COUNCIL TAX REFORM

Local Government minister Nick Raynsford, revealed that council tax could be scrapped and replaced with a local income tax which could hit middle-class families hard but significantly reduce bills for low-income households. The town hall funding system could probably not be reformed before 2006, but the government could fight the next election on a commitment to abolish council tax. The move would also mean Labour adopting a flagship Liberal Democrat policy. The idea emerged after a Whitehall review of local government finance discovered deep hostility to the council tax among people who thought it was too high and should be reformed.

Several options will be examined by ministers, including introducing a local income tax, reforming business rates and a complete overhaul of council tax. Under the Liberal Democrat proposal, local income tax would be administered by the Inland Revenue at an estimated rate of 3.5p in the pound. The party reckons households with an annual income below £39,000 would be better off while those above that would pay more. Central government block grants would be phased out eventually, but a "safety net" system would ensure disparities between wealthier and poorer parts of the country are evened out.

The party says it will be able to make large savings in administration costs by the move, because 4% of council tax revenue went on bureaucracy alone, compared with 1% of income tax. Edward Davey, Liberal Democrat local government spokesman, called for Labour to announce the end of the council tax immediately saying, "Labour inherited this unfair tax from the Conservatives, so what is stopping ministers addressing the council tax problem directly? Council tax is now so unfair to millions of pensioners, and people on low incomes, that it must be scrapped."

Children who inherit large sums from the sale of the family home when their parents die could also receive their parents' backdated council tax bill. Stephen Byers said, "A deferred-payment scheme would provide all pensioner owner-occupiers with a choice - either to pay the tax as it falls due or to defer payment until the family home is sold ... Such a scheme is simple, not means-tested and uses the value of the home as security for the tax liability." Ministers are worried by the increasing number of pensioners who struggle to pay their council tax bills. More than a million have failed to claim the council tax benefit to which they are entitled.

There have already been widespread protests over this year's proposed council tax rises, but the problem could become far worse in 2007, when the next nationwide property valuation is due. The local government minister, Nick Raynsford, has threatened to force councils to cut spending rather than allow excessive tax increases. Mr Byers's suggestion is modelled on the deferred payments scheme operated by local councils for elderly people who go into residential care homes. The patient is given free residential care for life in return for signing an agreement for the bill to be paid retrospectively from the sale of the family home.

Mr Byers wants the Treasury to lend the money to pay the council tax bills of "asset-rich, income-poor" pensioners. The loan would be repaid when the properties are sold. The idea has yet to be agreed by Gordon Brown. The Deputy Prime Minister, John Prescott, who is in charge of local government, may also think that there are better ways he could use any extra Treasury money. Some heirs may also object to having to settle council tax bills out of what they regard as their rightful inheritance, but the proposal is in tune with Tony Blair's interest in exploring new ways of financing public services, other than through direct taxes.