Local and Central Government
Relations Research 32
January 1995
The feasibility of a local
sales tax
A recent study suggests that a single stage retail sales tax based at county or
regional level could significantly increase local authority autonomy in the
United Kingdom but might raise a number of operational problems. The study,
by John Hall and Stephen Smith of the Institute for Fiscal Studies, found that:
A local sales tax would be more appropriate as an addition to local tax
revenues rather than a replacement for the council tax, which appears to be
operating reasonably well.
Only 15% of local spending is currently financed by local taxation. A local
sales tax would reduce local authority dependence on central government
grants.
A local sales tax levied at an average rate of 4.5% on all goods and services
currently subject to VAT would raise the same revenue as the council tax at
present.
Central government would need to transfer grant between authorities in
order to avoid some individuals facing high local sales tax rates simply
because there are few retail outlets in their local area.
There would be some revenue loss for high tax areas through individuals
shopping in lower tax areas. This ‘cross-border’ shopping might also lead to
a loss in sales and in retail floorspace in high tax jurisdictions and could
change the geographical pattern of retail development.
Cross-border shopping effectively rules out a district-based sales tax but not
necessarily one set at county or regional level.
Poor households would pay roughly the same percentage of their
expenditure in local sales tax as richer households. The poor would pay
more in local tax than under the present council tax (because of council tax
rebates), and the rich would pay less.
A sales tax confined to household utility bills would be simple to administer,
and would avoid the problem of cross-border shopping. However, it would
hit poorest households hardest and hence necessitate some form of rebate
scheme.
Local taxation
and finance
Why do we need another local tax?
Given the relatively smooth introduction and
operation of the council tax, it has been argued that
the United Kingdom no longer suffers from the
wrong local tax but rather too few local taxes.
Only about one in every six pounds spent by the
average local authority is presently paid for by local
citizens through the council tax. Central
government pays for the remainder in the form of
grants based on what it believes each local authority
would need to spend to provide a ‘standard’ level of
service.
This narrow local tax base means that local tax
bills are very sensitive to changes in local spending
decisions. Indeed, on average, a 1% increase in local
spending increases council tax bills by roughly 6%.
Whilst these high ‘gearing ratios’ may ensure that
local authorities are accountable to their electorates
for their spending decisions, they also mean that
council tax rates are extremely sensitive to changes in
government grant. An additional local tax would
help reduce dependence on changes in the
distribution of grant and hence give local authorities
a greater degree of autonomy. This report assesses the
suitability of a local sales tax.
What type of tax?
A local sales tax could take a variety of forms:
•
A local value added tax (VAT), operated on the
same basis as national VAT. However (as with
trade within the EU), this would lead to
adjustments in tax liabilities every time goods
were moved across authority boundaries during
production. Since finished goods would typically
include components produced in many different
local authority areas, this could be an
administrative nightmare.
•
A restricted base local sales tax. A tax on utility
bills such as gas, water and electricity would
avoid cross-border shopping problems and could
be targeted at households rather than businesses.
However, as has been highlighted in recent
debates over the extension of VAT to domestic
fuel, such a tax would hit poor households much
harder than richer households.
•
A single stage levy on all retail sales could be piggybacked on to national VAT. This would only tax
sales to final consumers so would minimise the
additional compliance costs for businesses.
However, Customs and Excise would have to
assess what percentage of the sales of each
business were made to final consumers.
The cross-border problem
A major problem might be that individuals can
‘avoid’ a high local tax rate by shopping in
neighbouring jurisdictions with lower tax rates. In
addition, shops might choose to follow their
customers and migrate towards these lower tax areas.
This, in turn, would increase tax revenues in low tax
areas and reduce revenues in high tax areas, leading
to even greater cross-border tax rate differentials.
Evidence from the USA - where many local
authorities already operate local sales taxes - suggests
that the extent of cross-border shopping is far more
severe when set at city level than at state level. This
suggests that the cross-border problem might be
substantial for a district-based sales tax, especially in
London and the Metropolitan areas where many
alternative shopping centres already exist, but might
be limited for a sales tax levied at the county or
regional level.
Central government would have to redistribute
grant between local authorities if it wished to prevent
some households facing low tax rates simply because
they lived in local authority areas which contained a
major retail centre and vice versa. If central
government fully equalised the tax bases of county
authorities, there would be very few areas in which
sales tax rates would differ by more than 0.5%
between counties, given current patterns of local
authority expenditure. Empirical research in the USA
suggests that differentials of this size will not
generate a significant loss in local tax bases as a result
of cross-border shopping.
Impact on local authority finance
Accountability
The burden of a local sales tax would fall on those
individuals who shopped within a local authority
area, rather than those who live there. Local
authorities with clusters of retail outlets, such as outof-town shopping malls, might be able to ‘export’ a
significant proportion of the local tax burden to
those who did not benefit directly from local
authority services. For example, a central city
authority could collect revenue from commuters as
well as the local population. Since the full cost of
extra local spending would not be borne by local
residents, local accountability would be reduced.
Unpredictable yield
It would be difficult for local authorities to predict
the likely level of receipts in a given year. This might
be a problem for those authorities which made overoptimistic forecasts since local authorities are legally
forbidden from running current budget deficits.
Hence, relying on a local sales tax might force local
authorities to make hasty and inefficient budget
adjustments half way through the financial year.
‘Lumpiness’ of the yield
It is likely that local authorities would only be able to
vary the sales tax rate by a discrete amount (perhaps
in steps of half a percent) to minimise the
administrative burden of the tax on business. Hence,
a sales tax might be too inflexible to function well as
a local tax because the minimum change in the sales
tax rate might have huge revenue implications for a
local authority. For example, a 0.5% cut in the tax
rate might require a local authority to cut
expenditure by £29 per head.
Distributional implications
Recent controversies over the community charge
(poll tax) and the extension of VAT to domestic fuel
have suggested that new taxes must be perceived as
fair to be generally accepted. Assuming that a local
sales tax were levied on the same goods as national
VAT, the tax bill as a percentage of annual
expenditure would be roughly the same for all
income groups (Figure 1). This would tend to be a
higher percentage of their annual income because the
poor tend to spend a higher proportion of their
income than the rich.
A local tax would place less of a tax burden on
poorer households than either the council tax or poll
tax without rebates or a local utility tax but more of a
burden than a local income tax. However, taking
council tax rebates into account, poorer households
would be worse off if the existing council tax were
replaced by a local sales tax raising the same amount
of revenue (Figure 2).
Local sales tax rebates would be difficult to
administer since authorities would need to know
both how much the household had spent on taxable
goods over the year and where these purchases were
made. Hence, it is likely that any workable system of
sales tax rebates would have to be based on estimates
of the average local tax bills paid by poorer
households. A local sales tax with such an inexact
system of rebates might cause significant hardship to
poor households with above average expenditure or
living in high tax areas.
One method of avoiding the problems caused by
cross-border shopping would be to tax goods and
services supplied directly to people’s homes, most
obviously utility bills. This would require much
higher tax rates than a local sales tax which raised
the same amount of revenue because far fewer goods
would be subject to the tax. In addition, the tax
burden as a percentage of total expenditure would be
far greater for the poor than for the rich: poorer
households spend a higher proportion of their
income on water, heating and electricity than richer
households. So, a local utility sales tax would almost
Published by the
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York YO3 6LP
Tel: 01904 629241 Fax: 01904 620072
ISSN 0958-3823
certainly need to be accompanied by an extensive
rebate scheme.
About the study
These results are based on information on incomes
and expenditures for a sample of over 7,000
households in the Family Expenditure Survey 1992.
Incomes are equivalised to reflect the lower standard
of living of larger families than smaller families with
the same household income. The data was matched
with budget information for over 300 local
authorities in England for 1994/5. We assume no
changes in either individual or local authority
behaviour as a result of the introduction of a local
sales tax.
Further information
Further details are available in Local sales taxation
available from the Institute for Fiscal Studies, 7
Ridgmount Street, London WC1E 7AE, Tel: 0171 636
3784 (price £10.00).
Related Findings
The following Findings look at related issues:
5
6
7
11
17
25
26
31
Alternatives to the community charge (Dec 90)
Attitudes to the community charge (Jan 91)
The community charge in Scotland: the second
year (Jan 91)
A new tax for local government (Jun 91)
Options for a local income tax (Jul 92)
The effect of Standard Spending Assessments
(Oct 93)
Implementing the Council Tax (Apr 94)
The operation of the non-domestic rate
(Nov 94)
For further details of these and other Findings,
contact Sally Corrie on 01904 654328 (direct line
for publications queries; answerphone may be
operating).
The Joseph Rowntree Foundation is an independent, non-political
body which funds programmes of research and innovative
development in the fields of housing, social care and social policy.
It supports projects of potential value to policy-makers, decisiontakers and practitioners. It publishes the findings rapidly and
widely so that they can inform current debate and practice.