​Will setting tax rates locally help to drive economic growth?

17th October, 2017

In its ongoing discussions about business rates devolution, the Government is exploring the possibility of allowing local authorities to set their own rates. This would probably be a popular move among local leaders – the latest DCLG consultation on the subject reported that a significant number of local authorities were in favour of being granted powers to reduce the business rates in their areas, in order to gain more flexibility and encourage growth locally. But what impact might this have for local economic growth – and what issues might it raise?

While the What Works Centre for Local Economic Growth has not looked at the economic impact of setting taxation at the local level, it has looked at the impact of policies that offer local tax breaks, such as enterprise zones. Lessons can be drawn from these findings to help guide the localisation of the business rates multiplier.

The evidence found by the What Works Centre shows that enterprise zones can have a positive impact on both boosting employment and addressing unemployment inside the area they cover: out of 27 studies looking at the impact of enterprise zones on employment, 15 found a positive impact of enterprise zones, while seven out of nine studies looking at unemployment also found a positive impact. However, evidence of their impact on poverty and wages was mixed, with half the studies investigating this issue finding a positive impact.

What’s missing from the existing studies is an assessment of the impact of the specific characteristics of different types of enterprise zones. For instance some enterprise zones in the US and France only offer tax rebates on the basis that businesses hire a certain proportion of staff locally; but as there is no counterfactual (i.e. another similar area where firms would not have specific hiring requirements), there is no way to assess the influence of this precise characteristic on the overall success of the programme.

There are also potential risks associated with place-based tax rebates, although they are not fully understood. One major concern is displacement. Are enterprise zones successful at creating new activity, or do they simply attract nearby companies, at the expense of those surrounding areas that do not benefit from the programme? Research seems to suggest that displacement effects are indeed common, meaning that the headline impacts of enterprise zones must be treated with caution.

Overall this suggests that local tax rebates can have a positive impact locally, but the exact reasons for their success and wider impact are not entirely clear.

Coming back to the current debate on business rates, this suggests that allowing local authorities to reduce the business rates multiplier could be investigated and implemented as a way to foster economic growth, but this would need to take into account a number of potential issues:

  1. There is a risk of job displacement between local authorities, with potential effects on neighbouring areas. Making sure there are specific safeguards to ensure good policy coordination (for instance, a limit on the multiplier reduction, a cross-authority pooling of revenues, etc.) will be critical.
  2. Rates reduction should be implemented under a strict assessment process, laying out clear objectives and risks. Local authorities are unlikely to provide the level of tax reduction that enterprise zones do, and in some areas a business rates rebate might be too modest to have a substantial impact of the economy, but large enough too significantly erode local revenues.

Ultimately, the effect of any fiscal incentive is unlikely to be significant, especially if applied in sluggish economies. The reason why some areas are less attractive to firms relates to their local characteristics, such as the level of skills of their population and the quality of their infrastructure. Although fiscal incentives can act as an “extra push”, they do not tackle the core issues that must be addressed to make places more prosperous, and should not be considered as the Alpha and Omega for local economic growth.

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