Tuesday, 22 November 2016

Economic Myths: Business rate hike may force UK's shops to raise prices

The Guardian repeats the usual bleating from the owners of retail premises:

An analysis by Paul Turner-Mitchell, a business rates expert, and the property agent CVS has found that the business rates for 485,435 retail premises in England, which account for more than a quarter of all properties liable for rates, will rise from £7.7bn a year to £8.2bn over the next five years.

Mark Rigby, the chief executive of CVS, said: “The retail sector is facing a significant shift in structural dynamics, with most reporting challenging conditions ahead.

“Add to the mix the already ‘lethal cocktail’ of increased operating costs from the national living wage and apprenticeship levy, and a near half a billion pounds increase in business rates per year for the next five years is simply unsustainable. Something will have to give – whether that’s store closures or even higher prices at the till.”

They fail to make a distinction between marginal costs (i.e. the cost of each extra unit) and fixed costs. The profit-maximising price/output level is dictated by marginal costs, not fixed costs. Here's the relevant article from Economics Help and here's the diagram:

The article does not mention fixed costs at all. Clearly, the National Living Wage and the apprenticeship levy increase unit costs, so these might result in lower output/higher prices. In economic terms, those things are very bad indeed (whatever their political/social appeal).

But changes in fixed costs like Business Rates won't make a difference to prices, unless they are so high as to wipe out profits altogether; in which case
a) shops will threaten to shut; either landlords concede on the rent to balance out the BR increase or they don't care and shops go out of business
b) in which case landlords are stuck paying the Business Rates themselves with no rental income to cover it
c) local average rents will fall, Business Rates will fall and the shop will become viable again.
d) owner-occupier businesses (our much loved 'small local shops') are usually much less profitable (before rent) than tenant businesses, who have to make the rent each month, and can't be insulated with rent reductions. Well so what? Get with it or get it rented out.

And anybody who has travelled outside his home town knows that freely transportable goods sell for the same price all across the UK - despite the huge disparity in Business Rates. Why would anybody think that this will suddenly change?

It is only goods and services consumed at point of purchase (restaurants, pubs, cinemas etc) whose price includes a location rent element where there is any noticeable different in price between expensive areas and cheap areas; assuming that those businesses are already charging the profit maximising price, why would anybody think this will suddenly change?


Bayard said...

"why would anybody think this will suddenly change?"

Because they think that the whole of commerce works on cost plus.

OTOH, if business rates go up across the country, then everyone is facing the same increase in expenses, thus everyone can afford to increase their prices without fear of losing out to the competition. However, demand for more price sensitive items will then fall off. It won't be any different to when VAT last went up, but only if the increase is uniform, which I bet it isn't.

Lola said...

To make that work really well they need to scrap all these:

Mark Wadsworth said...

B, we've had the cost-plus discussion business before. In practice, that is how it works out for competitive businesses. Non-competitve businesses like landowners work on "profits minus" which is the more relevant point.

L, yes of course, better a lower rate on all land than a higher rate on some, that's just extra distortions.

FrankC said...

Check my sums somebody. Retail business rates rise from £7.7bn to £6.2bn over five years. That's £500m or £100m per year. Divide that by the number of retail premises and it works out about £200 per business per year, or £4 per week. Mark Rigby should go back to school.

Mark Wadsworth said...

FC, ha, well spotted and good maths although it's from £7.7 bn to £8.2 bn not £6.2 bn.

And £500 million increase divided by 500,000 shops = £1,000 per year = £200 per week, not nothing, but not huge.

More to the point, business rates = about 1p - 2p for every £1 of retail turnover, so one-tenth as much as VAT. And only one third of the rent paid to the landlord. Funny how the "property agent" doesn't think that 5p rent for every £1 turnover has any impact on business viability or prices, but 1p or 2p business rates does... (h/t Trader Paul on Twitter for reminding me).

Sobers said...

Your point (c) is where your chain collapses. Business rates don't fall with rents. They are only revalued every 10 years anyway, so there's a huge time lag between actual rents dropping and any potential rates reduction, and even then they seem to bear no resemblance to actual rents in an area.

A friend of mine runs a small restaurant and shop in a small town in Wales. We are talking back of beyond Wales, not near a large urban centre. In the last ten years since the last rate revaluation the town council have (in their infinite wisdom) allowed the town centre to be decimated by allowing out of town retail parks to grow up and by putting charges on town centre parking that used to be free. As such the high street retail environment is dire - shops boarded up left right and centre, charity shops everywhere. By any objective assessment the business rate valuations should have fallen through the floor in the recent revaluation. My friends rates went UP. What you are forgetting is that it is the State doing the valuations, not an independent party, and as such will never want to reduce its tax take.

Dinero said...

I see the point that you noticed that the agent left out Rent from his statement.

However I don't see the relevance of the chart from Economics help.

Mark Wadsworth said...

S, For sure, at the bottom end, Business Rates are objectively too high (higher than LVT would be). But as long as they do not exceed the rental value, it is not the end of the world.

My point c) stands - provided landlords do the decent thing and reduce rents, which is what BR is based on.

And as you well know, BR valuations are supposed to be every five years but the landowners lobby successfully got them deferred.

"What you are forgetting is that it is the State doing the valuations, not an independent party, and as such will never want to reduce its tax take."

More Homey propaganda. Quite clearly, in some areas, BR bills have gone down and the overall total has not increased faster than RPI. Those are the rules.And the govt (incl the Scottish govt) goes out of its way to make sure than Council Tax increases slower than other taxes or preferably not at all, and C Tax was intended to be less than Domestic Rates from the off.

Mark Wadsworth said...

DIn, did I really not explain.

A change in variable costs per unit = changes the optimum price/output level.

A change in fixed costs = has no effect.

Bus Rates and rent = fixed cost = have no effect.

That is why the linked chart and article ONLY mention variable unit costs (or marginal costs or whatever you want to call them).

Bayard said...

S, that's the difference between theory and practice, which, as you no doubt know, is greater in practice than it is in theory.
Why does your friend not appeal? ISTR a few years ago there were roving bands of professional appealers who were going around businesses guaranteeing to bring down their rates. Obviously the bureaucrats in charge of the re-rating know f-all about what they are doing. Again, ISTR a spokesperson, when challenged on this point actually admitted that they tended to err on the overcharging side, because anyone who felt they were overcharged would appeal and have the rate properly set, whereas someone who thought they were undercharged would keep very quiet.

Mark Wadsworth said...

B, that's a big mistake. Far better to deliberately under-assess and charge a higher tax rate to raise the same total revenues.

Dinero said...

The chart is a diagram of profit maximizing price setting for a monopolistic supplier. Retail is competitive market, where prices are a competitive level of profit plus variable costs plus fixed costs.