Business rates devolution has been on the political agenda for several years now but the process so far has been drawn out. Despite a first step being initiated in 2013 that allowed local authorities to retain up to half of the growth in business rates, progress has stalled on increasing this to 100 per cent. The legislation, which had been making its way through Parliament for implementation in 2020, was dropped from the legislative programme following the General Election. But the Government has announced it is committed to pursuing the devolution agenda, with or without primary legislation. Part of the system is currently being piloted in some areas, such as Greater Manchester and the Greater London Authority.
The aim of full business rates devolution is to achieve two goals:
- Provide a funding tool for local authorities, while central government grants are declining;
- Incentivise economic growth and good policy practice locally. Fiscal autonomy would encourage local authorities to improve their economy by aligning fiscal interests with economic imperatives.
But while many concerns have been expressed regarding the fiscal risk for local authorities, less has been said about the ability of the business rates system to provide a sufficient incentive to local authorities to support economic growth.1
This briefing analyses the effectiveness of the current business rates growth incentive and explores how the system could be adjusted to be more in line with economic needs across cities. First, it describes the state of demand for commercial space across cities. It then explains the current growth incentive and proposes several adjustments to make it more effective to a wider number of cities. Finally, it investigates how business rates could recognise and reward the contribution of other places beyond cities. Before getting into the core of the analysis, Box 1 below summarises how business rates are calculated and how the system works.
Box 1: How business rates work
This box provides a brief summary of how business rates work. The main components of the business rates system are described below.
Baselines, top-ups and tariffs
In the initial year, each local authority is given a business rates baseline and a funding baseline. The business rates baseline is equal to the amount of business rates generated locally in this specific year. The funding baseline is the amount of money a local authority is presumed to need to deliver services. If the business rates baseline is higher than the funding baseline, the authority will pay a tariff so that it only retains enough money to cover its financial needs. If the business rates baseline is lower than the funding baseline, the authority receives a top-up. This means every local authority in the country is only left with a sum of money equalling its funding baseline.
Baselines, top-ups and tariffs must be reset after a certain number of years. This is because over time financial needs and revenues can change considerably and the system may no longer represent the economic reality of the area.
The shorter the period between resets, the lower the incentive to increase revenues: as growth is measured relative to the business rates baseline, frequent resets prevent accumulating extra money year-on-year. On the other hand, although a long period between resets increases local authorities’ incentive to generate more revenues, it also makes the system less responsive to economic change and reduces the amount of money left for redistribution.
Rateable value and revaluation
Business rates are based on the estimated property value of non-domestic properties. The Valuation Office Agency (VOA) is in charge of evaluating the open market rental value of each property on a fixed date and for a set number of years – this is the rateable value.
Rateable values need to be updated over time to adjust to market prices. In the past, revaluations have taken place every five years. However the latest two revaluations were seven years apart, with the latest revaluation coming into force in 2017. In the 2017 Autumn Budget the Chancellor announced that starting in 2022 rateable values will be updated every three years.
Business rates bill, multiplier and revenue cap
The amount of business rates due for each property is calculated by applying a multiplier to properties’ rateable value. There is also a range of relief to support specific businesses, such as the small business rates multiplier (which is lower than the standard multiplier) and the small business rates relief (which offers discounts of up to 100 per cent on business rates). Local authorities can also apply discretionary reliefs.
One specificity of business rates as a tax is that there is a cap on the total amount of business rates that should be generated annually, and the total yield is determined in advance. Opposite to most taxes – where the value of the tax base varies but the rate remains constant – in the business rates system the multiplier (i.e. the tax rate) is the variable, and is calculated so that the total properties’ rateable values (i.e. the tax base) generates the expected yield.
Because of the cap, the multiplier changes at each revaluation to reflect the changes in rateable values and ensure the overall system generates the same amount as the previous year. It also changes every year in line with inflation.
100 per cent retention mechanism
Under the current system, which was introduced in 2013, half of business rates revenues are retained by local government as a whole. In addition, individual local authorities are allowed to retain up to 50 per cent of the growth they generate. This means that, while baselines, tariffs and top-ups remain fixed for the period, 50 pence of every additional pound generated above the business rate baseline year-on-year is retained locally.
The 100 per cent retention system proposed by the government would mean that all business rates revenues are retained by local government as a whole, and that individual local authorities can keep 100 per cent of additional growth above the baseline. This aims to give local authorities an incentive to increase their business rates revenue.