Welcome to this month’s Policy Update. In these updates, The Entrepreneurs Network focuses on a recent policy development and set out (nearly) everything an entrepreneur needs to know about the topic. If you’re joining us for the first time, you can read our past updates here. Oh, and if you have any comments or questions, send them here.

This month, we’re looking at Business Rates. It’s a topic that often comes up when we speak with entrepreneurs. It’s also an issue that politicians are devoting a fair bit of attention to, with a special focus on the future of the high street. Chancellor Philip Hammond announced a few minor tweaks at the last budget including targeted relief and discounts for local newspapers, public lavatories, and a two year 33% cut for 90% of high street retail properties. This followed an arguably more significant announcement at the Spring Statement last year, when he announced Business Rates would be revalued every 3 instead of every 5 years.

Calls for reform to the Business Rates system are frequent. The most recent came from the Housing, Communities, and Local Government Commons Select Committee. Pointing to the fact that “Amazon UK’s business rates amounted to approximately 0.7% of their UK turnover, while high street retailers are paying considerably more, with business rates as a proportion of turnover ranging from 1.5% to 6.5%”, they argued for urgent reform in their report High Streets and town centres in 2030. The committee asked the Government to review a range of proposals including “a sales tax, an increase in VAT, an online sales tax and ‘green taxes’ on deliveries and packaging” to fund a reduction “in business rates for retailers in high streets and town centres”.

Now, the influential Commons Treasury Select Committee has launched their own call for evidence on The impact of Business Rates on Business (by the way, the deadline for written submissions is April 2nd). Due to the perennial unpopularity of Business Rates, I think it’s likely that we’ll see a fundamental rethink in the coming years and it’ll probably look like whatever the Treasury Select Committee recommends.

The economics 
Before I run through the potential changes it’s worth getting the basics right. Business Rates are a tax assessed on the rental value of a non-domestic property and paid by the occupant.

The economics of Business Rates can be quite counter-intuitive. Economists tend to distinguish between the legal and economic incidence of taxes. In plain English, the person who legally pays the tax isn’t always the person who bears the cost. For example, take the Soft Drinks Industry Levy (or the Sugar Tax as you might know it). While the tax is paid by soft drinks manufacturers, consumers bear the cost through higher prices for sugary drinks. 

Economic theory predicts that the least-price responsive person will ultimately bear the burden of a tax. In the case of Business Rates that’s not the tenant but the property-owner. As tenants can move premises or, worst case scenario, cease trading, the landlord is the one who eventually bears the brunt of the tax. Real world data confirms the theory and finds that rents adjust in response to rate hikes and cuts. Data from the British Property Federation suggests that after three years changes in rent will blunt 75% of the impact of a rate hike on businesses.

What are the alternatives? 
The Labour Party has called for a number of reforms to Business Rates. First, they want Business Rates to be revalued annually rather than every three years. Annual changes will reduce the risk of massive hikes that take a while to adjust through rents. Second, they want to exempt new investment in plant and machinery from future business rates valuation. Currently, an office that invested in a new air conditioning system or a factory that installed solar panels would be hit with higher business rates. 

Labour are also open to “fundamental reform of the business rates system to ease the burden on traditional high streets and town centres in the age of online shopping; support the traditional fabric of our communities, including community pubs and incentivising free cash machines; and create a fairer system of business taxation.” Though on this front they’re lighter on detail.

The Liberal Democrats, on the other hand, have called for a more radical change. They want Business Rates scrapped altogether and replace with a tax on commercial landowners based on land, not property values. The policy aims to reduce administrative costs for entrepreneurs. For example, under the status quo, every firm in a business park would have to make their own Business Rate payment. Under the Lib Dem alternative, the administrative burden would be shifted to the business park’s owner reducing paperwork significantly. Because the tax would only be levied on the value of the land underneath the building, it would remove perverse disincentives against investment in building improvements of the status quo.

What do think tanks think?
There seems to be broad consensus emerging among think tanks on the left, right, and centre that shifting the way rateable values are assessed from the value of property to the value of the land underneath it. This move has been endorsed by IPPR, IFS (including in their ultra-influential Mirrlees Review), Adam Smith Institute and Institute of Economic Affairs. It was also endorsed in my report on Tax Reform for the APPG for Entrepreneurship. The big challenge of any shift to taxing land values would be administrative. While the Government has developed an imperfect way of valuing properties, they lack a similar process to value the land underneath. But it’s not infeasible – other countries such as Estonia do it without great difficulty.

Radically changing the tax system will always be difficult. Reforms create winners and losers, and often the existing winners are winning because they’re well-organised politically. That said, it’s hard to argue that status quo is fit for purpose. It’s reasonable then to expect reform in the next few years, what form that takes is still an open question. But the upcoming Treasury Select Committee Report will probably give you a good idea of what it will look like.

Sam Dumitriu
Research Director
The Entrepreneurs Network