Will councils price commerce out of the high street?

Local councils could become less dependent on central government grants if local control over the business rate is restored - but it could mean higher bills for businesses, according to new research from the Institute for Fiscal Studies.

Business rates have been set nationally in England and Wales since the 1990 reform of local government finance - the measure that introduced the poll tax - and in Scotland since the beginning of the current financial year.

But the Labour Party is committed to returning the business rate to local control, which it says would help to re-establish dialogue between councils and commerce. In a consultation paper released in February it asked for proposals on the relationship between the business rate and the council tax.

The IFS study, published by the Joseph Rowntree Foundation as part of a series on local government finance, emphasises that it is not possible to reinstate the system that existed before 1990, because of changes in the system of distributing government grants. Businesses pay much less towards council spending than they did when rates were set locally, while government grants now contribute much more.

The effect of returning business tax to local control would depend on the proportion of council spending businesses would be expected to bear, and the balance between local taxation and government grant. If business were to contribute about 60 per cent of extra spending - the proportion it paid under the old system - then the business rate would be likely to increase by about 4 per cent, with council tax payments decreasing substantially in high spending areas. The biggest changes would occur in inner London.

The IFS has put forward four models of how a localised business rate might work. One of the most important variables is to determine how much equalisation should take place of government grant - in other words, districts that yield high rates losing grant in favour of poorer areas.

The researchers concluded that even with what is known as full equalisation of the business rate, the rate levied would vary enormously, with the highest rate half as much again as the lowest. The study also suggested that other forms of local taxation, including a local income tax, would be more effective in broadening the local tax base.

Abolition of the old system was in part caused by concerns that businesses were moving out of highly taxed areas, where their income was most needed. IFS researchers agree that a return to a localised business tax could lead to location choices being influenced by business tax rates.

Stephen Smith, of the IFS, says: "I think evidence as to whether it matters is relatively unclear. Most of the studies have found it very difficult to find any evidence - but that is not surprising, as they are quite long- term factors. There is evidence of a different sort. The previous system might have had big effects. Businesses had to be considerably more profitable to continue to trade, and this would obviously have had an effect on location."