Since 2013, the business rates retention scheme has let local authorities retain 50% of the tax they collect on commercial properties like shops, offices and factories. In 2015, the Government went further and announced plans to pass 100% of business rate revenue to local authorities within this Parliament. The Government hopes that ‘the rates retention scheme will provide a strong incentive for local authorities to promote growth’.

The debate so far has adopted the assumption that business rate retention provides councils with an incentive to grow their local economies, but our recent research suggests that for many councils the incentive is elusive.

High-growth economies may not benefit from rate retention

Rate retention rewards local authorities for growing the business rates income they collect. Rateable values determine the business rates payable by businesses. Local authorities benefit when new commercial property is built, or when enhancements and/or change of use make existing properties more valuable. But they’re not allowed to gain or lose when ‘revaluations’ update local rateable values to reflect current prices in the rental market for these properties (see our paper on the Local Government Finance Bill 2016-17 for more on this). There are no revaluations in the period we look at here.

It might be expected that areas with strong economic growth would benefit more from rate retention. But in areas with growing economies, total rateable value doesn’t necessarily rise. Many authorities have experienced high growth in Gross Value Added (GVA) – a measure of economic output – since 2009 but have seen their rateable value decline over this period.

Authorities with high GVA growth but falling rateable value

Looking at all authorities, we found no relationship between local economic growth and growth in rateable value:

The absence of a link between local economic growth and growth in rateable value blurs the financial incentive for local authorities to drive local economic growth.

As said before, what causes rateable value to go up is the construction of new commercial properties or the expansion of existing ones. But in urban economies, GVA increases may be driven by businesses with relatively low property requirements in sectors such as technology or finance.

In fact, the highest percentage rates of growth in rateable value since 2012 have taken place in more rural authorities; and rateable value has actually fallen in the most urban authorities since 2012.

Wider economic trends can have a large impact on rateable values

Rateable values can be subject to wider economic forces that local authorities can’t generate or control. An individual authority will struggle to counteract adverse trends that lead to falls in rateable value, and thus rate revenue. Analysis of England-wide data on changes in rateable values by category between 2010 and 2016 reveals:

 – There has been a large decline in the rateable value of the ‘financial and professional services’ sector, which could indicate that the sector needs less floor space. This could reflect bank branch closures and a rise in online banking.

 – There has been no rateable value growth in the ‘offices’ category, at a time of high labour force growth. This could indicate that office space is being used more efficiently (working from home, hotdesking, etc). It may also reflect the large increase in the number of self-employed, who require little or no commercial office space.

 – High street shops have registered a decline in rateable value, alongside a large rise in the rateable value for hypermarkets and superstores. There is no reason to suppose that new superstores are located in the same authority as the high street shops they might in part replace. So the business rates income from many high-street shops in different authorities is replaced by one large superstore paying high rates to one authority.

 – The decline in smaller stores is also accompanied by a rise in ‘warehouses’ – perhaps related to the rise of online retailing. The total rateable value of ‘large distribution warehouses’ rose by 16.1% between 2010 and 2016.

 – The ‘industrial’ sector registered a -2.8% decline in rateable value – £263m in absolute terms.

For example, Redcar and Cleveland Council are losing £10.4 million per year as a result of the closure of SSI Steelworks in October 2015. This type of large swing in revenue could easily outweigh any changes driven by a council’s policy.

Features of the system have a critical effect on outcomes – and are outside the control of local authorities

The UK Government will continue to make decisions on business rate reliefs, revaluation of properties, and full retention of rates in certain sectors. These powers will have a strong influence on some individual councils’ revenue levels.

For example, since 2012 Selby District Council has lost £1.2 million of rate revenue per year due to the revaluation downwards of Eggborough Power Station. But it’s also gained £5.37 million per year from the decision to use biomass at Drax Power Station (this was defined as renewable energy, thus 100% of business rates were retained locally).

A broader view of local government funding

A growing local economy has a range of benefits for local authorities. However, as things stand local authorities won’t necessarily find that it provides them with more rate revenue to spend.

Local authorities have faced large reductions in central grants in recent years. Some of them will be able to offset this to some extent by driving up rate revenue. But there is no guarantee that a growing local economy will bring financial health to a local authority. And a link between gains in rate revenue and spending pressures is even less likely. Other funding mechanisms, balancing needs with incentives, may continue to be required.

Note: This blog was based on research that was published in the August 2017 edition of the journal Local Economy (32:5, pp. 399-419): see Growing pains: Property taxation and revenue incentives in English local government.

Picture credit: Newington High Street 8 by Alan Denney Creative Commons Attribution Non-Commercial (CC-BY-NC-SA 2.0)