Five reasons why the business rates system doesn’t work – and how to fix it

How the Government can make business rates system more efficient and make the most of devolution

Andrew Carter

Deputy Chief Executive, Director of Policy and Research

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With Government in recess and journalists on the hunt for political stories, the upcoming revaluation of business rates has risen to the top of the news agenda, prompted by opposition to the changes from some of the UK’s biggest employers’ groups.

The impending revaluation is intended to ensure business rates are set at a level which reflects the rental value of the property they occupy. This has a significant bearing on how competitive a business environment cities can offer, and the revenue generated by the tax is crucial for funding local government.

The problem is, however, that the forthcoming revaluation comes two years later than planned and seven years after the last revaluation.  This delay has worsened an already dysfunctional business rates system, which increasingly does not work for either businesses or local government for the following reasons:

  1. It is volatile. The lengthy gap between revaluations creates major shocks to the business rates system for both local government as a revenue stream, and for firms as ratepayers. As a result, businesses across the country are facing dramatic changes in their business rates bill – with many in London and the South East facing significant increase in rates.
  2. It is not responsive to economic conditions. The current five-year revaluation cycle means that over time businesses are often paying rates based on out of-date valuations.  This is the especially the case since the last revaluation, which occurred before the 2008 recession and came into force in 2010.  Since 2010 businesses in prosperous areas such as London have been paying less in rates than they should be, while companies in poorer places such as Burnley and Hull have been paying more – hence why London firms are now facing particularly large hikes in their rates. 
  3. It is complex and poorly understood. The long and technical process of valuation, the lack of correlation between the rates and businesses’ ability to pay, and the annual changes in the business rate multipliers, all combine to make the system opaque and hard for businesses to navigate. 
  4. The appeals system creates financial uncertainty for local authorities. The large volume of appeals to the Valuation Office Agency (for example, to raise issues or changes in property valuation),  and the delays in solving cases, mean that many places might have to refund several years’ worth of rates to businesses, putting their budget at risk.
  5. It can reward perverse behaviour. Because the tax is primarily based on growth in commercial floor-space within the revaluation period, the current system rewards space-hungry developments which are often out of town. This can be to the detriment of town and city centres, and the firms based in them. By the same logic, the system does not reward behaviour that supports business and public investment, and economic growth which does not increase net rateable floor space.

With the Government now considering reforms of business rates ahead of the tax being devolved to local authorities in 2020, how can it make the system more effective and ensure it maximises the benefits from devolution? Three things stand out in particular.

Firstly, more frequent revaluations are needed on a yearly or bi-annual basis, to make the system more accurate and timely, reduce volatility, and to maintain the legitimacy of the tax. More frequent revolutions would also have the additional effect of reducing the significance of appeals. 

Secondly, the Government should replace the fixed yield with a fixed rate. The current system requires that business rates should generate a fixed yield in revenue irrespective of the state of the overall economy. This both amplifies the volatility in the system and creates distortions which benefits more economically vibrant places. Removing the cap on business rates and moving to a fixed rate system would make it more responsive to the wider economy and the ability of firms to pay.

Finally, extend the period of time between resets of the system. Revenue from business rates is used to fund local government, and the amount of baseline funding places receive is reset every five years to ensure that it broadly reflects their level of need. This creates uncertainty for local authorities towards the end of this period, as they don’t know how much business rate income they will retain after resetting. It also gives places only a small time-period in which to accumulate growth, and therefore less incentive to make this a priority. Carrying out the reset every 10 years instead wouldn’t prevent similar issues arising at the end that period, but would provide authorities with more long-term certainty and greater incentive to grow their economy.

Making these changes will be critical in creating a business rates system that works for both local government and businesses, makes the most of devolution and offers the stability places need to drive local economic growth.

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Comments

ASR
13 March 2017 10:25

I think the simple solution would be to scrap the business rates system and replace it with a tax linked to productivity, something akin to a local corporation tax. That way you can effectively tax both the high-street and digital retailers, in a fair way, that accounts for ability to pay. It does away with a number of the issues you have with business rates (at the very least points 1-4), and if avoidance can be dealt with across the board then it would nullify concern 5 as well.

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John Harrison
12 March 2017 14:07

You paradoxically ignore any mention of online retailers, normally with warehouses in lower valued locations, enjoying a material competitive advantage over those located on City High Streets. A sustainable means of creating a more level playing field between the two groups in terms of the business rates each pays needs to be found if the decline of our city centres is to be halted and reversed and on liners contributing a fairer share. There is no obvious solution with the possible alternatives of turnover and profitability perhaps better reflecting an ability to pay but with both subject to greater volatility and, therefore, unacceptable uncertainty for ongoing local government funding. Your 10 year revaluations approach does nothing to address this key issue,

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Dr Paul Greenhalgh
19 February 2017 17:58

Fully agree with points 3, 4 and 5 but implicit within your first 2 points is that market rental values are both volatile and don't reflect economic conditions; they aren't and they do. The reason why businesses in Greater London and wider south east are facing a hike is that they have been underpaying for the last few years (market rents in most sectors eclipsed 2008 levels a few years ago); conversely businesses in the north of England have been overpaying - in many sectors market rents are still below their 2008 zenith - a fact that most commentators have ignored.

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