Local Income Tax

HL Deb 09 February 2004 vol 656 cc941-70

4.1 p.m.

Lord Newby rose to call attention to the case for replacing council tax with local income tax; and to move for Papers.

The noble Lord said: My Lords, this afternoon we are raising the case for local income tax, because of the importance and urgency of the need to reform local government finance, and, in particular, of the need to replace the failing council tax.

We start from the premise that decisions by government should be made as close to the people as possible. We believe that local decisions are most likely to reflect local circumstances and that decisions taken that are removed from those who are affected by them or have to be implemented by them are, in many cases, likely to be ineffective or inefficient.

This approach has been vindicated by the failure of many of the Government's centrally set targets—ailure now opena fly accepted both by the Cabinet Secretary and in the Prime Minister's new found enthusiasm for localism. However, if more decisions are to be made at local level, it is both logical and necessary that the funding to implement them should also be raised to the maximum possible extent at local level. That used to happen, but it is certainly not the case today. At present, about 75 percent of the revenue of local councils comes from national government. A mere 25 per cent is raised and set locally. To make matters worse, the sole significant source of locally raised revenue is generated by the council tax; a tax introduced in panic by a Conservative government to rescue themselves from the greatest failure in taxation in our lifetimes—the poll tax. Council tax itself is now failing.

Council tax is failing partly because it is expected to bear too great a burden, but also because it is a thoroughly unfair tax. Paradoxically, it has to bear too great a burden because it represents such a small proportion of total council spending—for every 1 per cent of expenditure increase by a local council, council tax has to rise by 4 per cent—and, because it is a stagnant rather than a buoyant tax, it has to be changed annually to secure additional council income. That inevitably means that, for some councils in some years, council tax has to rise by a very large percentage to deal with a relatively low percentage increase in local spending. In years such as this one, most local councils budget for increases several times that of inflation to meet modest additional expenditure needs. Indeed, for 2003–04, the average increase has been 13 per cent throughout the country and, on average, in double figures, irrespective of which party controls the council. Indeed, at 16 per cent, Conservative councils have had the highest average rise compared with Labour councils at just under 11 per cent and Liberal Democrat councils at just over 10 per cent. In total, since Labour came to power in 1997, council tax bills have gone up 70 per cent.

for the forthcoming year, a survey published last week by the Local Government Chronicle, suggests that three quarters of unitary authorities and 70 per cent of county councils plan to increase council tax by more than 5 per cent. The response of the Government, like their Conservative predecessors, is one of outrage: "How dare these insolent councils propose increases which go beyond the arbitrary 5 per cent ceiling on tax increases that the Government have set?".

Also like their Conservative predecessors, their response is to threaten to cap such increases. Nick Raynsford sent out 56 letters to local councils last week saying that they must moderate their council tax increases or they would be capped. In some cases—Islington, for example—those letters went to councils that were planning to increase council tax by less than 7 per cent, which represents an expenditure increase of less than 2 per cent, which is hardly profligacy.

This year, the situation is exacerbated for many councils in the midlands and the south because the funding formula has changed. They do less well than before, but they are still expected to meet the same nationally set standards in social services and education, for example. That has led to many proposed double-digit council tax rises, and the threat of legal action against the Government. The council in south Gloucester, for example, proposes to initiate a judicial review of any capping decision against it on the basis that it is having to propose a high council tax increase only because of changes in the funding formula, not because of major changes in overall expenditure levels.

Council tax is creaking at the seams to generate the income that local councils need. However, it is fatally wounded because its unfairnesses have led to a collapse in its credibility amongst taxpayers the length and breadth of the country. Council tax is unfair because it is completely unrelated to income. It operates under a banding system that puts a ceiling on what the richest pay and a floor under what the poorest pay. As a result, the poorest 10 per cent pay over four times more of their income in council tax than the richest 10 per cent.

The poorest 20 per cent of pensioners pay nearly six times more as a proportion of their income than the richest 20 per cent of non-pensioners. In a year when state pensions rose by 2.6 per cent and council tax by 13 per cent, it is hardly surprising that pensioners have become the most vociferous opponents of council tax.

In order to mitigate the unfairness of the tax, we have a system of council tax credits for poorer households. However, some 2 million eligible households do not claim it, so many of the poorest end up still paying the tax. Liberal Democrats would scrap council tax and reinvigorate local government by introducing a local income tax as the principal means by which local people pay for local services. We would do so for several reasons. A local income tax is fair. It is quite simply related to ability to pay. It is also cheaper to administer and needs no special bureaucracy or benefits system. The council tax in the current year will cost some £569 million to administer. In comparison, a local income tax would save at least £300 million of that.

Local income tax is buoyant. Unlike council tax, revenue would rise automatically as the local economy grew. Local income tax helps decentralisation. Over time, it would allow national income tax to be cut, with tax power pushed down to local council level. Local income tax is also more accountable. As a general principle, raising tax close to people makes it easier for them to see how their taxes are spent. More people would pay local income tax than council tax, so more people would be aware of the cost of their councils. Finally, local income tax is tried and tested. It successfully operates across the developed world from America to Sweden to Japan.

How would our plans for local income tax work? That tax would work very much like national income tax. Local councils would set a rate for local income tax and that would be added to the national income tax rate. At the same time, council tax would be abolished, so the total tax burden across the population as a whole would be unaffected. It would be administered through the existing Inland Revenue PAYE system, so people need not fear that officials in their local town hall would know their earnings.

People would have the same tax-free allowances as they do for national income tax. They would then all pay the local income tax rate on all their incomes up to a limit of £100,000. We have set a cap of £100,000 on local income tax for two reasons. First, because we would also introduce a new 50 per cent tax rate on incomes above £100,000 and we wish to guarantee to high income earners that 50 per cent would be the maximum combined tax rate that they face. We also believe that without such a cap there could be too great an incentive for the highest earners to move from high tax authorities to low ones. That is a distortion we are keen to minimise.

Our system would produce a national average rate of local income tax of 3.75 per cent. We have calculated this using CIPFA figures and by assigning to local government some £1.7 billion from the tax take for those who pay 50 per cent on their earnings over £100,000. I would be delighted to send any noble Lord who is interested in the details a full breakdown of our costing.

The tax could be administered by the Revenue in broadly two ways, both of which would use the PAYE system. In the first, one would link different local income tax rates to tax codes; in the other, one would abolish the existing codes in favour of an end-of-year reconciliation process. Both are technically capable of producing the right answer, and we would consult taxpayers, employers and other stakeholders before deciding which of the two options to adopt.

It is inevitable that the scrapping of one tax and its replacement by another will lead to gainers and losers. How does local income tax fare? We estimate that approximately 70 per cent of households would be better off or unaffected by the switch to local income tax. Those who will be better off will be the less well-off households now. For example, for a household on median income, and currently living in an average band D council-tax property, local income tax would save them some £460 per year. An equivalent pensioner couple on an income of just over £14,000 would save £1,080. Losers would be high income earners and some dual or multiple income earning households, but this is inevitable if one replaces an unfair, regressive tax with a fairer, progressive one.

The Government have belatedly accepted that local government finance is in a mess and last summer established the Balance of Funding Review to examine the problem. The only suggestion that appears to be receiving much support is some form of fairer" council tax, whatever that might mean. Indeed, in answer to a question from me last week, the noble Lord, Lord Rooker, was unusually Delphic in saying whether the Government were considering local income tax as one of their options under the Balance of Funding Review. Weekend press reports said that the Government have ruled out both local income tax and relocalisation of the business rates—another change incidentally which is long overdue from the review. I would be grateful if the Minister could lift the veil a little on government thinking in this area.

As for the Conservatives, Oliver Letwin, in an interview with the Independent on 10 December last year, indicated that he wanted to raise the share of council budgets raised locally from 25 to 50 per cent— a laudable aim—but he wanted to retain the council tax. The implication of this was that council taxes might have to double. This seems such an implausible proposal that I cannot really believe that it represents Conservative Party thinking. Perhaps the noble Lord the Conservative spokesman could be a bit more explicit today.

Given the problems facing council tax, it is hardly surprising that, outside Parliament, the interest in and support for local income tax is growing. For example, in its response to the Balance of Funding Review, the Local Government Association argued that moving towards local income tax should be considered as a major new contributor to local government income. Opinion in the country is also showing a strong and increasing level of support for local income tax.

Local government funding is in a crisis. Council tax simply cannot bear the demands being placed on it. A local income tax would be fairer, easier to collect and more transparent than council tax. It is a buoyant source of funds. For these reasons it is commonly applied across the world. It is time that it was introduced here.

Lord Barnett

My Lords, before the noble Lord sits down, I appreciate that the case is made and the Motion is in favour of a local income tax rather than a case against, but he rushed rather briefly over the case against. Would he not accept that the issue is rather more complex; that by transferring it all to pay-as-you-earn it will be seen in due course more as a central government tax than a local tax?

Lord Newby

My Lords, I would have been delighted to have spoken for half an hour on the subject and would have happily dealt with the noble Lord's question at some greater length. My noble friend will deal with that in her summing up.

Lord Marlesford

My Lords, I, too, have a short point before the noble Lord sits down. He indicated that the tax would be capped at £100,000. He expected the average rate to be 3.75 per cent, but he indicated that there would be variable rates. Does he have a proposal for limits to either the bands or the rates that local authorities will be allowed to charge?

Lord Newby

My Lords, I think the whole question of the detailed administration of the tax is one that we would need to put out to consultation. There are a number of options for limiting bands, but the principle under which we are operating is to give greater control to local councils and local communities to set rates of taxation which meet local need. We want to get away from prescriptive, central government controls on locally raised taxes as far as we can. I beg to move for Papers.

Baroness Farrington of Ribbleton

My Lords, I remind noble Lords that this is a timed debate and that we are now into the 17th minute of the 15 minutes that were allowed for the noble Lord, Lord Newby. In drawing the House's attention to that I cast no blame on the noble Lord, Lord Newby, for what has happened.

4.18 p.m.

Lord Desai

My Lords, we are all grateful to the noble Lord, Lord Newby, for raising this very interesting topic. Indeed, the interventions of the noble Lords, Lord Barnett and Lord Marlesford, reinforce the point that I want to make, which is that the topic of local income tax will arouse interest and controversy. I am grateful to the noble Lord, Lord Newby, because he makes me feel young again. In the 1960s and 1970s we were endlessly discussing local income tax; it is a topic that needs serious non-partisan consideration, which is what I shall give it.

I want to emphasise several general problems. The successive property taxes that we have had in this country—rate support grant and council tax—failed because they were very badly implemented. If there were a continuous if not a quinquennial upgrading of property values and if the tax were to fall on property values, then it would be a much fairer system to tax wealth than tax income. Notions of progressivity which rely only on income—and on earned income at that—have a problem; earned income does not represent spending power and we would get lots of anomalies, as we did on the poll tax.

I remember taking part in a debate in 1975 on the rate support grant. I am always astonished that the British middle classes celebrate increasing property prices. Newspapers tell us daily how high house prices are rising. But people complain bitterly as soon as there is the slightest suggestion of increasing taxes. People say, "How can you tax our wealth? Our wealth is illiquid". The fact that their wealth is illiquid is not a sufficient reason for leaving it untaxed. My first priority would be to have a much better and much more efficient system of revaluing property so that the property taxation rate did not increase steeply but the valuation of property kept in line with trends of property supply and demand. As property is the most local of assets, fairly taxing local property values would provide a better outcome than would taxing income. I shall discuss income tax in a moment.

The Conservative Party's panic in the 1980s about rate support grant was due partly to a total failure to understand what the rate support grant was about. I was on the Opposition Benches at the time and was trying to give a little lecture to Ministers on how the rateable value was the notional income that a property owner could earn from his property. Ministers looked at me like they had never in their lives even heard of the idea. They thought that the rates had been pulled from thin air. At that time, first in Scotland and then in England, the Conservative Party failed to grasp the nettle of revaluing properties. After a very substantial increase in property values, they lost their nerve. For political reasons, they grasped at the strange idea of the poll tax—the community charge, if anyone remembers it.

Tony Travers, Andrew Adonis and a third author whose name I forget wrote an excellent book on the poll tax. The poll tax was astonishing because although the policy had been devised by the finest minds in the Conservative think tanks and the Civil Service and backed by the then Cabinet with the exception of the Chancellor, they got it completely wrong. So forethought does not always guarantee good policy.

If we cannot continuously revalue property on the basis of inflation, as the Bank of England has done—and we have the tools to do it—and if we cannot find a better system of wealth taxation, then local income tax may be the second best option. I am leaving aside issues such as the taxation of business income. In the British constitution there is a great problem of diversity and local control. We want very much to have diversity in everything except expenditure standards. We impose national standards. We are obsessed with uniformity. As I have said before in other contexts, we believe that uniformity is equality. That fallacy haunts British politics, in top-up fees and elsewhere. I do not know why we cannot allow diversity of provision. Why cannot we allow local authorities to decide not to spend more money on secondary schools but on something else? By not allowing diversity in expenditure, we impose certain rigidities on local authorities in terms of how much they are obliged to spend. Whatever means of local taxation are allowed, when there is a contribution from the central authorities, there will be the problem of leverage outlined by the noble Lord, Lord Newby. As long as local income tax is a small proportion of total revenue, there will be leverage whereby 1 percent extra spending will entail a multiple percentage point increase in the local tax.

The noble Lord's party serves a very useful function by never coming to power but having good ideas. However, I think that it should think further about this idea. It should consider the problem of how to allow for diversity in expenditure without harming minimal standards.

I worry that the notion of income implicit in proposals for a local income tax attaches not to where income is produced or earned but where it is spent—that is, the local authority in which the income earner resides. One problem in this respect is that commuter towns will always do better than areas distant from the more prosperous commercial areas. Another problem which has always haunted British local finance is the inequality of revenue between local authorities. While it is true that equity between high earners and low earners across the country would be better served by replacing council tax with local income tax, we would still be left with the problem of the existence of poor local authorities and rich local authorities. Therefore, it would still be necessary for central government to intervene and contribute a large part of the total revenue of poor local authorities.

I do not say that as a criticism. We live in an unequal world and inequalities are bound to exist. The problem is how we overcome these inequalities and compensate poorer communities. It may sound heartless, but I think that we can do that in two ways. First, we can maintain the current central government dispensation. However, I think that that has grown beyond belief; it is much too large a proportion of local revenue. Secondly, I return to the idea that we allow for diversity of provision. In a very cruel way, that means that poor local authorities get poor services. Services will not be as poor as their income levels are low, but they will have to make decisions.

Ultimately, people can move. I do not believe that people have to stay where they are born. Our principles of local finance are based on the superstition that those who are born in a region should stay there. I think that we ought to encourage mobility. We ought to say, "If you choose to live in an area—perhaps a rural area or a poor area—tough luck. If you do not like it, move. Or live there. If you are rooted to the soil and enjoy the local rainfall or football team, you have to pay the price. You are grown up people, you pay the price". Uniformity and the idea that no one should have to move and that people should be compensated for not moving are not a good basis for local finance.

I think that we need tough love. Tough love says, "Yes, there will be diversity in expenditure". To the extent that wealth taxation is not feasible because the great British middle classes will not tolerate it and no political party has the guts to impose it, it appears that we will have to resort to local income tax. The noble Lord's proposal has one merit—with which there is also a problem, as my noble friend pointed out-which is that it will have to be centrally administered. As it will be centrally administered, it will be thought to be a central tax. That can be avoided only by allowing such wide variation in the local tax that it is seen as local.

I would therefore urge one proposal. As the Liberal Democrats will never come to power anyway they may as well try this out. I would allow a much wider range than 10 per cent in the local income tax and then wait to see what happened. If people want to live in areas liable to high local taxation that is their problem. If they do not like it they can move out. I believe that the way to make local income tax work would be by allowing much greater variability so that it stands out as a local income tax and is not subsumed under national taxation. I do not like the kindness shown to people who make more than 100,000. I do not see why one should be kind to them, or why we are so delicate about the rich. If people earn more than £100,000 they should pay whatever surcharge the party of the noble Lord, Lord Newby, wishes to impose on them when it comes to power, as well as local income tax. I thank the noble Lord for his thoughtful comments and for the fine way in which he initiated the debate.

4.30 p.m.

Lord Lucas

My Lords, I find this a rather depressing subject for a debate and a little dishonest too. It does not address the problem at all, but puts up the glittering prize of local income tax—which I agree has plenty of superficial appeal—with the dishonesty of never going into the detail of the effects it would have locally.

For instance, the noble Lord, Lord Newby, said that it would be 3 per cent on average. Yes; but down in the south-west it would be 7 per cent because it is an income-poor area with high property prices. If we replaced the current system with a local income tax it would therefore bear heavily on counties in the south-west.

There are many details that would make the idea of a local income tax extremely difficult to put into practice. The noble Lord, Lord Desai, mentioned several; including the fact that so many of us travel to work. Where does this income tax belong: to the city centre, where so many of us go to work and where many of the problems and needs are; or to the leafy suburbs where we all go home to sleep? Does it belong to Wandsworth where I lay my head, Westminster where I do my work, or Hampshire, which is my main residence?

As soon as we begin to go into the questions of what it would look like in practice, how it would work and what the flows of taxation, benefit and disbenefit would be, we find ourselves defeated. All sorts of governments over the past 30 or more years have considered local income tax. They have done their best to go down that road, because all of them have seen difficulties with the system we have, but all of them have universally rejected local income tax.

I am absolutely certain in my heart that should there ever be a Liberal Democrat government they would reject it too, because they are not daft people; they just feel free to have a complete dissonance between what they say and what they really believe. The noble Lord, Lord Newby, opened his speech by saying that decisions by government should be made as close to the people as possible; that is fascinating considering that the other day the Liberal Democrats proposed, through an amendment by the noble Baroness, Lady Hamwee, that any significant planning decision should effectively be appealed automatically to the Secretary of State, taking all significant planning powers away from local authorities.

There is no consistency there and none of the hard-headed realism with which those parties who find themselves in government have to contend, leaving imagination to their Back Benches. The Front Benches have to be serious and sensible, which makes for a core of sensible decisions and policies.

Apart from that issue, I found myself agreeing a great deal with the analysis presented by the noble Lord, Lord Newby. We are in an untenable position. We have seen in the course of this Government's period of office council tax being used as another of Gordon Brown's stealth taxes. It has increased, as the noble Lord said, by 70 per cent at a time when income tax by and large has not. It has been pushed to the point where it is causing pain in some wholly inappropriate corners of the economy. As he also said, letters have gone out to all sorts of councils saying that they cannot raise their council tax by more than 5 per cent. Two days later, a message comes that says, "Oh, by the way, it's all right; we're finding a way of fudging the figures so that you can raise it by 7 per cent". It is not real. Departments are not realising what is happening when we get down to the details of a single local authority's finance.

The Department for Education and Skills has passported its increase in education expenditure on all councils, which means that some councils are finding that 100 per cent of their increase in income this year has to go to schools. Where is the money to come from for all the new things that are supposed to happen? Other government departments have let that happen, because they think centrally and they do not realise how it spins out to the individual local authorities.

Looking back over our years in power, it is one of my sadnesses that we did so badly by local government. We did not respect, promote or protect it. We did some daft things, such as the poll tax. I do not look back on that with any pride. The current Government have not faced up to any of the problems and they have made matters much worse by using council tax as a central government tax and by the changes in the support grant regime, which have been deliberately designed to move money from rural to urban authorities and from the south to the north. That has caused extreme difficulties for pensioners in the south, as is well known.

It is not an open system; we cannot penetrate the mathematics by which things are done. The end result is there, but we cannot see the process. Central decisions are taken in a dark and smoky way and the results and the pain are felt locally. I am in the happy position of not knowing what our policy is; it is of course possible that we do not have a policy, but I shall be enlightened later on. I am therefore in a position to speculate. I would like to see us make an honest appraisal of all that has happened over the past 25 years. As the noble Lord, Lord Desai, said, we have become very dirigiste in what we demand of the way in which money is spent locally.

Let us be honest and say that that is now central government expenditure. Let us set a national funding formula for schools centrally and let that money be provided centrally. Let us accept that a plethora of social services have become part of the National Health Service. Let us get rid of the artificial distinction that we spent so much time debating during the previous Session on the strange Bill that allows the health service to fine local authorities for not removing people from hospitals. Let us recognise that the health service now extends into the community and that all those services are really part of the National Health Service and should be administered as such.

Let us remove from local authorities all the expenditure and functions that are essentially mandated centrally, and let us give local authorities—as is beginning to happen in a small way in the National Health Service—a function of scrutiny where they take the part of the local community in assessing how national quangos or structures are doing in providing services locally. Then we will have a local authority that is facing towards its customers. It will be possible to have a child with special educational needs and go to the local authority and expect to be welcomed and helped, rather than meeting the reaction, "Oh goodness, here comes another bill; hide under the table and go away for two years".

We would have local authorities that were interested in being responsive to their citizens because that is what they would be responsible for doing. At the same time, we would reduce the mass of financial requirements on local authorities. We would get down to local people being asked to pay for services that were local in subject. I imagine that we would leave them refuse disposal, planning and a number of other functions for servicing the local community, as well as a big scrutiny function. That could be done with much less money than we require local authorities to spend at the moment.

We would also take another look at the business of unitary authorities and say that, if we were removing the responsibilities from local government, it would be daft not to get down to a sensible pattern of unitary authorities across the country. There has to be a national figure to provide the balancing between rich and poor authorities and some element of fairness across the country. However, we would find that we were providing at least half of local authority finance with a much lower council tax. In council tax bills, even a pensioner pays £100 or £150 towards their district authority. I reckon that that pensioner thinks that he is getting value and that that is not too much.

If that pensioner paid £300 for everything, that level of taxation could survive the inefficiencies and inequalities that come with a property tax. As the noble Lord, Lord Desai, said, in the mix of taxes that people pay, it is not a bad idea to have some that are asset-facing rather than income-facing, and to have a tax that is so clearly and obviously local, because an individual property is identified at the end of it.

We ought to start at a different point. We should not say that we have to find another way to raise money for what local authorities do now. Instead, we should ask, "What should local authorities do? Where are we?". Having decided that, we should then find a way to finance it. We would find that the council tax was a perfectly acceptable way of doing so. It is imperfect, but all taxes are. However, it would be a perfectly reasonable part of the pattern of taxation, nationally and locally.

Something needs to be done. We are clearly in a position where things are going wrong and it is not easy to find a way out. However, it is not right for us to look at what the Motion proposes as a way of raising additional money in ever-more complicated and difficult ways, for a result that is ever-more obscure. Let us try to get back to a situation where we can have local government being as free as possible to spend what it needs to spend, to do what it needs to do, because we have truly focused ourselves on what those local needs are.

As a last thought, for goodness' sake do not let us go back to the days of Derek Hatton and his bite on the business rate. He ran an extraordinary scam in Liverpool, and was impoverishing the local population so that it had to be supported by central government and became financially dependent on him. The whole problem spiralled in an extremely unpleasant and unhappy way for Liverpool, and Liverpool is in many ways still living with that. We really should not be so irresponsible as to let such a situation happen again. If we are to have taxation, let it be local taxation—let it to be something that applies directly to local voters.

4.43 p.m.

Lord Laming

My Lords, I congratulate the noble Lord, Lord Newby, on initiating what I regard as a very important debate. I think it important not only for the future financing of local government in this country, but for the much larger issue of the value that we place on local democracy. I am conscious that many noble Lords who have taken part in the debate have held senior positions in local authorities, and I hope that they will share my real concern about the health of local government in our country.

When I became a chief officer in a large local authority in 1975, I detected a trend that was already well established and has persisted since. It is simply this: that successive governments have produced a stream of new legislation that has imposed new rights and duties on local authorities, while devising new ways to control their expenditure and limit (heir freedom to act. Although the noble Lord. Lord Newby, said that the Government bore about 75 per cent of what local authorities spent, if we add specific grants to that—one was announced only a few weeks ago—I suspect that in many parts of the country, nearly 80 per cent of finance to local authorities is likely to come directly from central government. As he indicated, the remaining 20 per cent has to bear a wholly disproportionate burden of employer and other costs. The system is no longer sustainable.

I well understand that when a Secretary of State responsible for a service does battle with the Chancellor of the Exchequer and wins some money that is much fought-over, he or she wants to guarantee that it will go to the service for which he or she is responsible rather than it being reallocated through some general fund. Although that may be understandable, there are serious implications of pressurising local authorities in that way.

I should like to give two examples from evidence to the Victoria Climbie inquiry. The first is of the pressure placed on local authorities to conform to a national agenda. It was so great that local authorities that gave evidence to the inquiry implied that they were little more than agents of central government. Requiring local government to dance to the centrally composed tune is certainly not new, but I suspect that it is therefore becoming increasingly difficult to attract good people to put themselves forward for election to councils or, indeed, to become senior officers in situations in which they recognise all too clearly that conformity is prized over innovative leadership.

There are even more grave dangers. In a modern, open democracy, there must be checks and balances in the distribution of power. Those checks and balances need to be respected and, if necessary, defended. However, that will happen only if the majority of citizens feel engaged with their local communities and confident that their participation actually matters. The right to vote was hard-won. It is both a privilege and a responsibility. It should be cherished. Not far from your Lordships' House is a plaque to commemorate the great effort made by women to get the vote. In many countries the franchise has yet to be achieved.

But what happens in this country? In the area in which I live we have a parish council, a district council, a county council, and, if things go wrong, we may even get a regional council. In addition, we have voting for parliamentary and European elections. On the face of it, that would give the impression that local residents felt empowered and very much involved in their local democratic processes. Sadly, the reverse is true. Few of my neighbours know the names of their elected representatives, and in some of the elections the turnout is less than 40 per cent. The stark reality is that the majority of the electorate just do not think it worth their while to get to the nearby polling station.

We need to take seriously the reason for the apathy developing in relation to such matters. Some of it is due to the fact that, over the years, a pattern has developed, particularly in local government, in which central government make claims annually about the generosity of the annual settlement for local authorities, only for the local authorities to announce large increases in council tax or cuts in services. There then follows a period of attrition between central and local government—a period of mutual recrimination—with the voter ending up believing neither. That is no credit to the democratic processes in our society.

The reality is that few people, if any, can now agree the basis of funding of local government in our society. My second illustration from the Victoria Climbie inquiry is that the evidence from the authorities that spent up to, or slightly above, the government allocation on a service displayed both a sense of virtue and a feeling that, if anything went wrong, the fault would lie with the Government as the Government had assessed the needs in the area and allocated funds to meet them. I totally reject the notion that anywhere in Whitehall has the machinery to assess the needs of a group of service users, be they in Torbay, Birmingham, Scunthorpe or anywhere else. To think that Whitehall can determine the needs of local users across the country does not make sense.

But where a local authority was spending well below the Government's allocation for a particular service, it was claimed that the grant allocation system was simply a crude distribution formula. It was claimed to be nothing more than a way of dividing the cake and certainly did not attempt to be an indication of the needs of the area. I might have been better persuaded of that if some alternative method of assessing needs of local people had been proposed. But, I suppose, the reality is that in many parts of the country, if there is no way of meeting local need, it has been decided that there is no point in assessing it.

I know that the Government have such matters in mind, but I urge them to accept that the current situation requires a far-sighted review of what we expect of local government. Here I recognise many of the points made by the noble Lord, Lord Lucas. When we have decided the precise job and function of local authorities, we should then decide how we should finance them. It is important that we do so recognising that the current system of local government finance is a mess and is doing great harm to the democratic processes in our society. Furthermore, the current arrangements cannot be sustained for much longer. What is needed now is a thorough review of local government and its financing.

So I am speaking neither in favour or against local income tax. It is worthy of serious consideration as one possible way of funding local government. But there are other ways that equally ought to be considered. I urge the Government to take the issues seriously and urgently to see what proposals may be brought forward to improve the transparency of both the functions and financing of local authorities. In this day and age we must find new ways of relating to the electorate. We must create new ways of engaging with local people and find better ways of securing their involvement. Our society will be helped only by greater transparency in the funding of local authorities.

However, perhaps above all, we need to find new ways of establishing clear links between raising finance and spending on services. At the moment people do not understand the connection between raising money and spending on particular services. If we ignore this opportunity to look seriously at what our society expects of local government and how it should be financed, we will continue to harm the democratic processes which we should cherish, defend and promote. In a modern, open and inclusive society local government is an important component and I hope that the Minister, who has great experience in such matters, will assure us that the Government are taking them forward both robustly and seriously.

4.53 p.m.

Lord Bradshaw

My Lords, I begin by declaring an interest as an Oxfordshire county councillor. I also much welcome the noble Lord, Lord Bassam, who is to reply today, because he has, as the noble Lord, Lord Laming, has said, enormous experience of local government and has no doubt wrestled with some of the problems we are debating. I take the point made by the noble Lord, Lord Desai—I am not arguing from a particular political point of view, but perhaps more from having dealt with such problems in local government.

Our tax system should follow a few principles. A tax should be easy to collect, cheap to administer and difficult to avoid. It should be progressive, so that it falls most heavily on those best able to pay; and it should be fair, so that everyone should pay and, ideally, the benefits and social security system should take care of the disadvantaged, probably by direct rather than indirect payments to them. An example of a fair tax is the petrol tax, because it is extremely difficult to avoid, everyone pays it and if one has a big car one pays more. On the other hand, vehicle excise duty is an example of an unfair tax because many people do not pay and those who do pay the same amount. That does not fit well.

The council tax and its predecessor, the poll tax, do not have most of the qualities that I have described. But, because it is property-based, it does have certain attractions, because property is a fixed asset that cannot move. But property values are extremely crude. The noble Lord. Lord Desai, pointed out that they need updating regularly to be effective. Both the council tax and the old rates system were updated irregularly and, partly as a result, fell into disrepute. The council tax also bears heavily on retired people and is difficult to collect in areas with highly mobile populations. That disadvantage also afflicted the poll tax.

Regarding the expenditure side of the equation, the authority of which I am a member is about to set a budget—I hope tomorrow—which represents a 6.25 per cent increase in council tax. If the authority's charges that have to be made for providing services are taken away, 32 per cent of that money will come from the rate support grant, 29 per cent from the business rate and 40 per cent through council tax. Council taxes are very high in Oxfordshire. This year the increase from government grant is 18.1 per cent—and I gratefully acknowledge that the Government have given us a grant that is way above inflation. But there is a 2.1 per cent reduction in the business rate. I do not understand the reason for that, but I do know that currently there is a revaluation and the matter needs to be attended to. The council tax increase should be 8.2 per cent, but because Oxfordshire's district councils, which are controlled by a variety of all three parties, are to take away tax relief on second homes and cause people to pay for empty houses, the increase will really be 6.2 per cent. The point made by the noble Lord, Lord Lucas, about laying his head in Wandsworth, doing his work in Westminster and having his home in Hampshire, can be accommodated if there is a system that takes account of second homes and empty properties—and includes business rates. If the business rate had remained constant, our increase would have been about 5 per cent.

It is clearly impossible to defend a system of financing local government which depends on national government and the rate support grant. The system is hideously complicated and it is very difficult to understand, as. other noble Lords have said. My attention was initially directed to the short-term measures that can be taken to correct the anomalous council tax situation without raising aggregate public expenditure and could release local government from some of the pressure it is under on, for example, highway maintenance.

My short-term suggestion relates to the number of lines of public expenditure, to which the noble Lord, Lord Lucas, and others have referred. They are passported directly from central government through local government to the schools. The pension money for the police and fire services, which do not have centrally funded schemes, has to go through local government. The money should go straight to the services. Local government can do nothing about it—it has no option but to pay—so why does the money have to pass through its books?

Council tax would be reduced by a corresponding amount and I suggest that it is a lot of money. Council tax will fall from its present height, which is causing a great deal of public protest, to a figure which people are prepared to pay. But the Government, the Daily Mail, the Daily Express and the Sun would have to give up the business about post-code lotteries. It is argued that it is the very antithesis that people should have different services in different places. I will support that provided there is a safety net through which people or poor areas do not drop.

Once that overall reduction has been made, council tax will fall. However, I plead with the Minister to allow councils to have a little extra money to deal with the terrible state of repair in which our buildings, schools and roads now stand. We do not have the money to keep them in good repair, which has been the case year after year. We are presiding over a multitude of crumbling wrecks and highways with potholes.

I then suggest that for about four years we should have an index related to the cost of locally provided council services. It would last for only four years because nothing lasts longer than that. It would give the opportunity of phasing in the income-tax based system, described by my noble friend Lord Newby. However, I accept that it needs a great deal of work. We cannot roll it out tomorrow, next year or the year after that.

I repeat that the benefit system must take care of welfare benefits. I am not in favour of having winter fuel payments, council tax benefit and so forth. I am in favour of paying a decent old-age pension, a disability pension or whatever, and let the person decide what he or she wants to spend the money on. It is no business of government whether they give someone £200-worth of fuel, a free bus pass or whatever unless revenue is generated—there may be an argument for that—because people should be allowed to spend their own money.

There remains the position of the business rate. I assume that business property is being revalued and it could be made subject to the same index to which I have referred so that the business rate payer would be protected against the Derek Hattons, to whom the noble Lord, Lord Lucas, referred. The business rate could rise only as fast as the basket of council services rose in value. I would be prepared to see some top slicing of that to cater for the areas of the country in which there are bad pockets of disadvantage and there is a case for equalisation across the country. It should not be too big. Furthermore, it should be an index system so that it cannot be manipulated by one political party or another in favour of people who are more or less inclined to support them at the polls.

I accept that local income tax cannot be phased in immediately. I have offered an interim solution and I hope that the Government will give it some serious thought. The suggestions I have made would bring council tax under control—and I emphasise that it needs urgently to be brought under control. We have to bring council tax under control while we move to a more equitable system, whatever that is, and I am prepared to put my weight into examining income tax. if the Government have better ideas, no doubt the Minister will tell us.

We must tackle the immediate problems of the unfunded pension funds of the police and fire services, which are threatening to cripple certain local authorities. For example, in Merseyside the unfunded pensions of policemen is a huge burden on the ratepayers, and that is unfair. We must give local authority non-statutory services, such as the roads and buildings, some much-needed relief. We have to control the business rate by an index based on the cost of providing council services and, taking the point made by the noble Lord, Lord Laming, offer a way of restoring the position of most council-provided services so that they are funded locally. That in turn will give people an incentive to vote in the elections. Turnouts of 40 per cent have been mentioned but I can assure the noble Lord that turnouts are as low as 15 per cent. That should alarm us all because if they are that bad we are in a parlous situation.

I hope that the Minister will listen to what we say. I am not grinding a political axe and I await his reply.

5.6 p.m.

Baroness Hamwee

My Lords, after six sessions on the Planning and Compulsory Purchase Bill, which I am sure the noble Lord, Lord Bassam, will agree is rather full of acronyms, I have been trying to think of some acronyms on this subject. Yesterday I was prompted by two which took my fancy and which are particularly relevant to my age group. KIPPERS is "Kids in Parental Property Eroding Retirement Savings". However, that can be countered by going SKI-ing—"Spending Kids Inheritance". I could argue that they have some relevance to a property-based tax, but I shall not try to.

I wondered about PALS—a "Proven, Accountable, Local Scheme". The policy has LEGs—"Local, Efficient, Greater Accountability". I wanted somehow to get fairness and transparency in, but "Fair, Accountable and Transparent", FAT, did not seem to have quite the right ring. So I thought why not just FAIR because it is "Fair, Accountable, In-use and Right"?

I welcome the balance of funding review, which the Government are now undertaking. Perhaps I should qualify that a little by saying that I welcome the fact that it is happening. I detect, as does the noble Lord, Lord Bradshaw, a Punch and Judy element to suggestions, including as recently as last week in Questions in another place, which come from anyone other than the Government. That is just what the public hates. I hope that today the Minister can assure us that Ministers do not believe that local income tax, or other proposals, should be rejected just because they are not invented here.

After all, it is generally acknowledged that a review of local taxation is required to address fundamental flaws. That term was recently used by the Audit Commission, which was even-handed in its analysis of where government and local authorities need to look to change their ways and the issues they need to look to. Government need to look at transparency; reducing direct control over councils through targets; reducing ring fencing; and recognising the importance of public engagement. The noble Lord, Lord Laming, spoke so effectively about that.

Engagement needs transparency—that has been an issue for a long time. I am sure that noble Lords who have local experience will have found how difficult it is to consult local communities on what should be the level of tax and the spending that will be enabled by that tax—again, taking a point made by the noble Lord, Lord Laming—because of the gearing effect. There is no faith in the system.

Early in my local government career, I realised what a problem that was in my ward in Richmond-upon-Thames, which neighboured the London Borough of Wandsworth. People living in Richmond in local authority housing, as it then was, were paying far more than people literally on the other side of the road in bigger houses in Wandsworth. That was all to do with government grant—how much came from the centre.

We are currently witnessing the importance of investing in one's locality—to take one current, interesting example, now that the constraint on the level of council tax on second homes has been lifted, I have read reports of local authorities saying that they will not collect at a higher rate for second homes unless they can spend what they collect in their areas. We know that the Government focus on new localism; we need true localism.

As I said, engagement is important, because the real debate should be about the use, benefit and value of local services. The harder a tax is to pay, the less people are willing to consider paying for services from which they do not feel that they benefit directly. Education and social services—especially the latter—seem to have few advocates.

The noble Lord, Lord Desai, discussed diversity of standards. Perhaps he meant diversity of provision rather than of standards, although the two go hand in hand. Recent experience has been of a practical limit rather than any legal constraint. Many local authorities spend in excess—although that is an odd term to apply—on education because they want to spend more than central government say that they should or need to on education. That is not always easy to cope with; that forms part of the dialogue with local people. Reference has been made, especially with respect to education, to the issue of passporting.

Lack of engagement means a detachment—almost a divorce—from the whole political process. I need only run through a list of terms: capping, which brings the process into disrepute; ring-fencing of government grant; and centralising. On the point raised by the noble Lord, Lord Lucas, I would say that to argue for more centralisation of services is a dodgy path down which to go.

To take local education authorities as an example, to argue for more centralisation of services is a very dodgy path down which to go. Their services are joined up with leisure and social services, to take only two examples. The noble Lord said that social services are now part of the health service. I agree with the first part of what he said, but go on to say that what we need is localisation of the health service, not centralisation of social services.

Your Lordships may be grateful that there is not time today for me to discuss targets set by central government. My noble friend Lord Newby rightly discussed ability to pay. Under the current system, there are problems not only with council tax itself but with the council tax benefit scheme, which is complex, so often benefit is unclaimed.

Council tax costs a fortune to collect. I understand that the collection rate in London is down this year. Interestingly, the tax base is up—no doubt because of second homes council tax payments, which we shall discuss in relation to the London precept. Should local tax be based on property? I understand that revaluation or rebuilding, which is in the programme, is likely to cost about £250 million—not an easy solution.

Local income tax has been rubbished—although not this afternoon—on the basis that it is easily avoided or evaded. I assumed that that is what is meant by comments such as, "Fat cats do not pay income tax"', which I have heard from members of the Government. That itself is a rubbishy statement. If anything, it is an indictment of the income tax system generally, because local income tax will be small in the scheme of things. If fat cats are avoiding paying their fair share, that must be tackled; it is not a reason to say that local income tax would be a bad tax.

I cannot remember who raised this point, but I make it clear that our proposals extend not only to earned income but to all income. I do not know if the "not invented here" syndrome extends to rejecting any type of tax employed outside the United Kingdom. As my noble friend said, local income tax is in use from conservative-minded states in the United States and in Switzerland to more progressive Scandinavia. As I said in my opening remarks, it is in use. Mind you, so was the poll tax, was it not, in Papua New Guinea? So local income tax is fair, accountable, in use and right.

The noble Lord, Lord Desai, proposed a quinquennial upgrading of property values to reinvigorate the rating system. I hate to think what might be the cost of that, or what scope it might provide for gerrymandering. He said that assets are part of wealth. There are many issues surrounding people staying in large homes with earned incomes that are not immediately comparable with the size of the home. I am not sure that dealing with that is the role of local taxation.

The noble Lords, Lord Desai and Lord Lucas, talked about local income tax not being spent where it is earned. Again, that is part of a bigger issue concerning business rates. London now exports about £20 billion to the rest of the country. I do not say that it should export nothing, but that is an issue for Londoners. There would need to be some sort of equalisation scheme. That is not to say that we throw up our hands and do not have faith in the system, but there would need to be such a scheme.

The noble Lord, Lord Lucas, said that when we consider the problems, we find ourselves defeated. That might be true for those who were involved in the introduction of the poll tax and then the council tax May I dispose of one point: the suggestion that when one is on the Front Bench, one adopts an entirely different point of view. Many of us on the Front Benches—this applies in spades to the noble Lord, Lord Hanningfield, know what it is like to be in government, because local government is real government and gives a real sense of responsibility. His particular accusation concerned planning appeals. As he well knows, we were dealing with a limited right to deal with a specific problem.

However, when the noble Lord, Lord Lucas, had finished knocking us, he admitted that there are problems. As I said, he mentioned centralisation. I detect no confidence that central government are more efficient than local authorities at providing services in a cost-effective manner.

In preparation for today's debate, I consulted the ODPM website to read the papers on the Balance of Funding Review. I was looking at a PowerPoint preparation labelled "Nick"—I think that it was Mr Raynsford's presentation of the problems of the council tax—when my screen froze. Up came the message, "Error: cannot be corrected. Save presentation and quit". The Government should take that advice.

5.20 p.m.

Lord Hanningfield

My Lords, I, too, thank the noble Lord, Lord Newby, for initiating the debate. There have been some very valuable contributions, on which I shall attempt to comment. I am still very much part of local government as leader of Essex County Council. We shall present our budget next Tuesday, with a council tax increase of 4.7 per cent, one of our lower increases, which we have worked very hard to achieve.

We have discussed this subject previously. I am very pleased to be joined on the Front Bench by my noble friend Lord Dixon-Smith. He and I went through a lot together over many years in Essex County Council, which he knows as well as I do. In my early days in local government, in 1976, the Layfield committee said: Whoever is responsible for spending money should also be responsible for raising it so that the amount of expenditure is subject to democratic control". At that time, rates were becoming extremely unpopular. Many householders were paying considerably more in actual terms than they pay now in council tax. Under that system, in real terms, rates would have been very expensive now. I attended a very large local government meeting, attended by around 1,000 people, at which the then leader of the Conservative Party, the noble Baroness, Lady Thatcher, said that she would abolish rates as they were so unpopular. That is why the community charge/poll tax was introduced. It was unpopular and was replaced with council tax, which is now becoming as unpopular as the previous two systems.

The major reason for the unpopularity of each system is that governments do not contribute enough money to them. They did not put enough money into rates. If the then Secretary of State had put much more money into poll tax when it was introduced, as the later Secretary of State for the Environment Chris Patten did, it would probably still exist. Governments try to do it on the cheap: each year, when the Chancellor works out his Budget, he wants to keep down expenditure, and thinks that we can keep grants to local authorities down, which increases the taxes that they must raise. That has happened very much during the period of this Government, particularly in education, as I have experienced.

Last year we had to raise council tax by 16.7 per cent, mainly to fund schools. We have since been vindicated by the Audit Commission. Just proving how money can alter tax levels, after the Audit Commission's report last year, the Government announced an extra £340 million for local authorities, which has fundamentally changed our level of council tax, as it has done for quite a lot of other local authorities. If governments put more money into the system, they can keep down the level of council tax. That is why the noble Lord, Lord Laming, was so right in saying that the local government crisis has happened because often people blame it for council tax levels that are not its doing.

In the UK we raise less revenue locally than in any other European country, except the Netherlands, and considerably less than in the USA, Canada, Japan, Australia, New Zealand and other countries. The amount of money that we raise locally is very low.

To start with, the Conservative Party is not in favour of local income tax. For the moment, we believe that we should retain council tax. My right honourable friend the shadow Secretary of State David Curry is carrying out a long-term review of how that might happen. Consequently, the shadow Chancellor, Oliver Letwin, when he said that 50 per cent of money should come from locally generated income, did not mean that council tax would double, as suggested earlier, but was asking how more money would be raised locally. I shall return to that matter later.

I wish to respond to some of the comments made during this extremely good debate. All the contributions were very valuable and pro-local government, which I was very keen to hear. I hope that the Minister will be pro-local government in his response. As has been said several times, he, too, has a local government background.

The noble Lord, Lord Desai, made a very valuable comment, to which I attach tremendous importance, on diversity of provision. That is what local government and local democracy are about; we do not need to have exactly the same provision everywhere. The noble Lord, Lord Laming, commented on that also. That is a fundamental point that we should all consider. Other countries do not insist that exactly the same benchmarks apply everywhere. As a country we need to move towards that approach. I am pleased that James Strachan, the chairman of the Audit Commission, has said several times that he believes in, "Deregulation, deregulation, deregulation" and more autonomy for local government to take its own decisions. If we could do that, we would not have some of the problems that we have on the raising of council tax.

My noble friend Lord Lucas commented on the complications of collecting tax. We are very much against local income tax and the problems associated with it. However, I am afraid that I cannot agree, and I hope that my colleagues on the Front Bench do not agree, that we should remove services from local government to reduce the level of council tax. Centralising services entirely would result in either a communist or fascist state. We believe in local autonomy; centralising all services is not the answer. We must find a way through the problems. There may be some ways of funding services differently. I shall return to that point later.

The contribution of the noble Lord, Lord Laming, was valuable, as it highlighted the crisis in local government. According to opinion research and MORI findings, local government has become much more unpopular in the past year. Local government services are not unpopular. Libraries, education, environmental protection and other such services are popular, but people are not very keen on local government, mainly because of the level of council tax. The level of council tax depends very much on how much money the Government provide.

Neither most of my Front-Bench colleagues nor I would defend the previous Conservative government in that respect, as they did exactly the same thing. A future Conservative government will not do the same things as previous ones, in the same way as the current Labour Government are not doing the same things as the previous one did. Different governments can have different policies. We need to convey to people that, unless governments provide sufficient funding, they cannot expect services to be delivered locally to targets that they have set. The noble Lord, Lord Laming, made that very valuable point.

The noble Lord, Lord Bradshaw, made a very thoughtful contribution. I did not notice him speak much in favour of local income tax. He suggested a way forward now and gave the Government assistance on how we might reduce council tax bills. He proposed the idea, which I like, of funding the police nationally. That would instantly reduce the council tax bill by about 12 per cent. As there is not much local accountability in police funding nowadays, it could contribute towards a stabilisation of council tax at present.

We need perhaps to find some means of funding some education expenditure from the national purse. I would be reluctant to say that it should all go. Local schools are popular. The education service is a fairly popular service. It is more popular than the health service, which is a national service, although the Government are now trying to deliver it locally. It would not help anyone to turn the education service into the health service. It would not help the Government; it would not help the education service. There is a lot to be said for keeping elements of the education service locally. Schools are by nature local. I hope that any system that any of us work out will not centralise the education service. That would be a mistake and we would live to regret it—

Lord Bradshaw

My Lords, does the noble Lord accept that I meant that those parts of the education system that are funded nationally—that is basically teachers' pay—should be passported straight through and not touch local government? All the specialist services—inspection, or special needs, or the part that local government does add—would be funded locally.

Lord Hanningfield

My Lords, I accept that point from the noble Lord, Lord Bradshaw. I said that we ought to find some way of some of the education funding, perhaps for the moment to keep council tax bills down, being looked at nationally. They were all very valid contributions.

Although I was attracted to local income tax when I saw it operating in Sweden, one reason why I and my colleagues are against it is that people do not want another tax. I have realised that people dislike new taxes. It would do a lot of harm to local government if it were to be funded through another tax that people did not like. It is far better to keep the tax system that we have but find ways of doing it better. We do not want to increase total national expenditure. Therefore we need to find ways in which money that goes into national government now can be raised in a local way. One could raise local business rates, subject to some constraints, so they could not go too high to upset business. One could use vehicle excise duty. One could use more income generation from businesses locally. New local government legislation helps us in that respect.

We need to find many ways—although we do not want to raise the total pot of money—of using locally money that comes into the National Exchequer and to have some local discretion in ways that we can do it. That is the way that we need to go forward over these next few years; not to have a new tax and disturb everyone and further upset the relationship between local government and central government, but to find ways of redistributing the pot so that there can be more democratic control locally. I would not agree with local income tax. This has been a valuable debate, and I thank the noble Lord, Lord Newby, for introducing it.

5.32 p.m.

Lord Bassam of Brighton

My Lords, I have greatly enjoyed the debate this afternoon, I suppose because it brings a sense of dejd vu. I do not know about other noble Lords, but we have been debating and discussing how to raise money for local services and locally-administered services for much of my political life, certainly in great earnest since the mid-1970s.

I have enjoyed the range of contributions and the important points that have been made. I congratulate the noble Lord, Lord Newby, on introducing a timely debate on the complex and important subject of local government finance. As the noble Lord, Lord Hanningfield, said, it has certainly been wide-ranging. We have had the noble Lord, Lord Lucas, wanting to take education out of the local funding arrangements; we have had the noble Lord, Lord Bradshaw, wanting to take the police out; we have had the noble Lord, Lord Hanningfield, saying that we should take some of education out of it and perhaps think about taking the police out. We have had the noble Lord. Lord Bradshaw, suggesting that he would put his ful I weight behind local income tax, but that he would not have it introduced immediately, perhaps phasing it in after four years. We were not sure in the end whether the noble Lord, Lord Bradshaw, was in favour of local income tax.

A range of different views have been expressed. The noble Lord, Lord Desai, made the point that there is not a lot wrong with property-based taxes, but they seem to have fouled up in the past largely because of bad implementation. The noble Lord, Lord Lucas, concluded that although council tax was perhaps imperfect, it could be made more tolerable. We had a telling contribution from the noble Lord, Lord Laming, who expressed his continued support and affection for local democracy, given all of his experience in local government, but pointing us towards something of a funding crisis. He reminded us of the important point of needing checks and balances in the balance of power between local and central government.

If that gives us a flavour of where we have gone in the debate, I hope that it is a useful starting point. Perhaps I should begin the Government's response by giving some background to how we see things. This year's local government grant settlement was very generous, despite what many noble Lords have said about local government's funding from central government. Over recent years, there has been a generous level of support for local authorities in England. That is the essential context of the issues that face the local government finance system. Il is the reality of what is happening now.

Last Thursday, the Minister responsible for local government put proposals before the other place confirming that the total of formula grant would be £46.1 billion in 2004–05, an increase of 5.5 per cent compared with 2003–04. On top of that, specific: grants take the overall increase to 7.3 per cent. I do not know about other noble Lords, but some 15 of 16 years ago towards the end of Mrs Thatcher's regime, I would have seen that as very generous largesse indeed.

This is not in itself a one-off increase. It is part of a programme of sustained growth and investment in vital public services delivered by local government. Overall, government funding to English local authorities is up 30 per cent in real terms over the past seven years. This is in stark contrast to the previous four years of the last Conservative government, when year on year cuts were the norm. A real terms 7 per cent funding cut occurred over that period.

Some noble Lords, such as the noble Lords, Lord Hanningfield and Lord Lucas, have recanted on the Tory record. Those noble Lords should not be let off their responsibility for what life was like when we had a Conservative administration nationally, and much of local government was run by Labour and the Liberal Democrats, with a small percentage of it run by Conservatives. We had to live with cuts, and they damaged services greatly. Over the past few years, we have done a lot to put that right and to take us forward to a new and more modernised level of local government services—

Lord Lucas

My Lords, perhaps I may pick the Minister up on that point. I agree with what he said, but he is talking about average figures. One can take the example of some of the south-western counties, where the entire increase this year is below average, and the entire increase has been passported through to education. Some counties are having to raise their council tax by 7 per cent in order to cut the budget for other services by about 5 per cent.

When there is such variation across the country, you cannot deal with these things on averages. The difficulty is not that the average is wrong. The difficulty is that the variation is so wide that there are some real losers. The Minster is putting counties in exactly the same position that he objected to my government putting them in. If it is medicine that I should take, it is medicine that the Minister should take too.

Lord Bassam of Brighton

My Lords, I was about to say that it is a fair point, but I am not so sure that it is. During the life of the Conservative administration, we had to live year on year with budget reductions. The noble Lord will say that there were winners and losers in that scheme, and I bet that he could probably find some big winners too. Year on year, we have had real, genuine increases. Over the period of time that I have been talking about, I described a 30 per cent growth in real terms. If the noble Lord could match that with the Conservative record, I would be very impressed indeed.

I am also happy to say that in recent grant settlements, we have removed ring-fencing from £750 million of specific grant. I thought that the noble Lord, Lord Laming, was concerned about specific grant. Again, this year, we have reduced specific grant from 13.3 per cent to 11 per cent of the total grant. That is part of our general commitment. In the past, I have referred to reversing the trend of ring-fencing of grants to local authorities so that there can be more localised control and adjustment of the way in which funds are used.

The noble Lord, Lord Hanningfield, referred to new local government legislation. The Local Government Act 2003 provides councils with more independence and flexibility, including financially, and it paves the way for even greater freedoms for councils to improve their services. Councils now have more powers to trade and to charge for discretionary services and retain income from some fines and penalties. They will also have incentives to work with local businesses through the business improvement districts and growth incentives schemes. The Act also provides for authorities, rather than the Government, to decide how much they need to borrow.

Another important new freedom for councils introduced by the 2003 Act is that councils can now, if they wish, reduce the discounts on council tax for second homes, to which the noble Baroness, Lady Hamwee, referred. That will generate extra local revenue and will enable those local authorities that can benefit from it to spend the revenue on local services.

Having set out our generous stall, it is worth saying that we expect local authorities to deliver services in a cost-effective way. It is clear that the public are unhappy about the unreasonably large council tax increases in recent years. We, too, are concerned. We were disappointed that the average council tax increase in the past financial year was 12.9 per cent. In our view, that is an unsustainable trend. We have made clear that continued year-on-year increases in council tax on the scale that we have seen in the past year will not be acceptable to voters or to the Government. Electors will make their views clear through the ballot box. If necessary, the Government will use their capping powers. We do not make that threat lightly. We would prefer that councils answer directly to their electorates for their decisions. But we cannot stand aside if councils continue to impose unreasonable increases.

Given the generous grant settlement for 2004–05 and the scope for efficiency improvements, our view is that local authorities can and should deliver council tax increases in low single figures in 2004–05; so we are now looking at proposed council tax rises very closely. I congratulate the noble Lord, Lord Hanningfield, on his low single figure increase in Essex.

We are pleased that initial indications suggest that many authorities have listened and are planning increases in low single figures. But despite the significant extra investment, some local authorities have not listened and have indicated that they will impose large increases. Under those circumstances, it appears inevitable that the Government will have to use their capping powers this year. As of today, the Minister for local government and the regions has written to 65 local authorities where we have seen reports of council tax increases not in line with single figures.

I now turn to the Balance of Funding Review. For the benefit of noble Lords who are not familiar with its work, I would like to give some background. In the 2001 White Paper, the Government proposed to set up a high-level working group to address an issue repeatedly raised by local authorities and the Local Government Association. Local government argued that the fact that local authorities raised only one quarter of their own funding on average, and relied on central government for the rest, was bad for local democracy. They also argued that it caused the problem of gearing, about which we have heard much today.

The review steering group has met several times under the chairmanship of Nick Raynsford, the Minister. It has discussed the principles of a successful local government finance system and commissioned independent research. That is all available on the Office of the Deputy Prime Minister's website, about which we have also heard today. It is transparent and available for everyone who can get past the frozen screen to become engaged with. We have also held public consultations. The review is discussing possible local options. Perhaps I might emphasise two of its findings so far.

First, the research shows that much of the public are not clear where accountability for local government services lies or where the money comes from. What matters to them is not where local authorities get their money, but that services are efficiently delivered. There seems to be no sign of a direct link between the balance of funding and local election turnout. Probably, that was a surprise to many of us.

Secondly, our consultation shows that there are many concerns about aspects of the local government finance system, particularly gearing and the impact of council tax rises on taxpayers with fixed incomes. However, there was no clear or simple view of what needs to be done. There are no easy fixes or quick wins and we do not want knee-jerk conclusions.

There are options for reform: the review is looking at four. The noble Lord, Lord Newby, will be glad to learn that one of them is local income tax. The others are a reform of council tax, which seems to be favoured on the Benches opposite; relocalisation of the business rates, which seems to be partly favoured on the Benches opposite; and a mixed option of smaller taxes or charges. Here, I should emphasise that the fact that the review is hearing evidence on different options is not an indication that the Government accept that the balance of funding must be changed or that they favour any of the reform options themselves.

Many responses to the review consultation said that there were serious problems with council tax. But most of them suggested that council tax could be reformed rather than abolished. It is a tax that has done a good job for a decade and has been widely accepted until recently. It has advantages: for example, it is relatively easy to understand—the noble Lord, Lord Bradshaw, mentioned a test—and to collect. Overall, in 2002–03, local authorities in England collected more than 96 per cent of the council tax due in that financial year. That compares favourably with collection levels in the latter years of the old ratings system, which, again, was an easy tax to collect.

What kind of reforms might we be talking about? There are changes such as the revaluation of domestic property, to which we are already committed, and which is currently planned for 2007. That will ensure that a council tax bill is based on the up-to-date value of the house rather than its value in 1991. By the way, revaluation is not an exercise designed to raise more tax overall. Our 2001 local government White Paper made clear that its overall impact would be neutral. But it is necessary to avoid the valuation base losing touch with reality, a point made by many noble Lords, and is a real problem. People would not think it right for income tax to be based on 1991 income, though some might see some benefits. Similarly, we cannot continue to assess council tax on 1991 property values. At the same time as the revaluation we will consider the case for change to the existing bands.

A point that came through strongly in the consultation was that people thought that council tax should reflect more closely people's ability to pay and should more accurately reflect variations in property values. Ways of doing that mentioned during the review included, for example, introducing new bands or a system of "regional banding". However, I should make it clear that we are not committed to any particular changes to the banding system. Before changing the banding system for council tax, we would need to examine very carefully the impact on those groups, such as pensioners, on low or fixed incomes living in high-value properties.

The review has identified that a key issue is resolving the problems of council tax benefit, to which the noble Lord, Lord Newby, referred in terms of take up. This is an in-built way to achieve what the Liberal Democrats say they want; that is, to introduce more "progressivity" into local taxation. Council tax benefit helps people on low incomes, including many pensioners, with their council tax payments. The problem is that some are not aware of their right to this money. Some of those who are aware are put off by the perceived stigma of claiming a benefit and are therefore reluctant to claim other than the slate pension. Central and local government together will do all that they can to ensure higher take up. We are already abolishing the restriction that limits the maximum council tax benefit for people in council tax bands F, G and H from 1 April. We are also considering whether any other improvements can be made to the system.

I now turn to the idea of local income tax, the second option being looked at by the review. Of course, it is the solution put forward by the noble Lord today. The Balance of Funding Review consultation showed support in some quarters for replacing or supplementing council tax with a local income tax, or at least considering the case for one. Perhaps it is worth pointing out that the Prime Minister has made it clear that the Government do not favour replacing council tax with local income tax. However, we are certainly prepared in the review to listen to reasoned argument. This is one of four issues on which we are asking expert organisations—in this case, the Chartered Institute of Public Finance and Accountancy—to provide further evidence on the pros and cons. It will give its presentation at the next meeting of the Balance of Funding Review Steering Group in March.

I turn to the specifics of the proposal for local income tax put forward by the Liberal Democrats and advocated by the noble Lord. I fear that these particular proposals could involve us in making disruptive and complicated changes to the tax system, a matter to which the noble Lord, Lord Hanningfield, drew attention. Moreover, the noble Lord, Lord Bradshaw, said that we should not do this for at least four years, and then only after careful phasing.

First, the proposals would do little to improve the flexibility of local authorities. The Liberal Democrats would increase the proportion of local funding coming from central government by using £1.7 billion of their proposed higher rate tax increase to increase grant and keep bills down. Since authorities in poor and deprived areas would be able to collect less income tax than the richest areas, the noble Lord's proposals would mean that the poorer authorities would become more heavily dependent on grant. As a consequence, there would be less flexibility and a worse gearing effect for those authorities than at present.

Secondly, the proposals would involve substantial costs which are not mentioned in the Liberal Democrats' proposals. They would combine their local income tax proposal with an increase in the level of the personal allowance to £5,000, but this would cost an extra £2.4 billion.

Finally, the proposals have weaknesses which the Liberal Democrats have not considered. They have two ideas for how the tax would be collected—the first being to collect it during the year through tax codes, and the second to collect it at a standard rate across the country, then settling up at the end of the year with individual taxpayers by means of adjustment processes what they should have paid. The first proposal would impose additional burdens on employers—have they been costed?—who would need to deal with local income tax rates for every local authority in which their employees lived, and to account separately for the different amounts of local income tax they were subtracting from their employees' wages.

The noble Lord, Lord Newby, said that this would reinvigorate local democracy. However, the second proposition for local tax collection seems a rather odd compromise, satisfying no one. It would be a local income tax in which, most of the time, the bill you paid had nothing to do with the rate set by your local authority. How would such a system promote local accountability and flexibility, and how would it aid the taxpayer in understanding how much money their council was asking from them to spend on local services? In addition, given that the mechanics of the tax system mean that under or over-payments would not be fully settled for months or years to come, this approach would be doubly complex and unpredictable for individual taxpayers, local authorities and the Inland Revenue. I am not sure whether this proposal would make local income tax more accountable because it would be a local tax administered nationally.

The third issue highlighted by the Balance of Funding Review consultation was the relocalisation of non-domestic or business rates. We have been told by the noble Lord, Lord Lucas, that we should not look at that, but nevertheless we are considering it. For the past 10 years local authorities have collected business rates although they have not set the level of rates or kept the proceeds. Central government now set a national business rate and redistribute the money to areas on a per capita basis. Relocalisation, a return to the pre-1990 system, is not something the Government have favoured in the past, although I understand the strong demands being made for it locally.

Most consultation responses from councils have argued that relocalisation would resolve the balance of funding problem and encourage better partnerships with local businesses. But many in the business community would be strongly opposed to any change in the current level playing field for business. The Balance of Funding Review is continuing to look at this issue.

I shall conclude my remarks by saying how much I have welcomed this debate. It has provided us with a valuable opportunity to air some important issues, even if they have given me a sense of dejci vu and the noble Lord, Lord Lucas, something of a depression. It is particularly useful that this debate has taken place during the Balance of Funding Review and I shall invite all those within the Government working directly on the review issues to take careful note of all the valuable points that have been raised in your Lordships' House. I have enjoyed the debate and I look forward to more of them; they are of great value. I look forward in particular to hearing more from the noble Lord, Lord Newby.

5.54 p.m.

Lord Newby

My Lords, noble Lords will be relieved to learn that they will not hear much more from me today on this issue. I thank all noble Lords who have taken part in the debate. All the contributions have demonstrated, first, the importance of the issue and, secondly, that the problem of finding a system of funding local government is neither new nor easy to resolve. Members on these Benches look forward with eager anticipation to hearing the outcome of the Balance of Funding Review and the Conservative review looking at alternatives to the current system. I am sure that we shall return to these matters in due course. In the mean time, I beg leave to withdraw my Motion for Papers.

Motion for Papers, by leave, withdrawn.