In order to finance their expenditure, governments need to raise taxes. There are a number of considerations which ought to be made before deciding to introduce a new tax.

Adam Smith put forward four ‘canons’ or principles of taxation. He argued that a good tax was one which had four characteristics. Smith said that the cost of collection should be low relative to the yield of the tax. He also said that timing of collection and the amount to be paid should be clear and certain to all parties concerned. The means of payment and the timing of payment should also be convenient to the taxpayer. Smith also said that taxpayers should pay taxes according to their ability to pay.

Economists today have argued that in addition to Adam Smith’s precepts, a good tax should be one which leads to the least loss of efficiency, or even increases in economic efficiency. Taxes should not interfere with the workings of free markets, where there are no market imperfections. In particular, high taxation should not discourage workers from working or entrepreneurs from taking risks. A good tax should also be compatible with foreign tax systems, and in the case of the UK, particularly with EU tax regimes, to facilitate world economic co-operation and prevent tax evasion by international companies. A good tax should, in addition, automatically adjust to changes in the price level, which is especially important in a high inflation economy. No tax possesses all of these qualities. In practice, many taxes possess all too few of these characteristics.

Before introducing a new tax, it would also be appropriate to consider the allocative effects that it would have. Taxes can have an important effect on the allocation of resources within an economy. Income taxes raise the cost of earning money and therefore may reduce workers’ willingness to work. Income and profit taxes are likely to discourage entrepreneurial activity. The incidence of taxation is another important consideration. The incidence of a tax measures the final tax burden on different people. Furthermore, indirect taxes are likely to discourage consumption of particular goods and services, and this may be desirable if there is evidence of market failure, though likely to lead to misallocation of resources where there is no market failure.

Local government expenditure must be financed by taxation. Some of these taxes will be local, but some will come from central government revenue raised through the national tax system.

Local authorities could consider using a local rate of income tax as a source of revenue. One of the advantages of a local income tax is that it would be progressive, and would hence tax people by their ability to pay. This would mean that there would be no need for a system of rebates because those who could not afford to pay would not be taxed in the first place as there would be tax allowances.

The amount collected each year would rise automatically, as incomes rise. It would automatically adjust to changes in the price level.

There are also a number of disadvantages associated with a local income tax. It would add to the burden of the workforce, and could therefore act as disincentive to work and to entrepreneurship. Furthermore, different rates of local income tax in different areas could result in migration.

A local income tax would cast a narrow tax net. There would be only a small tax base. Not everyone would pay, even though everyone would be benefiting from the same local services that would be provided by the local authority. There are 35 million voters in England, and only 20 million of these would have to pay income tax.

An alternative way for local government to raise revenue would be to levy a property tax. The administration costs of a local property tax would be low. There would also be no overlap problems with neighbouring areas, and problems with migration as with local income tax. Property tax is difficult to evade and therefore it is easy to enforce.

To some extent, property tax relates to peoples’ ability to pay. This is because the rich tend to live in more valuable homes than the poor. The amount of tax paid is determined by the value of the property. However, as property values do not relate directly to peoples’ earnings there is not a disincentive effect. Furthermore, a property tax could encourage efficient use of living space. People would be encouraged to make full use of the space available in their property. A property tax could also be considered as a new tax in the sense that it would be a tax upon something that has not yet got a tax on it.

There are a number of disadvantages of property tax that would need to be considered. One of the less desirable attributes of a property tax is that it tends to be regressive because the rich do not spend as great a proportion of their income on their homes as the poor do. A property tax would also not identify any link between taxation and spending, and would not, therefore, encourage saving.

There are a number of ways in which local authorities can raise revenue. All taxes have their own relative merits and weaknesses.