Osborne’s business rate devolution is a game-changing move

5 Nov 15

The chancellor’s decision to fully localise business rates signals a shift to a mode of civic entrepreneurialism that will leave local authorities fending for themselves and at the mercy of local property markets.

George Osborne’s announcement to the Conservative Party conference in relation to the full localisation of business rate devolution took many by surprise. The reality of the situation is currently difficult to fathom ahead of the 25 November Spending Review, however, what is positive is the exposure this traditionally esoteric issue has received in recent weeks and the opportunity for debate it presents.

The original Business Rate Retention Scheme (BRRS) was introduced in 2013 and gave local authorities the potential to retain 50% of business rate income and up to 50% any of growth in business rates revenue, synonymous with construction of new employment (commercial and industrial) floorspace. 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%, but what does this actually mean for the planning and management of public sector finance?

Upon closer examination, the gap between the rhetoric and reality of the announcement exposes iniquities in the future funding of public services. Local authorities are only really able to benefit from business rate retention via new additions to the statutory rating list. This is because they already receive empty property rates (notwithstanding the problem of empty property rate avoidance) on existing property, while any relative value uplift on existing property is stripped out during the national revaluation exercise. 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 and face an uncertain future.

The chancellor has also suggested that local authorities will now have the power to lower the rate of business rate taxation 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 to accommodate potential change.

There is also some uncertainty in relation to the flexibility of any reduction in the local business rate level. Will it be uniform at the local level or will local authorities have the ability to adjust taxation for different types of property, businesses and locations? For instance will it be possible to exempt small businesses from business rate taxation altogether, or to vary the level of empty property rates faced by commercial landlords? So far, this level of detail has not been released in the English proposals

Furthermore, the current Business Rate Retention Scheme has a safety net in place for those local authorities that see a reduction in business rate income by more than 7.5%. The recent commentaries presume that the 7.5% safety net will stay in place in its current state but this has yet to be confirmed.

Indeed, the chancellor indicates that local authorities will now be able to keep all of the proceeds above their baseline funding position. In the current scheme this provision is capped and disproportionate income funds the safety net provision through a levy paid to central government – a kind of local public finance quid pro quo. 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 safety net provision will be funded. A mechanism is already in place to fund the existing shortfall in safety net payments through the Settlement Funding Assessment and presumably, this mechanism could be extended, with a top slice of the Settlement Funding Exercise paying for the unfunded safety net facility. However, any additional cost burden on this mechanism will have knock on implications elsewhere in the settlement of local funding.

Moreover, how will the new Local Infrastructure Levy (LIF) 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 businesses in a defined area have to vote in favour of an uplift in property tax. However, under the infrastructure levy 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 (LEP) 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.

So, central government has transferred 100% of existing business rates and potential growth to local areas, yet they have also transferred 100% of the risk in relation to civic finance. It is worth noting that there isn't any new funding in the chancellor's announcement, only the potential for business rate growth and therefore conceivably in some locations 100% of nothing.

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 business rate retention scheme went live in 2013. In the current scheme, they are only liable for 50% of this liability; 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. Without revision, 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. However, what seems certain is that change is around the corner, both in England and in the devolved administrations, and that local authorities will be expected to fend for themselves through a new model of civic financialisation and entrepreneurialism.

It is now likely that local authorities will attempt capital development programmes in order to stimulate business rate growth. Yet certain local authorities are more able to engage in this process than others, while all locations will now be subject to the arbitrary whim and cyclicality of the commercial real estate market.

  • Kevin Muldoon-Smith & Paul Greenhalgh

    Kevin Muldoon-Smith is an associate lecturer in the Department of Architecture and Built Environment at Northumbria University and a consultant at R3Intelligence. He specialises in contemporary methods of urban finance and public sector innovation. Paul Greenhalgh is a reader in property economics in the Department of Architecture and Built Environment at Northumbria University.



     

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