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Council Tax, Local Income Tax and The Myth of the Fireman and the Nurse
A Scottish Action Against Council Tax Report
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Over the past two years or so, there has been much talk, by those political parties opposed to the concept of local authority funding by local taxation under the principle of ability to pay, of Local Income Tax (LIT) being unfair to many households.
If memory serves, these scare tactics first received prominence when Charles Kennedy, the then leader of the Liberal Democrats and advocate of LIT, was confronted by the fact that the Council Tax/LIT "break-even-point" for a two adult household, in a band D property was that they each earned around £20,000 per annum. This imaginary couple were subsequently dubbed the Fireman and Nurse; the intended strong implication being that these household circumstances constitute some kind of average or norm, and consequently, normal households with a bit more income would be unfairly treated by LIT.
Things have moved on little in the past two years, and since we have more reliable published data for household income for 2005, our analysis is more exact for that period. Also, none of the basic principles has changed since then. Therefore, unless specifically stated otherwise, all calculations refer to 2004/05 data.
Let's now look at Scottish household income from two aspects:
Source of the Data on Scottish Household Net Incomes.
The statistical data used in this short study are taken from "Scotland's people", Results from the 2005 Scottish Household Survey (which is a Scottish Executive National Statistics Publication) - Tables 6.42/6.43 of which are to be found on Page 130 of:
From the glossary of terms contained in Appendix 1 of the above, it would appear that the income bands quoted in the above referenced tables represent net annual household income. This, in terms of the survey data means the income, which might normally be called the combined "take home pay" of the main householder and partner (if any), but which excludes the income of any other household adults, except in so far as they may contribute "dig money" to the main householder. The first 2 columns of Table 1. have been extracted from the above referenced data.
Imaginary Couple's Net Annual Household Income.
In order to compare the imaginary couple's income with the statistical data, we have reduced gross incomes by amounts which we consider to be credible employee standard deductions. The applied deductions are income tax, employee national insurance contributions and a 5% gross pay, tax free pension contribution. In this way, the couple's £40,000 combined gross pay converted to net household annual income is calculated as £28,856. - see Table 2.
Table 1. Percentage of Households in Each Net Income Band
From 2005 Scottish Household Survey.
Chart 1. - From Table 1. Data
The chart has been drawn to illustrate the upper and lower values of each net income band and also a median line The upper and median net incomes are indeterminate for the over £40,000 band.
Observations from Statistical Data.
Reading from the median line on Chart 1, an income of £28,857 represents approximately 84%, indicating that about 16% of households have a higher net income.
Again, from the median line, 50% of all households appear to have a net annual income of approximately £13,500.
Clearly, we must recognise that the £40,000 gross annual household income of our imaginary couple in no way typifies Scottish household income, since they are in the top 16% of all households.
If we are to postulate that a net annual household income of £13,500 is typical, we would have difficulty in determining the tax liabilities without making assumptions as to the type of household and whether there are one or two wage earners. Since the widely quoted fireman and nurse scenario assumes a two adult household with no dependants and no savings, then we will do the same here. We will consider (see Table 2.) that the £13,500 may be made up of one wage earner with a gross income of £18,530 or two wage earners, each with a gross income of £7,833, both households contributing 5% of gross income towards a retirement pension. It is noted that £7,833 in 2004/2005 was fairly close to the minimum wage for full time employment.
Table 2. Household Income and Deductions - £
The table assumes income tax personal allowance, thresholds and tax rates for tax year 2004/2005.
Table 3. Local Taxation Rates - LIT Applied to Basic and Higher Rate - £
Table 4. Council Tax for Glasgow 2004/2005. - £
Burt (Ref. 1 - Section 10, para's. 46 & 47) uses, as an example when discussing LIT, modelling work carried out by Stirling University. This work estimates the amount of LIT required, under various scenarios, to remit the total council tax receipts in Scotland, including the Council Tax Benefits granted by Westminster. Of these, the most commonly quoted scenario by Scottish Labour is "6.5% applied to earned income subject to income tax at basic and higher rates", payable in 2006/07.
Burt goes on to estimate, again presumably using 2006/07 tax data, the LIT payment for our notional couple (2 x £20,000 gross income) as £1,670 under 6.5% LIT. This figure is arrived at apparently without taking account of tax allowances beyond personal allowance. Is this notional, relatively well-off couple really contributing nothing towards their retirement pensions?
The same incomes as in Table 2 are used in Table 3 to calculate LIT liabilities applied to earned income subject to income tax at basic and higher rates.
Of particular interest is the 5.35% rate as it represents approximately the same total remittance as the 6.5% rate, but assumes that Westminster would continue to contribute a grant roughly equal to the Council Tax Rebate grant which it pays at present.
Scottish Labour politicians, including the Finance Minister, are adamant that this would not be the case and that Westminster would cease to pay the 3% of total council funding that the Council Tax Rebate represents. If this punitive measure were indeed taken, it could be seen as vindictive in the extreme. An analogy exists here with recent statements regarding the Welsh Assembly which apparently is to be given additional legislative powers. Westminster would be required to approve any new or changed legislation. The Welsh Secretary, Peter Hain, when asked about a Westminster possible veto, said it would be very unlikely to be used as "we (Westminster) would be likely to reap a bitter harvest".
Comparison of LIT and Council Tax.Glasgow has been chosen for this comparison as it has one of the highest Council Tax rates, and it also contains some of the most deprived areas, in Scotland.
At the 5.35% LIT rate, the imaginary couple with the relatively high net household income of £28,856 would pay about £1,309 as opposed to Council Tax of £1,185 if in band D or £1,448 if in band E.
The much more representative couples with a net household income of £13,500 would pay, under all LIT scenarios in Table 3, less than Council Tax - even in band A.
Council Tax Rebate.
Neither couple with a net household income of £13,500 would qualify for Council Tax Rebate if occupying a property below band G.
What Would I Pay in Local Income Tax?
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Council Tax is unfair. It is based on purely notional property values. But the value of your house does not pay your Council Tax. You cannot sell off a few more bricks from your house every month to pay your Council Tax. In practice most of us have to pay our Council Tax from our incomes. And our incomes may bear no relation whatsoever to the value of our homes.
Take the following examples (figures refer to 2011-2012 tax and pension rates):
Jean Black is a 74-year old widow. Her only income is her state pension and pension credit of £137.35 per week (£7,142 per year). She has modest savings that make her ineligible for Council Tax Benefit. (The interest on her savings struggles to keep pace with inflation, so it is not real income.) She lives in her married home, a Band D house in Glasgow. Even with the single person's discount of 25%, she pays £910 in Council Tax, excluding water charges -12.74% of her income. If, like many pensioners - see below - Jean does not claim the Pension Credit to which she is entitled, her Council Tax will represent 17.13% of her basic state pension of £102.15 per week (£5,312 per year).
John and Jessie Green also live in a Band D house. John is the only wage earner. Jessie stays at home to look after their two young children. Their total income, including benefits, is £25,000. Their Council Tax, £1213, represents 4.9% of their gross income.
Paul and Moll Brown also live in a Band D house with their two grown-up sons, Henry and Joseph. All have jobs, and the total gross family income is £90,000. They pay exactly the same Council Tax as John and Jessie Green - but this is only 1.3% of their total gross family income.
Jeremy and Margot Gray live in a two million pound mansion (Band H). Both are company directors, and their joint incomes are £200,000. Their Council Tax, £2,426, represents 1.2% of their gross income.
It is true that people on very low incomes, and with little or no savings, are eligible for Council Tax Benefit, Income Support, Pension Credit and other benefits. But there is overwhelming evidence that means-tested benefits do not work fairly, and cannot be made to work fairly. Many people do not claim the Pension Credit, Council Tax Benefit and other benefits to which they are entitled. For example, in a report published on 25th June 2009, the Department for Work and Pensions estimated that, UK-wide, the number of people who did not claim Council Tax Benefit in 2007-2008, although they were entitled to claim it, was between 2.33 million and 3.06 million. And even modest savings make people ineligible for Council Tax Benefit. Needless to say, an income-based tax would do away with the need for a separate Council Tax Benefit.
What if Council Tax were replaced by a flat-rate income-based tax ring-fenced for local government expenditure (Local Income Tax, or LIT)? There are two points to remember:
So how would Local Income Tax affect the people in our example? Assuming that their personal allowance is their only tax-free allowance, their TAXABLE incomes in 2011-2012 would be as follows. (If, of course, they had other tax-free allowances, their taxable incomes would be even lower.)
Jean Black: No taxable income. Her pension is less than her tax-free allowance of £9,940
John and Jessie Green: £17, 525 (25,000 less £7,475)
Paul and Moll Brown's family: £60,100 (£90,000 less £29,900 [£7,475 x 4])
Jeremy and Margot Gray: £185,050 (£200,000 less £14,950 [£7,475 x 2])
Depending on the proportion of Council expenditure met from central government grants, most political parties have estimated that the amount of Local Income Tax would be between 3% and 5%.
If LIT were set at 3%:
Jean Black would pay nothing (compared with £910 Council Tax), as her income is below the tax-free allowance.
John and Jessie Green would pay £526 (3% of £17,525) compared with £1213 Council Tax.
Paul and Moll Brown's family would pay £1803 (3% of £60,100) compared with £1213 Council Tax.
Jeremy and Margot Gray would pay £5,552 (3% of £185,050) compared with £2,426 Council Tax.
If LIT were set at 5%:
Jean Black would pay nothing (compared with £910 Council Tax), as her income is below the tax-free allowance.
John and Jessie Green would pay £876 (5% of £17,525) compared with £1213 Council Tax.
Paul and Moll Brown's family would pay £3,005 (5% of £60,100) compared with £1213 Council Tax.
Jeremy and Margot Gray would pay £9,252 (5% of £185,050) compared with £2,426 Council Tax.
So clearly those on lower incomes would benefit compared with those able to pay their fair share.
Most of us can easily work out what we would pay under a Local Income Tax, whatever the tax rate.
Gross Annual Income = £24,000
Total Tax Free Allowances = £7,475
Therefore Taxable Income = £16,525 (£24,000 minus £7,475)
Therefore Local Income Tax at 3% = £496; Local Income Tax at 5% = £826
Gross Annual Income = £40,000
Total Tax Free Allowances = £7,475
Therefore Taxable Income = £32,525 (£40,000 minus £7475)
Therefore Local Income Tax at 3% = £976; Local Income Tax at 5% = £1,626
SAACT's Response to Critics of Local Income Tax
This feature counters the criticisms of local income tax made by various individuals and organisations. SAACT's responses are shown in bold italics.
(1) "Local income tax (LIT) will make Scotland the highest-taxed part of the UK and this might encourage businesses to leave."
Council expenditure budgets, including the local taxation derived element, are independent of the method of collection of the local taxation except insofar as the cost of collection is concerned. It follows that, contrary to mischievous propaganda, the total amount of required taxation would not be affected by the method by which the local taxation is levied, except that more efficient collection would reduce the overall requirement. It is true, however, that under a properly administered and progressive LIT system, those with very high incomes would be required to pay more of their fair share and thus would cease to be subsidised by those of lesser means. It is also true that those with more modest incomes would consequently be required to pay substantially less than at present or even nothing at all.
(2) "There will be serious service cuts at council level unless local income tax is set at 4.5p or higher."
Even at 4.5p, the average wage earner (on c.£26,000 pa) would still only pay £720 pa - as compared to an average band 'D' council tax of £1,149. (Also, note that the band 'D' figure would now have been very much higher had there not been a council tax freeze for the past seven years.)
(3) "Replacing an unfair tax with an unworkable tax will cause more misery than we can know."
LIT works perfectly well in several other countries within Scandinavia and parts of the USA. To the best of our knowledge, variable Scottish income tax has not been deemed "unworkable" by HMRC.
(4) "Hard-pressed students, who are currently exempt from the council tax, would have to pay."
Most unlikely to affect students as they wouldn't pay any LIT unless their annual earnings exceeded £10,000 or £192 per week (i.e. about 30 hours at the National Minimum Wage hourly rate of £6.50)
(5) "The PAYE system does not easily deal with taxpayers who receive income from different sources, including pensioners receiving pensions from different employers or those who have various part-time jobs - this will particularly affect those on low incomes who will be exposed to incorrect PAYE codes, and these practical issues
HMRC copes very well with, for example, pensioners receiving several pensions from different sources, at present. 6 "Regardless of the rate of tax chosen, there will be uncertainty as to the yield that can be obtained, as revenues derived from income taxes can be more volatile." Surely volatility of yield is also experience d with the existing national income tax and other existing taxes, including Council Tax. Certainly, unemployment and low wages would mean a lower yield. These circumstances, however, under LIT, would result in a n automatic adjustment through the income tax system in "ability to pay" and therefore cost much less than the present cumbersome bureaucracy of the council tax benefit system.
(7) "LIT would be technically complex and challenging to implement because of the complexities of tax law, and trying to sort out what would happen to the 400 million council tax benefit."
Clearly, the complexity and challenges were not found to be insurmountable by several other countries. Also, the Council Tax Benefit problem has fairly recently been resolved by the UK government. should not be underestimated."
(8) "Investors and businesses who are thinking of coming to Scotland will be scared away because of the extra income tax."
No more than being scared away because of high council tax.
(9) "Wealthy people who have unearned income from sources like share dividends can avoid LIT whilst poorer people would have to pay."
As a matter of principle, LIT should be applied to all sources of income - including savings and investment income. LIT could be levied in exactly the same way as HMRC deals with income tax applying to dividends and other unearned income.
(10) "The UK tax system does not give across-the-board allowances for disability and, in the absence of such allowances, the burden of LIT will be higher on disabled people than on the general body of taxpayers."
Bear in mind that disability/incapacity/housing benefit is non-taxable and that LIT would be payable on taxable income in excess of personal allowance.
(11) "LIT will be more intrusive into people's lives because it would require far greater knowledge of their personal circumstances than a property tax would."
LIT would be no more intrusive than at present, with national income tax.
(12) "The 281 million of savings that need to be made to create a 3p local income tax could be used instead to reduce the burden of the council tax."
There is already a commitment for HMRC to to set up a separate tax system for Scotland. However, setting the LIT rate at nearer 5p would obviate this problem and would be welcomed by the vast majority of local t axpayers.
(13) "LIT would bring unwelcome extra bureaucracy and cost to businesses because of all the extra paperwork created in sorting out employees' income tax. Lib Dem proposals for different rates for different areas would make it even worse."
Some politicians who claim this to be a difficulty should recognise the analogy regarding cross-border differential income tax proposals from Calman or those in the new Scotland bill. In this context, well esta blished relational data base technology renders tasks like this entirely practical using attributes such as NI numbers, postcodes, tax codes, etc.
(14) "Families will be worse off, or there will be cuts in public services, because the 3p rate will not be enough to fund current service levels."
Even a 4.5p rate of LIT would be most acceptable for the reason given at item 2, above. Namely, that an average wage earner on £26,000 pa would still only pay £720 pa in LIT - as compared to an average band 'D' council tax of £1,149.
(15) "Water and sewerage charges are collected by local authorities on behalf of Scottish Water - the consultation did not present any proposals on how such charges will be set and collected under LIT."
Hopefully, water charges would also be based on ability to pay.
(16) "The SNP's centralising LIT proposal reduces the control that councils have over local finances."
Initially, it would be much easier and cheaper to implement a nationally-set tax. Later, after the system had bedded down, it could then be changed to a locally-set tax if this is seen as a real problem.
The following other features appear in SAACT Newsletters (see "Newsletter Archives" Page):
Some Basic Tax Facts (Issue 2, October 2006)
Council Tax or Income Tax? (Issue 2, October 2006)
Local Taxes - Ease and Cost of Collection (Issue 4, March 2007)
Local Accountability (Issue 5, April 2007)
Comparison of Local Taxation Using Various Fairness Criteria (Issue 6, June 2007)
© 2011 Scottish Action Against Council Tax