Is it time for a business rates revolution?

Higher business rates are threatening the survival of small businesses and sparkingcalls for wholesale reform of property taxes. Simon Wilson reports.

What are business rates?

They are the commercial equivalent of council tax. They are calculated as a proportion of the rent (or "rateable value") that could be charged on a property, as assessed by the Valuation Office Agency. The current system of business rates was established in 1990, when the Thatcher government stripped councils of the power to set levies and gave it to the Treasury. Thatcher's attempt to overhaul the system of domestic rates ended badly (not least for her) and the troublesome poll tax was swiftly junked by her successor, John Major.

By contrast, Thatcher's reform of business rates has survived more or less unscathed and today rates paid by the UK's 1.9 million commercial properties bring in about £26bn a year (compared with £43bn in corporation tax), or around 5% of the overall tax take. Many think it's time for reform.

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Why's that?

Because many businesses especially smaller ones, and retailers situated in prosperous cities and well-off smaller towns where rents have surged regard the current system as horribly unfair. The fundamental issue is that the tax is based on rental values, not on a business's income or profits. In one way that makes it a "good" tax: it's relatively easy to assess and hard to avoid. On the other hand, the system has led to imbalances in how much is paid by different sectors.

Retailers and factories are relative losers from the system: they pay around 40% of business rates, despite accounting for about 17% of national economic output, according to Philip Aldrick in The Times. That's because retailers tend to need prime locations in town centres, while manufacturers need high-spec, valuable buildings in which to make stuff.

Who are the winners?

One sector that does quite nicely is professional services firms, such as banks and accountants. They account for a hefty 16.6% of the economy, but pay 12.7% of the business levy. But even more striking, say critics, is the way in which the business rates system conceived in the pre-internet age today hands a huge and unfair advantage to internet businesses, who locate their warehouses in cheap, out-of-town areas and thus pay little in rates.

These are basic injustices, say critics such as the CBI and the Federation of Small Businesses and the situation will only be made worse by "outrageous" changes due to take effect from April. Business rates are not being reformed, and on average they are not being increased: the government's overall take will remain fixed in real terms. But the basis on which they are being calculated is being updated from 2008 property values to 2015 values and many think that's having extremely unfair results.

Why are the changes controversial?

For some businesses, in parts of the country where property values have risen more slowly than the average, it's great news. The revaluation (and doubling of the threshold at which the levy kicks in, to a rateable value of £12,000) means that shops on struggling high streets in northern England and Wales will get a boost. The government says that, overall, bills for 75% of ratepayers (which include buildings such as schools, hospitals, and so on, as well as shops and businesses) will pay the same or less. But the other quarter mostly in the richer south-east of England face massive leaps (up to 400% in some cases, though capped at 42% in the first year), which in some cases could push them over the edge.

Who might suffer?

The town destined to be worst affected is Southwold in Suffolk, says Oliver Shah in The Sunday Times, where business rates are set to surge 177% on average. But many affluent towns and cities face daunting rises, made worse by the fact that George Osborne postponed the revaluation so that it didn't kick in just before the 2015 general election. Many hospitals and universities will also face steep rises in bills, whereas Amazon is set for a tax cut of £148,000 across its nine centres, according to CVS, a consultancy.

The novelist Jeanette Winterson, who owns Verde's, an upmarket deli in London's Spitalfields area, says her shop will have to close after its rateable value jumps from £21,500 to £54,000. She has made a plea for the government to freeze the rise and reform the system. "Make no mistake: the character of London will change irrevocably," she argues in the Financial Times. "Once small businesses and local pubs are gone, they will not return. This is species wipeout."

Is this just whingeing by the rich?

Winterson's deli is no more deserving of compassion than a struggling insurance outfit in the West Midlands that is looking forward to paying much less. But the anger against business rates is not simply "self-serving whingeing", says Paul Johnson of the Institute for Fiscal Studies in the Financial Times.

The system hits some sorts of business harder than others. It distorts investment and economic activity away from property-intensive businesses and cuts incentives to improve properties. It is the occupier, not the owner, who bears the cost of any increase (at least in the short term). And increasing the levy by almost half overnight is an unacceptable shock to impose.

How to reform the tax

The simplest overhaul would involve much more frequentrevaluations and a shift to a straightforward land valuetax for business (including agricultural) property. In theshort term the chancellor, Philip Hammond, will probablyend up inventing various reliefs to quell the anger of smallbusinesses worst affected.

In the longer term, though, amore nuanced reform is needed, says Nils Pratley inThe Guardian one that takes into account regionalvariations in prosperity, but also reflects changes inthe make-up of the economy. A "purely property-basedapproach will only continue to create more distortions anddeepen resentment".