Making sense of the business rates conundrum

George Osborne’s plans for business rates devolution have so far thrown up more questions than answers, says Kevin Muldoon-Smith

The chancellor’s announcement on business rate devolution at the Conservative Party Conference took many by surprise and has received considerable attention in the press over the last few weeks.

What it all means is currently difficult to fathom ahead of the impending spending review. However, what is positive is it’s given exposure to what is traditionally an esoteric issue and has opened up opportunity for debate.

The original business rate retention scheme (BRRS) gave local authorities the potential to retain 50% of business rate income and up to half any of growth in business rates revenue from new assessments added to the rating list, synonymous with construction of new employment. The remainder was returned to central government and redistributed in England in a similar way to the previous formula grant method of funding.

The chancellor’s recent announcement has extended the 50% principle to 100%. Local authorities will now be able to retain and exploit 100% of local business rates income. But what does this actually mean?

The fine print – who really benefits?
Upon closer examination the reality is that local authorities will only be able to retain growth associated with the addition of net new floorspace. Any increase in the value of existing floorspace over time (traditionally captured by the national rateable valuation exercise) will still be stripped out of business rate income. In other words, it is only possible to create business rate growth through the construction of new properties and any increase in the value of existing business stock is precluded. This means that any location that does not have the space to accommodate new construction, or does not have the underlying rental values to support new development, will be at a disadvantage. It raises questions around what type of local growth is getting the boost – economic growth, new jobs or new property development?

The chancellor has also suggested that local authorities will now have the power to lower business rates in order to attract new businesses. This is potentially a positive development. However, it is important to note that the uniform business rate has not been abolished; it will still exist. All that has changed is the ability for local authorities to lower this rate at the local level if they so wish. It is difficult to imagine local authorities already facing budgetary pressures agreeing to further decreases in local taxation. Presumably, only those authorities with a budget surplus will have sufficient budgetary tolerance.

Freedoms and incentives
Also, will councils have the freedom to introduce business rates that vary, e.g. for different types of property, businesses and locations? Will it be possible to remove small businesses from business rate taxation altogether? The Scottish Government announced a degree of simplicity where local authorities will be able to lower the business rate against local criteria. So far, this level of detail has not been released in the English proposals.

Surprisingly, the current debate has largely ignored the issue of empty properties. Under business rate retention, the higher rate of empty property liability means local authorities are not rewarded with any additional income for attracting new businesses into vacant premises. Failure to include empty property rates in the recent announcements is a missed opportunity. If government abolished empty property rates, or if local authorities had the power to alter the rate, this would incentivise councils to promote indigenous economic growth by rewarding them for creating conditions whereby vacant space is reoccupied, rather than the current situation where they get penalised.

The current BRRS has a safety net in place for those local authorities that see a reduction in business rate income by more than 7.5%. It’s expected that this will stay in place in its current state; but as yet, this hasn’t been confirmed. Local authorities will now be able to keep all of the proceeds above their baseline position. In the current scheme this is capped and disproportionate income funds the safety net provision through a levy paid to government. Now that this levy has been abolished – and given that the original levy contribution was not enough to fund the safety net in the first place – it is unclear how the new provision, or regeneration schemes like ‘new development deal’ areas, will be funded. A mechanism is already in place to fund the existing shortfall in safety net payments through the settlement funding assessment; presumably, this mechanism could be extended, with a top slice paying for the unfunded safety net facility.

There are many other areas of uncertainty. How will the new local infrastructure levy work in practice? At first glance it looks like a classic business improvement district (BID), where businesses in a defined area agree to pay an extra level of business rates, after a local ballot, to fund local improvements. Importantly, under a BID, a majority of business in a defined area have to vote in favour of an uplift in property tax. Under the infrastructure levy scheme there isn’t any provision for a local ballot, rather, an elected mayor would only need to secure the agreement from a majority of private sector local enterprise partnership members. This opens up a discussion in relation to the democratisation of fiscal decentralisation, especially in relation to who decides and who pays for new local infrastructure.

Risks and more uncertainty for local government
The fact remains that local authorities can only plan their spending in the medium to long term if they have a degree of certainty in relation to future income. Under the current system this is not possible. Although government has transferred 100% of existing business rates and potential growth to local areas, it has also transferred 100% of the risk. It is worth noting that there hasn’t been any additional finance given to local authorities, only its potential. The issue of risk is particularly important in relation to the rateable value appeal process. Local authorities are liable for the cost of any successful appeal backdated to 2010 (and beyond where historical appeals have not been resolved), three years before the existing BRRS went live in 2013. In the current scheme, they are only liable for 50%; after 2020 it will be 100%. Many local authorities already find that the cost of successful backdated appeals more than outweighs the proceeds of any growth. The new proposals will only make this issue worse.

There is still a great deal of uncertainty in relation to the 2020 business rate changes and what the practical impact will be in local areas up and down England. As ever, the devil will be in the detail. However, what seems certain is that change is around the corner and that local authorities will be expected to fend for themselves. Developing urban models and systems of intelligence that can monitor and help manage and plan these new systems of urban finance will be central to ensuring the ongoing security and resilience of public sector service provision.