Growth and Liability: Securing Public Sector Service Delivery In the 21st Century

The Chancellor's announcement on the 5th of October at the Conservative Party Conference in relation to business rate devolution took many by surprise and has since received considerable attention in the press over the last few weeks. This was then followed by John Swinney announcing at the SNP conference that local authorities in Scotland would also be given the power to cut business rates by the end of October 2015. The Chancellor of the Exchequer, has proclaimed that, no longer will local authorities, and the local areas they represent, have to march to Central Government with a begging bowl for handouts. Two dichotomous trends are prevalent in recent commentaries. The first is positive; some local authorities and pressure groups have generally welcomed the announcement as an opportunity for local authorities to stand on their own two feet and exploit their local wealth. The second is more circumspect, concerning the potential impact of the 2020 changes, in relation to equality between areas and the potential race to the bottom following the announcement that local authorities will be able to reduce the business rate multiplier at the local level.

The reality of the situation is currently difficult to fathom ahead of the impending Public Spending Review. However, what is positive is the exposure that this traditionally esoteric issue has received in recent weeks and the opportunity for debate that has been revealed. This debate, and the overall uncertainty, raises multiple concerns in relation to the long term security of public sector service delivery in England. Primarily, how will authorities securitize public sector service delivery through the performance of local property markets? This is especially prominent in relation to the announcement by the Local Government Association that a dozen local authorities are on the brink of financial failure. The remainder of this article is structured around a series of critical questions that probe the uncertainties and ambiguities in the recent announcements in relation of Business Rates and Business Rate Retention.

100% of what?

The original Business Rate Retention Scheme (BRRS) gave local authorities the potential to retain 50% of business rate income and up to 50% any of growth in business rates revenue from new assessments added to the rating list, 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%. Local authorities will now be able to retain and exploit 100% of local business rates income but what does this actually mean? The consequence is that some locations will be net winners and some will be net losers. However, there still appears to still be an element of equalisation in the scheme as the top up and tariff mechanism will remain active. In other words it will still be growth above a baseline that will be important at the local level.

What type of growth?

The Chancellor's announcement would appear to suggest that local authorities now have the potential to retain all growth in the value of local business rates. However, upon closer examination the reality is that local authorities will only be able to retain growth associated with the addition of net new floorspace or new assessments added to the rating list. 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 (see Muldoon-Smith and Greenhalgh 2015). In other words it is only possible to create business rate growth through the construction of new business properties, any increase in the value of existing business stock is precluded.

It is important to note that the Uniform Business Rate has not been abolished; it will still exist (although it may be called something else). All that has changed is the ability for local authorities to lower this rate at the local level if they so wish. It seems likely that the national rate will still operate in the same fashion following national revaluation. 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. Therefore there are question in relation to what type of local growth is getting the boost, economic growth, new jobs or new property development? If the latter, there is the risk of displacing existing businesses from older properties if new floor space development is not matched with a concomitant increase in occupier demand. This may also lead to an increase in rateable value appeals. This is because the value of existing property could be affected in those locations where businesses have vacated (because of blight) and also in new development locations, where the value of older premises decrease as new property is added in to the local property supply (counteracting the windfall of new development).

What are the implications of a reduced local rate of taxation?

The Chancellor has 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, what are the implications for local authority budget setting and planning? Presumably, any reduction in the local business rate will reduce the overall business rate income for a local authority and reduce the ability to fund services. Yes, the influx of new businesses will contribute to the local economy, but how will that contribution be captured and fed back into the funding of public services? Those local authorities already facing budgetary pressures will not countenance a further decrease in local taxation. Presumably, only those authorities with a budget surplus will have sufficient budgetary tolerance. Therefore, it is unlikely that there will be a race to the bottom as local authorities compete for new business.

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 remove small businesses from business rate taxation all together?

What about empty property rates?

Surprisingly the current debate has largely ignored the issue of empty property rates. Currently landlords pay a tax on empty business properties equal to the maximum business rate multiplier, currently set at 0.49p in the £. If local authorities are to have the power to lower the business rate, then they should also be given powers to alter the current level of empty property rate liability. There could even be room to consider removing empty property rate liability altogether in certain locations. In the current system small businesses, those businesses who underpin the new economy, pay business rates in accordance with a smaller business rate multiplier (0.48p in the £), they are more likely to receive discretionary rate relief and are also more likely to either go bust or move quickly to new property if their circumstances change. Under business rate retention, the higher rate of empty property liability means that local authorities are not rewarded with any additional income from attracting new businesses into existing vacant premises. This further reinforces the point that local authorities only benefit from the proceeds of new development. Failure to include empty property rates in the recent announcements is a missed opportunity. If Government abolished empty property rates this would incentivise local authorities 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 safety net

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%. This ensures that there is an element of redistribution in business rate retention. However, there is also an element of closing the stable door after the horse has bolted. Although the safety net is welcomed, what is the point in this redistribution if local businesses have already left an area in a flight to quality towards those locations that have been able to construct new business floorspace? The Netherlands provides an example, in recent decades, of a country that followed an entrepreneurial model of local government finance based on property. Following a period of deregulation, municipal locations pushed through new office space construction without any obvious demand for it. The consequence was a glut of supply which prompted market filtering and displacement as existing occupiers moved into new office space at comparable rents to their previous property, generating eye watering vacancy rates in less resilient locations. In the Netherlands structural vacancy (e.g. business properties without any obvious relationship with demand) is a perennial concern. There is even a specific set of government ordnance measures to deal with this concern. Do the recent announcements indicate a similar trend in England? Perversely, local authorities who have seen a net reduction in business rate income, but not by 7.5%, may welcome more loss to take them over the threshold as they will then receive a windfall from the safety net. These local authorities exist in a stranded limbo, unable to exploit growth and unable to access the safety net.

It is also worth noting that recent commentaries presume that the 7.5% safety net will stay in place in its current state; as yet, there isn't any confirmation of this. The Chancellor's announcement indicates that local authorities will now be able to keep all growth above the baseline position. In the previous scheme this ability was capped and any disproportionate growth was paid to Central Government via a levy. It is this levy that was designed to cash flow the safety net and one off regeneration schemes such as the New Development Deal areas in Newcastle, Sheffield and Nottingham (which exist outside of the national business rate retention scheme). 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, or one of regeneration schemes like New Development Deal areas, will be funded. A mechanism is already in place to fund the existing short fall in safety net payments through the Settlement Funding Assessment. Presumably, this mechanism could be extended, with a top slice of the Settlement Funding Exercise paying for the unfunded safety net facility.

What are the implications of the infrastructure levy?

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. However, 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 (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.

The devolved administrations

So far the emphasis has been on local authorities in England and the introduction ahead of 2020. However, John Swinney announced at the SNP conference that all 32 local authorities in Scotland would be given the power to lower the rate of tax on business property on the 31st October 2015 under powers in the Community Empowerment (Scotland) Act passed in June this year. Business rates work differently in Scotland, the rate is set nationally but the proceeds are already retained locally. However, what is different is the time frame for the changes (the end of this month) announced at the SNP conference and the greater detail in relation to the flexibility of the new power. Local authorities in Scotland will be able to lower the rate against local criteria, such as the type of property, its location, occupation and activity. So far, this level of detail has not been released in the English proposals.

What about certainty

Within all of the hyperbole surrounding business rate devolution, 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 Central Government has transferred 100% of existing business rates and potential growth to local areas, they have 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 back-dated 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 this will increase to 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. Without decoupling both empty property rates and the liability for rateable valuation appeals from business rate retention, it will not be possible to derive economic growth from the existing business rate model.

Conclusion

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 (Scotland is moving ahead even quicker). As ever, the devil will be in the detail, however, what seems certain is that change is around the corner in England (and the devolved administrations) 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 on-going security and resilience of public sector service provision in the 21st Century. Paramount in this concern will be securing, harnessing and exploiting the power of urban data. In recent years R3 Intelligence has developed a hybrid, multi-criteria urban property information model for all locations in the UK, which has the underlying ability to monitor, manage and plan business rate retention activity. The resource utilises existing and new forms of data to provide baseline monitoring and future scenario modelling in order to plan the urban finance, property market and public service interrelation.

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