About this essay

The essay forms part of CPP’s programme of work on funding fair growth. This programme considers the options that an incoming government, serious about delivering progressive change, will have for funding the policies needed to enable fair growth across the UK.

Key terms

• Devolution – the transfer of powers away from central government. In this essay we discuss the sub-national devolution of powers to local government, rather than the devolution of power to the constituent nations of UK e.g., Scottish Parliament.
• Fiscal devolution – an increase in local powers over taxes and spending, including the capacity for councils to raise money through taxation.

• Fair growth - economic growth that raises the living standards of all people and places and is delivered in line with the path to net zero.

Funding fair growth is not just about tax and spend policies at the national level but also about ensuring places have the financial resources and powers to drive growth from the bottom up. In this context, this essay explores devolution and the extent to which more local powers over taxation, spending and specific policy levers can support growth and reduce inequality. It concludes that while stepping back from the UK’s current model of overt centralisation could have significant benefits – equipping places with more of the resources they need to invest in fair local growth – we must learn from the international evidence and balance the risks and trade-offs. Given the depth of existing inequalities within and between places, national redistribution and centrally administered funding formulae will be a necessary part of the mix in the short to medium term. CPP is exploring different reform options - including via deliberative research with a citizens’ jury - and will publish our proposals in the autumn.

Introduction

CPP is an economics think tank, which has played a part in shaping the consensus and delivery of devolution as a driver of inclusive local economic growth. This has included calling for more targeted funding for local areas based on needs and enabling places to pool existing funding pots as a precursor to the single, multi-year funding settlements seen in recent trailblazer deals. As such, we have been at the frontier of devolution both with local government – particularly through our Inclusive Growth Network – and with national government in exploring the merits of, and options for, greater devolution to places.

Recent years have seen both the Conservatives and the Labour party commit to more devolution. The process started during George Osborne’s tenure as Chancellor was expanded as an integral part of the Conservative government’s commitment to Levelling Up under Boris Johnson. The case was made that narrowing inequalities between places requires empowering local leaders to develop for themselves the solutions that work best for their communities. A devolution deal has been promised for every part of England that wants one by 2030.[1] The Labour Party has vowed to “go even further than the government on devolution”. Their report, A New Britain, which sets out the recommendations drawn from their Commission on the UK’s Future, led by former Prime Minister Gordon Brown, calls for every town and city in England to be given further powers to help develop new economic growth plans, as well as further devolution to Scotland, Wales, and Northern Ireland. While Labour has been hesitant to reveal exactly what this means in practise, devolution is expected to be a fundamental pillar of the party’s economic plans should it form the next government.

Yet despite the rhetoric and some notable developments on the ground, the UK devolution story is still in its infancy compared to other advanced economies. In this context, this essay explores progress to date, and outlines the strength of evidence on whether, how and when devolution, particularly of fiscal levers, could spur fair growth. It concludes with plausible options for advancing the agenda.

Background: UK devolution in perspective

The UK is an international outlier among advanced economies in terms of the powers that local governments have to spend and raise money locally. On the spending side, the latest available data from the OECD suggests that the UK sits around the bottom third of member nations in terms of subnational spending as a proportion of total national spending, with less than a quarter (23%) of spending decisions being made locally. On the taxation side, only 5.1% of total UK government tax revenue is accounted for by local government tax raising. The UK is also unique among OECD countries in its dependence on property taxes (council tax and business rates) to provide virtually all local tax revenues, compared to an average of around 33% of local taxes across OCED local governments (Figure 1).[2]

The political consensus around the need for more devolution, particularly within England, comes after huge cuts to local government budgets. As CPP has set out previously, central government cut local government spending more than any other part of the public sector during austerity and the poorest areas bore the brunt.[3] During the period of 2013-2017, the most deprived 20% of areas experienced an average cut in central government funding of £233 per person, compared with £135 per person in the least deprived areas. This had significant economic and social impacts, with one study in The Lancet estimating it cost 9,600 lives as a consequence of reductions to services such as housing, planning and homelessness prevention.[4] Alongside cuts to local government funding, the complexity of funding also increased. Between 2010 and 2018, at least 177 different funding pots were developed, indicating the degree of fragmentation and churn in the local economic policy landscape.[5] However, new funds failed to make up for the cuts during austerity and the resource required for local places to bid and compete for these only further intensified the strain, particularly on those places with the least institutional and financial capacity. The relationship continued to fray between levels of local government funding and local populations’ level of need.

Since 2010, devolution settlements have largely centred around a ‘deals-based’ model that permits the transfer of specific powers and narrowly defined policy areas. These became increasingly more ambitious, notably with the introduction of devolved joint health and social care budgets, and the new ‘trailblazer’ devolution deals signed with Greater Manchester and the West Midlands earlier this year marked a considerable step change in the funding arrangements of both combined authorities. Recognising that the current funding system for mayoral combined authorities is “fragmented, [and] overly reliant on centrally administered funds”, each combined authority will now instead receive a ‘single funding settlement’ covering a whole spending review period.[6] This settlement will increase mayoral autonomy significantly – giving mayors far greater freedom to reprioritise across their own budgets and make spending decisions in line with the needs, wants, and strengths of their local areas – something which has been virtually impossible under the previous system. Recently the Department for Levelling Up, Housing & Communities published new guidance setting out its intentions to make the single funding settlement the new norm – rolling it out to all areas in England with a devolution deal, as well as allowing local authorities to pool different funding streams together; a pilot scheme of 10 local authorities was announced as a first step.[7]

While single funding settlements for Greater Manchester and the West Midlands mark a considerable and welcome step forward, they will not be introduced until the next spending review period – likely 2025/26 – and there is still no guarantee that this will become the norm for most authorities beyond then, especially with a potential change of government in the meantime. In any case, the majority of local government funds will remain highly dependent upon central government transfers to function. Around 60-70% of revenue funding for England's mayors comes from central government transfers, compared to 33% for Berlin, 32% for Madrid, 26% for New York City, 16% for Paris, 13% for Frankfurt and 5.6% for Tokyo.[8] But even between different areas of the UK, the degree of actual control over revenue spending differs significantly, largely a consequence of the UK’s uniquely layered, ad-hoc, multi-tiered system of local governance in which different areas can have significantly different levels of power and autonomy. A recent report by the think tank Onward highlighted these disparities in local revenue control. In London, only 8% of revenue spending is currently controlled by the mayor, but in the West Midlands this is just 0.4%, with 84% of their budget being controlled by national government. While 43% of capital spending in London is controlled locally, largely due to Transport for London and the 80:20 rule on affordable housing that ensures 80% of Homes England funding is funnelled into areas with affordability pressures, this falls to just 26% in the North West and 28% in the West Midlands.[9]

Could fiscal devolution help encourage fair growth?

There is mixed evidence internationally on the relationship between the level of devolution in tax and spend and fair, inclusive growth (often defined in the literature as growth in economic output and reduced inequality). This is likely to be, in part, a consequence of the sheer multiplicity of factors influencing economic outcomes, not limited to governance or finance arrangements, as well as path dependency, policy efficacy and practice. What is clear is that the UK is an outlier in the degree to which our system is currently centralised (as set out above) and, despite experimenting with a more devolved relationship between national and local government in England, there is huge scope to go further. Our centralised system of governance and finance, characterised by fragmented funding pots and overt ringfencing, does not provide a stable basis for long term planning and investment. Reform is needed, and a consensus is emerging on the potential for fiscal devolution to mitigate these barriers to strategic decision making and investment, and hence spur growth and reduce regional inequality in the UK.

Nevertheless, the empirical evidence from other countries is not always clear cut. While some studies show positive effects on growth, many others find no significant effects. This is also true for reducing inequality – indeed some studies suggest that fiscal devolution can increase spatial inequalities. In its extensive volume on devolution and inclusive growth, the OECD summarises that much of the success of fiscal devolution depends on the country in question, the quality of its institutions and the internal political economy constraints.[10] Also focusing on the strength of local institutions in Europe, Economists Rodríguez-Pose and Muštra find the quality of local and regional government is a critical factor in determining fiscal devolution’s success.[11] In this context, quality is measured based on citizens’ perceptions and experiences of corruption, quality and impartiality in health, education and policing in their region of residence. However, it is difficult to know the relevance of this measure to a country like the UK where the provision of health and education is almost entirely determined by national government, not local.

A recent paper from the Institute for Government (IfG) elaborates further on the absence of clear-cut evidence on fiscal devolution and growth. They argue that most studies only look at the overall level of fiscal devolution in terms of shares of government spending or taxation at local level, but this is too broad to provide meaningful and conclusive results. Their central argument is that different policy areas are likely to be more amenable to devolution than others.[12] So rather than advocating for more devolution as a whole, it is important to explore which tier of government is best placed to deliver specific policy goals and consider the best funding and financing regimes to support these.

In light of the above context, it is helpful to set out the theoretical arguments for and against the devolution of more economic policy levers. While many focus on the benefits – typically better local knowledge and giving areas a share in the proceeds of growth – there are also potential costs, such as risking greater inequalities between places and increased harmful competition. The IfG’s paper helpfully sets out some pros and cons of devolving more economic levers and using this framework they argue that the benefits of devolution outweigh the costs in several key policy areas: skills, transport, employment support and some latter stage Research and Development. But even for these policy areas, they argue it is essential to think through carefully the correct tier of government to whom to devolve. Transport, for instance, requires pan-regional bodies alongside combined and local authorities, since some routes and networks span a wide geography.

The devolution of economic levers alone can also only go so far in achieving fair inclusive growth. CPP has previously identified health as a leading indicator of inclusive growth in the UK and the integration of social policy areas like health with economic development strategies is a core component of the work undertaken by the members of our Inclusive Growth Network.[13] Therefore, while the devolution of fiscal powers is important, it does not by itself ensure greater integration within or between local public services.

The benefits and costs of devolution of economic policy levers

Source: Institute for Government: How can devolution deliver regional growth in England? [14]

International case studies of devolution

While the international evidence on the success of devolution is mixed, there are notable European success stories, which – while each have their own institutional and political histories – offer insights applicable to the UK. Germany, which had high levels of spatial inequality at the point of reunification is often used as a critical reference point, while the Nordic countries are also relevant with their high levels of devolution and high standards of living. However, it is important to remember that the emphasis on devolution in these case studies often masks the substantial levels of national redistribution taking place even within highly devolved economies, and again with mixed evidence of success where it comes to fair growth.

The centrally planned heavy industry of the former East German city of Leipzig, for example, was largely incompatible with the advanced West German economy following the reunification of Germany. Around 90% of jobs vanished in the city in the six years that followed reunification.[15] But in the second half of the 1990s, Leipzig developed a long-term strategy for economic renewal based around five ‘future industries’ – automotive, healthcare, energy, logistics, and the creative industries. It used federal funding from the Länd (regional government) for large-scale investment in public infrastructure, business support services and employment support for former heavy industry workers, targeting major additional investment to support the development of parts of the city most heavily impacted by reunification.[16] German reunification also saw smaller town and rural areas in East Germany receive disproportionately higher rates of investment from their Länder’s, that was viewed as essential to converging East Germany with West and establishing a greater degree of economic harmony across the whole of the new German state.[17]

Each Länd is guaranteed a minimum level of finance to reach a basic standard of expenditure and public services everywhere, redistributing a portion of VAT shares to Länder with below average revenue, and providing supplementary grants to Länder with limited fiscal capacity.[18] Each Länd is also free to retain a proportion of locally raised taxes, such as income tax and VAT, meaning that with the cost of funding essential public services guaranteed, they are free to use their remaining revenue to support the development of the local economy.

Many other economically successful countries are highly devolved. But again, they mix high degrees of fiscal devolution with strong mechanisms for compensating poorer parts of the country that have structurally smaller tax bases. For instance in Denmark, municipalities receive 70% of their income from local taxes, but an annual review of municipal revenue and spending requirements is used to provide additional grants to areas with an identified structural deficit in their revenue base.[19]

Swedish devolution also reveals both costs and benefits. Municipalities gather 81% of their funds themselves and between them they handle: civil defence, cleaning and waste management, emergency services, environmental and health protection, housing, libraries, all education policy up to post-secondary, planning and construction issues, social care for elderly and disabled people, water and sewerage, budgets and tax rates, economic operations, health care, regional growth, allocation of EU Structural Funds, and public transport.[20] On the one hand, Sweden shows that a healthy social democratic country with high levels of equity can accommodate high levels of devolution. But some forms of devolution have come at a cost – an OECD report on devolution of education in Sweden in the 1990s found that municipalities struggled to cope with average student performance deteriorating while inequality in outcomes (measured through PISA rankings) rose.[21] The report blamed a lack of capacity in local government, which was not used to having education powers, combined with limited central government levers to improve things locally.[22]

What does this imply for UK devolution?

A key takeaway from these examples is that for fiscal devolution to contribute towards fairer, broad-based economic growth, then poorer areas will need higher levels of public investment in order to kickstart (and likely maintain) their development. Fiscal transfers between richer and poorer areas will inevitably need to continue, and potentially increase in the short-term, to ensure that public service needs are met in areas with structurally weaker local tax bases. Local government capacity to take on new powers is often neglected in public debates about the benefits of devolution – but clearly, local government needs to have the necessary bureaucratic infrastructure in place in order to take on new powers and make a genuine success of them. Where central government has sometimes recognised this, and the maturation of combined authorities has started to bolster the quality of strategic leadership in certain places, there has not yet been a purposeful and systemic drive to rebuild capacity in the local government sector.

Within a UK context, where local government finance has been hollowed out to such an extent that some places now struggle to fund statutory services such as waste collection and social care, there are serious questions about the capacity for many places to take on tax raising powers in the short to medium term. It might also have to be the case that those places which depend wholly – or predominately – on locally raised revenues, are of a minimum economic scale. Given the existing level of spatial inequality in the UK, wholesale devolution of taxation could otherwise risk further entrenching inequality as poorer areas struggle to maintain spending with much smaller tax bases than more affluent ones. For these reasons, the evidence suggests the UK’s current starting point requires gradual and incremental devolution of fiscal powers, combined with a concerted effort to rebuild the capacity of local government so that it can play an increasingly concerted, strategic role in integrated public service delivery and inclusive economic development.

Where could the UK go from here?

There are several options for growing the institutional capacity of local government and enhancing its ability to deliver long term fair growth. First, before we get to devolution of tax raising powers, it is possible to introduce multi-year financial settlements for local governments now, quickly giving places greater certainty over future revenue streams and enabling longer-term economic planning[23]. Giving local governments greater powers to pool existing budget sources could also have a similar effect. To this end, the current government has recently announced it is piloting a new scheme that will allow ten local authorities to pool three existing local growth funds. This is welcome but government could go further, faster given the relatively small sized funds involved, the potential immediate benefits and the limited downside risk.

Another step is to continue expanding on deeper devolution settlements for more places. Through the ongoing extension of the combined authority model, England is starting to build institutional capacity for regional governance to support growth. The new ‘trailblazer’ deals for Greater Manchester and the West Midlands, are clearly the standout examples but beyond them, three areas – Hull and East Riding, Greater Lincolnshire, and Hampshire and the Solent – are seeking a mayoral deal, while the current North of Tyne Combined Authority is due to be expanded to become the North East Combined Authority.[24] Eight further areas, including Lancashire, Cornwall, Surrey, and Buckinghamshire, are currently seeking non-mayoral devolution deals which will see a further deepening of local powers in these areas, but without a directly elected mayor.[25] Capitalising on this momentum to align administrative boundaries with functional economic areas will be a critical feature of the devolution agenda whoever forms the next government.

With clear boundaries and increasingly effective governance and leadership arrangements, a first potential step – and one advocated over the decade since the beginning of England’s devolution story – is for places to have the power to raise additional tax-based revenues, over and above current sources of revenue and capital investment, e.g. a hotel or tourism tax. Other options might include: retaining a proportion of locally generated Value Added Tax (VAT), a separate local income tax, and/or the (much touted) wholesale reform of council tax and business rates. Again, there are economic and political pros and cons to all these options, such as: technical concerns about the design of new (relatively regressive or progressive) local taxes; economic concerns, including tax competition between places; and political concerns over the impact at the ballot box. Yet each of these fiscal devolution options present opportunities to increase resources available for investment in fair local growth.

Better targeting of central government funds to local areas could be another step towards supporting fair growth. Hollowing out local government finances in the poorest places is arguably the antithesis of a public policy approach geared towards growth from the bottom up – but that’s exactly what happened from 2010-2019. Centrally allocated local government finance should be based on need, not on which place can prepare the best bid. This means rigorous deprivation targeting via the local government finance settlement and through additional (ideally streamlined) pots of funding. As the IfG recently showed, since 2020/21 more deprived places have seen a greater increase in spending power (Figure 2). This has been driven by two new local government finance settlements which have focused on giving poorer areas greater uplifts, yet these changes to funding allocations are not set for the medium to long term. One powerful policy option is for central government to set a long-term formula for allocating funding based on deprivation indices (i.e. the Indices of Multiple Deprivation).[26]

The trade-off here is that by giving central government a greater role in redistributing resources to areas, places are less able to share in the proceeds of success as any additional growth-based tax revenues go back to the Exchequer. This may, theoretically at least, reduce local incentives to pursue growth enhancing policies and undermine their capacity to make appropriate, timely and independent investment decisions that could be growth-enhancing over the long term. However, the flip side is a system in which relying on locally raised taxes would drive up inequalities – at least initially – due to colossal difference in the current tax base between local economies. There is a middle ground and there are ways for the UK to edge away from our current position at the extreme, centralised end of the spectrum, but the risks and trade-offs would need to be managed. How the public view the trade-off between redistribution between areas and places having a stake in local growth is a key issue CPP will explore with our citizen’s jury and report more fully in the autumn.