Christian Spence, Head of Research & Policy at Greater Manchester Chamber of Commerce
06 Mar 2017
Whilst nobody likes a tax, business rates is one that people love to hate. As a Fellow of British Chambers of Commerce (BCC) leading on the reform of business rates for two-and-a-half years, I’ve heard more nightmare stories from members than for any other issue, and have spent hours in rooms in Whitehall working through proposals with other business groups, local authorities, HM Treasury, the Department for Communities and Local Government (DCLG) and the Valuations Office Agency (VOA). I often say, and only partially in jest, that I started a 12-month project over two years ago and think I may now be approaching the half-way point.
The history of business rates is a long one. Many know about the large changes to business rates that took place in 1990 under the Thatcher local government reforms when the level of rates was nationalised, but not many know that the system dates back a lot further: the Act for the Relief of the Poor 1601, passed under Elizabeth I, is the first piece of legislation.
How did the issue start?
As an issue, business rates really came to the fore after the recession. Commercial property prices tumbled as businesses struggled or failed, plenty a strong downward movement on rents. Companies were often able to renegotiate leases as supply increased and demand softened. But business rates were not only locked at their pre-recession level, remaining as a fixed percentage of the assumed market value of the property at the previous revaluation in 2003, but increased further in 2010 when business rates became a higher percentage of higher values, calculated against rents two years previously in April 2008 – about as close to the top of the overheated market as it was possible to be. Wanting to minimise large changes to the rates payable, the scheduled revaluation for 2015 was delayed, giving the system another two years to become even more out of sync with the real world.
In April, the changes in the UK commercial property market since 2008 will be passed into the business tax system in one go (albeit with some limited transitional arrangements). The result of that has been clear in the press over the past few weeks, as the House of Commons passed its Brexit bill and then ran off for half-term, allowing a media frenzy on rates to emerge with little comment from government ministers.
Calling for reform
Working with its members, BCC developed seven key principles of the current system which require fundamental reform.
Above the line
Business rates is an input tax that is payable regardless of turnover, profit, or ability to pay. Government policy is driving up input costs to businesses, whether through environmental taxes, increased minimum wages, auto-enrolment for pensions, higher employer national insurance or the forthcoming apprenticeship levy. At the same time, output taxes, particularly corporation tax, have been falling steeply, so revenue raised from business increasingly comes from the input side, burdening business regardless of its success.
Predictability of income
Business rates is neither pro-cyclical or counter-cyclical. Instead, it’s how-much-would-you-like-to-raise-next-year-Mr-Chancellor-cyclical. The uprating of the national multiplier each year, currently at RPI but expected to change to CPI in 2020, means that government revenue from this tax on rental values increases every year, even if rental values fall. It has an in-built escalator, something that when applied to fuel infuriates everyone, but slips by here with little issue. It’s just about the only tax in HM Treasury’s army that does this and it’s hard to see why it should continue. Of course, it’s convenient for government, but meaningless for business.
The slow frequency of revaluations (normally every five years, but currently seven) means rents and rates become disconnected over time. This can work in companies’ favour, and arguably that has happened in place like London since 2008, where rents have risen much faster than rates, but overall it means that areas with weaker property markets subsidies those with faster economic growth. A system which levies a percentage of what your property’s value was, or was thought to be at a previous time, is not ideal. Our view? Speed up the revaluations to keep up with the market, but you’ll have to change the system, because …
It’s hard to get across just how bureaucratic this system is. If you operate a large site with a variety of uses, e.g. office space, toilets, kitchens, reception, warehouse, yard, factory, and have major plant and machinery including such modern-fripperies as air conditioning and micro generation, your valuation formula may not just run to dozens of lines, but dozens of pages. An extra x% for one thing, subtract y% for another. It’s insane, and costs a fortune. It also generates a lot of appeals – the 2010 revaluation resulted in over a million appeals. When a system generates tax bills that nearly one-in-two payers feel the need to dispute, there’s something wrong. There are now so many appeals, that the back-log is nearly 300,000.
Each of those businesses is required to pay these rates, every year, until the appeal is resolved or rejected, meaning many will pay more than they should up to seven years after the valuation was first arrived at. Also, the costs of centrally valuing every property (and more besides), only to give 100% relief to around to one-third of them isn’t efficient. That’s why we’ve argued for a self-exemption for the bottom-third of properties. Just submit your lease details, show that it’s below the level, and nobody needs to visit you and measure how big your toilet space is.
The administrational complexity caused by including productive investments in the valuation creates perverse incentives. Why improve your premises if you’re going to be taxed on the increase in value? Why invest in machinery if it will add to your tax bill at the next revaluation? And it also creates odd incentives on the recycling of government money. Want to follow government advice and decarbonise your energy supply to try and reclaim some of those environmental input taxes I mentioned earlier? Go ahead, and government will subsidise your investment through schemes available from the Department for Business, Energy and Industrial Strategy (BEIS), but DCLG will come along later and tax you for doing so. So we have a system where BEIS levies taxes on your energy and then gives you subsidies to change your behaviour, but if you do, VOA will come and visit you to work out its value and ask DCLG to tax you on it. This does not meet any criteria of tax efficiency.
Disconnect between business and local government
One of the most common complaints about business rates is that companies simply don’t know what it’s there for or who receives it. “I don’t even get my bins emptied!” is a common response. Your local authority bills you, historically sending it all (now just half) to Whitehall who keep some then send it back to local authorities under a complex formula linked to deprivation and need. The system lacks significant transparency and the tax causes resentment between business and local government. The move to 100% retention by 2020 (though some areas will start a pilot this April) will set out a framework where this relationship could be improved, but it won’t happen on its own. For that to occur, there will need to be significant engagement between local authorities and their rate payers, and things like infrastructure levies may help, but there is a lot of work to do.
Large by comparison
This has been the big sticking point in reform. Government, as part of its ongoing fiscal consolidation, has insisted that any changes to business rates must be revenue neutral, i.e. however much it raises before the reforms, it must raise afterwards (plus indexation, of course). This means that the winners and losers are amplified, as the rules make this a zero-sum game. As government has been happy to cut revenue by lowering corporation tax, clearly this is not just a cash issue. The challenge, of course, is that business rates is so entwined in the local government finance system that large changes to revenue and the system overall would require large-scale reform of local government and local government finance.
But there’s another dimension to this which I suspect is where the blocks on radical reform come. Basically, it raises too much money. At £26bn, the UK raises a larger share of taxation from property taxes than any other developed economy, and around double the OECD average. I fear that not only does the fiscal neutrality argument stop serious reform, it actually makes the matter worse. The larger the revenue share gets, the harder reform in the future becomes.