Andy Burnham’s plans for regional mayors to keep a portion of locally-generated income tax as an alternative to grant funding risks making regional inequalities worse, the Institute for Fiscal Studies has said.
Last week Burnham set out proposals to allow mayors to retain a greater share of business rates from April next year and to get a yet-to-be defined share of income tax from 2028 to reward efforts to boost local growth.
The IFS said that directly linking mayors’ funding to the performance of local income tax and business rates revenues could provide stronger financial incentives for policies and investments that help boost incomes and support the development of commercial property.
The think tank added that permanently assigning a share of tax revenues to mayors could also give them longer-term clarity over their future funding than existing grant funding, enabling longer-term spending and investment.
However, it said that replacing grant funding with a share of tax revenues is “not an unalloyed good” because greater rewards also mean greater risks. The IFS said revenues in different places could diverge for reasons completely outside mayoral control and can be uncertain on a year-to-year basis.
The IFS said that aligning the design of the new system with the government’s – and mayors’ – objectives and appetite for risk will be important and that designing an appropriate system of “equalisation” would be essential.
David Phillips, head of devolved and local government finance at the IFS, said it is estimated that between 6% and 9% of local income tax revenues would be enough to fully replace integrated settlements for economy-related functions provided to mayoral strategic authorities in the North and Midlands.
Phillips said that in London less than 1% of local income tax revenues would cover the Greater London Authority’s existing integrated settlement, because the settlement is lower and income tax revenues are much higher per person than for other mayoral authority areas.
He said the government will need to decide whether to roll other grants into the new revenue-assignment system, on top of integrated settlements – particularly in the case of Greater London.
Phillips added that ministers will also need to decide whether Greater London receives as big a share of local revenue – and future revenue growth or decline – as other strategic authorities.
The IFS estimates that per-head income tax revenues in Greater London are more than three-and-a-half times higher than they are in the West Midlands.
“Big differences in income tax revenue mean some sort of equalisation system will be vital if the government does not want to exacerbate, rather than help address, regional inequalities,” it said. “Carefully designed equalisation systems can ameliorate the trade-offs between equalisation and incentives, but not eliminate them.”
The IFS said the simplest approach for income tax retention would be to set an across-the-board percentage for retention. But it noted that this would mean mayoral authorities benefited most from increases to the incomes of the rich, as income tax rates increase with income levels.
The think tank said an alternative approach could be to assign a fixed number of percentage points for each tax band. “This approach would also reduce both inequalities in tax revenues between mayoral strategic authorities and the volatility of tax revenues over time,” it said.
Phillips said that while the tax proposals would represent a “significant” change for England, they were “far from radical” in the context of regional-government funding in other countries.
“Currently, England’s mayoral strategic authorities – particularly those outside London – rely overwhelmingly on grant funding from the government. By 2028, much more of their funding will come from tax revenues raised in their areas,” he said.
“This will provide greater financial reward if their economies and revenues perform strongly, but also more risk if the economy and revenues perform poorly – perhaps due to factors entirely outside of their control.
“With the new PM Andy Burnham placing a priority not just on growth but also on tackling regional inequalities, designing an appropriate system of ‘equalisation’ will be vital. Trade-offs between providing rewards for growth and protection from the risk of things going wrong cannot be avoided entirely.”
The government’s Rewiring the State policy paper, which was published on Friday and sets out thinking on the devolution of power from Whitehall, confirmed that ministers are alive to the danger of driving further inequalities. “We will consider how these growth incentives can be balanced with the need for fairness between places,” it said.
Elsewhere, the IFS noted that Burnham’s plans for regional mayors to retain a greater portion of business rates would create an immediate tension in Greater Manchester, Liverpool City Region, the West Midlands and the West of England.
In those areas, regional mayors and local authorities already retain 100% of their business rates. The IFS said that allocating a bigger share to mayors would require reducing the share allocated to local councils.
According to Rewiring the State, ministers will unveil a “fiscal devolution roadmap” alongside the Autumn Budget. There will also be a white paper detailing “the full set of reforms” and a “clear timetable” for their implementation.
The Autumn Budget is due to be delivered on 28 October.