Here’s how Andy Burnham’s devolution revolution could drive growth

Could the devolution of tax and spending powers be the key to unlocking greater economic prosperity? Andy Burnham thinks so. He argued in a speech last week that “the stark imbalance in resources between national government and local government is holding back growth”. He promised the “biggest rebalancing of power our country has seen” to deliver “good growth in every postcode”.

The fact he framed it this way is significant, because many arguments for more devolution have nothing to do with economic growth. JP Spencer, director of devolution policy at ThinkLabour and adviser to the Burnham camp, argued last week that English mayors should have greater control of services such as childcare, further education and policing, in order to inject greater democratic accountability into public services. A laudable objective – but it’s not about growth.

Another argument is that handing more control of spending to local leaders could allow for policies better tailored to their environment, informed by local insights, relationships and experiences. With more skin in the game, local governments may even be encouraged to spend more wisely than they would if simply following diktats from Whitehall. Sounds great – but, again, it’s not really about growth.

Instead, if the new government is serious about using devolution as a growth policy, it should be focused on the tax side. And it should be aware that this is far from a slam dunk. The international evidence is decidedly mixed. But an OECD review of the evidence concluded that greater devolution of tax revenues has a “broadly positive” relationship with growth, whereas spending devolution has much weaker effects. Given the UK’s dire economic performance of late, “broadly positive” effects aren’t to be sniffed at.

The UK is the least fiscally devolved country in the G7. Just 5% of UK tax revenues are collected by local government, compared with 14% in France and more than 20% in Japan. Relatedly, local governments are unusually reliant on grants from central government for their funding.

Rather helpfully for a new prime minister looking to change this, the ball is already rolling. Rachel Reeves announced in her Mais lecture in March that a “roadmap” for future fiscal devolution would be published this autumn. But what’s to be the destination?

The most common growth-related argument for tax devolution is based around incentives. If local leaders are directly allocated a share of local tax revenues, they share in the upside when their area outperforms. The financial reward for economic success gives an incentive to pursue growth-friendly policies. Equally, decisions that harm growth are punished.

One option, hinted at in the Mais lecture, would be for English mayors to retain a portion of the income tax generated in their area. Anthony Breach and Oscar Selby at the Centre for Cities thinktank estimate that allowing the Liverpool City region to keep 6% of local income tax revenue would be enough to fully replace the grant it currently receives from central government. For the West Midlands and Greater Manchester, the equivalent figure is 4%; for West Yorkshire and Greater London, it’s just 2%.

If a mayor does the hard yards to boost economic activity – by improving transport links, courting international investment or encouraging housebuilding, say – they’d get to keep some of the resulting uplift in tax receipts, which could then be ploughed into the next round of growth-friendly policies.

This is a compelling argument, but there’s an important catch. Governments generally try to avoid “postcode lotteries”, by taking measures to equalise funding across regions. Indeed, Burnham talked in his speech about his desire to “strive for equivalent living conditions in all parts of Britain”. If areas that succeed economically are rewarded with more funding, and areas that struggle receive less, that’s a recipe for growing inequality between places.

The government could try to soften this by siphoning off some of the uplift in taxes when an area is growing strongly, in order to transfer funds to struggling areas in need of support. But that blunts the incentive for regional leaders to pursue growth in the first place. Similarly, regular “resets” of the system, to take account of areas’ changing circumstances, would reduce the incentive to grow. This tension would need to be carefully managed.

Going down this route would raise other thorny policy questions. To take just one: what happens in a recession, when tax revenues fall everywhere due to no fault of the mayors? Are they expected to cut back? Is the Treasury expected to step in with additional support? If so, does that mean the Treasury takes a portion of revenue growth in the good times, to pay for support in the bad? Doesn’t that further dull growth incentives? It gets very complicated, very quickly – yet countries such as Germany and Poland have shown it can be done.

An alternative view is that tax devolution is important less because it improves local incentives and more because local tax revenues provide greater certainty. The idea is that local leaders will be able to borrow against future tax receipts to finance long-term investment in local infrastructure – which, all being well, will itself generate additional tax revenues. Andy Haldane, also reported to be advising Burnham, previously made this case in The Observer.

“For the big cities, this could be a big deal,” said Thomas Pope from the Institute for Government. But for it to happen at scale would require not just tax sharing, but also greater borrowing flexibility for mayors and mayoral development corporations – and perhaps a change to the fiscal rules, which currently constrain such borrowing. The Treasury, which would be acting as the ultimate financial backstop when things go wrong, will no doubt have views about that.

Burnham wants to rewire the British state. There’s a good case for doing so. But like an electrician rewiring a house, he’d be wise to proceed carefully, one circuit at a time, testing as he goes, rather than rip out everything all at once. Otherwise he risks a nasty shock.

Photograph by Alastair Grant/AP