Stern.

Our energy and transport policy frameworks have to create thecertainty and incentives needed to drive a dramatic and rapid shiftin private investment and individual behaviour. The currentframeworks are not delivering this, as recent work from theinfluential Office of Climate Change confirms.5

4. See http://driving.timesonline.co.uk/tol/life_and_style/driving/news/article3267180.ece

5. Analytical Audit, Office ofClimate Change, 2007.


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Regulation in particular is being neglected as a policy option. It isbeing used in some instances to establish minimum standards ofefficiency for products, housing, energy generation and in transportfuels. But we can and must do more both on minimum standardsand in using regulation to set transformational standards, as thegovernment has opted to do with the commitment to zero carbonhousing from 2016 onwards.

Risks and opportunitiesThere are of course risks to new environmental taxes. At a time ofrising energy prices, the need to design environmental taxes to avoidharming the poorest is a particular concern. The Conservativeaccusation that all environmental taxes are stealth taxes is alsopotentially very damaging. It is manageable, however, in particularby matching tax reductions elsewhere and by use of revenue toachieve similar environmental ends. This has often been done in thepast despite the Treasury’s ostensible resistance to hypothecation.

This is not just a climate change agenda. There are also importantopportunities to use taxation to influence product design, and thusthe carbon, waste and water impacts of the products we buy. Tescois in the process of labelling every product for its carbon impact.Surely the government can find ways to use VAT to discourage themost wasteful products and stimulate positive innovation, as GreenAlliance argues in a recent report.6

Green taxes can also create new economic opportunities, incombination with regulation, procurement and public spending.This is an agenda in which the prime minister has shownconsiderable interest, but with little concrete policy impact to date.He established the Commission on Environmental Markets andEconomic Performance, which considered how we can make the

6. Hannah Hislop and JulieHill, February 2008, Goodproduct, bad product? Makingthe case for product levies,Green Alliance.


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most of these linkages and offered yet more evidence that emissionstrading alone will not drive the necessary technologicalbreakthrough and new employment opportunities.7

ConclusionEmissions trading is not a magic bullet. New taxation measures,combined of course with additional regulation and public spending,are essential to shift the energy and transport choices of investorsand public alike and secure the targets to which the government isnow so firmly committed. Some of those who have been mostresistant to change now agree. Post-Digby Jones, the CBI nowrecognises that competitive markets will only deliver climate changegoals if governments design them to do so.

‘Market forces will drive big changes, but they will not bythemselves be enough to do the job. The full range of public policiesmust be deployed to create the right incentives. Priorities includepromoting an effective market price for carbon; revenue-neutral taxreform to reward greener behaviour; and bigger, more focusedresearch and development programmes to finance new technologiesand solutions until they become commercial.’8

So the political space exists for a much bolder approach. There isstrong support for green taxes in principle and in some specific areasin both opposition parties. Chris Huhne and Greg Barker representthe two main opposition parties on the recently established cross-party Green Fiscal Commission.9 Intriguingly, climate changecommittee chair Adair Turner is also a member of that commission.Labour should take heed. It is time to rediscover the ambition for asignificant tax shift that Labour had in opposition.

SStteepphheenn HHaallee is director of Green Alliance

7. Commission onEnvironmental Markets andEconomic Performance,November 2007, Commissionon Environmental Marketsand Economic PerformanceReport.

8. CBI Climate Change TaskForce, November 2007.

9. For more information, seewww.greenfiscalcommission.org.uk.


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Taxation and progressive politics: the local dimensionChris Leslie

The big pictureWith what is widely recognised as a breathing space in 2008 beforeany possible general election, now is a good time to take stock ofLabour’s message on local public services and taxation. We knowthat there are thorny issues involved, but bold politics is required toregain any initiative. All three major political parties are vying forthe localism crown. David Cameron is apparently offering a ‘postbureaucratic’ era. Nick Clegg is allegedly keen to press for widerdemocratisation of local services. So which way could Labour go?

I must concede that there would be few takers for a bet that anyleading politicians will grab the local government finance bull bythe horns. The smart money says that it is just too difficult andanyway tax changes always upset the losers, but fail to impress thewinners.

Yet council tax is a runaway train already unpopular and gettingmore so every year. The political price of a solution can only goupwards. But there must be a prize to be won by solving this issue.More urgently, there is a bigger picture demanding a fresh look at


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local government finance: solving the policy and delivery blight thata dysfunctional finance regime leaves over modernised publicservices.

Labour’s achievements so far result from modernising the oldmachinery of government and investing more to target the public’sconcerns. Citizens have banked those gains and now expect moredramatic improvement.

A governing party cannot rely solely on extolling the achievements ofthe past. Labour must show that it has a plan for the future. Labour’sresponse should be: ‘We have done a great job with the old tools thatwere available in 1997. They have taken us half the distance, now wemust create new tools to finish the job.’

There are some green shoots of hope – including the occasionalacceptance that crude national targets are no longer the only option,and gradual moves towards a ‘place-shaping’ concept in servicedelivery. Some of the recent white papers and five-year plans haveshifted from seeking to just join up government nationally to joiningup locally. Whether on public health, or economic growth, Labourplans now depend on local councils coordinating and leadingpartners across the public, private and third sectors.

Yet nationally Labour’s narrative too rarely mentions the vitalposition of local government in its plans. That may explain whycouncils are still held back by controls designed for the 20th century. Atthe heart of those systems is local finance.

Council taxCouncil tax is the tip of the iceberg; looming and politicallydangerous, but only a small part of the challenge. A tax whichworked well when it raised £8.9bn in 1993, works badly when it hasto raise £24.9bn in 2008. Average Band D council tax was £580 in


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1994 and it is set to be £1374 in 2008. It has become Britain’s mostunpopular tax with 67 per cent believing it is unfair.

The problem is the system, not the councils that use it. Localgovernment is generating £100m of savings every month, more thanany other part of the public sector. And councils are improving servicedelivery faster than any other part of the public sector.

Council tax keeps rising because it is only 25 per cent of funding forcouncils. This causes the ‘gearing ratio’ where all the financialuncertainty has to be carried by one quarter of the budget; so a £1 risein spending requires a £4 rise in council tax.

And council tax is becoming more arbitrary every year. Each newhome that is built has its tax band calculated on the forecast of what thehome would have sold for in 1991 if it had been built then – a bizarremethodology. Labour is pledged to build three million new homes by2020. Only by revaluing on updated and relevant prices can thisarbitrariness be addressed.

These problems create another. To manage these upward pressuresgovernment can find itself capping council tax. This converts the onetax available for local choice into a national property tax, with minorlocal variations. This is a highly undesirable way to drive local spendingdecisions.

But revaluing rates on today’s prices, reforming the structure ofthe property tax giving more local flexibility and then abolishingcapping would in isolation cause as many losers as winners. It is forthis reason that we need to press for significant transitional relief –at least £4bn to ease the move to the reformed arrangements whichshould see all new council tax bills initially dampened by £200.These are the basic building blocks of a strategy to move from thecurrent dysfunctional council tax arrangements to a saner, moresensible approach. However, if done in isolation from the rest of the


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finance system the same weaknesses in the new council tax couldeventually re-emerge.

Symptoms of unstable local finance The gearing ratio and cost shunting are symptoms of the problem.There are more.

The nationalisation of business rates in 1990 ended the link betweenthe fortunes of the local economy and those of the council. TheTreasury review of economic development revealed the central role thatcouncils need to play in coordinating sub-regional development. As aresult new incentives have been created through the supplementarybusiness rate and proposals for simpler income from planning gain.

Specific grants, money with strings, make for good nationalheadlines and initiatives, but reduce local financial flexibility andpolitical entrepreneurialism. Ring-fenced grants reached £15.4bn by2004. Thankfully, Labour’s plans for devolution and joined-upgovernment have begun to reverse this. This year £5.6bn has been putback into area funding as part of the local area agreement process.

The bigger problem is that most central grant funding is allocatedusing complex statistical forecasting to guess at the relative needs ofeach council. The system is flawed in both practice and principle. It usesdozens of correlations, such as the numbers of children with specialeducational needs, to calculate spending required. But this delicatemodel is then filled using census data up to 10 years old. Inevitably theassessment is, at best, crude and almost always challenged by localcouncil leaders.

More serious is that a ‘needs only’ system removes incentives forsuccess. Perversely, a council that solves problems will eventually havetheir grants cut! Councils respond by arguing over the statistics withcentral government, rather than looking outwards to see how they can


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increase the wealth of their communities. So a vicious spiral is createdwhere seeking better funding, councils encourage the centre to secondguess the cost of their delivery plans. In turn, Whitehall is given a greenlight to revert to the very micro-management that Labour’s other plansare trying to reverse. This Whitehall dependency culture is smotheringstrong political leadership and Labour is best placed to recognise andreform it.

Causes of unstable local financeThese are symptoms of deeper causes; the need for fairness across thenation and the mismatch between command and control governmentof the 20th century and the joined up government in the 21st.

‘Resource equalisation’ is used to ensure that poor areas (where localrevenues could never meet needs) are not left with fewer services thanthose with less need. To ‘equalise’ spending in all councils requires about£17bn of around £100bn spent by local government in England. It isimportant that there is basic fairness in available resources, but resourceequalisation is only one small part of the overall grant.

Local government is now the coordinator of joined-up delivery frompublic health, through worklessness to economic development. Yet forevery £1 spent by councils, £4 is spent by other local services. Localgovernment success now depends on the ability these other localquangos have to tailor spending on national goals to localcircumstances. The finance regime must be reformed to supportjoined-up government.

Reforming local finance for 21st century governmentWe need to move from analysis to solutions. In principle reform shouldcreate:


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� A connection between the councils and the local economies forwhich they are taking responsibility

� Incentives to improve communities, service solutions for citizensand better joined-up government

� Equalisation to ensure that less wealthy areas are not disadvantaged� An environment where fiscal problems are better solved by

improving the area represented by a council, than by arguing withcentral government

� Greater autonomy from central government and greateraccountability to local people

� Space for central government to drive forward its national policies

Reform must not be about making it easier to raise taxes. Instead taxesshould be transferred from central to local government. There should bemore pressure on local government to deliver value for money, but thatpower should transfer to local people from central government.

The New Local Government Network (NLGN) set out acomprehensive solution in our recent publication Pacing Lyons: a routemap to localism. Many solutions that look plausible at national level willnot work at local level. Income tax is the fairest of taxes: nationally. Yeta local income tax raises £1534 per head in Blackburn with Darwencouncil, £7118 per head in Richmond upon Thames and £46,647 in theCity of London. Those who advocate a local income tax need to addressthe equity issue seriously.

A more sophisticated alternative would be to swap the allocation ofgrant with the allocation of elements of tax revenue. If the Treasury gavecouncils a slice of the revenues generated locally then local authoritiesmay have a stronger motivation to influence that revenue rather thanrevert to arm-twisting ministers for grant formula tweaks. For example,it might be possible to allocate the most commonly paid slice of income


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tax (currently the revenue from the 10p starting rate) and substitute thisfor grant, on the basis of a flat rate per person employed in an area. Ifthis were the case, councils would then know that they can improvetheir finances when they create new jobs and improve the employabilityof their citizens.

Giving councils an automatic first call on elements of some currentlynational tax revenues could provide incentives and avoids the risk ofunfair localised taxes. By increasing this funding, smaller central grantscan focus on equalisation. It is then possible to simplify the system, sofreeing councils to focus financial strategy on their communitiesinstead of on Whitehall’s statisticians.

Joined-up government requires that councils and their partners canredirect existing resources to meet local circumstances. Where a localarea agreement (LAA) has been signed by local public sector partnersand by ministers, the local arms of national public services should beallowed to redirect their grant funding so that it matches the LAAstrategy.

Council tax reformBefore these reforms can be implemented the problem of council taxmust be resolved. Referenda on council tax simply transfer anunreasonable choice between less services or higher taxes from townhalls to local people. More fundamental reform is needed.

Revaluation is the key to reform. Yet the politics of losers mean thata one-off cut in council tax may be needed to cancel out increases forthe losers. NLGN have proposed that a new 10 per cent increase inincome tax for those on £200,000 or more could deliver a £205 cut incouncil tax.

All properties in England could then be revalued on today’s prices. Aless intrusive system could be employed using either the last actual sale


p. 31

price for a home, or a projection of property value based on sale pricesfor similar properties in the vicinity. This can be achieved today usingthe Land Registry database, or one of many online propertyinformation systems.

In Escape from Council Tax, NLGN proposed that councils, havingrevalued properties, should have more local flexibility to adjust thenumber of tax bands from today’s A to H, to vary the rates at which eachband applies and to vary the difference between bands. Councils couldthen tailor property tax to be fairer in each area. The new system is sodifferent that a new name – the local property levy - would be neededto avoid confusion.

Conclusion: the urgency of reformFinancial systems reflect the underlying structure of government. In the20th century big government and national programmes solved socialproblems. Local finance was always an afterthought.

As a new way of governing and delivering joined-up services emergesso a new finance regime is needed. Reform could demonstrateunderstanding of the cornerstones of 21st century government:devolution and citizen-centred delivery.

As the governing party Labour can seize the opportunity first and soshrug off promises from other parties by pointing to achievements inoffice. But time is short. All parties want to lead this agenda. If Labourhesitates others may adopt the logic of recent reforms and, by applyingthem more thoroughly, become the inheritors of Labour’s pastachievements. More reason for Labour to act boldly and do so now.

Chris Leslie is director of the New Local Government Network


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The Progress Essays

How do we makethe case fortaxation?

David Coats, Sonia Sodha, Howard Reed,Stephen Hale and Chris Leslie

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