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The devolution of business rates must offer equal rewards to all

The government is currently in between consultations on plans to hand over 100% of business rates revenue to the local government sector in England before the end of the parliament, replacing grants that complement the 50% of revenue that is retained under the present system. Their key aim, among a number of things, is to create ‘incentives to push for local growth’.

These reforms are hugely important. They will help shape the scope, distribution and affordability of public service provision across the country. Fundamentally, the level and quality of local services will increasingly come to depend on the performance of the local economy.

Among the most important questions that government consultations will seek to answer is the main mechanism by which the total pot of business rates revenue will be distributed between authorities and across time. This question gives rise to a fundamental trade-off for Whitehall: between ensuring an acceptable level of funds for services, and instilling a financial incentive that compels local authorities to grow their economies.

Many aspects of the new scheme are yet to be agreed, but two important things have already been announced: first, the amount of funding that every local authority will get from business rates revenues in the first year of any new scheme will be determined by its need for funding (‘funding need’), with resources redistributed within the scheme by a system of tariffs and top-ups; second, in subsequent years each local authority will be able to keep every extra pound of business rates that it collects; third, the levy on ‘disproportionate’ business rates growth will be abolished.

‘Tying the provision of vital public services directly to local economic

composition and performance is in many respects a strange and risky exercise’

Taking these announcements together, and amending the existing structures of the present scheme to accommodate a new system of 100% retention, IPPR modelling has shown that for most authorities, these reforms will likely fail to apply strong incentives to grow the local economy.

To the extent that the scheme does generate incentives, these would vary across local authorities depending on the ratio between business rates revenue and funding need: areas with a low funding need and high revenues would experience a strong incentive, while those with a high funding need and low revenues (the majority) would experience a weak incentive. This could lead to a distribution of incentives across the country that reflected the perfect inverse of the actual need to boost earnings, jobs and tax receipts. As a result, existing geographical imbalances in economic growth and in public service investment will likely widen.

To illustrate this with an example, a poorer local authority such as Barnsley, with a funding need of around £120m in 2019/20, and local business rates collection worth around £50m, would receive its full funding need of £120m in the first year of a full retention scheme. Of this, £70m would need to come from a ‘top-up’ which is then frozen in real terms annually. This means that a 2% increase in their business rate revenues would yield a reward of just 0.8% in additional retained income. Conversely, for a richer authority like South Bucks in Buckinghamshire, with business rate revenues worth around £30m and a funding need worth around £1m, a 2% increase in business rates would see retained income rise by more than 50% in a single year.

To address these problems, IPPR’s new report, Better Rates, has set out an alternative proposal. Our ‘growth first’ scheme retains the spirit of the proposals currently under consultation, but it performs better against the government’s own objectives by providing a far more redistributive allocation of rewards and incentives.

Under our scheme, the increase in a council’s funding after the first year is calculated by multiplying their business rates growth rate by their funding need. This gives all local authorities an equal incentive to grow: for example, both Barnsley and South Bucks would see a 2% rise in business rates receipts translate to a 2% rise in their retained income.

Although further devolution of tax and spending power is to be welcomed, a system limited to the fiscal devolution of business rates alone has significant limitations. Balancing the aim of providing good incentives to drive local economic growth, with the need for a system that is fair and transparent, is an enormous challenge when you have so few levers to pull, and when there is such a high level of local and regional inequality.

Furthermore, tying the provision of vital public services directly to local economic composition and performance is in many respects a strange and risky exercise. With the economic effects of Brexit expected to bite over the short to medium term, these challenges are likely to get worse before they get better.

Photo by chris__reed

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