Shorter Papers and Comments: The 1990 Reform of U.K. Local Authority Finance

In April 1990 the U.K. Government implemented the largest change to local authority finance in England and Wales in the postwar period. It involves the introduction of a poll tax on domestic residents, the centralization of local business taxes, and an overhaul of central government grants. This paper analyzes the effect of these reforms on local government and the wider economy.


In April 1990 the U.K. Government implemented the largest change to local authority finance in England and Wales in the postwar period. It involves the introduction of a poll tax on domestic residents, the centralization of local business taxes, and an overhaul of central government grants. This paper analyzes the effect of these reforms on local government and the wider economy.

In April 1990 the U.K. Government implemented the most significant change to local authority finance in England and Wales in the postwar period. It involved the introduction of a completely new tax on domestic householders (the community charge, a poll tax), the centralization of the current local taxation of business, and an overhaul of the method by which the Government allocates grants to local authorities.1

The most controversial of these proposals is the imposition of a poll tax. The most famous attempt to impose such a tax in England (in 1381) ended in its withdrawal following the peasants’ revolt. Historically, poll taxes appear to have been highly unpopular, even by the standards of taxes in general, and the current proposal has proved to be no exception. The new tax has produced widespread opposition, the most dramatic manifestations being the largest riots in London in this century and the biggest swing against a government in a parliamentary by-election since 1935.

The controversy over the poll tax has overshadowed other aspects of the reforms, such as the changes in the system of government grants and centralization of local business taxation, which themselves represent a significant change in the relationship between central and local government. In this paper the effects of all aspects of the reforms are analyzed.2

I. The Objectives of the Government and the Reform Proposals

Local authorities represent a major sector of the U.K. economy, with spending representing 10 percent of gross domestic product (GDP) in 1988/89. In financing expenditure prior to April 1990, approximately equal amounts were derived from local governments’ own resources and from central government grants. The major source from local resources was a property tax, known as the rates, levied on all buildings, both domestic (residential) and nondomestic (business), which was the sole local tax. Central government grants had two functions: to equate tax levels across different authorities for a given level of services (negating the effects of differences in the local tax base) and to influence the level of expenditure through variations in grant amounts.

The broad features of the reforms are contained in a consultative document (Green Paper), Paying for Local Government (HMSO (1986)). The objectives of the Government since 1979 have been to contain local expenditure at affordable levels; to encourage local authorities to carry out services more efficiently; and to reduce detailed controls over local government. In the view of the Government, local government spending was excessive due to a lack of accountability to the local taxpayers. This lack of accountability was endemic to the system of local authority finances, affecting all three principal forms of revenue, in particular:

  • Nondomestic rates (those rates paid by businesses) were paid by organizations to which the local authority was not directly answerable.

  • Domestic rates, which do affect voters, were directly paid by only a minority of the local electorate and varied in a way that had little regard to the use made of local services.

  • Central government grants were calculated in a complex manner, which made it difficult for the local electorate to evaluate the true cost of services being provided.

The reforms changed the way in which all three sources of revenue operate. Domestic rates have been replaced by a new tax, called the community charge (a poll tax), which is levied at an equal rate for each adult, with rebates for the poorer members of society. Like the rate rebates they replace, they cover up to 80 percent of the charge.

Nondomestic rates continue to be levied, but the poundage (the term for the tax rate) is now set by the Central Government. Although the revenues continue to be collected locally, they are paid into a central government pool and then reallocated on a per adult basis. Hence, non-domestic rates have changed from being a local tax to being, effectively, a central government tax levied specifically to finance local authorities.

The system of government grants was changed and simplified. It now aims to ensure that a given level of services provided implies an equivalent community charge in different local authorities, with the level of the grant being independent of actual expenditure. Hence, local authorities must finance all marginal expenditure increases from the community charge.

In order to understand the effects of these changes, consider two authorities under both the old and new systems. One authority, labeled N (for needy), has low property values and high per capita service needs. The other, labeled P (for prosperous), has high property values and relatively low needs. The situation under the rates is shown in the upper panel of Figure 1 (based on King (1988b)). The vertical axis shows the per capita level of services, and the horizontal axis represents the rate of tax (poundage).

Figure 1.
Figure 1.

The Two Systems of Local Finance

Citation: IMF Staff Papers 1991, 004; 10.5089/9781451956917.024.A009

Note: Based on King (1988b).

In the case of authority N, property values are low, and hence the lines Tn and Dn, which represent the revenue from the all rates and domestic rates, respectively, are less steep than the corresponding lines Tp and Dp for the more prosperous authority. The lines In and Ip show income after the general grants. The difference between line T (total local tax revenue) and line I (total income) represents the level of government grants. At a given level of tax (Tg), which is the same for each authority, they pass through a fixed level of services, Sg, defined by the Government as the grant-related expenditure assessment (GRE). Since N requires more services, this level is higher for N than for P; the assessment equates tax rates among different authorities for the level of services given by the GRE.

The income lines (In and Ip) are less steep than the respective tax lines (Tn and Tp). This is because the Government sought to equate the marginal increase in the tax rate for additional expenditure. Each extra pound of expenditure per capita involved a rise of 1.1 pence in the poundage of the local authority, which generally brought in over £1 in revenue per capita. Hence, at higher poundages, the grant from the Central Government was reduced, and the tax and income lines thus move closer together.3 The income lines, In and Ip, also have a kink at a level 10 percent above the Government’s defined level of services (the GRE), Sg. At this point, the marginal tax rate faced by the authorities rises from 1.1 pence per pound of extra expenditure per capita to 1.5 pence per pound.

The lower panel of Figure 1 shows the arrangements under the new system. The vertical axis still represents the level of expenditure and revenue per capita, but the horizontal axis now represents the level of the community charge. The lines Cn and Cp, representing the revenues from the community charge, are parallel, since it is a poll tax. The lines T’n and T’p, as in the upper panel, reflect total tax receipts; that is, the sum of the community charge and business rates. Since receipts from business rates are no longer under the control of local authorities, the line T’n (or T’p) is parallel to the line Cn (or Cp). Lines I’n and I’p reflect total income including central government grants. These income lines pass through the projected expenditure points, Sg, at the same tax rate, Cg. Since neither nondomestic rates nor government grants are related to actual expenditures, this line is also parallel to the community charge lines, Cn and Cp.

Comparing the top and bottom panels, several features emerge. Under the old system, grants were calculated to equate poundages, while the new system equates levels of the community charge. Hence, a low-resource authority, like N, will have to raise a larger amount of money from its tax base. Also, the marginal tax price of the community charge on the domestic sector (the slope of lines Cn and Cp) is between that of domestic and total rates (the slopes of the D and T lines, respectively). The tax price rises for domestic rate payers and falls to zero for nondomestic rate payers.

The reforms also change the tax paid by individuals within a given authority. The move from a property-based tax to a per capita charge involves a shift in the tax burden; those with high-value properties pay less, and those with low-value properties pay more. The view of the government is that this change will eliminate the ability of councils to levy high taxation on “prosperous” households in order to cross-subsidize households paying relatively small amounts of rates.4

II. Analysis of the New System

This section focuses on the implications of the reforms for local accountability and equity, business taxation, and the wider economy.


The Government’s argument is that the new system will improve the accountability of local government. It will raise the number of taxpayers, broaden the tax base, and reduce the number of people who receive services without paying for them. In terms of the number of taxpayers, there were over 35 million electors in England in 1985, while the number of householders was under 18 million. Since only one person per dwelling was formally a ratepayer, this implies that only half the electorate actually paid rates. However, the effective incidence was certainly much higher. For example, if spouses are added to the total, the number of ratepayers would rise to 30 million people, making the rates a fairly broad-based tax. Thus, although the community charge will have both a higher actual and effective incidence than the rates, the differences are probably not large.

A second issue relates to the marginal tax rate faced by domestic taxpayers. On average, the cost of an extra pound of expenditure in England (excluding London) under the old system was 69 pence if the authority is to the left of the kink in Figure 1 (King (1988a, p. 142)). Under the rates, a rise in spending across different local authorities meant an equal increase in the property tax rate; hence, the marginal tax price faced by the domestic sector was proportional to the domestic ratable values. It is difficult to see an efficiency (as opposed to equity) argument for such variations in the local marginal tax price. Under the new system, the marginal tax price will be unified at 1. For many authorities, particularly those with low property values, the new system implies a substantial rise in the marginal cost of extra spending falling on domestic taxpayers.

The significance of this change depends on the degree to which the domestic tax price affects spending behavior. Under the rates, since the domestic tax price was proportional to domestic ratable value per head, the correlation between domestic ratable value and expenditures measures the importance of this connection. Figure 2 shows scatter plots for four types of English local authorities: inner London boroughs; outer London boroughs; metropolitan districts; and nonmetropolitan counties. The vertical axis shows budgeted spending in excess of GRE per head in 1989/90, and the horizontal axis shows the domestic ratable value per head. All four sets of authorities show the expected negative correlation. Regressing excess spending against ratable values plus dummy variables representing the different types of local authorities yields the following results:

Figure 2.
Figure 2.

Relationship Between Domestic Ratable Value and Spending

Citation: IMF Staff Papers 1991, 004; 10.5089/9781451956917.024.A009

excessspending=55.9(11.3)0.64(0.12) ratable value + 106.7(15.2) inner L+53.0(11.1) outer L+ 28.0(8.7) metropolitanR2=0.36SE=36.7No.ofobservations = 104,

where excess spending is spending over GRE per head in pounds sterling; ratable value is domestic ratable value per head; inner L, outer L, and metropolitan are dummy variables representing inner London boroughs, outer London boroughs, and metropolitan districts, respectively; R2 is the proportion of variance explained by the equation; and SE is the standard error of the regression (standard errors for coefficients are reported in parentheses).

The results indicate that marginal domestic tax prices have a significant effect upon spending decisions. The coefficient on ratable value per head is negative, as expected, and is significantly different from zero. These results imply that by raising the tax price to unity, the local authority reforms will lower local spending in England (outside London) by about 2½ percent of total expenditure.

A further issue is whether making the new tax a per capita charge will strengthen the connection between taxation and services. In the words of the green paper “a community charge would provide a closer reflection of the benefit from a modern people-based service than a property tax” (HMSO (1986, p. 25)). Although it is true that much spending by local authorities is oriented toward people, the large component is education, where cost is not related to charge-paying adults. Recent evidence on the provision of benefits by Cheshire County Council, reported in Bramley, LeGrand, and Low (1989), indicates that benefits from local government services rise with both income and socioeconomic class,5 implying that a poll tax is not a satisfactory benefit charge. However, when rebates are taken into account, the poll tax is quite a good reflection of benefits across income bands, even if it is still regressive across socioeconomic classes (Bramley, Le Grand, and Low (1989, Figures 6 and 7)).

Cost and compliance represent another issue. The rates were cheap and easy to collect. The community charge will probably double administrative costs, due to its wide coverage and the need to keep up-to-date information on residences. Evidence from Scotland indicates that there may also be a considerable problem with compliance; Strathclyde has initiated legal action against 350,000 people for nonpayment of the community charge, over 1 in 6 taxpayers. The evidence from Scotland also indicates that local authorities may have used the confusion surrounding the introduction of the new system to raise revenues significantly more than expenditure (Hughes (1989)), presumably in order to lower future increases in taxes for which the local authority will be more directly accountable.


Any poll tax, even one with rebates for the less well-off, is likely to be regressive. The Green Paper (HMSO (1986)) concedes that, as well as a beneficial principle, the ideal local tax would have a redistributive principle. However, it concludes that “no tax could satisfy both aims simultaneously” (p. 24, emphasis in original), but that the rates failed both tests, being badly correlated with both income and services.

Table 1 shows a comparison of payments of the rates and the community charge among different income bands for the same total tax revenue. In comparison with the rates, which were themselves a fairly regressive tax, under the community charge the well-off (top three deciles) and very poor (bottom decile) gain at the expense of those in the middle. Even as a percentage of income, however, the gains to the well-off are much larger than to the very poor. For example, the top income decile gains about 0.8 percent of income on average, the bottom decile, 0.2 percent.6 The community charge is clearly a very regressive tax.

Table 1.

Percentage of Net Household Income Paid Under the Rates and the Community Charge

(Ranges of equivalent household income; in pounds per week)

article image
Source: HMSO (1986, Annex F).Note: Equivalent household income measures relative standard of living by adjusting actual income for differences in household composition.

A positive number indicates a gain under the community charge.

Nondomestic Taxation

Business rates under the old system made up over half of rates received by local authorities, with each £1 of extra expenditure raising local business taxes by an average of 74 pence. Differences in local rates of taxation imply differences in costs for similar business. In general, however, the rates were a relatively small part of aggregate costs, representing some 1.9 percent of net output in 1982. Overall, Bennett (1988) concludes “rates do not have a general effect on business decisions, but can be of major significance in the case of a restricted number of high tax locations” (p. 159, emphasis in original). Clearly, the uniform business rate will solve such problems, although at the cost of a considerable loss of local fiscal autonomy.

Macroeconomic Effects

The most significant effect of the reforms on the macroeconomy have to do with the housing market. The rates were the only important tax on housing, and their abolition will raise housing consumption, further distorting behavior in an already distorted market.

The community charge lowers the marginal cost of living in a more expensive house, since the local tax bill is no longer affected by property values. Calculations of the cost of trading up on a house indicate that the rates represented one fourth of the rise in costs, and the implied fall in the cost of housing could raise house prices in the long run by 15 to 20 percent (Spencer (1988) and Hughes (1988a, 1988b)). These effects may have been one element in the sharp increase in housing values in the United Kingdom in 1988 and 1989.

The supply response to this increase in demand will be delayed because of the costs of moving and lags in the system. The current rate of increase of the housing stock of about 1 percent a year could well double, although some of this increase will come through improvements to the current stock of housing rather than new houses. This implies that the construction industry (in its broadest sense) will experience a significant increase in demand over the medium term.

The increase in house prices also has implications for the macroeconomy, particularly consumption. Both the permanent income and life-cycle theories of consumption imply an important role for wealth in consumption decisions. The boom in house prices has probably been a major factor in the fall in the U.K. household saving rate over the late 1980s (Muellbauer (1989) and Muellbauer and Murphy (1989)).

International Comparisons

There are few examples of poll taxes in the modern world; Japan has a prefectural and municipal inhabitant tax, which forms an important part of the local taxation system, raising 48 percent of income. However, the rate of tax is progressive with respect to income. Tanzania introduced a poll tax in 1984/85, with a flat rate charge of 200 shillings per adult in Dar es Saalam. The following year this was changed to a progressive charge, going a long way up the income scale. Overall, the international evidence does not provide examples of an important residence tax unrelated to income.

III. Conclusions

The reform of U.K. local authority finance was both far-reaching and radical. The most controversial part of the reforms involves the replacement of the existing tax on property with the community charge, a poll tax. This tax is generally more regressive than its predecessor and significantly more costly to administer. Although it might be expected that such a lump-sum tax would improve efficiency, its main effect is to further distort the housing market. For businesses, the switch to a uniform national rate of property tax ends distortions caused by large differences in the rate of tax, but the effect of this change on behavior is unlikely to be large. For local government outside London, the reforms raise the cost to electors of £1 of local services from an average of 70 pence to a uniform rate of £1, which may lower spending by some 2½ percent in the long run.

Overall, the reforms simplify and improve many areas of the relationship between central and local government. Nevertheless, outside commentators have been almost uniformly critical of the reforms. There appear to be four reasons for this. First, many people believe that the imposition of a poll tax represents a significant backward step in the tax system. Second, the reforms, by lowering the tax base, reduce local autonomy and limit choice. Third, attempts to avoid the tax will lead to disenfranchisement of voters. Finally, given the scope of the reforms and the unsatisfactory nature of the existing system, many believe an opportunity for a radical improvement of the system was lost to the objective of containing expenditure.


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The discussion here focuses on the arrangements for England. Those for Scotland and Wales vary in some minor respects. In Scotland the most important reform, the community charge, was introduced in April 1989. The discussion also concentrates on the effects of the new system when it is fully operational, rather than the implications of the transitional arrangements.


This is particularly true given the recent announcement of a further review of local authority finance, which will almost certainly result in a radical change to the community charge.


The income lines, Ip and In, are parallel, since the Government ensured that equal increases in the tax rate provided the same increase in expenditure per capita across authorities.


Interestingly, the tax price faced by the median voter in any given authority is similar under the two systems (see Table 1 below).


This picture may not be accurate for some urban councils where social expenditures are considerably higher.


The reason the very poor gain is that many of them are pensioners and single parent families, who are the group who gain most from the change. HMSO (1986, Annex I) indicates that pensioners and single families generally gain, other single adults lose, while couples are broadly unaffected.

Long-Run Money Demand in Large Industrial Countries: Volume 38 No. 1
Author: International Monetary Fund. Research Dept.