Council Tax Unfair? Better System Proposed

Economists have argued for years that council tax in the UK was rushed in and badly thought out. After the poll tax fiasco of the early 1990s, a substitute was urgent. The answer was council tax, but this was almost as unfit for purpose as the poll tax it replaced.

So if the experts know council tax is an unfair mess , why has there been no reform? There seem to be three main reasons. First, while everyone can think of big improvements , there is no consensus on what exactly should replace it. So although almost any sensible reform would be better, nothing changes.

The second reason is politicians' and policymakers' fear of rocking the boat. There would certainly be losers as well as winners from any decent reform - and those losers would complain vociferously.

Finally, council tax is cheap to collect and yields a lot of revenue. Perhaps there is also the fear that if the stone is lifted, we would also need to address the problem of paying for local government.

Historically "domestic rates" were the main source of local government income in the UK, but their contribution to local spending had fallen to a low of about 10% by 2010.

Since then, local governments have increasingly borne the burden of austerity, however, with the result that council tax now covers 30% of their spending. But the system is creaking. The Thatcher government's deeply unpopular flat-rate "community charge" (poll tax) was a per-person levy supposed to pay for local services. Council tax was a hybrid - part property tax and partly a charge levied by local government.

These days, the house values providing the tax-base for council tax are still fixed at hypothetical 1991 values, even for new houses. But in the real world, UK house prices have increased , more than fivefold since 1991. And in London they have increased by a factor of eight compared to only 3.5 in the north, creating another problem of perceived fairness.

To make matters worse, the house values themselves were not used to calculate the tax, but rather eight value bands. These have not been updated, still stopping at £320,000 - reflecting the prices of a forgotten world. The result is the single occupant of a house worth £2.5 million may pay less than their married neighbours with a child in a one-bedroom flat.

The poll tax was supposed to represent a payment by residents for local services, so is levied on people not property. To retain an echo of this per-person charge, council tax has a 25% discount for single people. Paying is the liability of the occupier, not the owner.

So how could it be improved?

The most obvious reform for property taxes is to revalue all houses at current prices and wrap up stamp duty (another bad and unpopular tax) and council tax in a single payment. This could be charged as a percentage of a home's value - a "proportional property tax" (PPT). Then all houses would be revalued every year.

There are objections and complications to such an obvious reform. It would be impossible to remove the government's stamp duty revenues without replacing them. So a proportion of the total revenue from any PPT would go to the Treasury, with the rest helping to fund local government. The total revenues would still have to be divided between the two.

A second complication is older people who bought houses in the 1980s, for example, and who are now retired. For them, paying the same proportion of current values as those in work might be a stretch. One suggestion is that housing-rich, income-poor people could roll up their tax liability, so it was only paid when they sold the house or after they died.

However, some oppose such a delay since it removes the incentive to downsize (a move that would cost less if stamp duty had been abolished as part of the reform).

But could people suddenly find their liability leap fivefold if their house was revalued?. This fear is unfounded, since the tax would not be the assessed value of the house but some very small proportion - maybe 0.5%. Still, it might need strong and articulate political leadership to convince people of this.

As for the task of revaluing houses every year, these days AI can give accurate and almost instantaneous valuations. But homeowners should have a right to appeal the valuation. This would be free if experts judged the AI value was more than 5% out. If not however, the homeowner would be stuck with that valuation and would also have to pay the costs of the appeal.

To solve the problem of dividing the revenues of a PPT, there should be both nationally and locally set rates of tax on the value of houses. A recent calculation concluded that a rate of 0.11% of house values would offset the Treasury's lost stamp duty revenue. On a £1 million house, that works out as £1,100 a year.

Councils would then set their own rates, with the receipts paying for local services. This would provide some incentive to permit new house building, as tax receipts would rise to cover the extra costs rather than disappearing into national coffers.

This would also resolve the problem of how to divide PPT revenues between local and national government and avoid imposing a sudden, massive jump in property tax liability for people in southeast England. This is where the majority of £1 million-plus houses are located.

Setting the local rate at a uniform national 0.51% - yielding the same national total as council tax - would mean the owner of the £1 million house suddenly being hit with an annual bill not of £1,100, but £6,200. This would create serious opposition. So where house prices were higher, the local rate could be lower and still yield the same revenue.

An advantage of the PPT is that it could also be an effective and collectable wealth tax . Houses are the biggest element in personal wealth so the national rate of PPT could even be set higher than the 0.11% rate, increasing Treasury revenues and addressing appeals for a wealth tax.

This article was co-published with LSE Blogs at the London School of Economics

Paul Cheshire receives funding from ESRC. He is affiliated with the Centre for Economic Performance.