Developing a local government finance system that works for all?

Property and land are increasingly significant to local government financing – but their valuation and taxation need urgent reform to fund local services and support growth

In recent years, there have been several political narratives designed, and promoted, to rebalance the way parts of England are governed; variously associated with devolution, decentralisation,  Powerhouses (Northern) and Engines (Midlands). More recently, emphasis has fallen on designing a new inclusive national industrial strategy that will work for all places. Concurrently, there is growing interest in the value of land and property and its potential taxation as a panacea for the largely unfunded welfare, infrastructure and development requirements of devolution and local place. Land value capture, infrastructure premiums, local asset-backed vehicles, bond mechanisms, direct property investment, more efficient exploitation of local authority assets and the sweating of local anchor institutions, have all received attention in recent years as the funder of first and last resort for new models of local governance and economic development.

Hidden value

However, these new models of devolved governance and economic development, in large part, do not align with new methods of local government finance. Moreover, we argue that in certain cases they exist in direct opposition. One of the government’s flagship devolution policies, the Business Rate Retention Strategy (BRRS), introduced in 2013, allowing councils to retain 50% of new business rates, and the more recent announcement of the 100% BRRS (planned for introduction in 2020) illustrate this situation. The BRRS only rewards business rate growth generated from new property development – growth derived from existing property is stripped out of the BRRS. Furthermore, empty property taxation is rewarded more than thriving business centres – this is because empty property rates are levied on the maximum business rate multiplier rather than the lower small business rate. Moreover, only buildings with large floorplates generate tax as small businesses largely exist outside of the Business Rate Mechanism.

Within the BRRS, there is an implicit assumption that new property development can act as a proxy for economic development – however, this is not borne out in reality. Those locations with buoyant rental levels, that can attract new commercial development, have an advantage over areas where demand is low and viability is a challenge. This is where the folly of using new real estate development as a convenient proxy for economic growth is evident. Certain locations with buoyant job prospects, for example the A19 corridor in Sunderland which is dominated by Nissan, or the Golden Logistics triangle in the Midlands, do not translate into the BRRS. This is because industrial property, although space hungry, does not translate into significant business rate income due to its low rental value. This demonstrates a clear contradiction between models of devolution and fiscal decentralisation, and a modern industrial strategy that works for everyone.

A more comprehensive debate

Current efforts to improve the BRRS mostly involve complex alterations to the underlying administrative system, for example re-designing the reset mechanism. However, such changes to the technical fabric of public administration will not alter the underlying flaws in the BRRS. In order to improve this situation, a more comprehensive political and economic debate, that unites property, finance and tax policies is needed. Alarmingly, none of the major political parties mentioned BRRS in their election manifestos. Furthermore, the legislation that underpins 100% BRRS, the protracted Local Government Finance Bill, fell following the recent national election and was not included in the government’s legislative programme outlined in the Queen’s Speech.

The recent radio silence in relation to the BRRS has contributed to the uncertainty about how local places will develop post-2020 when the 100% BBRS was due to begin. However, this hiatus gives practitioners and academics some time to reflect on how the BRRS can be improved to better support local welfare requirements, and in order for it to more coherently translate into local economic development and industrial growth. In order to do so, those involved in devolution and decentralisation should broaden and reinterpret the all too narrow consensus of real estate, as it is defined, in the BRRS. Hitherto, the potential exploitation of land and real estate value has mostly been associated with new development opportunities, and the potential investment of new property tax. This limited perspective ignores the value and potential reward of existing property stock. In response, policy makers should seek a more comprehensive approach that combines the societal, environmental and economic value of all commercial real estate, rather than only providing a sop for new development.

One way of improving this situation is to reduce the rate of empty property rate taxation below the small business rate multiplier. This would be an easy win, as it would incentivise local authorities and landlords to promote small business growth, rather than rewarding dormant potential. It still remains the case that local authorities can potentially make more income from empty rates than business rates. This became more pronounced when the government significantly increased the threshold for small business rate relief in 2016. This relieved the small business community of a burdensome tax but also uncoupled most of the small business sector (and the new economy that it represents) from fiscal decentralisation. More problematic, but potentially more beneficial, is to lever in the potential value growth of existing commercial property. Currently, any new property value created through strategic industrial support initiatives, for example improved design, individual place-making, infrastructure and transport is lost. While the added worth derived from improvement in building performance, designed to deal with issues such as climate change, economic productivity and new ways of working, cannot be easily captured.

Capturing the value of industry   

Business rate retention only accounts for 30% of local authority funding. However, it is unlikely that this policy and its wider stated aim of incentive based financing, will disappear from policy. Given the recent announcements from the Local Government Association that local authorities would see a 77% reduction in central funding by 2020 and a potential £5.8bn funding gap, it cannot. Local authority reliance on local property tax will only increase as a proportion of total spend as they fight tooth and nail to remain solvent and then to provide a realistic set of welfare services.

Unfortunately, the recent obsession with Brexit has pushed much of the devolution and fiscal decentralisation debate off the political agenda and even further from the public consciousness. This needs to be countered, recognising that the largely political project of Brexit, much like austerity before it, is potentially less important than the real economic crisis of how public welfare is funded in the future. The central challenge for those interested in fiscal decentralisation, and new forms of local governance, is understanding how the fairly rigid administrative system of property valuation and tax, upon which fiscal decentralisation is reliant, can be adapted. The first task is to capture more of the rich and diverse industrial base in England, and then secondly, to offer a more comprehensive account of economic value as it is reflected in local property markets.