The Role and Significance of Rates Relief for Supporting Businesses in Wales

This paper reports on a study which seeks to evaluate the role of small business rates relief as a means of government support for small businesses, in terms of both the financial benefit for recipient businesses and the symbolic significance of rates relief as a form of state support for the small business community in general. In doing so, the paper engages with the theoretical debate regarding the effectiveness and targeting of support to small businesses and how best to achieve this. The paper is based upon a survey of 391 small businesses receiving rates relief in Wales. The study contributes to the literature by filling a gap in our knowledge of business perception of the impact of rates relief and identifying some of the positive and negative aspects of such support mechanisms.


Introduction
This paper seeks to examine small business rates relief within the broader context of government support for small businesses, and to assess its role and effectiveness as a mechanism of support. The paper differs from previous studies in that it is not concerned purely with the financial impact of rates relief, but rather with the broader social and symbolic significance of rates relief as a mechanism of government intervention. There is already a broad base of literature which looks at the economic impact of property tax and property tax reliefs and this literature is considered as part of the study. However, our aim is to take a broader and more holistic view which goes beyond the immediate financial impact of rates relief to examine factors such as the impact on local rural communities and the psychological impact upon small business managers who receive rates relief.
Tax-based mechanisms are widely used by governments as part of the package for providing support to small businesses (Baldock, 1998). In the UK, rates relief has been used extensively, not only as a national scheme, but also as a component of area-based interventions such as Enterprise Zones (Potter and Moore, 2000) and Business Improvement Districts (Cook, 2008). In the USA, property tax abatement schemes have been widely used at a state level as a means of encouraging private sector economic development (Dalehite et al. 2005).
Due to current austerity measures in the public sector, resources for business support at a local level have been reduced dramatically and as a consequence it can be argued that national mechanisms for supporting businesses have assumed greater significance. National governments are anxious to demonstrate continued commitment to the provision of support to small businesses while simultaneously they recognise the need to meet "value for money" criteria. This paper arises from research conducted for the Welsh Assembly Government into the benefits of the small business rates relief scheme (SBRR) for Wales.
This paper is structured as follows: firstly, we examine the existing literature on property taxation and property tax reliefs and evaluate the findings within this literature. We highlight some of the issues arising from previous studies and thereby establish the rationale for a study which takes a broader holistic view. Secondly, we set out the context of the current study which is based upon business perception of the Welsh small business rates relief scheme. Following this the methodology of the study is explained and the results are presented. Finally, we discuss the significance of the findings and draw conclusions from the study.

2.
Rates relief as a mechanism for business support 2.1.

Rates relief within context
Support for the Small and Medium-sized Enterprise (SME) sector derives from the widely recognised economic and social significance of such businesses. Few would question that engagement with the business sector is an important part of national government policy (HM Treasury, 2010). This engagement takes many forms, which can be divided into the two broad areas of regulation and intervention (Mason, 2009), and can be understood in terms of a desire to achieve some sort of behavioural change in the small business, usually one of increased investment, development and increased employment (McGuinness and Hart, 2004). Therefore, if the aim of engagement is to change the behaviour of small businesses, it is important to understand the behavioural responses of small businesses to government regulation and intervention. If such involvement has a psychological impact upon the small business manager, then change may occur even if there is little real financial benefit to the business arising out of government intervention.
Although the need to support the SME sector is widely recognised, there is still a great deal of uncertainty as to how this is best achieved. Unfortunately it is an area of policy-making that is still under researched (Mason, 2009). The dilemma for the public sector is in ensuring that any support that it gives is equitable, practical and accessible. The challenge for policymakers is to design interventions that have the desired effects in supporting target businesses while avoiding unintended negative consequences. Equally important is the efficient targeting of support and the avoidance of deadweight and displacement cost (Sloan and Chittenden, 2006). Understanding the ways in which schemes impact upon different types of businesses and localities therefore becomes important if intervention is intended to encourage growth (Smallbone et al., 2002), support certain industries (Wyld et al., 2010), economic regions (Potter and Moore, 2000), or support rural communities (Smallbone et al., 2003).

Impacts of Rates Relief Schemes on Business finance
There is an extensive literature examining the economic impact of property taxes and much of this literature is concerned with the extent to which property taxes are capitalised into property prices. The capitalisation argument, as developed by Oates (1969) is that, ceteris paribus, differences in property prices exactly equal the present value of variations in local services and expected tax liabilities. As applied to the context of rates relief, this means that a fall in property taxes resulting from a rates relief scheme will result in higher property prices which will ultimately push up property costs such as rent or mortgages such that there is no real financial benefit to the business receiving rates relief.
However, there is disagreement in the literature as to the extent to which this capitalisation occurs (Palmon and Smith, 1998a). Furthermore, there are differing theories that disagree on the mechanisms at play and who ultimately bears the economic cost of property tax (Zodrow, 2001). Despite over 40 years of theorisation and empirical modelling of tax capitalisation, there is still a lack of consensus as to the extent to which it takes place. Wales and Wiens (1974), Chinloy (1978) and Gronberg (1979) find little significant capitalisation. Edel and Sclar (1974), Gustely (1976), King (1977), Rosen and Fullerton (1977), Richardson and Thalheimer (1981), de Bartolome and Rosenthal (1999), Oktem and Huang (2011) and Stadelmann and Billon (2012) report varying degrees of partial capitalisation. Oates (1973), Church (1974) and Reinhard (1981) report full or over-capitalisation. Yinger et al. (1988) not only find very low levels of capitalisation but also suggest that those estimates of previous studies are overstated. As a result of the variations in findings of these earlier studies, more recent work on capitalisation has focused largely upon refinement of the economic models used to account for the impact of other variables. For example, Palamon and Smith (1998b) attempt to separate out the impact of variations in public services from the impact of variations in taxes. Hoyt (1999) and Brassington (2001) look at the impact of community size upon the level of capitalisation. Oktem and Huang (2011) examined the impact of market imperfections on the degree of capitalisation; Stadelmann and Billon (2012) looked at the impact of the supply of property upon the level of capitalisation.
Whilst this ongoing debate on capitalisation is an extremely important one, within the broader context of government support for business, the above discussed studies leave a number of important questions unanswered. In particular, three important points mean that there is still a need for more research into the impact of business rates relief. Firstly, most of the studies referred to above have been focused on residential property tax and in fact relatively few studies have been undertaken which look at commercial property taxes.
Secondly, within the context of government tax relief schemes, the question of the degree of capitalisation is less pressing. The concern of policymakers who are setting business property tax levels lies with the broader impact upon levels of investment, employment and, in times of economic difficulty, business survival. Thirdly, while recognising the fact that such reliefs may well be capitalised into property prices and rentals, the case for retaining such schemes does not depend solely on modelling of the net financial benefits that accrue to businesses. This is because the costs of withdrawing or downgrading reliefs will fall directly on businesses, at least in the short term. Attempts to alter Rates Relief schemes therefore has political significance as businesses perceive such instruments as indicators of government support for the business community. There are therefore likely to be significant social and political externalities associated with changes to rates relief schemes.

Wider impacts of Business rates relief
Despite the arguments regarding capitalisation, rate relief is still a popular and widely used mechanism for business support by governments (Wolkoff, 1985). This may be partly due to the easier administration and control of such a direct intervention. But also indirect support through business advice and third parties can be costly for government and has had questionable success (Bennett, 2008). On the other hand, tax-based mechanisms are widely seen by governments as an effective means of supporting businesses. Research conducted at an international level appears to show that, other things being equal, those countries that keep rules and regulations to a minimum and offer tax and other financial incentives tend to have better performance in terms of new business development. These studies also show that excessive taxation can be an obstacle to entrepreneurship (Fogel, 2001). Wolkoff (1985) in a study which looks at the use of property tax abatements to encourage economic development in the USA suggests that the success of any tax incentive programme will depend upon the impact of the incentive upon firm behaviour. In the present study, we consider whether this impact on behaviour can arise out of the social or psychological benefits of incentives rather than purely out of economic benefits. Previous research has indicated that tax is both a priority and an emotive issue for small business appeared to have a significant effect on self-employment but were ineffective in generating meaningful changes in levels of entrepreneurial activity (Donald and Mohsin, 2006).

The use of rates relief in practice
There is general evidence that public subsidies and tax reduction schemes benefit small businesses by lowering costs and easing cash flows (Soufani, 2003;Belso Martinez, 2009).
However, there is little research specifically on the impact of nondomestic property tax.
There are summaries and updates on property valuation (Hudson, 2005) and articles that refer to the role of rate relief as part of a mix of measures to support businesses within UK Enterprise Zones (Potter and Moore, 2000) and more recently in Business Improvement Districts (Cook, 2008).
There is also general comment on the significance of business rates as a fixed cost over which small businesses have no control (Laramie and Mair, 1993). This has implications for the impact that rate relief may have on small businesses. As a fixed cost, rates can be a particular burden in economically difficult times when shrinking revenues can squeeze profitability. Rate relief can therefore be viewed as an intervention that is particularly relevant in situations where businesses experience very tight profit margins.
However, very little research has been undertaken to evaluate the impact of rate relief schemes, and that which is available predates the existing schemes under examination in this paper. The findings from these studies may perhaps hold useful lessons. Damania (1986) noted that the impact of non-domestic property taxes upon geographical variations in business activities is fairly unclear and evidence is contradictory. Various statistical analysis of the relationship between business rates and regional employment performance, for instance, produce conflicting results which generated a debate as to how these impacts can best be measured and assessed.
While less satisfactory as an approach, it is possible to infer the potential impacts of rate relief by examining studies of other specific tax interventions. As an example, a recent study based in Chile attempted to assess the impact of corporate tax rates (a direct cost) upon the demand for capital and labour. The study found that cutting tax rates had little impact on labour demand in small businesses. Rather, it tended simply to reduce the demand for capital (Rodrigo and Felipe, 2010).
Logically, we can argue that if firms treat business rates as an overhead cost, reductions in business rates are unlikely to translate, for example, into increased employment (i.e. increases in wage costs). Even if rates were seen as a direct cost there is still no guarantee that a cut would stimulate employment. On the other hand, there is evidence from UK enterprise zones that tax incentives, alongside other measures, can contribute towards the attraction of inward investors and increases in employment with a high proportion of new local jobs (Potter and Moore, 2000).
As regards the likely variation in the impacts of rate relief on different types of business, there is little hard evidence available to support hypotheses. Intuitively, it is quite likely that the relative importance of rate relief will vary between types and sizes of business and between business locations. An important dimension of this study will therefore be an assessment of the relative burden of non-domestic rates on different types and size of business and to evaluate the relative impact that the Non-Domestic Rate Relief (NDRR) scheme has on different groups.
There is also evidence that threshold levels in financial interventions can often create unintended negative consequences. This is likely to be an issue for small business rate relief schemes which are threshold based. This can be seen in studies of the effects of VAT thresholds which suggest that such thresholds are a barrier to sales growth, employment generation and investment (Chittenden et al., 1999). More recent studies support this conclusion, providing evidence that firms can be proactive in managing their activities to stay below threshold levels (Onji, 2009;Parry, 2010). It might be expected that similar behaviour would be found in relation to threshold based rates relief schemes.
The preliminary conclusion from the literature reported above is that little research has been conducted previously on the impact of rates relief on business and this probably reflects the belief that rate relief on its own represents a relatively small amount of money for the vast majority of businesses. To illustrate this point, Baldock (1998)  roughly 20% more will see their business rates significantly reduced.' (BBC, 2010).
Commentary surrounding the evolution of the Welsh Small Business Rates Relief Scheme since 2007 therefore highlights the fact that the expansion of the scheme reflected multiple objectives of government including responding to political lobbying from business groups, providing support for Welsh communities as well as being seen to support small businesses in Wales.

SMEs in Wales and the costs of SBRR
The current economic downturn has revived long-standing questions about the significance of SMEs for regional employment and output (Mason and Brown, 2011;Neumark, Wall and Zhang 2011). In the UK as whole, micro (0-9) and small businesses (10-49) combined currently account for 45.6 percent of total employment. The figure for Wales is slightly higher (47.8%) where businesses in these size bands account for 11.5 million workers (Table 1).
The importance of micro and small businesses also varies across sectors nationally (see Table 2) and there are some differences in the context of Wales. Small businesses contribute a higher proportion of employment compared to the UK in agriculture, construction and the service sector in general. On the other hand, the proportion of employment in small businesses in manufacturing is relatively low (24.9) compared to the UK average (32.9%).  Assembly is committed to a more inclusive approach to small business support rather than attempting to concentrate resources on high growth firms. The costs of providing a broad base of support through this mechanism is not insignificant. In 2011-12 the total for transitional, mandatory and discretionary rates relief amounted to £160,014,000 or 15.4% of the rates bill of £1,037,259,000. 1 There has been discussion concerning the costeffectiveness of this level of support. In terms of the issues addressed in this paper, it is pertinent to note that the Business Rates Wales Review (2012)  which have social as well as economic consequences." (p. 11). It was also noted that "rates tend to form a higher proportion of total operating costs for smaller businesses. Evidence from some SME representative organisations indicates that the level of rates remain a major concern for SMEs." These comments indicate that providing support for struggling businesses in the current economic climate is considered to be legitimate justification for this level of lost rates revenue. In this regard, it is relevant to note that the Welsh Government

Methodology
A survey of businesses in receipt of rates relief in Wales was conducted during 2010. The purpose of the survey was to examine variations in the financial sensitivity of businesses to local rates and the importance of rates relief to their current sustainability through recession.
The survey was also designed to explore the attitudes of businesses and to provide an understanding of the wider political sensitivities surrounding business rates relief. The survey generated 391 responses from small businesses. Various issues were followed up using indepth interviews with 15 businesses.
An attempt was made to generate a sample return that broadly reflected the types of businesses in receipt of rates relief. To achieve this, the authors compiled data related to SBRR's recipients in 15 Welsh Local Authorities involving nearly 29,000 observations.
Questionnaires were posted to a random sample of 2,400 addresses. These were extracted from the total dataset in proportion to the distribution of businesses across the different local authority areas. Through repeat mailings, it was possible to generate a "quota" sample of 391 business replies based on geographical area. Figure 1 shows the distribution of questionnaire respondents across the local authority areas.
The responses also cover a cross section of SMEs by sector and by number of employees (see Figure 2). The retail and wholesale and accommodation and catering sectors accounted for the largest number of businesses with 0-1 employees (34.5 per cent and 31.0 per cent, respectively, of total businesses with 0-1 employees) whilst the manufacturing, storage and distribution sector accounted for the largest number of businesses with over 21 employees (45.5 per cent of total businesses with over 21 employees). Predictably, over two-thirds (76.9%) of respondents were microbusinesses employing 5 or less people and only 6.9% employ more than ten people.

Figure 1 Questionnaire Responses by Authority
A high percentage of the responses were from established businesses (Figure 3).

Fifty per cent of businesses from all sectors had been established for over 10 years, with 83
per cent of the retail sector established for over 10 years. The least established sector responding was manufacturing with 28.9 per cent of this sector established between 0 and 5 years.

Significance of rates payments in relation to turnover and business costs
In order to assess the potential sensitivity of businesses to receipt of rates relief, respondents were asked to indicate the significance of rates payments in relation to turnover and business costs. The replies indicate that the financial significance of rates payments varies widely. At one extreme, rates represent less than 2 per cent of turnover for some businesses (41.5 per cent of replies) while at the other end of the spectrum, there are as many respondents claiming that rates account for over 10 per cent of turnover (18 percent of replies) (see Table 3). This diversity is also reflected in assessment of rates as a percentage of business costs. There are 78 businesses (26.6%) that indicate that rates account for less than 2 percent of total costs but an equal number (also numbering 78) claim that they currently account for over ten percent (Table 4).
The significance of rates as a proportion of turnover and also business costs also varies systematically with size of business as measured by employment. Rates amount to over ten percent of turnover for a third of all businesses in the smallest size category (0-1 employees) and for 22% of businesses with 5 or fewer employees. A similar pattern exists in relation to proportion of business costs. Rates actually account for over ten percent of business costs for nearly one third of all businesses with 5 or fewer employees. These findings tend to confirm the expectation that businesses in the smallest size bands will be particularly sensitive to the availability of rates relief.

Significance of rates relief for business survival
Respondents were asked to indicate whether rates relief had been a significant contributor to business survival in the past 12 months. While some stated that rates relief had little effect upon survivability (38%), a considerable minority of respondents (79 or 22.2%) claimed that receipt of this relief has been "very significant" for remaining in business. Although the association is less strong, generally higher proportions of businesses in the smaller categories regard relief as "very significant" for survival (Table 5). Businesses were also asked to indicate whether rates relief had influenced any of their business decisions in the past 12 months. Around half of respondents claimed that this had been influential (Table 6).
Taken together, these replies appear to suggest that rates relief not only impacts upon very small businesses operating within very tight margins but also has an influence on the operations of other slightly larger businesses.  Spearman's correlation: -0.28 (p-value=0.605)

Variations in the significance of business rates by industry type
Tables 7 and 8 show how the significance of rates in turnover and in total cost varies across different sectors. Compared to average, a much higher proportion of businesses in "accommodation and catering" and "personal services" have indicated that rates account for a high proportion of turnover and total business costs. By comparison, businesses where rates costs are only a small proportion of total cost (under 2 per cent) are over-represented in "manufacturing" and "professional and financial services" (as well as post offices that are eligible for 100 per cent rates relief). There is also some variation by sector in terms of the significance of rates relief for business survival (Table 9) though these differences are not strong. Even so, rates relief appears to be a more widespread factor for business survival for providers of accommodation and catering services in particular.

Attitudes of owners towards rates relief as a mechanism of state support for small businesses
Business owners were provided with opportunities to express their views about rates relief as a form of business support through open questions in the questionnaire. The level of response to these questions was much more extensive and detailed than is customary for questionnaires of this type, reflecting perhaps the current difficult trading conditions for many businesses and, as will be seen below, the strength of feeling in the business community towards local property tax. To give maximum scope to express opinion, respondents were asked to say what rates relief meant to their business. Responses were grouped into a number of categories that broadly reflect two dimensions; first, variations in the financial significance of rates relief for business sustainability; and secondly, the extent to which rates relief has significance beyond any financial benefit as an indicator of government commitment to providing support for small businesses.
Many microbusinesses clearly operate on very tight margins and the economic downturn has led to significant financial difficulties. Typical responses in this category include: "In the current economic climate, it has been vital to minimise our overheads. Without rates relief we would probably have considered selling the business." "In the last 12 months it has been crucial for us to remain in business" "Would close without it and are still near to closure since the reduction in relief from

50% to 25%"
"Just about makes the business profitable" "Helps to keep overheads manageable -but only just" For some small businesses, rates relief is clearly perceived to be significant enough to have an influence on financial stability. For other businesses, however, the economic downturn has placed downward pressure on existing employment. In this context, rates relief was viewed as a financial contribution towards the retention of employees including part-time and casual workers. Rates relief: "keeps people in a job".
"It means we can employ more staff to help with the workload" It means "the difference between employing staff or losing staff" "It enables us to use casual staff for a specific task" "It has enabled us to avoid redundancy in the present difficult economic conditions" At the other end of the spectrum, however, as our data analysis demonstrates, rates relief is an insignificant contribution towards business performance. The amount, for some businesses, is "too small to make a difference" and therefore "has very little effect". Rates relief therefore means "nothing" or "not a lot" to many of these business owners.
While many respondents noted the financial importance of rates relief, others drew attention to the significance of rates relief in a wider political context. "Helps to compete with bigger shops" Finally, issues were raised by many businesses concerning the principle of supporting business through offering relief on taxation and rates in particular. Some respondents reacted to questions concerning relief by commenting on the tax itself. This suggests that many businesses consider that local business rates are too high in the first place and this tends to influence their attitudes towards rates relief. Some respondents held negative views of rates relief for this reason: "It is small relief. Rates payments loom large still." "A mild but significant reduction in the outgoings under the heading of 'useless overheads'" "Relief' at having one less bill to pay" "To bring the rates down to an acceptable level, for a small business" "The amount of relief is miniscule. The extent of rates we pay is extensive and is crippling businesses like ours." "Rate relief helps but the basic business rate has gone up enormously for the business. The system is flawed. Small businesses are being over-taxed and high business rates do not help the local economy"

Conclusions and Implications
This study has examined rates relief within the broader context of government intervention measures aimed at supporting small businesses. The study has sought to evaluate small business rates relief both in terms of the financial benefit for recipient businesses and the symbolic significance of rates relief as a form of state support for the small business community in general. In doing so, the paper engages with the theoretical debate regarding the effectiveness and targeting of support to small businesses and how best to achieve that.
The study contributes to the literature by filling a gap in our knowledge of the impact of rates relief and identifying some of the positive and some of the negative aspects of such support mechanisms. In particular, the paper adds to previous understanding of non-domestic rate relief by identifying the relative importance of rates relief between different types and sizes of business.
The survey findings indicate that rates relief is a significant benefit for many small businesses. The evidence also suggests that in the current economic climate, even quite small financial benefits derived from rates relief have been significant in contributing towards the survival and continuity of many small businesses. The data shows that this is particularly the case for businesses employing five or fewer people and for small accommodation providers in the tourism sector. Our findings support those previous studies which suggest that there is a benefit to small businesses in lowering costs and easing cash flows, particularly for those businesses where rates are fixed cost over which the business has no control (Laramie and Mair, 1993). Where these businesses are located in small rural communities, our study found that their survival and continuity has a wider social impact in terms of local employment and local services.
The findings also show, however, that rates relief represents a relatively unimportant form of financial support for some beneficiaries. This raises issues of targeting relief to where ithas the highest impact and how that can be done with equity and without negative consequences to competitive environments. It also, particularly in times of tightened government spending, raises questions about the most efficient form of that spending. Rates relief must be seen as one tool of intervention among many available.
The lack of clarity found in previous statistical studies looking at the impact of nondomestic property taxes upon geographical variations in business activities (c.f. Damania, 1986) can be explained by the wide range of financial impact found in this study. If business rates are of marginal financial importance to some businesses but of critical importance to others then the impact on, for example employment, will inevitably be a mixed picture.
The study also found that even when the direct financial impact of rates relief was minimal, there could be a positive psychological impact., Strong views were held concerning the importance of rates relief as an indication of support for the business community in the present economic circumstances. Rates relief therefore appears to have symbolic significance. This is an important finding for central and local government policymakers. The direct nature of rates relief support makes it clear to recipients that such support is coming from government, in a way which is not so evident in other more indirect means of small business support.
Studies previously referred to in this paper have pointed to some negative consequences of such intervention (c.f. Chittenden et al., 1999;Onji, 2009;Parry, 2010). This study suggests that a further negative consequence is the way in which rates relief draws attention to the actual levels of local taxation. Replies to the open questions in this survey show that rates relief is also a rather controversial form of business support in that relief from rates tends to draw attention to the payment of this particular tax which is regarded as excessive by many businesses in relation to the local services that are provided.
Although focused on Wales, the findings of this study have wider implications in terms of our understanding of the impact of rates relief as a mechanism of government financial support.
These findings suggest that while rates relief has financial significance for some types of business, it has a much wider effect as a demonstration of State support for the business community. In these terms, withdrawal or scaling back on resources available for rates relief could be damaging for relations between business and government. These arguments are germane also to current plans for the UK Government to set up Enterprise Zones within England that include tax breaks alongside reduced planning restrictions and investment in "superfast" broadband. Our findings suggest that the offer of business rates discounts may be significant for some small businesses but perhaps not sufficient to prompt relocation without other measures in place.