Local government finance in England is not working. By this point, I don't have to caveat this statement. The sector is in near-total agreement that the system, to the extent that there even is a coherent system, is broken. In our recent State of Local Government Finance survey, only 4% of senior council figures said they were confident in the sustainability of council finances (down from 14% in 2023), and over 50% of all respondents said they were likely to issue a section 114 notice in the next five years if nothing changes - coincidentally the likely lifetime of the next parliament. The sector's diagnosis of the problem - the costs of services rising faster than the capacity to pay for them, is clear. What is much less clear is what the next government might do about this.
We've put together a series of proposals in our LGIU@40: For the Future of Local Government manifesto. These are aimed at fixing the system of local government finance, resetting the strained relationship between local and central government, and empowering local governments to work for their communities. Alongside this, we have been working with researchers at the University of Northumbria led by Dr Kevin Muldoon-Smith to investigate how local government finance works - and it does work - in other countries.
There are many useful conclusions we can draw from this research about how other countries manage local government finance. In places like Italy, Japan and Germany, we have seen that they usually have a more sophisticated method for determining how much local authorities need to meet their duties, reducing the threat of 'unfunded mandates'. They also often have guaranteed and protected systems for moving wealth around to areas that need it more: England is a real outlier in not having a systematic method for equalising different territories, instead the most prominent method for achieving this in recent years has been through the competitive bid process for determining 'levelling up' funding.
On top of all of these differences, there is a relatively fundamental difference relating to one of the most omnipresent talking points of this general election campaign: tax. In many other countries around the world, local governments are partly funded by retaining a share of national taxes. This usually means a share of some combination of personal or corporate income taxes, VAT, corporate profits. The big taxes that are usually set by national governments - and raise a lot of money - are put in the hands of local governments.
National taxes can either be retained based on the contribution of residents in a given area (as with income tax in Germany) or redistributed according to need (as with VAT in Germany), which isn't technically retention but should still be part of the conversation. More often, countries choose to do a combination of both. This means that national taxes can be used to fulfil different objectives: equalising territories, making up for differences in the capacity to raise local taxes, or rewarding areas for their local economic successes.
The advantages of a system like this, compared to what we have in England, are significant. First, as a rule, national taxes raise more money than local taxes. Across the UK, VAT, income tax and national insurance together raise around two-thirds of revenue. Compared to something like a tourism tax, or retained business rates, these taxes are bigger, more popular, and more buoyant earners, meaning they are better placed to address the serious funding crisis across English local government.
Tied to this, national taxes, crucially, already exist. This means new taxes do not need to be introduced, and existing taxes do not need to go up, to implement any of these changes. Although whether they will have to be raised to fund the level of public services we expect is another question.
There would be complications. If national taxes are shared out based on need, some areas would gain more than they put in, and some, inevitably, would lose out. If national taxes are retained based on local generation, then rich areas will keep more than poor areas. Whatever way you cut it, a system like this will result in winners and losers. But exactly the same is true about local government finance now and widening the pool of revenue sources can only help to strengthen financial resilience.
In the countries we have analysed, the assignment of national taxation is not a replacement for local taxes, but another source of income alongside local taxation (which itself is often much more varied than we have in England) that allows local governments to pull different levers to deal with changing financial circumstances and take advantage of local opportunities. In England, at the moment, councils can raise council tax, only by a few percent without a referendum or special permission, and that is pretty much it in terms of raising significant revenue (and the restrictions mean that average council tax now is only 2% higher in real terms than in 2010-2011). In Japan, by contrast, there are at least 24 different local taxes. National tax assignment should be considered alongside a much broader set of local taxes, to ensure that sufficient revenue is accompanied by significant flexibility and local control.
In our survey, 68% of senior council figures favoured local government retaining a share of national taxes. However this would look in practice, and there are endless different ways of doing it, it can and should be considered as a way to shore up the financial resilience of councils, a task that should be top of the agenda for whoever forms the next government.
Greg Stride is senior researcher at the Local Government Information Unit (LGiU)
