Neil Amin-Smith: Research reveals 100% rates retention pilots are not cost-neutral

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When the government announced 100% business rates retention pilots it said the scheme would be “cost-neutral”. However, research by the Institute for Fiscal Studies shows that cannot be the case. Neil Amin-Smith reveals how the conclusion was reached.

Since 2013-14 the business rates retention scheme (BRRS) has meant that English councils bear (up to) 50% of the real-terms changes in local business rates revenues. In April 2017, four city regions plus Cornwall began piloting 100% retention of the real-terms changes, and as of April this year have been joined by a further 11 pilot areas.

Paul Johnson, director of the Institute for Fiscal Studies, will feature as a guest speaker at Room151’s 10th Local Authority Treasurers Investment Forum/FD’s Summit conference on 20th September. See our conference page here.

In our recent paper we estimate that the councils taking part in these pilots will receive extra funding of £873m in 2018–19, money that would otherwise have flowed into central government coffers.

We therefore disagree with the government’s previous assertions that the pilots are “cost-neutral at the point of delivery”. Given this isn’t small change we’re talking about, it’s perhaps worthwhile setting out how we arrived at our estimate of such substantial gains to pilot councils.

Forecasts

First, using councils’ own forecasts of their 2018–19 business rates revenues, as stated in their NNDR1 returns, we estimated all pilot councils’ expected income from the BRRS in 2018–19.

We then estimated the income that each pilot council’s forecast implies they would have received if they had remained under the standard 50% retention scheme, i.e. there were no 100% retention pilots. £873m is the difference between pilot councils’ income under the two scenarios.

Why are they set to gain such a significant sum? In large part, it is because the way the 100% retention pilots have been implemented means pilot councils are retaining 100% of the real-terms change in revenues since the BRRS was set up in 2013–14, not just 100% of the real-terms change from when they became pilots.

The extent to which each individual pilot area is set to gain thus reflects their respective real-terms growth since 2013–14.

Councils in the Berkshire pilot, for example, are set to gain £53m in total, or 8.3% of their collective core spending power, largely due to around 13% real-terms growth in rates revenues since 2013–14.

By contrast, Liverpool is set to gain only £2.5m, or 0.6% of its core spending power, having experienced less than 1% real-terms growth since 2013–14.

Pools

Of course, the modelling task is not as simple as the above suggests. One reason for this is the existence of business rates “pools”. As part of the BRRS, groups of councils are allowed to form pools and councils in any such pool are subsequently treated as one entity for the purposes of rates retention. Under 50% retention, being treated thus can enable councils to reduce certain payments into the scheme.

New pilot councils in 2018–19 took part in pilot schemes as business rates “pools” rather than as individual councils. This impacted on our modelling in two ways.

Firstly, within pools constituent councils may decide how to allocate revenues between themselves, complicating any calculation of exactly how much income would flow to each pilot council.

Furthermore, in some pools a portion of their collective total revenue is set aside into a general fund, meaning it is not possible to breakdown revenues by individual councils.

We address this by modelling those pilot councils in pools at the level of their respective pools. This allows us to abstract from intra-pool allocation decisions, but means we are not able to calculate the gains made by individual pilot councils within pools.

The second issue posed by the ability to form pools was that we do not know what pooling arrangements pilot councils would have made in the absence of the pilot schemes.

Our counterfactual assumes that they would have formed the same pools as they have for the pilot schemes, something they would have been free to do. However, they may not have done so, and this could have implications for any estimate of the increase in funding of pilot councils.

On the one hand, if, in reality, most pilot councils would not have pooled in the absence of the pilot schemes, our calculation of the extra funding flowing to pilot areas is likely to be an underestimate — since councils tend to gain from pooling.

On the other hand, councils might have formed different pools in the absence of the pilot schemes, ones that could, perhaps, have been more financially beneficial.

We also model councils that entered pilot schemes in 2017–18 as not in pools in either scenario, but we cannot be sure what pooling arrangements they would, or wouldn’t, have made in the absence of the pilot schemes.

Gains

In light of these considerations, we performed various sensitivity checks. We tested the implications of alternative pooling arrangements and found that they would have made little difference to the overall gain expected to accrue to pilot councils.

In summary, we have estimated that pilot councils are set to gain around £870m, although we are not able to estimate individual gains for those councils in pools.

Sensitivity checks show that alternative pooling arrangements in the absence of the pilot schemes would not make a significant difference to our results, and there can be no doubt that implementation of the 100% retention pilot schemes will not be anywhere close to “cost-neutral”.

Neil Amin-Smith is research economist at the Institute for Fiscal Studies.