20.From the announcements made so far, we understand that the 100 per cent retention system will be an extension of the existing Business Rates Retention Scheme (referred to in this report as ‘the Scheme’ or ‘the current system’) and share its structure. We therefore begin by describing how the current system works and explaining the terminology, which appears throughout this report and in the glossary at the end.
21.In brief, the Scheme permits local authorities to retain a proportion of their business rates over a set period of time; however, because their revenue varies widely, central government levels the playing field by redistributing revenue according to authorities’ spending needs via ‘top ups’ and ‘tariffs’ at the start of the retention period. In addition, separate mechanisms, ‘levies’ and the ‘safety net’ operate to ensure that authorities’ revenues do not diverge too much during the retention period. Overall, local government keeps 50 per cent of locally collected business rates, and thus 50 per cent of any growth, with the other 50 per cent being remitted to central government. We anticipate that the 100 per cent retention scheme will operate in a similar way; crucially, the Government has said that top ups and tariffs will be retained.
22.When the Scheme was set up, a ‘start-up funding assessment’ (now known as the ‘settlement funding assessment’) calculated how much funding each authority required on the basis of an assessment of needs, undertaken in 2012–13. This funding comes from two sources: Revenue Support Grant and funding provided through the Scheme (an authority’s baseline funding level, also known as an authority’s ‘local share’ of business rates). The local share, which is 50 per cent, is split 80:20 between district councils and county councils to set an authority’s ‘business rates baseline’. Baseline funding levels are fixed, subject to being uprated by the increase in the Retail Prices Index (RPI), until the system is ‘reset’. The reset was planned to take place in 2020 and every ten years thereafter.
* This is the need that is funded through business rates income, which can be larger or smaller than actual rates collected in each local authority. This need is referred to as ‘baseline funding’.
** Although some authorities pay tariffs above 50%, the levy on growth is capped at 50%.
23.Whether a local authority needs more business rate revenue, or raises more than it needs, is determined by comparing its baseline funding level with its business rates baseline. If the business rates baseline is greater than its baseline funding level, an authority must pay a tariff. If the situation is the reverse, an authority receives a top up. Tariffs and top ups operate each year to ensure that each authority receives its baseline funding level; however, the amounts of the tariffs and top ups are calculated at the outset of the scheme, remaining fixed until the reset. This is illustrated in Figure 1 above.
24.Adjustments for disproportionate gains and losses in business rate revenue are made during the reset period via levies and the safety net. Authorities which experience disproportionate growth in business rates income pay a levy, which reduces the share of growth they actually retain. The levy is then used to fund a safety net to protect authorities which experience a significant decline in their business rate income, for example, as a result of the closure of a major business in the area. The safety net guarantees that, each year, local authorities will receive at least 92.5 per cent of their original baseline funding. Therefore, no local authority’s business rates income will be more than 7.5 per cent below the baseline funding level. During the first two years of the 50 per cent retention system, the money raised by the levy was not sufficient to fund the safety net:
In 2014–15 the Secretary of State paid £145 million to authorities by way of safety net payments (£69 million in 2013–14). The Levy Account was credited with £120 million […] (£25 million in 2013–14).
25.Reforms to business rates over the years have aimed to create and strengthen the incentives for local authorities to develop local businesses. Before the current system was introduced in April 2013, business rate revenue in England was paid to central government. A paper on the economic benefits of local business rates retention said in May 2012:
By reintroducing a fiscal incentive for local authorities to permit development, business rates retention could go some way towards reducing their planning restrictiveness, thus increasing the supply of business premises and reducing costs for business, which in turn would allow for the expansion of existing businesses and/or the start-up of businesses which otherwise might not have been viable.
The planning system is one of the ‘levers’ that authorities have to enable local growth; however, their responsibilities for local transport infrastructure, education and training, housing and the local environment are also significant.
26.Incentives alone do not ensure growth; the way in which they are structured is important. The May 2012 policy paper identified the relevant considerations for a growth incentive as:
c)incentivises the intended behaviour;
d)targeted at appropriate decision maker;
e)simple and transparent; and
f)predictable, long-term and credible.
It said that the Scheme “seeks to provide the simplest and most substantial incentive consistent with sufficient redistributive mechanisms to protect authorities’ funding needs” but that “the size of the incentive will be affected by the size of the local share of business rates, the levy on disproportionate gain used to fund the safety net and by the length of time until the next reset”. Much of the evidence we heard related to the impact of the system on growth incentives. David Phillips of the Institute for Fiscal Studies summed up the challenge:
The important thing to recognise is there is almost an inherent trade-off between equalisation, on the one hand, and incentives, on the other. That is a trade-off that is difficult to avoid, but what might be worthwhile thinking about is when it is that growth incentives matter. You could have two kinds of systems: those that give weaker incentives but for longer, so you get to keep somewhat less of the revenue but for more years, or you get to keep all of the revenue, or more of it, for a shorter period of time. Thinking about what would matter to councils more, this immediate bigger incentive or a longer slower incentive, could be worthwhile.
27.Looking at how the current system operates revealed the issues which need to be addressed in preparation for 100 per cent retention. The move from 50 to 100 per cent retention suggests that any issues would double in size or, at least, be magnified. Andy Hall, Business Rates Assurance Manager at Boston Borough Council, agreed with this assessment, adding “Without some reforms, alterations, adjustments and refinements, in light of the experience we have had so far, we are not going to achieve what we think we are going to achieve”.
28.David Phillips, Senior Research Economist at the Institute for Fiscal Studies, said that, although it was too soon to make an overall assessment of the 50 per cent system, for which only two years of outcome data are available, we could learn lessons from it in terms of “pitfalls to be avoided when designing the new system”. Witnesses argued that these pitfalls included appeals, the operation of incentives, the apportionment of revenue between districts and counties and the link between growth and new net floor space construction. Local authorities also highlighted the risks and volatility inherent in business rate revenue. All would be magnified under 100 per cent retention.
29.The DCLG and Local Government Association Business Rates Retention Steering Group is approaching implementation in a similar way:
In delivering 100 per cent rates retention, we will need to look again at the critical issues and decisions taken in setting up the 50 per cent rates retention system. It may be that the answers that were appropriate when local government retained 50 per cent of the business rates and still received significant sums of Revenue Support Grant are no longer the same.
Moreover, the move to 100 per cent rates retention provides an opportunity to look again at the existing design parameters in the light of the experience of the operation of the scheme in the three years since 2013–14.
30.Chapter five reviews the likely impact of the reformed system, its set up and operation, and, in doing so, will look in detail at how the issues outlined above may pose challenges. The next chapter will look at the evidence we received about appeals which appear to be severely undermining the current system and, unless resolved, will continue to impact on the reformed system.
35 For all publications relating to the Business Rates Retention Scheme, see DCLG, , accessed 26 May 2016
36 As well as the Greater London Authority and fire and rescue authorities.
37 Uprated each year by RPI.
46 See, for example, District Councils Network () para 3 and Leeds City Council () para 2.1.7
47 Local Government Association, Business Rates Retention Steering Group paper: Design of the retention system, April 2016
9 June 2016