The government’s plan to allow councils to retain 100% of business rates income could encourage greater inequality between councils without promoting growth, according to a new report from the Institute for Fiscal Studies.
The think tank has released detailed statistical analysis which modelled the theoretical impact of the new system if it had been operational between 2006 and 2014.
It found that local authorities that would have seen the biggest increased in retained business rate revenues were often not those that experienced the biggest growth in spending needs.
The IFS study found no relationship between changes in business rates tax bases and economic growth.
David Phillips, associate director at the IFS, said: “Areas seeing lots of new developments aren’t guaranteed strong economic growth. And growth doesn’t necessarily rely on large-scale property development.
“This does not mean the incentives for councils to encourage property development that are provided by business rates retention aren’t useful.
“But it does suggest that if the government wants to encourage councils to take a more active role in promoting growth, other incentives could play a useful role as well.”
He said that such measures could include allowing councils to retain part of other taxes such as income tax.
The study did find a link between changes in the value of business premises following revaluations and local economic growth.
But it said that most of the impact of these valuation changes is removed from revenues actually retained by councils, meaning “little incentive for councils to boost local business property values”.
The report also found that the divergence would hit shire district councils particularly hard.
Neil Amin-Smith, research economist at the IFS, said: “As we move to 75% and possibly 100% business rates retention, it is worth considering whether counties should bear a larger share of the changes in revenues.
“Doing this could help limit the scale of funding divergences among districts and stop counties — who fund social care services — from getting ‘left behind’.
“But it would also shift more of the incentive to boost business rates revenues and some more financial risk on to counties as well: a risk that could come back to bite if business rates revenues fall rather than grow in real terms in future.”
Increasing the frequency of resetting top-ups and tariffs would reduce divergence but would also “lessen the incentive for councils to boost tax bases and tackle underlying spending needs”, according to the report.
Responding to the study, Claire Kober, chair of the Local Government Association’s resources board, said: “A fairer system of distributing funding between councils is urgently needed and this distribution mechanism, along with the way the new system of business rates retention is set up, should take into account issues such as those identified in the IFS report. No council should see its funding reduce as a result of this new system.
“Councils must be rewarded for growing their local economies, but areas less able to generate business rates income need to remain protected.”
The LGA is working with the government on the shape of the new business rates retention system and the Fair Funding Review.
Writing on Room151 this week, Chris Buss, executive director of resources and assets at the Royal Borough of Kensington and Chelsea, said: “Unless additional resources are made available the fairer funding mechanism will pit rural areas against metropolitan areas, and districts against counties, as each tries to defend their corner.”
