House of Commons - Office of the Deputy Prime Minister: Housing, Planning, Local Government and the Regions

Select Committee on Office of the Deputy Prime Minister: Housing, Planning, Local Government and the Regions Ninth Report

6 Business Rates

Background

144. Business rates (also known as national non-domestic rates) are chargeable on all non-domestic properties, except land or buildings used for agriculture.[185] They are collected by local authorities and are the means by which businesses and others who occupy non-domestic property make a contribution towards the cost of local services. The rates are paid into a national 'pool' and then redistributed to local authorities according to the number of people living in the area (except in the City of London where special arrangements apply). Business rates are therefore currently operated as a hybrid of local and national taxes.

145. For the purposes of the Balance of Funding, however, business rates are treated as a tax controlled by central government. The Government has set the annual rate in the pound since 1990 when business rates were "nationalised"; previously local authorities set local business rates. The amount payable in business rates by a business is a percentage of the rateable value of the premises. The percentage or "rate in the pound" is set annually by the Government, not by local authorities. The Government determines the level of payments by fixing the rate poundage - currently 45.6 pence in the pound in England and Wales. There is, however, currently a limitation: the national rate in the pound can only be increased in line with inflation.

146. Every five years there is a national revaluation of non-domestic property. At revaluation the rate in the pound multiplier is re-set to ensure the national yield remains the same in real terms. For an individual business this means that its rates bill will only increase in real terms where the rental value of its premises has increased by more than the national average since the last valuation. For a business where its increase has been less than the national average, its rates bill will fall in real terms.

147. The Committee considered three issues:

i. whether the annual increase in business rates should be limited to the increase in inflation;

ii. whether business rates should be "relocalised", that is, whether each local authority would set the rate in the pound in their area; and

iii. if rates were relocalised, what safeguards should be put in place to protect business from excessive increases.

Balance of funding: business rates

148. The contribution which business makes through the business rates to local government has been capped at the amount in real terms which business paid when the new system came into operation in 1990. As local government expenditure has increased since 1990 by significantly more than inflation, the proportion of local authorities' revenue which comes from business rates has therefore gone down each year since 1990 and a larger proportion has had to come from government grant, the council tax and other sources.[186]

149. Although business had doubts about the system when it was introduced in 1990 (the Confederation of British Industry (CBI), for example, it was reported, had said in 1990 that local authorities would have no incentive to provide services to businesses or to take business interests into account in planning new schemes),[187] the Committee discovered that business considered that the system of rates "works acceptably and there is no wish in the business community to abolish them or change them".[188] The Committee found that witnesses from business liked the current arrangements and were strong advocates of the status quo:

"There are a number of reasons why the current system is attractive to businesses. It is not simply that it is pegged to inflation and council tax is not; it is a national scheme. It enables businesses, both local and national, to plan their investment and their cost base over a five year period. It is fair in the sense of being between authorities. There is not a competitive element between localities which, depending on how prosperous the economy is, can quite easily destabilise the cost base and the abilities of some businesses depending on where they are located."[189]

"We would be opposed to doing away with the national business rate and relocalising it, because businesses need consistency, certainty and simplicity above all."[190]

"It gives business vital protection against unaffordable rate increases and eases planning over both the short and long term."[191]

"The [business rate] has also achieved a fairer distribution of rate liability, with the national poundage ensuring that bills are more closely aligned to ability to pay than they would be if companies were exposed to arbitrary local variation."[192]

"The thing to remember about business rates is it is a tax on inputs, so regardless of profitability businesses will be paying a proportion, so the proportion of profits will vary quite significantly. That was important, I think, last time under the localised system, because significant increases affected very much those businesses which perhaps did not have the margins and were not as profitable as others. I think that is an important point to remember."[193]

150. As well as business rates, local government is financed by central Government from taxes (for example, corporation tax, income tax and VAT) paid by businesses themselves and by their employees, who also pay council tax. The gross contribution which business makes to local government revenue is therefore greater than the amount paid in business rates. When the Committee pointed out that in County Durham, for example, over the last three years there has been a 30% increase in council tax, the witness from the North East Chamber of Commerce said it was "perfectly fair" that the increases in business rates had been pegged to inflation "because that environment has enabled our businesses in the North East to create more jobs and wealth to enable others to pay council tax".[194]

151. Because the total contribution from business rates has been capped at the amount in real terms paid when the new system came into operation in 1990, the other pillars of the local government revenue - the council tax and government grant - have had to carry more of the burden when local government has needed to spend more. As the table below shows, in 1990-91 £10 billion in business rates was distributed to local authorities, which provided 29% of the balance of funding. By 2004-05, although the cash amount had increased to £15 billion, this provided only 20% of the balance of funding.

Funding of revenue expenditure from business rates £ billion		Balance of funding from business rates
Rating system
1985-86	6.7	28 %
1986-97	7.6	28 %
1987-88	8.1	28 %
1988-89	8.8	28 %
1989-90	9.6	29 %
Community charge system
1990-91	10.4	29 %
1991-92	12.4	32 %
1992-93	12.3	29 %
Council tax system
1993-94	11.6	28 %
1994-95	10.7	25 %
1995-96	11.4	25 %
1996-97	12.7	27 %
1997-98	12.0	25 %
1998-99	12.5	25 %
1999-2000	13.6	25 %
2000-01	15.7	27 %
2001-02	15.1	24 %
2002-03	16.6	25 %
2003-04	15.6	22 %
2004-05	15.0	20 %

Local Government Finance Key Facts: England, the Office of the Deputy Prime Minister and National Statistics, February 2004 and www.local.odpm.gov.uk

152. In their evidence to us the New Policy Institute suggested that "if the business rate had gone up in line with council tax since 1997/98 the council tax increase that we have seen since then would have been reduced overall by about a third".[195]

153. No one wants to pay more tax, and the Committee recognise that business makes a substantial contribution to the costs of providing local services not only through business rates but also through national taxation and the payment of local authority fees and charges. We do not agree with the Treasury, however, that "the approach we have at present for setting the level of business rate is right".[196]

154. First, the world has moved on since 1990. Many local authorities now offer a range of business-support services to encourage economic development and regeneration. In addition, local authorities now provide a wider range of services to business. Local authorities are, for example, responsible for waste collection and disposal and they have been at the forefront in implementing the Government's the National Waste Strategy which is a requirement of the EC Waste Framework Directive 75/442/EEC.[197] Local authorities advise on waste minimisation techniques and some provide waste disposal and recycling centres.[198]

155. Secondly, the current arrangements have become unbalanced and put too much of the strain of raising local revenue on the council taxpayer. It would be neither practical nor sensible to put the clock back to 1990 to increase the proportion of local revenue which comes from the business rates to 29% again. But, if the business rates remain frozen at the 1990 level, by 2015 only 17% of local government revenue will come from business rates (see Chart 4, below). The strain will inevitably fall on those parts of the system which are not capped, in particular, on the council tax payer. In the Committee's view it would be both practical and sensible to halt the decline in the proportion of local revenue which comes through business rates.

156. The Committee therefore recommend that the cap which prevents business rates increasing by more that the rate of inflation is removed. Irrespective of whether business rates remain at a uniform national rate set by central government or are relocalised and set by local authorities, the Committee believe that the proportion of local government revenue which is raised nationally through the business rate would be fairer at a level of 25%.

Relocalisation

157. Until 1990, the "rate in the pound" which businesses paid varied from one local authority to another. Each local authority had discretion to decide how much they needed to levy from local businesses. The result was "over 350 different business rates - for example, in 1985 rate poundages varied by more than 196 pence on the pound, with Gillingham charging 151p and Newcastle-upon-Tyne 347p".[199] While accepting that there was a significant variation in rate poundages before 1990, the Committee noted that the rateable values of identical businesses could vary across the country. As the rates bill paid by a business is the product of the rateable value of its premises multiplied by the rate in the pound, it did not make financial sense that in 1985 businesses in Newcastle-upon-Tyne, where rateable values were likely to be lower than Kent, paid as much as 2.3 times the rates of comparable businesses in Gillingham.

158. The evidence which the Committee received from business opposed relocalisation of business rates. The focus of concern was the level and effect of increases in business rates which a number of authorities had imposed when rates were under local control:

"It was the scale of the annual increases [before 1990] which was particularly the bone of contention. […] The analysis at the time, before the national non-domestic rate was introduced, suggested that the annual increases across a range of local authorities was way in excess of the rate of inflation at the time, and it was that scale of impact which was of particular concern. Some identified the impact in terms of their profitability, some identified the impact as being a reason why they would reconsider where they based their business operations. […] I suppose our view is informed by what happened the last time round. […] all the evidence, talking to businesses at that time, was that the net impact, particularly of the larger-scale increases in certain local areas, was a negative one.[…] The rates often bore very little relationship to the wider economic context. Even at times of recession rates varied enormously and were increasing significantly. There was a massive variation in the rates which did not bear any relation to the property market, to economic conditions, but bore relationship to what local authorities wanted to set the rate at."[200]

"I can remember before, when local rates were localised and it brought a great deal of acrimony. Businesses now have had a substantial period of time with the national non-domestic rate. It has enabled jobs and growth to happen in the North East. For a number of years after the nationalisation of the business rate, Newcastle struggled actually to come to terms and put right the damage that occurred before, with businesses moving to other areas where the business rates were lower. So I think the national rate system is robust: it is not broken; we should not fix it. The equalisation seems to work very well and I think that is a very robust basis on which to continue."[201]

159. The arguments in favour of relocalisation were advanced by local authorities, their representative organisations and by the policy research bodies from whom the Committee took evidence:

"If the business rate were returned to local control, it would bring the balance of funding back in line broadly with the 50/50 split as it was previously, slightly less because obviously business rate since 1990 has not increased as much as council tax and as much as national income tax support for local government. That would help in terms of restoring the balance of funding."[202]

"I do not think that the lack of accountability argument really works because we never hear that in relation to corporation tax or the many other charges that fall on businesses. Businesses do not have votes in general elections. I think we are a fairly mature capitalist democracy now. People know that they work for businesses and their pensions are invested in the shares of businesses and so ultimately it is about people and people own businesses."[203]

"[…] there is no evidence that location of business is particularly influenced by the level of business rates. On the contrary, the evidence of the Cambridge studies in the 1980s and the experience of the enterprise zones which gave ten-year rate-free periods afterwards was that what is important is the total property outgoing. To the extent that the property tax rises, the rents go down. What we experience, certainly in my enterprise zone, was that the rents rose within the enterprise zone so that the total property outgoings remained the same inside and out. […] Commercial property tax is a tax on commercial rents in effect and the CBI has completely misconceived that element. Furthermore, they argue that business pays other taxes; well so does every other taxpayer, we all pay a variety of taxes. The other point they seem to overlook is that business is both a huge supplier of services to local government, actually benefits from local government activity in that sense, and they also indirectly benefit from many of the services we provide. We think that at the moment they are not paying a fair share. The final point is that it has to be kept in proportion. Business rates amount to something like 3% of turnover. I am not saying that is insignificant, but a change in that is not of itself hugely burdensome. We do need to revisit the question of business rates."[204]

160. The Committee believe that returning business rates to local control would significantly increase local authorities' control of their revenue. It would shift the central / local government balance of funding from around 75% / 25% to around 55% / 45%. In the Committee's view it must be a priority to make a change in the balance of funding. This change would reduce the effects of gearing, take some of the pressure off the council tax payer and it would provide a real link between local authorities and business. Although it might require primary legislation, the restoration of business rates to local authority control can be achieved faster than some of the other reforms, such as the introduction of local income tax which have been proposed as part of the Balance of Funding Review. The Committee therefore recommends that the Government returns business rates to local authority control as soon as possible, but no later than 1 April 2006. In addition, the proportion of local government revenue derived from business rates should account for at least 20% of total local government revenue.

Safeguards for business

161. The Local Government Association told us that, if business rates are restored to local control (which the Association favours), there have to be strong safeguards.[205] Cllr Chalke from the Local Government Association pointed out that:

"we cannot allow the extraordinary increases which have been levied in the past on business; my own factory had a 29% increase in one year. You cannot allow that to happen. Business is in a competitive world, it is competing worldwide."[206]

162. There was some evidence from business that local authorities had learned lessons from the problems caused by large increases in business rates under the pre-1990 system and that local government as a whole was more attuned to the needs of business:

"We had really a once a year engagement with local authorities where we were given huge bundles of papers at very short notice for meetings where things went through on the nod, and businesses had no say really whatsoever in local authority finance. If you contrast that with today, we can have meetings with local authorities where the consultation is the contact for a wider discussion on education and other matters, that we can work with the local authorities on, so there is a much more positive situation now than there was before the nationalisation of business rates."[207]

"We would argue that one of the reasons why that conversation between business and local government has improved is because one of the major bones of contention which did exist before has been removed, in other words, the annual setting of a rate which was set locally. We recognise that life has changed and that local authorities probably are more focused on the needs of economic development in their areas, in some cases."[208]

163. But the picture was far from universal. The Committee heard that in the South West "the relationship between local authorities and their support for businesses, like everything, varies dramatically across the region. Some are very good and some are very poor".[209] Paul Woods, City Treasurer from Newcastle-upon-Tyne City Council, told the Committee that:

"there is considerable concern [...] among some local authorities in the North East not to deter business. We are very conscious of the concerns of business, so we would want to see appropriate controls, which would mean that the tax increases for businesses would not be substantial, so some limiting around the level of the local tax increase might be said to be appropriate as well. Significant partnerships are being built up with local business communities in the North East by individual councils, and there is a concern that those business partnerships could be damaged if there was a very negative reaction of businesses to the full restoration of business tax locally".[210]

164. The Government should, in the Committee's view, ensure that the improvements in relations between local authorities and business achieved since 1990 are protected. As the CBI put it to us,

"without any clear parameters […] there would be a real fear within the business community that local authorities would see the business rate as a way of reducing the pressure on council tax and would use that because of the pressure from local tax-payers on the local authorities. There would be far more pressure from that community to lower the council tax and push the burden onto business, rather than vice versa".[211]

The Committee received evidence suggesting the parameters which could restrict local authority increases in business rates.

Policy Exchange said: "there is an interesting idea being suggested as a way of perhaps allaying some of the more acute concerns of business, which is to link the rate of the increase that any local authority could apply to the business rate to the rate of increase in the council tax, so basically if you are going to put the council tax up by 4% then you can put the business rate up by 4% but no more".[212]
The CBI suggested that for dialogue to be meaningful: "there needs to be some comfort given in terms of the efficiency with which that money raised is spent, and I think there needs to be some ability on the part of business to influence how those decisions are made about where the money is spent".[213]

165. The Local Government Association also made the point that, even if increases in local business rates were linked to council tax increases, business should not be exposed to excessive increases. The Association said:

"this year [2004-05] is a very easy year to argue; the council tax has gone up on average by 6%; business rate went up by 2%. If the two had been together, it would have been a 4% increase; indeed if you had had a wider base it might have been even less. That is not a price which the business community would baulk at too much. If you go back to last year [2003-04] when it was an average of 12.9% increase in council tax, I do not think we should have been inflicting that sort of increase onto the business community."[214]

166. When business rates are restored to local control, the Committee recommends that the Government put in place a mechanism to prevent excessive increases by, for example, limiting the annual increase in business rates in an area to no more than the annual percentage increase in the council tax in the area.

167. For as long as the Government continues to set a national rate in the pound but with annual increases greater than inflation, the Government should consider:

enshrining in primary legislation the maximum rate of increase above inflation that can be imposed; and
announcing any increases above inflation as part of a three year rolling programme.

Equalisation

168. If business rates are returned to local control the Committee would expect that the grant distribution mechanism be adjusted to take account of the disparity in local authorities' business tax bases, and ensure that grant continues to allow each local authority to spend to provide a standard quality of service across the country. In addition, in their evidence to the Committee Policy Exchange pointed out that

"for equalisation purposes there are places, for example Westminster, where we are going to need to have some way of retaining some portion of their business rate take because otherwise they would be paying their residents a council tax benefit because they have been raising so much from business rates."[215]

185 "Agricultural land" and "Agricultural buildings", as defined in paragraphs 1-8 of Schedule 5 to the Local Government Finance Act 1988, are exempt from rating. In addition, rate relief is available for businesses with rateable values of up to £6000, where the business is set up on previously agricultural land or buildings. Back

186 Q 167 [Ms Bell, Director of Local Government Finance, Office of the Deputy Prime Minister] Back

187 Q 628 [Bill O'Brien MP] Back

188 Q 311 [Mr Lewis, Director of Finance, South West Regional Development Agency] Back

189 Q 456 [Mr Sugden, Director of Policy, Chamber of Commerce in the North East] Back

190 Q 299 [Mr Lewis, Director of Finance, South West Regional Development Agency] Back

191 Ev 49 HC 402-II [Confederation of British Industry] Back

192 Ev 49 HC 402-II [Confederation of British Industry] Back

193 Q 601 [Ms Turner, Head of infrastructure, Confederation of British Industry] Back