Business Rates Devolution

  • By Paul Honeyben

On 5 October, the Chancellor of the Exchequer announced substantial changes to the way local government will be funded by 2020. Most significantly, the full £26 billion of business rates will be retained by local government, Revenue Support Grant (RSG) will be phased out and local authorities will be expected to deliver new responsibilities with the extra net funding these changes imply. This briefing explores what these reforms could mean for London local government.

Background

A recap of the current system

Since 2013/14, local government has retained half of the business rates it collects under the business rates retention scheme. The remaining 50 per cent is pooled centrally by government and used to fund Revenue Support Grant (RSG) and other specific grants. In London, the retained 50 per cent is split between the GLA (20 per cent) and local billing authorities (30 per cent). A system of equalisation sees 25 boroughs receiving a top-up from, and eight paying a tariff to, central government, in order that boroughs receive an amount assessed by government as meeting their needs (the funding baseline). Any business rates growth above the expected baselines is split between central government, the GLA and the local authority in proportion to these shares, with tariff authorities paying an additional levy to government, capped at 50p in the pound. For authorities that do not achieve the baseline target, there is a safety net, which means that an authority cannot lose more than 7.5 per cent of its funding baseline in any one year. In 2015/16 London boroughs will be expected to collect £6.6 billion, with the GLA retaining £1.3 billion and boroughs collectively retaining £2.0 billion prior to top-up and tariff adjustments. However, a number of limitations with the current system, notably the negative impact of business rates appeals, mean boroughs are unlikely to achieve these targets.

The reforms - what is known?

The details that have been announced so far are that, by the end of the current parliament
(2020):

  • local government will retain 100 per cent of business rates locally
  • the core grant from Whitehall (RSG) will be phased out
  • local government will be expected to fund new responsibilities with the increased business rates funding
  • the Uniform Business Rate (i.e. the nationally set multiplier) will be abolished and instead local authorities will be given the power to reduce business rates by varying the multiplier locally
  • areas which choose to have city-wide elected mayors will be given the power to increase business rates by up to 2 per cent for spending on local infrastructure projects, as long as they win the support of local businesses through a majority vote on the LEP.

The full details of the reforms are still to be announced and, due to the level of complexity, are likely to take considerable time to be developed. However, some further detail will be announced at the Spending Review (November 25), which is also likely to include the findings of the government’s overarching review of business rates that has been running since the spring.

The reforms - what is still unknown?

Much of the technical detail of how the scheme will work in practice is still to be decided. For example, it is not known:

  • exactly what the “new responsibilities” will entail
  • whether the change to 100 per cent retention will be phased in over the next four years, or happen in 2020
  • how the safety net will continue to be funded (as it is currently funded by levy payments, which will be abolished)
  • whether the safety net threshold (currently 92.5per cent of baseline funding) will be revised
  • what the government intends to do with revenue generated by the Central List (worth around £1.3 billion in 2015/16)
  • whether local authorities will be given control of mandatory reliefs and discounts; or
  • whether the additional powers that metro mayors will have to increase rates to fund infrastructure will be in addition to or instead of existing powers such as the Business Rates Supplement that funds Crossrail in London.

The rational for devolving business rates

In 2015/16, the government expects to raise around £24 billion in business rates in England. With around half retained by local government, the remainder is used to fund (RSG). In 2015/16, for the first time there is a surplus of around £3 billion after the local retained share of business rates and RSG are deducted from the national total. This surplus is used to fund other specific grants to local government. By 2020/21 the national total is estimated to be around £26 billion and, with RSG disappearing completely, local government will only retain half of this, leaving an estimated surplus of £13 billion. Chart 1 shows the growing surplus by 2020.

Chart 1 – Estimated core funding and business rates 2015/16 to 2020/21 – England

Chart 1

It will depend on exactly which grants are rolled into the system, but initial estimates by London Councils suggest that by 2020 there could be significant additional capacity for other new responsibilities to be transferred to local government. Therefore, the reforms will attempt to simultaneously solve the issues of:

  • what to do with the inevitable surplus
  • the requirement to make savings elsewhere across public spending; and
  • simplifying the complex and opaque nature of the local government finance system.

Issues for London local government

The reforms pose a number of issues for local government and London in particular. Perhaps most important is the nature of what “new responsibilities” local government will have to fund through business rates. Demand-led services, social care in particular, are putting greater pressure on local government finances under the present system: the government will have to consider carefully whether funding other demand-led, potentially volatile, services from business rates is sensible or practicable.

The other big unanswered question is around how equalisation will work under full retention. It is likely that the national system of top-ups and tariffs will continue (albeit recalculated
against new business rates baselines). It is assumed that funding baselines, which represent the current assessment of need, will continue to be reset as previously proposed, and, depending on which other specific grants are rolled in to the system, will be adjusted to take into account their distributions. The next reset is planned for 2020, and future resets are anticipated to be every 10 years.

The reforms raise an important question for London and its relationship with the rest of the country. Under the current system, the latest estimates suggest that London’s share of the national £13 billion will be at least £4 billion by 2020, much larger than other regions. It is not yet clear whether all of the business rates raised in London will stay in London, if it did what new responsibilities would be funded from it, and at which tier of government these would sit. It is likely that the current 60 per cent/40 per cent split between what is retained locally between boroughs and the GLA will have to be revisited in light of which responsibilities are included.

A number of city, county and combined authority devolution deals are likely to be announced at the forthcoming Spending Review. It is unclear how the government views the relationship between these deals, which relate to functional devolution and public service reform, with the broader fiscal devolution of business rates, and whether the business rates surplus could be used in the funding of these individual deals.

The new local powers to vary business rates create several issues that will have to be resolved. It is unclear how the “power to cut business rates” will work in practice, for example, and whether there will be a limit imposed on how far the multiplier can be adjusted downwards locally, and how this could impact on how the safety net is triggered.

With regard to the 2p supplement to fund investment in infrastructure, it is not yet clear whether this will be in addition to, or in place of, the existing Business Rates Supplement (BRS) that funds Crossrail in London. While this is broadly welcome, if this simply extends the BRS approach to be more widely available to Metro Mayors, it may not mean any significant change for London.

There is no clarity about how the two new powers will work in places like London, where citywide increases to fund infrastructure could coincide with locally planned reductions. London has different LEP governance arrangements to elsewhere, with the London Enterprise Panel acting as an advisory body to the Mayor of London. While the closer visibility of the relationship between local business tax and local services creates a new opportunity to engage with local business, there will be a series of challenges around maintaining local political accountability, and questions around whether the current accountability structures are sufficiently robust.

Commentary

London Councils’ Spending Review submission asked for reforms to be made to the business rates retention scheme, including asking for:
full retention of business rates growth across all local authorities
100 per cent retention of business rates taxation by the end of the parliament
devolution of power to local government to determine mandatory reliefs
locally defined areas to be able to vary the national business rates multiplier according to the needs of their local areas; and
government to outline its intentions for the national business rates surplus, including clarifying which specific grants it is funding, and what other existing grants it intends to fund through this mechanism.

The Chancellor’s announcement is therefore broadly welcome. The move to full business rates retention directly addressed a number of the points that London Councils and the sector more widely have been lobbying for. However, with so much detail still to be clarified the final scheme parameters will be crucial in determining how welcome the policy change is.

The fact that local taxation will fund most of the services delivered by local government by the end of the decade implies a greater degree of local accountability; however, this will put even more importance on how those taxes are determined and whether they operate efficiently. It will be important, therefore, that current issues with the business rates as a tax are addressed before full devolution: most importantly, that an adequate solution is found to the funding uncertainty caused by rating appeals. Full devolution of business rates also means local authorities bearing 100 per cent of the risk of negative growth: a fully funded safety net system will therefore be a central requirement under the new system.

In welcoming the reform, there is, of course, still a lot of further work and clarification required and London Councils officers will continue to engage with civil servants, DCLG working groups and by responding to government consultations in the coming months.

Paul Honeyben