Fiscal autonomy is the key to localism

Local government is arguably one of the fundamental institutions of a free society. It ensures that local people have a significant degree of control over how the state acts in their community. Yet centralising instincts have dominated in recent decades and the central state’s power has increased at the expense of local government and other civil institutions.

This is contrary to the decentralisation advocated by Hayek, who called for a society formed from the bottom up by individuals and communities. In The Road to Serfdom, for example, he wrote:

‘Nowhere has democracy ever worked well without a great measure of local self-government, providing a school of political training for the people at large as much as for their future leaders. It is only where responsibility can be learned and practiced in affairs with which most people are familiar, where it is the awareness of one's neighbor rather than some theoretical knowledge of the needs of other people which guides action, that the ordinary man can take a real part in public affairs because they concern the world he knows.’

The market is the most efficient means of allocating resources but the state is still necessary to provide the legal framework within which a free society can operate. Independent and accountable local government is the best means of creating a state which is efficient and responds to people’s preferences. However, local government has lost its democratic legitimacy with consistently low electoral turnouts (for example, only 35% of the electorate voted in the 2009 local elections). This has fostered the perception of local government as a corrupt vested interest, which in turn has provided a rationale for centralising power at national level.

The government’s Localism Bill is an attempt to shift power back to local level but it is notable for what it leaves undone. Most importantly, it fails to deal adequately with the issue of fiscal autonomy. Council finances will continue to be strictly controlled by central government and as long as the central state holds the purse strings councils’ independence will in practice be severely limited. This is clearly a fundamental flaw in the coalition’s localism agenda. Clearly local authorities must raise a far higher share of their income locally if they are to gain a greater degree of independence and become more accountable to their electorates.

I suppose that we can virtually all agree that more fiscal autonomy for local councils could be beneficial. It would certainly increase localism and decentralisation of services, and make local democracy more relevant. Unfortunately, this blog posting fails to even mention the main obstacle to such a reform, let alone outline any realistic solution to it. The real stumbling block is economic.

If councils are to have real fiscal autonomy then they need to have complete financial independence from central government. That means that they need to be financially self-sufficient. The problem is, that while this is certainly achievable for some councils, it won't be for others. It would require every council's budget to match its income. That in turn requires those councils with the lowest income generating potential to have the lowest social costs. Yet we know that the opposite is more likely to be true. Councils with the lowest income per capita tend to have the highest social needs.

This dichotomy can only be solved by redistribution, and that currently requires government intervention. That is one reason for over-centralisation. The alternative is growing regional inequality. Fiscal autonomy would mean taxes having to rise in the poor areas, businesses would then flee, the unemployment rate would rise, and property prices would crash. As a result council income would spiral downwards. In the affluent areas the opposite would occur.

The current centralised redistributive system is designed, in part, to counter this problem, except that the degree of redistribution is highly politicised as the regional distribution of recent council funding cuts has demonstrated. Unfortunately, by the same token, any increase in fiscal autonomy at a local level could be compromised by the same political interests. Any council that tried to increase its own gross income by raising additional taxes might see its grant from central government correspondingly reduced. Fiscal autonomy would then be self-defeating. It would in effect resemble the harsh means testing that the unemployed are currently subjected to that dis-incentivises part-time or low paid work. Fiscal autonomy can therefore only work if it is accompanied by some redistribution via central government, but that redistribution must be calculated in an objective and transparent manner, and be independent of local taxation decisions. The question is, how can that be achieved?

There is of course an alternative solution. Instead of redistributing money from the poor regions to the rich ones, you redistribute those in receipt of state benefits and services in the opposite direction. Move the people to the money, not the money to the people. That is probably even more difficult to engineer though.

Finally, there is the other thorny issue of government borrowing. Historically, the second major reason for reducing the fiscal autonomy of local councils in this country was to deny them access to independent borrowing facilities. This was one of the principle reasons why the Thatcher government sought to reduce localism if I remember correctly. If local councils are now going to be more fiscally autonomous, then they will need to be able to borrow from time to time, particularly in a recession. Permanently balanced budgets will not work. So how do you organise this without ending up in the same mess as the Eurozone? Perhaps by restricting who councils can borrow from? If you limit their options to borrowing from central government, the BoE, or selling bonds to their local residents (c.f. Japan), then that might work. What won't work is unlimited borrowing or no borrowing at all.

I agree with Cantab83 that the huge variation in economic conditions among councils is a major stumbling block to genuine localism. Given fiscal autonomy, many high spending urban boroughs such as Newham and Hackney, would quickly hit financial problems and services would collapse. At least this would bring to the surface the huge subsidies from the suburbs and commuter belt that are necessary to support the people that live in these areas. However, rather than abandoning decentralisation, the solution is surely to decentralise further, down to individual and community level. For example, schools could be taken out of council control, while streets, waste disposal and so on could be transferred to private 'street associations' run by residents.

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