Lower business rates would benefit property owners not retailers

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Business rates may be the least conspicuous of major taxes. But recently they have captured more attention. Retailers, in particular, have protested loudly at the rates, which raise about £27bn in the UK, 4 per cent of total UK tax revenue. Earlier in the year the government commissioned a review. And last week, George Osborne, chancellor of the exchequer, agreed to transfer responsibility for the tax from central government to local authorities, which can cut — but will have limited power to increase — the rate of tax.

The protests of retailers have more to do with the state of retailing than the effects of the tax. Shopping now accounts for only one-third of total consumer spending. Since the global financial crisis the volume of food sales has fallen slightly, while retailers have been steadily adding space. Hence the travails of superstores.

Sales volumes of other items such as clothing and electrical goods have risen slightly but their prices have not, so shop takings have stagnated. At the same time, online sales have grown to about 15 per cent of retail spending in Britain. Business rates are not the cause of the pressure on retailers but they have become a convenient whipping boy.

The retailers wielding that whip believe the business rates they pay are a tax on shopkeepers and perhaps shoppers. Mostly they are wrong. Business rates offer a textbook illustration of the distinction between the formal and effective incidence of a tax — the distinction between the person who has the legal liability for payment and the person who ends up out of pocket

A property tax, like business rates, is both a tax on land and a tax on structures. But in varying proportion. A small shop in an ultra-prime London location might attract rents of up to £200 per square foot, and 90 per cent of this figure reflects the value of the land. An office block in the City of London commands £70 per square foot, of which the land might represent two-thirds. But an industrial warehouse in a depressed region could do well to recover £5 per square foot of space, almost all of which represents the cost of the building.

The Nobel Prize-winning economist William Vickrey wrote that a levy such as business rates is a combination of a good tax and a bad tax. Rents of Bond Street shops and offices in Mayfair are high because demand is high and these locations are scarce. If we tax work, or savings or beer, there is likely to be a fall in work, savings and beer consumption. But the supply of retail premises on Bond Street and office blocks in Mayfair is essentially fixed.

A tax on land values has been seen as a “good tax” since the time of the 19th century American political economist, Henry George, because it is a tax on economic rent, which has little or no distorting effect on economic decisions.

The corollary is that the main impact of business rates is on property values. If business rates in London were lower, rents and investment values of central London property would be higher. So if retailers had their way, and achieved substantial reduction in the rating burden, their joy would be shortlived: in the medium and longer term, the beneficiaries would be the owners of central London properties — real estate companies, pension funds, the Duke of Westminster and the Queen.

In less desirable locations, however, business rates are a tax on building costs rather than land values. That is Vickrey’s bad tax: an arbitrary and irrationally discriminatory tax on industrial and commercial activity.

A wholesale reform of business rates would produce large windfalls for an undeserving group. But a rebalancing between the elements of the good tax and the bad tax might make a lot of sense.

 

This article was first published in the Financial Times on October 14th, 2015.

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