A seemingly obscure element of local authority financing quietly published in June by the Department for Communities and Local Government risks failing on its own terms, but IPPR has an idea to make it work.

The government’s plans to hand over 100 per cent of business rates revenue to local authorities (LAs) currently risks failing on its objective to grow local economies. Richer LAs will receive strong incentives to grow, but for many poorer councils the rewards are minimal.

Many aspects are yet to be agreed, but four important announcements have already been made, including:

  1. Income in the first year will be determined by need for funding;
  2. In subsequent years, every extra pound of business rates will be retained locally;
  3. The existing ‘levy’ on ‘disproportionate’ business rates growth will be abolished;
  4. There will be a safety net for areas that see little or no growth.

Based on all government announcements so far IPPR has modelled what the government’s new scheme might mean for richer and poorer LAs respectively.

Example of a poorer, ‘top-up’ authority:

  • A poorer LA such as Barnsley with a funding need of around £120 million in 2019/20 and local business rates of around £50 million will receive £120 million in the first year.
  • But £70 million will come from a ‘top-up’ which is then frozen in real terms annually.
  • Thus a 2 per cent increase in business rates will yield just 0.8 per cent in additional retained income.

Example of a richer, ‘tariff’ authority:

  • For a richer authority like South Bucks, business rates are worth around £30 million and there is a funding need of circa £1 million – leaving a tariff of around £29 million.
  • Thus a 2 per cent increase would yield 50 per cent in additional retained income in a single year.

Without a change in direction, the current proposals are likely to see weak incentives where they are most needed, and excessive gains where there are already ample funds for investment. Moreover, cancelling the levy could cost £170 million a year. If this is found from the existing safety net, the minimum funding floor could fall to less than 70 per cent of funding need, rather than the 92.5 per cent in the present system.

IPPR’s new report, Better rates, sets out an alternative proposal.

Our ‘growth first’ scheme retains the spirit of the present consultation, but performs better against the government’s own objective of providing incentives to grow. We propose that any increase in a council’s funding after the first year is calculated through multiplying its business rates growth rate by its funding need.

This gives all LAs an equal incentive to grow. For example, both Barnsley and South Bucks would see a 2 per cent rise in business rates receipts translate to a 2 per cent rise in their retained income. Furthermore, the ‘growth first’ scheme would also generate the funds for a safety net, without the need fora levy.

Although further devolution of tax and spending power is welcome, our analysis shows that a system of fiscal devolution based on business rates alone has significant limitations. It is an enormous challenge to balance the importance of providing good incentives to drive local economic growth, with the need for a system that is fair and transparent, particularly where there is such a high level of local and regional inequality – and our current uncertain economic outlook.