Richard Kerley: A saving grace that is lying at our feet

AS THE new financial year for government, local government and many other public bodies approaches, there is a lot of thought going into how the proposed major cuts in public expenditure can be ameliorated. Sometimes action on these matters can play out dramatically in public - as in London this last weekend - and sometimes major changes can ostensibly take the dullest of forms. High in that second category must be The Non Domestic Rating Contributions (Scotland) Amendment Regulations 2010. Yet the changes captured in such a dry-sounding document may go quite a way to address the pending reductions in capital spending that are projected for Scotland over the next few years.

Governments everywhere make capital reductions when they are trying to reduce expenditure.

At Holyrood, the planned budget reductions are already heavily reliant on a dramatic reduction in capital expenditure that is in the order of a real terms cut twice the level that is anticipated for current expenditure.

And governments have always done this - if you read Barbara Castle's diaries about her time in Labour UK government in the 1970s, there is fascinating passage where she willingly agrees to reductions in hospital building and improvement as an alternative to cutting jobs.

In Scotland, this kind of change after several years of healthy growth in such capital spending will be a real jolt for those who have been expecting a new project for their service or their neighbourhood. Some will happen, indeed some, such as the Second Forth road bridge appear to be committed, but many others will fall.

This tendency of governments at all levels to see shelving capital expenditure on building and improving assets as an easy option is why we should welcome - although a little cautiously - recent developments in what is now called tax incremental financing (TIF). This is a somewhat obscure name for an exercise which in essence is quite simple.

There are still major areas of land in our cities and towns where development is not easy. They are often referred to as brownfield sites - that is, there has been an earlier, often industrial use that no longer continues and the land is abandoned, sometimes even contaminated.

The cost of development is high, therefore unattractive to private developers as it stands, and it is often also bedevilled by poor road links and transport connections.

The cost of getting the land into a condition fit for development is high, the current owners cannot finance this, and councils have limited money and many other priorities - in schools, transport and social work, sporting and cultural facilities.

The other side of the coin is equally unattractive. Nobody is making money from such sites. Not the owners - nobody is employed there, other than perhaps a few security guards. Government is not getting corporation tax or income tax; councils are not getting business rates.

Such decaying assets are generally a lose-lose for everybody concerned.

Tax incremental financing looks ahead, currently up to 25 years, which is similar in length to many private residential mortgages, and assesses what incremental income the council might eventually take from such land - mainly in business rates - if the land was brought back into use.

Councils are then enabled to borrow to finance the necessary pump priming investment. There is no easy formula to calculate what might be achieved in terms of investment leverage, but some of the project planning done in English cities shows positive net benefits from such borrowing for investment.

The difference in TIF as now proposed is that rather than the business rates going into the common pot as they do now, they are, in effect, partially reserved and ring fenced for the home council to receive a proportion of incremental rate increases in the sites concerned. That, however, is where things do get complicated, as the government is trying to find ways to define and try and prevent displacement of businesses from old locations into newly-established ones.

Does all this seem too good to be true? There are some factors that have to be taken into account. First and most important is that the investment will be directed primarily toward assets that will be productive in a financial sense.

That is why the first proposals in Scotland are for cruise-related developments in Leith docks and the recently announced town centre development at Ravenscraig in Lanarkshire.

The flow of business that can be estimated in each case appears to make a persuasive business case that is assessed by both the Scottish Futures Trust and the government itself.

However, some might question whether we have the capacity to plan 25 years ahead, and whether councils, in particular, have this.Yes we do, and yes they do, as long as we remember that such planning needs to allow for variance over time and we do not overload the system.

It's also worth remembering - if we think of Leith - that the early investment there, pushed and promoted by councils, was started more than 30 years ago.

Residents and visitors now take Ocean Terminal, Britannia and visiting cruise liners for granted - in 1980 few would have foreseen such a prospect.

We also need to recognise this can be a slow process. Letting was slow at Ocean Terminal and the car park barriers are in place but business is not yet good enough to levy charges. In the United States, such forms of financing development for brownfield sites have been in place for some decades, so there is extensive experience to be drawn upon in such long-term projects.

A third factor is that such planning will always involve some unpredictable and highly-beneficial upside for private owners of assets such as currently decaying land.

After the early experience of PFI, we now know more about how to write agreements that split windfall gains between private owners and the public, but it is still hard to spot all such possibilities a long time in advance or to create flexible agreements that can capture some of that uplift for the public.

Another consideration is the extent to which such forms of financing benefit the already relatively prosperous areas of the country.

Official figures show that the relationship between population and non-domestic rates income varies widely with, Edinburgh and Aberdeen showing a much greater intensity of non-domestic rates income than other large councils.

Even among smaller councils, such differentiation exists. Shetland, the second-smallest council in Scotland, has non-domestic rates income twice of smaller Orkney and larger Eilean Siar.

Within those same council areas, there can sometimes a be a complex redistribution effect.

It is hard to assess but there must be some worry that a newly-developed and enhanced Ravenscraig area may well impact on the other towns of North (and for that matter South) Lanarkshire and West Lothian.

Clearly though, government now thinks it a new policy instrument worth trying with plans to trial this in six council areas.

They also express it as a means to achieve "... sustainable transformation of places for the better..."

So perhaps tax incremental financing has the potential to improve those parts of the urban landscape of Scotland which can still make residents and visitors despair.

• Professor Richard Kerley is professor of management at Queen Margaret University