1. Government
January 14, 2016

George Osborne isn’t just devolving business rates to local authorities – he’s also devolving risk

By Kevin Muldoon-Smith

In 2013, chancellor George Osborne declared that government is determined to repatriate business rates (a tax levied on business property) to local areas. No more should proud cities be forced to come to national government with a begging bowl on a yearly basis for financial handouts.

The original “Business Rate Retention” scheme gave local authorities the potential to retain 50 per cent of business rate income. It also offered them up to 50 per cent any of growth in business rates revenue, a measure synonymous with construction of new employment (commercial and industrial) floorspace. The remainder was returned to Central Government and redistributed throughout England.

At the 2015 Conservative Party Conference, the chancellor extended this scheme: the 50 per cent principle became 100 per cent. That means that local authorities will now be able to retain and exploit 100 per cent of local business rates income.

Considered in tandem with “growth deals”, “city deals” and more recent “devolution deals” (agreed between Whitehall and local levels of government), these changes signal the biggest decentralisation of financial power in living memory. Increasingly, towns and cities will be expected to stand on their own two feet: they’ll fund their own public services and local economic development strategies through the proceeds of local business rate growth.

This type of local public administration model has been a common feature in North America for decades. In recent, years Rachel Weber has dissected the Tax Increment Finance Model in Chicago; while Harvey Molotch put forward the theory of the “local growth machine” in the 1970’s. But until the recent announcements, the English method of funding public administration had been one of the most centralised in the world.

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). However, what seems certain is that change is around the corner. A new relationship between urban economic development, public finance and real estate is upon us: local authorities are to mortgage the present on the future performance of local property markets through a new kind of civic financialisation.

So, what do these changes actually mean for local authorities and the towns and cities that they represent?

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Any location that does not have the space to accommodate new construction will be at a disadvantage

Upon closer examination, the gap between the rhetoric and reality of the announcement exposes major iniquities in the future funding of public services. Local authorities are only really able to benefit from Business Rate retention via the construction of new property. This is because the value of existing property – and any increase over time – is removed from the local finance calculation.

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.

Osborne 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. Yet, 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.

Surprisingly, the recent announcements have largely ignored the issue of empty property rates. Under business rate retention, the higher rate of empty property liability means that local authorities are not rewarded with any additional income for attracting new businesses into existing vacant premises (small businesses pay a lower rate of business rate taxation).

This failure to take account of empty property rates is a missed opportunity. If government abolished this charge – or if local authorities had the power to alter the rate – local authorities would be incentivised to promote indigenous economic growth: they’d be rewarded for creating conditions whereby vacant space is reoccupied, rather than (as in the current situation) getting penalised. This would provide a welcome boost to small businesses and the managed work space sector that supports this new economy.

There hasn’t been any additional finance given to local authorities, only its potential

So far, the criticisms of this new model of urban finance has focused on the need for equalisation between those locations that can benefit under the new proposals and those that will be worse off. However, the greater concern is one of financial uncertainty: 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. This is a concern for those local authorities with modest business rate portfolios, but also the more affluent core cities and central areas of London.

Under the current system, certainty is not possible. Although central government has transferred 100 per cent of existing business rates and potential growth to local areas, they have also transferred 100 per cent of the risk. And 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). In the current scheme, they are only liable for 50 per cent of this liability; after 2020 it will be 100 per cent.

Many local authorities already find that the cost of successful backdated appeals more than outweighs the proceeds of any growth. The new proposals in their current format will only make this issue worse.

Kevin Muldoon-Smith is an associate lecturer, and Paul Greenhalgh a reader in property economics, in the Department of Architecture & Built Environment at Northumbria University.

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