Contact: Jon Pittam, ext 7400

1. Summary

1.1 The Government has published draft regulations on the new prudential system of local government capital finance and a consultation paper on local authority business growth incentives.

1.2 The following decisions are sought:

· that there are no issues raised by the draft prudential regulations that need to be brought to the attention of the Office of the Deputy Prime Minister

· to approve the response to the Government's consultation paper on local authority business growth incentives, as set out in Appendix 1, subject to the views of the Cabinet.

2. Reason

2.1 The Office of the Deputy Prime Minister has requested responses by 29 and 31 October respectively.

3. Other options considered and rejected

3.1 Not applicable.

4. Conflicts of interest declared by the decision maker or a member or officer consulted

4.1 Not applicable.

5. Dispensation granted by the Standards Committee

5.1 Not applicable.

6. Reason for the matter being dealt with if urgent

6.1 Not applicable.

Approved by: Date:

Councillor T K Thornber

Contact: Jon Pittam, ext 7400

1. Summary

1.1 The Government has published draft regulations on the new prudential system of local government capital finance and a consultation paper on local authority business growth incentives. Responses have been requested from interested parties by 29 October and 31 October respectively.

1.2 The report contains a summary of the proposals and suggested comments for submission to the Office of the Deputy Prime Minister (ODPM).

2. Draft regulations on new prudential system of local government capital finance

Background

2.1 The main aim of the regulations is to give statutory backing to the CIPFA prudential code for capital finance, requiring local authorities to have regard to the code when setting and reviewing their affordable borrowing limits. The draft code was considered by the Cabinet in April 2003 and the final version is expected to be issued during October.

2.2 The regulations replace the existing regulations in the 1989 Local Government and Housing Act and place more emphasis on proper accounting practices than the previous regulations which contained controls based on concepts which did not necessarily match those adopted in the Accounting Code of Practice for local authorities, and therefore added complexity and duplication.

2.3 The County Council had three main concerns about the capital finance clauses within the Local Government Bill. Following amendment to the Bill and on the basis of the draft regulations the position on each of the issues is as follows:

· use of reserve power by the Government to set borrowing limits for local authorities which would override their locally determined limits

- this power can only be applied to all local authorities for national economic reasons and as the current draft regulations do not cover this eventuality, the Government would have to introduce further regulations in order to impose a national limit. The Act also gives the Secretary of State the power to impose a borrowing limit by direction on an individual local authority, if for example it was ignoring or breaching the prudential code. No further regulations are required to enable this power to be invoked.

· treatment of property leases

- when the draft prudential code was published for consultation it was envisaged that the ODPM would continue by regulation to treat property leases for prudential indicator purposes, in a manner which did not follow the accounting rules for determining whether leases are on or off balance sheet. The County Council's response to the draft code was to support a simpler approach based on proper accounting practices. The ODPM appear to have accepted this argument as the draft prudential regulations do not contain any specific provisions relating to property leases. This does not mean that property leases are entirely excluded from the definition of a capital liability, but that a lease would only be included if defined in accounting terms as a finance lease. Most of the County Council's property leases would not be finance leases

· pooling of capital receipts

- the Local Government Act gives the Secretary of State powers to issue regulations relating to the use of capital receipts, but the power to pool capital receipts by requiring local authorities to pay all or part of a capital receipt to the Government is confined to land held for housing purposes. The County Council had been concerned that these powers might be framed more widely.

Commentary

2.4 The key document in enabling the County Council to develop its prudential framework for setting future capital programmes is the prudential code, which has yet to be published. The regulations have a subsidiary role and there do not appear to be any issues on which the County Council needs to make representations. Changes made to the draft Bill and to the scope of regulations affecting emergency powers, property leases and the pooling of capital receipts can be welcomed.

3. Business rate growth incentives

Background

3.1 The Government's consultation paper follows an announcement made by the Chancellor of the Exchequer in his pre-budget report last November, to consult on a proposal to allow local authorities to keep additional rates income from the creation of new businesses in their area. Powers have been included in Section 70 of the Local Government Act 2003 to enable the Government to introduce a scheme.

3.2 The consultation paper outlines two main justifications for the proposals:

· to create a positive financial incentive for local authorities to work in partnership with other agencies to maximise economic growth

· a recognition that there is a mismatch between the costs of economic development and the benefits that accrue from it. Economic development poses direct costs on local authorities, but the benefits typically accrue either to individuals or in tax terms at national level.

3.3 Subject to the outcome of the consultation the Government intends to launch a scheme allowing local authorities to retain a part of the business rate revenues collected in their area from 1 April 2005. The Government has also indicated that the scheme is intended to complement existing business rate policy by encouraging greater co-operation with business. The scheme is not intended to pre-empt findings of the wide ranging review into the balance of funding in local government finance, which was the subject of the report to the last meeting of Cabinet.

3.4 As the Government's objective is to provide all authorities with an incentive to maximise economic growth, the Government's proposals are designed to make the scheme relevant to the circumstances of all local authorities. The proposals have been developed around the following principles:

· that the incentive should apply as much to low growth as to high growth areas

· that authorities should benefit because of their relative future performance rather than relative circumstances

· that authorities should not receive benefits which are disproportionate to their size

· that the scheme should cover all local authorities responsible for economic development but not Police and Fire authorities

· that the scheme should be as intelligible and transparent as possible.

3.5 Two other guarantees have been made by the Government:

· that no business will pay more in business rates as a result of the introduction of this scheme

· that the revenue available directly to local authorities will be additional revenue, as there will be no compensating reduction in the spending totals set in the 2002 spending review, and that the revenues will not be ring-fenced.

3.6 Having outlined the principles, the rest of the consultation paper deals with the practicalities of setting baselines for growth in business rates for individual billing authorities above which some or all of the increase would be retained by the local authority. Five options are exemplified all of which rely on the assumption that past increases (over the last eight years) are the best available measure of the scope for future increases in business rateable value, based at one extreme on a national average, at the other extreme on the individual authority's historic trend with three other options based on regional or sub-regional trends or groupings of authorities based on past historic trends. The consultation paper favours the latter two approaches, but invites comments from local authorities.

3.7 However in order to maximise the number of authorities that might benefit from the scheme, it is also suggested that a floor might be set at level below the baseline increase and in order to avoid any authority deriving a disproportionate benefit, a ceiling might also be imposed on gains. A link is then drawn between the level at which any floor or ceiling is set and that of the scaling factor - the percentage of any increase in business rateable value that is retained locally rather than paid into the national pool. This is on the basis that with a low floor in which most authorities would obtain some benefit, the scaling factor would need to be set at a lower level or vice versa. The proposed ceilings suggested are expressed in relation to formula spending share (FSS), with the suggestion that over the first three years of the scheme, no authority should be able to obtain an increase in locally retained business rates of more than 1% of FSS per annum, so that in Year 3 the ceiling would be 3% of FSS. Nationally, 3% of FSS represents about £1.6bn and the Government in publicising these proposals estimated that authorities could gain up to £1bn over the next three years, based on historical data.

3.8 The Government also recognises that to achieve its objectives it would be necessary to eliminate the effects of revaluation and business rate appeals from the data on which the system would operate. Adjustments would also need to be made for the effect of empty properties in order to avoid a perverse incentive in favour of new building as opposed to the reoccupation of empty property. As a result the calculation of the increase in business rateable value for the purposes of the incentive scheme will be divorced from the actual increase in rateable value for collection purposes.

3.9 A final consideration is how any locally retained business rate revenues should be shared between tiers, where unitary authorities are not in place - three options are suggested:

· based on relative FSS shares - approximately 85% to County Councils, 15% to District Councils

· based on relative levels of economic development spending, which would apparently reverse the proportions to 85% District Councils, 15% Shire Counties

· a compromise 50 : 50 split.

Commentary

3.10 In principle the County Council is supportive of any proposal to give local authorities direct access to business rate revenues and widen the local taxbase beyond the existing council taxbase. The Government's proposal is also a compromise between providing local authorities with the prospect of raising some revenue from business rates, while at the same time overcoming the political objection of business interests to the Government's earlier proposal to legislate to introduce a supplementary local business rate. However there are a number of reservations about these proposals:

· the scheme could be introduced either within the context of the existing national business rate or within the context of a local business rate subject to equalisation through the revenue support grant system. However it seems likely that some of the technical issues associated with the incentive scheme would be affected by the localisation of the business rate. The Government's intention of introducing the scheme from 1 April 2005 would appear to indicate that no change in the status of the business rate is currently contemplated by the Government pre-empting the balance of funding review. The County Council might wish to argue that the top priority should be to establish a means of returning the business rate to local control

· though the Government has stated that any business rate revenue retained locally would represent additional local authority spending power, this guarantee has no meaning beyond the current spending review period ending in 2005/06. In the longer term the effect could be purely distributional with some authorities gaining and others losing

· the calculation of baselines, the adjustments to rateable value and the use of floors and ceilings transfers some of the complexity of the current grant system to the incentive scheme, but as a means of distributing much smaller sums to local authorities. The scheme is not obviously transparent and intelligible.

3.11 Though the Government argue that part of the justification for a business rate incentive scheme is to compensate local authorities for the costs associated with economic development, this argument does not appear to have been given much priority in developing the proposals. Much more emphasis has been paid on the need to provide all local authorities with a financial incentive to promote economic development within their areas. Even if it is accepted that such an incentive is needed, the costs associated with development are likely to be greater in areas of high growth compared with areas which have experienced economic decline and may have significant levels of unemployment, low levels of congestion and surplus housing stock. This suggests that the scheme should be constructed so as to focus on the needs of authorities experiencing high levels of economic development and that the argument for a floor to offer access to business rate revenues to areas with relatively low levels of economic development is questionable.

3.12 On the issue of how any access to business rate revenues should be shared between tiers, if the Government intend to set a ceiling based on a percentage of FSS, then it would be logical to distribute revenue between tiers on the basis of FSS. A basis which resulted in a substantial share of the revenue being retained by District Councils would result in the ceiling quickly being reached and little of any additional revenue being retained locally. It would also run counter to the principle that authorities should not receive benefits which are disproportionate to their size.

3.13 The Government have included a number of specific questions in the consultation paper. A suggested response is included in Appendix 1, based on this report, subject to the views of the Cabinet.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

Appendix 1

Response to local authority business growth incentives consultation questions

1. Do you agree with the principles for the scheme?

1.1 The County Council supports the principle of widening the local authority taxbase by giving local authorities direct access to business rate revenues. It also recognises that the proposal represents a compromise, giving local authorities the prospect of raising some revenue from business rates, while acknowledging business concerns about removing the current cap on business rates provided by the link with the retail price index.

1.2 Nonetheless the County Council has major reservations about the proposals in the consultation paper:

· the scheme could operate either within the current national business rate framework or within the context of a localised business rate equalised through the revenue support grant system. However the approach to a number of the technical issues associated with the scheme would be different, and the proposal to introduce the scheme from 1 April 2005 therefore appears to presuppose that the business rate will remain a national tax in the foreseeable future. The County Council therefore considers that this proposal pre-empts the findings of the balance of funding review and believes that the priority should be to establish a means of returning the business rate to local control

· the promise that any business rate revenues retained by local authorities will be additional rather than in substitution for Government support is unverifiable beyond the period of current Government spending plans, ending in 2005/06. In the medium term, the effect of this proposal could be purely distributional between local authorities

· the proposed scheme mirrors many of the complexities of the current grant system as a means of distributing much smaller sums to local authorities. The scheme is not obviously transparent and intelligible.

1.3 The County Council is also concerned that the scheme gives too much weight to providing incentives to local authorities to maximise economic growth and insufficient weight to the impact upon local authorities' costs of economic development. More emphasis should be placed on the costs imposed by relatively high rates of economic growth in determining how business rate revenues should be shared.

2. Do you agree with using an eight year period for setting the trend?

2.1 As indicated in the response to the previous question (paragraph 1.3), the County Council has doubts about the principle of setting a baseline designed to provide incentives for all local authorities, rather than to give more recognition to the costs incurred by local authorities with high rates of economic growth. Irrespective of this issue of principle, it is questionable how far past trends are a guide to future potential for business rate growth, which at the local level may be much more influenced by strategic land use policies for the area, which may change over time.

3. Are there models for setting the baseline that the Government has not considered that need to be considered?

3.1 Within the limitations of the methodology, the five options exemplified cover the alternatives.

4. Which of the baseline models is your preferred option and why?

4.1 If the principle is to focus on providing incentives to all local authorities to maximise economic growth, the sub-regional model is the preferred model, as it places less emphasis on the historic rate of growth in the individual local authority area, which seems the least reliable basis for assessing future potential for business rate growth.

4.2 However in order to recognise the impact of high rates of economic growth on local authority costs, the national model would be preferable. In order to recognise both objectives, a combination of the national and sub-regional models, would be preferred.

4.3 Note for Cabinet report - the consultation paper suggests that the Government favours either the national historic growth or sub-regional models. The sub-regional model favours the Hampshire area - producing a lower baseline in 9 of the 11 district council areas. A combination of the national and sub-regional models produces gainers and losers at district level, but at County Council level would probably be slightly advantageous as compared with the sub-regional model.

5. Which of the two preferred options for floors and scaling factors do you think provide the best balance between financial support and financial incentive?

5.1 Of the two options, a high floor and high scaling factor best recognise that impact of high economic growth on local authority costs.

6. Do you agree with using formula spending shares as the measure for determining ceilings? Do you agree that a 1% ceiling in year one of the scheme rising in line with the scheme (ie reaching 3% in Year 3) provides an adequate balance of incentive and cap on gains?

6.1 Using formula spending shares as the basis for any ceiling seems reasonable. Given the uncertainties about the methodology, the ceilings proposed are realistic ones for the initial period of the scheme, but should be reviewed in the light of experience in operating the scheme.

7. How do you think benefits should be shared between tiers of local government?

7.1 Benefits should be shared between tiers in relation to formula spending shares. This conforms with the principle that local authorities should not receive benefits from the scheme that are out of proportion with their size. The alternative bases proposed would also not operate effectively alongside ceilings based on formula spending shares.

8. Would you like to volunteer to be part of the administrative dry run?

8.1 Though the consultation paper does not say so, the implication is that this invitation is to billing authorities to volunteer.