A new collection of nine studies published by the OECD examine the link between fiscal decentralisation, inequality and inclusive growth. Chapter 7, by researchers from the Institute for Fiscal Studies, examines how the design of sub-national finance systems can affect the degree of inequality in financial resources between different sub-national governmental units, using English local government as a case study.
For revenues, sub-national governments rely on a mix of grants from central government; locally-raised taxes; and locally-raised user fees and charges. It is not only the balance of these sources, but also the rules around tax and fee policy and fiscal equalisation that affect funding outcomes and the fiscal incentives faced by subnational governments. We use an ongoing shift in England’s local government finance system from equalising grants to a greater reliance on local tax revenues, aimed at incentivising growth, as a case study of the trade-offs between equalisation and incentives inherent in sub-national finance. In particular using data from 2006–07 to 2013–14, we show the significant fiscal disparities between local government units in England, and the factors that correlate with the size and changes in these disparities over time. We model proposed reforms to England’s local government finance system and show that even if revenues are initially fully equalised relative to assessed spending needs, significant fiscal disparities can re-emerge in just a few years. However, the scale of these balances depends significantly on specific design choices such as marginal equalisation for those units seeing the largest shortfalls in revenue, and revenue sharing in areas with two-tier local government.