Understanding the future of business rate retention

The move to 100% business rates retention remains contentious even as councils jockey to be included in pilot schemes. Adrian Jenkins writes that there are still battles to be had over how the scheme will work and who will be the winners and losers.

Earlier this year, we were asked by the County Councils Network to explore how business rate retention might work and how it might affect council councils.  Since then the fate of the policy itself has seemed somewhat in doubt, although now there are strong signals that some form of increased retention is likely, even if the shape of a new scheme in 2020-21 is still unclear.  The recent clamour amongst councils in two-tier areas to become 100% pilot-pools in 2018-19 shows that local government is keen to get more retention.

The work we did for CCN is therefore as relevant now as it was then, despite the changes in policy. We needed to understand how 100% retention or something like it might be implemented.  Of course, ministers could decide to do something different, or to make different assumptions, but by trying we did understand much more about how 100% retention might work.

Our starting point was to assume that a future 100% system would actually look very similar to the current 50% system: i.e. a funding baseline (BFL), a business rates baseline (BRB), and a top-up or tariff to make it fiscally neutral.

The BFL in a new 100% scheme takes the current BFL and adds additional funding streams. There are some obvious candidates (public health grant, revenue support grant, rural services delivery grant) but to reach the £10.5bn that is required to make 100% retention fiscally neutral is actually not that easy. Either the government will have to push the boundaries to find additional transfers, or a new system will need to be set up with a net tariff.

In national terms, the business rate baselines would be grossed-up from 50% to 100%. Single tier areas are simple but two-tier areas are not, and there are bound to be disagreements about the tier split between counties and districts. We modelled a county share of between 20% and 80%. The recent experience of negotiating the 100% pilot-pools might not help either: pilots have proposed a county share in the same kind of range. All the evidence points to a higher tier split for counties though, both to help contribute to the spending pressures from adult social care, and to create a more balanced system.

Baseline

Possibly the most important variable is the baseline reset. We assumed a full, 100% baseline reset in 2020-21, with a 50% reset five years later.  The full baseline reset could generate around £1bn, depending on growth between now and 2020-21. We also assumed that the surplus generated by the reset would be redistributed to local government based on BFL, although in practice it could either be used to offset the effect of the Fair Funding Review or to increase funding for adult social care.

Views on whether the baseline reset is a good thing or bad thing will largely depend on whether your authority has above-average business rate growth or not.  From the point of view of principle alone, we are uncomfortable with such a disruptive change. Disruption is not good for financial planning or the effective use of resources. And more importantly, it could seriously undermine the incentive-effect of rate retention: if authorities are not confident that they will be long-term beneficiaries of growth, then the incentive to invest in growth is diminished.

Other likely changes, however, should reduce risk and increase the incentive on growth: the safety net is set at 97% of BFL, and there is no levy. Removing the levy is controversial: it will give potentially enormous gains to high-growth authorities. Our modelling showed that there are grounds for considering a more sophisticated levy to mitigate largest growth.

Battles

What does our modelling tell us about how a new 100% retention scheme might be designed? Firstly, that it is likely to look very familiar, with the main building blocks being the same as the current 50% scheme.

Secondly, there is still a real battle to be had over the tier splits in two-tier areas. The 100% pilot-pools will tell us that there is no consensus yet between districts and counties yet, but our modelling suggests that the county share will likely increase significantly.

Lastly, the design of the scheme will determine who the winners and losers are. To date, these have mostly been high-growth district councils. The removal of the levy will give a long-term gain to those authorities with high-growth, but the baseline reset could easily wipe-out most of any gains that an authority has built up since 2013-14.  There is still much to play for.

Adrian Jenkins is a co-founder of Pixel Financial Management.