More Enterprise Zones

The government has announced the location of four new enterprise zones in Birmingham, Bristol, Leeds and Sheffield. So this seems a useful moment to revisit some of the concerns I raised when the decision to create EZ's was announced in the March 2011 budget.

Enterprise Zones will offer firms five year rebates on business rates, planning regulations will be simplified, Local Authorities will be able to keep business rate growth and government will ensure superfast broadband is available. To understand the impact it’s useful to distinguish between the effect on “UK plc” (i.e. national employment and growth) and what happens in the Enterprise Zone.

In areas with strong economies, planning certainly acts as a break on business expansion and development and Local Authorities often have few incentives to allow more development. EZ type reforms would help encourage growth in these areas. Some of this growth would come at the expense of other areas in the UK, but much of it could be additional. Overall, we might reasonably expect both local and national employment and growth to increase.

But EZ’s make these changes in areas with weak economies (or in the parts of OK performing areas that businesses don't want to locate in). Misguided local planning policies may not be helping in these areas but the fundamental problem is that these are unproductive places for business investment. Five year rebates on business rates and relaxed planning regimes attempt to offset these disadvantages for businesses. But they don’t address the fundamental problems such as the educational level of the local labour force or the fact that a centre city site is inappropriate for business needs. If EZs allow new development on an appropriate site that has hitherto been undeveloped in an area which is doing OK, these concerns would be mitigated. [This new development / redevelopment trade-off lies at the heart of my main concerns over the new national planning framework]

The evidence on whether this has any effect on local employment is, at best, mixed. Even if it does it is highly likely that much of this growth would come at the expense of other areas in the UK (p.24 of this SERC policy paper provides more detailed discussion). Overall we might hope for some small impact on local employment but should expect little, if any, impact on national employment and growth.

There are many reasons to think that the current planning system acts as a break on growth. Unfortunately, reform in local zones does little to treat this problem and it is hard to see this having much, if any, impact on total growth. In the current climate, spending money (or equivalently forgoing taxes) to shuffle employment around the country may not be the wisest use of funds.

[This is an update version of my post from 23 March 2011]

National Planning

The government published its draft National Planning Policy Framework on Monday. As with the announcement on business rate retention there has been little public debate. In turn, some of that debate has been plain silly - a complaint that I made about earlier contributions but that applies equally to reactions to the publication of the draft. In particular I would highlight the national trusts' fantastic before and after pictures (which made me wonder if we were reading the same document). The lack of serious debate is unfortunate, however, because these reforms are important and will have implications for economic growth and the environment for many years to come.

Setting aside the details, I think that the draft gets some big issues right, some wrong. Minor caveats aside, I support the presumption in favour of sustainable development. It cannot possibly be right that local bureaucrats and politicians get to say yes or no to development on a case-by-case basis. Instead, the presumption means that they have to say yes to things that are consistent with their local plan. Many other countries successfully run systems that are (at least) this permissive. But if, as this government does, you believe in localism then you have to give people a strong say in the development of their local plan to make the 'presumption' consistent with localism. The draft framework does this and again, caveats aside, I think this is a good idea. Finally, the government recognise that local authorities will need to be given incentives to agree to new development and have introduced a range of measures to provide these incentives. Whether these incentives will be large enough in practice is still open to debate, but I support the general principle.

So much for the positives, what about the things it gets wrong? I think a fundamental problem is that the planning framework is backward not forward looking. We have a growing population and changing industrial structure and yet the draft framework works to limit us to living and working within an urban footprint that we inherited from the 1940s (if not before). This is particularly evident in terms of policy towards the Greenbelt. Towns expand in to cities by building on countryside and merging with outlying towns and villages. We are told that the Greenbelt policy is specifically intended to prevent this. In other words, the urban system we have now is what we have to work with. This severly hampers the ability of our set of cities to adjust to fundamental structural changes. It assumes that growing cities can expand by recycling old land, but many of the places that have strong growth potential are not existing cities, but larger towns. In short it makes the planning system about redevelopment more than new development. I understand the politics behind this (c.f. the natural trust) but the restrictions come at a cost in terms of economic growth.

The other area where the framework is more backward than forward looking is in its approach to retail. Specifically, the government has decided to place a strong emphasis on town centre first policies. As regular readers will now, evidence suggests that these restrictions imposes substantial costs on households in terms of higher shopping bills. They also have the unintended consequence of creating more clone towns (as chains forced downtown drive out smaller retailers). Sequential needs tests then further limit competition with adverse impacts on employment and the cost of living. As with restrictions on Greenbelt development, these restrictions are also based on a 'zero sum' assumption - if we restrict out of town development than we will automatically get town centre development. But 20 years from now isn't it likely that the internet will fundamentally change the way we shop? Why shouldn't these restrictions on out of town developments hasten the move towards online shopping? Indeed, it is clear that this is already playing a role in what is happening in the high street. Overall, town centre first policies have costs as well as benefits and are based on a (possibly) outdated retail model. As I said, this feels more backward than forward looking and, once again, makes the planning system about redevelopment more than new development.

Overall then, pluses and minuses, and much to debate over the coming months (the consultation closes in October).

Summer Blogging

It appears that summer has finally arrived (at least briefly). With many colleagues away, and fewer policy announcements, we'll be blogging less frequently over the next weeks (we'll probably post two to three times a week).

We will continue to blog on relevant news and policy announcements. For example, we should have something on the national planning policy framework (assuming that the publication of Greg Clark's forward signals its imminent arrival). And we'll continue to provide links to previous blogs that are relevant for current stories. For example, here's some thoughts on the likely economic impacts of John Lewis' new town centre store format. Finally, we also have some pieces lined up with further thoughts on business rate retention, high speed rail and the impact of the Olympics (drawing on our work on Wembley and Emirates Stadium).

So please continue to check for posts and remember that you can keep up-to-date with our activities by following us on twitter (@lse_serc).

Extreme localism: local taxes and tax competition

Posted by Dr. Teemu Lyytikäinen, SERC

The government’s consultation on Local Government Finance leaves many details still to be determined. But there is one thing the document is very clear on: the government has no intention of allowing councils to set their own business tax rates. Why might that be?

It’s partly political. Localising business rates was in the Lib Dem manifesto, and both Nick Clegg and Vince Cable pushed strongly for it earlier this year. However, the Treasury and Eric Pickles apparently weren’t so keen – and neither were many business groups. The Coalition compromised on retention. And while this has been pushed as ‘setting Councils free’, the reality is that they could be much freer.

The bigger issue is that it’s not clear what the effects of full localisation would be. There are two main fears. The first is that some councils would set very high tax rates and waste the revenues on useless programmes and bureaucracy. The second fear is of the opposite scenario – local authorities undercut their competitors, with ‘tax competition’ producing a race to the bottom.

Let’s consider the evidence. Tax competition should show up in positive relationships between tax rates in neighbouring areas, results confirmed in a lot of empirical studies. But measuring these interaction effects robustly isn’t easy. Some recent SERC research [pdf] manages to do so using recent Finnish experience. Specifically, I isolate the causal impact of neighbours’ taxes (as distinct from confounding factors) by looking at responses of municipalities to forced property tax rate changes in their neighbourhood. Unlike previous studies, I find the average effect of a change in neighbours’ tax rates is close to zero.

The Finnish system may partly explain this – all local areas set taxes, but central Government takes a share of the cash to give to poorer areas. For councils that dampens incentives to outcompete the neighbours via tax cuts. (This incentive/equity trade-off will be central to the main debate about local finance reform.)

If localisation plus equalisation avoids tax competition, then some worries about a race to the bottom are groundless. But it still leaves substantial variation in local taxes – and thus, the lack of certainty the business community worry about.

And we still can’t rule out more subtle forms of tax competition. The results may mask a situation where neighbours with similar socio-economic characteristics could engage in a race to the bottom while tax rates could diverge in dissimilar neighbours. For example, two areas with low demand for social care could keep cutting taxes (and services); a high-demand neighbour receives more social care cases and has to raise its taxes even further. The resulting misallocation of resources across authorities is a big efficiency loss.

That still leaves us with the high tax and spend scenario. My research with SERC colleagues suggests this may not have been a major issue in the recent past (because councils appear to have spent increases in central grants on things that home buyers value) but it was a major worry in the years before that.

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PS: For those of you interested in methodological issues: my research applies the standard spatial econometrics methods on the Finnish data and compares the findings with our more robust policy change based estimates. This comparison suggests that the standard methods are not to be trusted. More SERC thoughts on the pros and cons of spatial econometrics are here.

The law of unintended consequences: business rate retention and house prices

Posted by Dr Christian Hilber, LSE and SERC

Most analysis of Monday’s local government finance proposals has focused on the shiny new stuff – retained business rates and Tax Increment Financing (TIF) – and the winners and losers reform might create. That’s not surprising. But it’s also not the whole story. Changes to business rates are also likely to affect local house prices – in ways that are actively unhelpful for Ministers’ housebuilding agenda.

Imagine a country where local government gets most of its funding from central government. There are two local areas, A and B, which are identical and receive the same amount of money. Now imagine that for some reason Ministers decide to double A’s cash. A can either improve local service quality, invest in infrastructure, or decrease local taxes. In each case, A becomes more desirable than B and demand for housing rises. If there are planning constraints, house prices in A go up.

SERC colleagues and I test this empirically for England, using council grant data for 2001 – 2008. (Our paper’s just been published here.) We exploit the fact that grant settlements sometimes change for reasons other than local need. We find that changes in grants are largely capitalised into local house price changes.

To see what business rate retention might do, repeat the thought experiment with a couple of changes. Ministers are essentially gifting some local areas with more money by allowing them to retain the local business tax take. Even if no local authority is directly worse off from this change – as Nick Clegg has promised – some areas will be better off than others.

For better-off councils, that translates into better services or lower taxes. That makes the winners more attractive places to live in – putting upward pressure on house prices and rents.

In turn, that creates further winners and losers. In ‘winning’ areas local property owners (homeowners and landlords) are better off as the value of their assets rises. Renters enjoy better local services and/or lower local taxes but they will have to pay for these via higher rents. Overall, therefore, there is no effect on renters – unless, as seems likely, many are frustrated would-be homeowners. Immobile would-be-homeowners are likely the main losers among the group of current renters. For renters with an attachment to their place of residence, owner-occupation becomes even less affordable. Also, some immobile renters may not value the improved services but they may still need to pay for them via increased rents. Other losers will be the property owners in the ‘losing’ areas as the value of their assets will decline.

In theory, developers should step in to build more houses in the ‘winning areas’. But there are obvious reasons for local homeowners to resist new development – not least since the value of their homes partly depends on relative scarcity. The political power of NIMBYs and BANANAs on local councils can be very strong.

To sum up – localising business rates creates an incentive for local authorities to approve commercial developments. This is desirable in itself. But it also produces a disincentive effect on residential development, via house price shifts.

So the interaction with planning rules and incentives is crucial. The last government’s reliance on top-down targets was ineffectual in increasing housing supply. However, the Coalition’s New Homes Bonus also seems too weak to generate any significant positive effects on the supply side.

So while there are many reasons to cheer moves to give councils more financial freedom, the unintended consequences could make the UK’s housing supply shortage even worse. This Autumn’s Local Government Finance Bill needs to make sure business rate reform and TIF properly joins up with the wider package of growth incentives. Doubling or even tripling the size of the New Homes Bonus and making it permanent, as the Centre for Cities recommends, would be one helpful step.

Minister for Cities

The government have announced the appointment of Greg Clark as Minister for Cities. Here are some thoughts on the issues and my suggestions for priorities in terms of economic growth.

There is no clear evidence of a direct link between decentralisation to local government and improved economic outcomes. Passing powers to city leaders limits central government’s ability to affect urban economic performance. The coalition’s approach to this is to combine decentralisation with incentives for growth. Fundamentally, if we want successful cities to grow the balance between decentralisation and pro-growth incentives has to be right. Here are some suggestions for priority areas for the new minister to think about this balance and the wider policy issues.

Planning: As recognised in the local growth review, in many areas the current planning rules work to constrain development. Ministers aim to tackle these issues with a presumption in favour of sustainable development, incentives for councils to adopt pro-growth planning frameworks, dropping brownfield targets and piloting land auctions. However, the extent to which these changes will be successful is not yet known.

Housing: Planning also affects the supply and cost of housing. Regional plans tried to force local areas to build more housing. The Coalition favours decentralisation, coupled with incentives. But, giving residents more say in planning (e.g. through neighbourhood plans) may reinforce anti-development tendencies. There is, as yet, little evidence on whether New Homes Bonus-type incentives will be sufficient to outweigh them.

Local Government Finance: The structure of local government finance provides a further barrier to development. The government is trying to address this through the New Homes Bonus, TIF, changes to business rates and a review of local government finance. It is unclear whether these changes will remove the fiscal disincentives – and the electoral disincentives remain large.

Education and Skills: There is strong evidence that more skilled cities grow faster, so to be successful cities need to be able to attract or educate and retain skilled workers. Cities also house a disproportionate share of poor families, placing considerable stress on urban school systems. The interplay between education, skills and success raises crucial policy questions for cities.

Innovation: An important driver of cities’ long term economic development but the minister should be very sceptical about calls for local innovation policy. Instead, focus on other policy areas (e.g. the supply of skills and business premises) that may be indirectly limiting innovation.

Transport: Growing cities need to invest in transport and to consider other ways to limit congestion, particularly through the introduction of charging. This raises questions about the appropriate governance arrangements for transport policy.

Decentralisation from central to local government has the potential to help city leaders raise urban economic performance, and help their citizens improve economic wellbeing. Decentralisation also raises important questions for central government – which needs to set frameworks and incentives that will help cities drive future economic growth in the UK. I've highlighted a few areas where the minister might like to start working.

Business Rate Retention: Growth vs Equity

The government has launched its consultation on allowing local authorities to retain business rates. The problem: Commercial development imposes costs on local authorities (to provide services to businesses) and to local homeowners, while the benefits are spread more widely. In other words, commercial development generates benefits for others (externalities) that are ignored when making decisions on whether to allow development. This means that local government will tend not to provide enough sites for businesses. The obvious solution (if you believe in decentralised decision making) is to allow local authorities to retain some of their business rates. This will provide better incentives. But these incentives come at a cost - some councils where the business base doesn't grow will be worse off than they would be under a system which redistributes all business rate growth.

Before introducing such a change, it's important to know if these disincentive effects matter. Research by my SERC colleagues Paul Cheshire and Christian Hilber show that they do - when business rates were centralised this reduced the supply of land for commercial development.

So, in principle, business rate retention could help. Whether it will depends on the details. Two broad points to note. First, this is not a return to the old system where local authorities set rates (look at for a post on that thorny issue by my colleague Teemu Lyytikainen later in the week). Second, it's also part of a wider set of reforms, so assessing the effect of this one change will be difficult. Now to some details:

1) Baseline: The government will use the current formula to establish the baseline, so there are no winners and losers at the start. After that, however, the government will need to decide whether the base grows as described in the spending review (which has the benefit of providing certainty on the retention of business rates) or whether the funding formula should be tweaked over the spending review period (presumably with a view to giving more certainty on total revenues, while increasing the uncertainty on how much business rate would actually be retained)

2) Redistribution: The government will introduce tariffs and top-ups to ensure that the redistribution embedded in the baseline continues (while allowing for unevenness to develop as a result of retention). There are a couple of ways to do this one of which offers stronger growth incentives than the other.

3) Incentives: Depending on the details of (1) and (2) local authorities will retain some business rate growth providing an incentive to work better with businesses. However, they will not retain all growth because the government will impose 'levies'. The government suggests a few different options for how they might do this. The bottom line, however, is that the higher the share retained the bigger the growth incentive. Centre for Cities have some analysis which suggests this figure should be between 40-60%. That is a starting point but, in truth, I don't think anyone has good evidence on what should be the share retained.

4) Using the levy: The money raised from the levy could be used to cushion big shocks or to protect those councils that can't achieve growth. The problem with the latter, as the consultation acknowledges is that it limits the incentive effect of the changes.

5) Revaluation: One way for a local authority to increase business rate retention is actually to restrict supply and raise prices. The government wants to avoid this by redistributing all of the proceeds from revaluation so that the incentive only comes from growth as a result of new development. I think this is problematic because it conflicts with the idea that the scheme is about the wider relationship between local authorities and business. Things that local authorities do to provide better business infrastructure, e.g. through TIF, could easily be capitalised in to prices. This way of dealing with devaluation removes the incentives to do this. More thought needed on this one.

6) Reset: The government will periodically reset the system. This has huge implications for how strong are the growth effects. I don't think we have strong evidence on what would work best although full resets on a non-fixed basis would weaken incentives and appear to create incredible uncertainty for local authorities trying to make long run decisions. That leans the argument towards fixed term, partial resets. But do not believe anyone that says that we, as yet, have clear evidence on the best thing to do on this question.

7) Pooling: Local authorities would be allowed to pool resources under the new system. In keeping with the government's decentralisation agenda, all pooling would have to be voluntary. This is another difficult area, where the uneven distribution of commercial development across local authorities in the same broad geographic area could make for some very difficult negotiations.

The consultation provides more details on each of these points as well as how this will interact with other policies (e.g the new homes bonus). Some thoughts on those will have to wait for another day.

Overall, I think the tradeoffs are increasingly clear - the scheme will give incentives for growth at the cost of some equality in funding across councils. The opposition are calling for the government to ensure that 'no council will be worse off' under the new scheme. I can't see the proposal being able to deliver that in either absolute or relative terms. However, for reasons that I have discussed before, I think this is the wrong equity question. In the end, we care about people and the assessment of the fairness of this depends on how it will affect individuals. It's clear that there will be winners and losers but it is way too simplistic to imply that all the losers will be in council areas that 'lose' (what about those who can commute to new jobs created in neighbouring LAs) nor will all the winners by in council areas that 'win' (what about homeowners near unwanted new commercial development). Don't expect constituency based politicians to see it this way ...