While the reform is aimed at “increasing the incentives councils have to grow [revenue] and their local economies...it also risks growing divergences between the funding available to different councils”.
Spending Needs, Tax Revenue Capacity and the Business Rates Retention Scheme, released yesterday, also said if 100% retention were applied generally councils that saw the highest increases in revenues would not necessarily be those with the greatest increase in their relative spending needs.
“This implies that central and local government face a difficult trade off when moving to 75% or 100% rates retention,” the report noted.
“More frequent and fuller periodic redistributions of revenues could limit the scale of funding divergences.
“But they would also dampen the incentives for councils to grow revenues and tackle spending needs.”
Under government plans, the share of business rates kept by English councils will rise from 50% to 75% in 2020, and in some places 100% retention is being piloted.
The report said it was also unclear whether the underlying assumption was correct that retaining business rate income would give councils an incentive to foster growth.
It said: “The report finds no relationship between changes in the councils' business rates tax bases and local economic growth, or indeed employment or earnings growth, in recent years.”
IFS associate director David Phillips said: “The lack of relationship between changes in business rates and economic and employment growth is important.
“Areas seeing lots of new developments aren't guaranteed strong economic growth. And growth doesn't necessarily rely on large-scale property development.”
Incentives provided by business rates retention could be useful, Phillips said, but if the government wanted to encourage councils to take a more active role in promoting growth, “other incentives could play a useful role [including] allowing councils to retain part of other taxes such as income tax."
Claire Kober, chair of the Local Government Association's resources board, said: “Councils must be allowed to use retained business rates income to plug the expected £5bn funding gap that would arise by 2020.
She added: “A fairer system of distributing funding between councils is urgently needed and this distribution mechanism, along with the way the new system of business rates retention is set up, should take into account issues such as those identified in the IFS report.
“No council should see its funding reduce as a result of this new system. Councils must be rewarded for growing their local economies but areas less able to generate business rates income need to remain protected.”
The report was funded by the Local Government Finance and Devolution Consortium, whose backers include CIPFA.
Neil Amin-Smith of the IFS has written a blog for PF based on the report.
