Thursday, 17 January 2013

Q. Businesses will go bankrupt

• Businesses which use lots of land would go out of business and/or move abroad (skip to article)
• Businesses need to own valuable land to use as security for borrowing (skip to article)
• Business rates are killing the High Street (skip to article)
• Retailers will push up prices (skip to article)
• The construction industry will be hardest hit (skip to article)
• FOOTNOTE: The rent-setting process (skip to article)

1. "Businesses which use lots of land will go out of business and/or move abroad"

a) This is nonsense on the facts, because the tax system suggested here would leave Business Rates (quasi-LVT) pretty much unchanged for the time being, the total collected would remain at approx. £28 billion a year, and taxes on business activity (around £400 billion) would be halved, from a marginal rate of over 50% (average overall rate 40%) down to a flat 20%. So no business (taking investors and employees together) would end up paying more tax.

b) According to the Generalised Land Use Database, about seven times as much land is used for private homes and gardens as it used for commercial premises. So we would expect the tax collected from residential land (£200 billion a year) to be about seven times as much as tax collected from commercially used land (£28 billion a year). Oh... it is. So that seems neutral as between land used for residential or commercial purposes, to the extent that there is a clear dividing line, which there isn't - what about shops at street level with flats above?

c) So under the halfway house tax system suggested here, with equal amounts collected from land values and from earnings, business activity comes out miles ahead. Under a full-on LVT-only tax system, the total tax collected from businesses would fall to negligible amounts. And that's even ignoring the fact that landowners pay the tax and it does not increase the effective cost on businesses.

d) How do we know this? Because there have been plenty of empirical studies which show that for every £1 reduction in Business Rates in Enterprise Zones, rents went up by £1 so the tenant ended up paying the same total amount.

e) "Ah yes," the crowd shouts, "But businesses which own their own premises, for them a £1 cut in Business Rates is a £1 gain."

Indeed yes, but it is still better to reduce the taxes on their actual trading profits and wages, which rewards good businesses, than to reduce a static tax which rewards good and bad businesses alike.

However high the Business Rates is, it is always a lot lower than the rent the owner could get by simply renting out his premises. So if there is a marginal business which struggles to make enough money to pay the Business Rates, then the owner has nothing to complain about - he can make himself better off by shutting up shop and renting out his premises to another business. Any business willing and able to pay the rent and rates will by definition, be a better one that the previous one.

f) As per usual, the opponent also miserably fails to distinguish between area and value of land.

Commercially used land can be roughly categorised into i. high value city centre land, used for retail or entertainment outlets and offices, and ii. lower value out-of-town industrial estates and factories. The rental value of the high value categories is hundreds of times as high as for the latter, so the rental value of a hundred acre site for a factory at the edge or town is still probably lower than for an office block in the centre of town.

g) If it were true that businesses flee areas with high rents (i.e. high rents plus Business Rates), why is it that high rent areas are full of businesses? All the high value retail and service businesses in town centres paying high rents could save themselves a fortune by relocating to the middle of nowhere, but they don't, because they'd have no customers and struggle to find employees. So there is no reason to assume that they'd flee from high tax to low tax areas either.

2. "Businesses need to own valuable land to use as security for borrowing"

a) Borrowing is not the best source of finance for businesses. The best is profits which are built up and reinvested, the next best is people prepared to put their own money in and take the risks and rewards by subscribing for shares.

b) Where does this leave our new business? Do we expect the bank to say "We'd love to lend you money, but first of all you have to divert huge amounts of profit into buying over-priced land out of over-taxed income and paying us a shed load of interest. Then after ten or twenty years, if you're still going and you've made a windfall gain on the land you bought, then we'll be happy to lend you money"?

c) Using land as security is only relevant for businesses which have stopped growing. If they were still growing organically, they'd be able to finance that from reinvested profits. If a marginal or failing business which owns lots of land ends up having to borrow from the bank to stay afloat, it would probably better to pull the shutters down sooner rather than later and just become a landlord.

3. "Business Rates are killing the High Street"

No they are not.

Not one single office or shop is standing vacant because of Business Rates, they are standing vacant because landlords refuse to reduce their rents. Or because landlords can't be bothered getting tenants in and would rather speculate on rising selling prices, so they allow their premises to fall derelict and claim empty rates relief.

Turning LVT into Business Rates would sort out both those negatives overnight.

And I am perfectly aware that there is a well-organised and well-financed campaign underway to have Business Rates reduced. Instead of using the Poor Widow as their human shield, they use the Small Independent Local Retailer: "Boo hoo! The small local shopkeepers are under pressure from the evil government intent on robbing their hard earned AND from the wicked giant out-of-town shopping centres. The High Street is dying! We must do something!".

Boo hoo indeed. Don't forget that giant out-of-town shopping centres are also liable to Business Rates. The huge great commercial landlords who own these centres stand to gain millions of pounds for every hundred pounds which The Local Butcher would save - and it's the huge great commercial landlords who are organising and financing the campaign. Their ability to wipe out the traditional high street will be enhanced by a cut in Business Rates, so be careful what you wish for.

4. "Retailers will push up prices"

a) Again, no need to speculate on the impact of land value taxes on prices. There is plenty of evidence - you just need to use common sense - that rents and taxes on rents have absolutely no impact at all on retail prices.

b) We all know perfectly well that most stuff you buy in shops costs pretty much the same wherever you are in the country. Prices are the same in a Primark in a retail park at the edge of a low-income town as they are in Primark on Oxford Street, London. Research backs this up, wherever you shop in the UK, prices for similar goods are within a range of +/- one percent.

c) Q: But we also know that rent and rates for shops in the best locations are much, much higher than for shops in less favourable locations? So why is this so if retail prices are the same in all shops?
A: It's do do with volume. If a retailer has a net mark up of £1 on something and can sell 1,000 a week from Location A, but can only sell 100 a week from Location B, then by and large, the rent for a shop at Location A will be nearly £1,000 a week and the rent for the shop at Location B will be less than £100.

Observed facts, simple logic. Prices are fixed and volumes drive rents. Taxes on rents do not increase the total rent which a tenant will pay. If the tax on the shop at Location A is £800, then the rent net of taxes will fall to less than £200.

d) We can also drag actual hard facts and figures into this. The British Property Federation's Property Data Report 2013, two-thirds of UK businesses trade from rented premises. So two-thirds of UK businesses are already paying in full for the value of land they occupy! It is just that they are paying a small part to the government and most of it to private tax/rent collectors. Further, retailers occupy about one-third of all commercial premises by value.

e) Business Rates are about 40% of rents net of Business Rates and raise £28 bn a year, so the net rents payable to landlords are about £70 billion, and the total rental value is about £98 billion, if we knock one-fifth off that for safety and assume that the site premium element of commercial rents is half the total rental value (for residential it's about two-thirds), the LVT payable on commercial premises would be £40 billion.

f) Further, it is definitely the case that taxes like VAT, PAYE push up prices and reduce wages. So if high retail prices are your concern, then shifting from taxing output to taxing land rents is a good idea, is it not?

UK retail sales were £311 billion, some of that is VAT-exempt, but the total VAT payable by retailers is about £45 bn, to which we can add £5 bn Employer's NIC (retail wages are quite low) and £10 bn Business Rates (one-third of £28 bn) = £60 billion.

So if we shifted from VAT/Business Rates to LVT-only, the LVT bill on retail premises would be £13 bn (one-third of £40 bn, from (e)), the total tax on retailers/owners of retail premises would fall by three-quarters; the tax bill for the one-third of retailers which are owner-occupiers would also fall by three-quarters. Quite how much of the LVT would end up being "passed on" to tenants in higher rents (to soak up their much higher margins) need not concern us here.

It is quite simply the case that there would be some combination of more output, fewer empty shops, more businesses, more employment, lower prices, higher profits. All of those are Good Things.

g) The matter is a bit more subtle with goods and services consumed at or near point of purchase, like pubs, restaurants, cinemas, where prices are higher in high rent areas. But again, any tax on the rents would not increase prices, it would merely reduce the rent which the landlord collects net of tax.

5. "The construction industry will be hardest hit"

No it wouldn't. The land speculators and land bankers would be done for, but actual builders would pay a lot less in tax and interest. I covered this topic in more detail here.

6. FOOTNOTE: The rent-setting process

People who wail on about LVT hitting businesses simply do not understand the (iterative) process by which rents are set.

a) In any town, you can rank every single plot/location from best to worst. So there is only one absolute best plot, and whoever bids the highest amount to trade from there pays that much in rent - quite willingly, that's how rents are set.

b) So businesses like Marks & Spencer, TESCO, Sainsbury's or John Lewis will all be bidding for the biggest and best plot, and perhaps the winning bid is £1 million a year. It makes no difference to those businesses whether they pay that rent to a private landlord or to the local council - the point is that they have stolen a march on their competitors and that is what they are paying for. If your shop is the first one outside the station or at the entrance the shopping mall/precinct, then you have a slight advantage over everybody else as people will visit your shop first.

Thought experiment: an evil supermarket chain wins the bid for the best site and pays £1 million a year rent. A manager from the supermarket chain bribes a local council official to ensure that no other supermarket ever opens up within a ten-mile radius, so this doubles the amount of profit the supermarket can make from that site. Assuming the corrupt official can do his sums, how much bribe can he ask for? He can ask for up to £1 million a year for his share of the extra profits. That bribe is still just "rent" - the supermarket is happy to pay it, simply to have a huge advantage over the other supermarket chains.

c) And so the losers from the first round then bid for the second, third and fourth best sites, and they happily pay £900,000, £800,000 and £700,000 etc. Again, whether they pay that to a private landlord or the local council makes no difference (what if, for example, the shops on High Street is owned by Crown Estates, or the shopping centre belongs to the local council or a public sector pension fund?).

d) Then there are second tier, smaller shops, like Boots or WH Smith, who end up putting in the winning bids for the £100,000 sites. And then along come Harry the hairdresser, Wendy the watch repairer, Tim the tattoo artist and Daisy the dentist, who can't possibly compete with Boots or WH Smith. They end up paying £10,000 a year each for the next best sites after Boots and WH Smith have had their pick.

e) Martin the manufacturer and Harriet the wholesaler need a lot of space for their factory and distribution centre and there is no advantage to them in paying hundreds of thousands of pounds in the town centre for a relatively small site with crap lorry access. All they need is to be within reasonable commuting distance of the town for their workers and being near a motorway or railway goods yard is a big plus, as is a big car park.

f) There are plenty of such sites surrounding the town where land is not really that scarce. So they end up bidding and paying £50,000 or £100,000 a year for a large site at the edge of town - entirely voluntarily, because that is what their sites are worth. The further away the site is from the town and the further from the motorway junction/goods yard, the lower the rent, and so if there are enough industrial units available, some of the sites will simply have zero rental value - not because they are worthless but because there are only a couple of low-margin businesses left bidding for them.

g) This is not some hypothetical example, this is how it works. The rental value of land varies enormously between town centres and surrounding developed land (and even the most marginal developed/developable land is worth a hundred times as much as agricultural/green belt land). The rent in a town centre is ten or a hundred times higher than the rent of land on the outskirts or in a particularly grotty or inaccessible part of town, and the larger the town is, the higher the ratio. And provided a town is allowed to expand, by definition there will be land at the margin which can be rented for more or less nothing (and on which the tax would also be more or less nothing).

h) Of course, even under full-on LVT with zero tax on profits, businesses will still fail. Fashions and technology will always change, some businesses will always be badly run etc. So if tattoos go out of fashion, Tim will find that his tattoo parlour doesn't generate enough profit to pay the rent. That's his problem isn't it? He can retrain and re-open as a tattoo removal parlour if he wants. The fact that the rental value is higher than his net profits is a clear indication that some other business would bid a higher amount than him. So if he shuts down and sacks his one or two remaining workers, then Nancy's nail bar or Estelle's espresso bar will open up instead and hopefully employ two or three people. That's called 'creative destruction" and is just the way that free-market capitalism works.

No comments:

Post a comment