Local income tax will never happen

Well, 'never' may be a little strong, but those who advocate the idea rarely seem to think through the consequences and the full implications. I think it's extremely unlikely that local income tax (LIT) will ever replace council tax (or local rates).

The latest advocate of LIT is Alex Salmond of the SNP. Different proposals to abolish Council tax formed part of the manifestos of the Scottish National Party and the Scottish Liberal Democrats during the Scottish Parliament general election of May 2007. The SNP version involves the centralised distribution of funds raised from the new tax throughout the Scottish local authorities whereas the Liberal Democrat's proposal devolves the distribution to individual authorities.

The last time the subject came up a few years ago it was the Liberal Democrats who were proposing the idea - they wanted to Axe the tax (Council tax). I remember an occasion when the then leader, Charles Kennedy and Vince Cable explained their proposals to an invited crowd at Chartered Accountants Hall over breakfast one morning. I posed a number of questions as to the practicalities of a local income tax - none of which could be answered with any degree of conviction.

By way of summary:

The arguments for LIT seem to be predicated on two basic ideas:
1 - A dislike of Council tax - which was a rushed replacement for the hated 'poll tax';
2 - A desire to reflect ability to pay; ie: the rich should pay more than the poor.

Extending the basic principle as applies for income tax generally to payments for local services has a degree of logic but also reduces the accountability of local councils. It would also reduce the number of staff they need to administer the system as compared with Council tax. Either redundancies or inefficiencies would be a natural consequence. Of itself that's not a reason to avoid the introduction of LIT. So why do I think it so unlikely? Principally because the practicalities are such as to scupper the plans IF anyone thinks them through before pressing ahead with their plans. Much the same could have been said as regards the dreaded 'poll tax' of course and that still came into being. But it was then hastily replaced by the present Council tax.

This blog is not the place to debate variations on Council tax as such but it is worth setting out some of the practical challenges that are generally overlooked by those advocating LIT:

Winners or losers? More people pay income tax than pay Council tax at the moment - so the tax burden would be spread and there would - by definition - be lots of losers! That's never an attractive prospect for those in power.

Is it fairer? Only those who are liable to pay income tax would pay LIT. So, if your tax favoured investments, residence status or business losses mean you have no liability to income tax in one or more years, you would have no liability to LIT. Of course, we could have special rules for such cases...

Wealthier vs low income communities? If local income tax was to the basis for generating funds for local authorities then those with a wealthier population would have more money or a lower level of LIT. Those with lower income communities would require greater subsidy from the wealthier areas. So we would need special rules in such cases....

Collection process? Either we would all need to file multiple tax returns or LIT would need to be administered by HMRC. Indeed, it has to be the latter as any other collection process would be madness. Employees would have their LIT coded out and be even more concerned than they are already about the level of tax deducted from their pay. This would create an additional burden on employers. BIG companies might be able to cope but smaller employers are close to their limit as regards the time, effort and complexity of the system they already have to administer. LIT could be the straw that breaks the camel's back. I fear it would lead to more 'cash in hand' payments that escape the tax system.

What about the self employed? Whenever anyone talks about LIT in theory, they refer to employees. But the self employed make up a growing section of the community. Their income can fluctuate by an enormous amount each year. They pay income tax anything from 9-21 months after they have earned their profits. They are supposed to have put the money aside to cover the liability. In practice if their income falls they often struggle to pay their tax. Would they get special treatment re LIT in years of falling income? We could have special rules to operate in such cases...

Effective rate of income tax? LIT would effectively add a few pence to the basic and higher rates of income tax. Regardless of any attempts at marketing spin the additional charge would be recognised as an additional tax levy. Instead of paying tax of 'only' 20% or 40% of your income you would be paying 23% or 44% (for example). The fact that the extra was hypothecated to your local Council would be of no compensation.

Do you agree with my summary or do you have an alternative view? Please add you comments to this post.