UK free ports – the tax breaks will all be capitalised into higher rents and land prices.

The consultation was full of glossy waffle:

The government is working to boost economic activity across the UK, levelling up towns, cities and regions across the country.

As part of this, the government wants to establish Freeports, which have different customs rules than the rest of the country, that are innovative hubs, boost global trade, attract inward investment and increase productivity. In doing so, the government wants Freeports to generate employment opportunities to the benefit of some of our most deprived communities around the UK.

And so on and so forth, ad infinitum. 

The main tax break is that there are no import duties on goods which move into the freeport and out again, which is much to be welcomed. Inevitably, they threw in a load more tried-and-failed tax breaks which we know will just be capitalised into higher rents and higher land prices. From The Guardian:

Eight English ports are to become freeports under plans announced by the chancellor, who said his policy for the controversial low-tax zones would “exemplify the future economy” and “unlock billions” in investment, trade and jobs. Businesses located within the freeports will benefit from tax breaks including no stamp duty, full rebates for construction and machinery investment, five years of zero business rates, and lower tariffs and customs obligations.

1. Stamp Duty Land Tax (SDLT) exemptions just lead to selling prices adjusting up accordingly. We have seen exactly this happen with house prices during the current SDLT “holiday”.

2. The “rebate for construction investment” means that the cost of the new building or improvement can be written off for tax purposes over ten years, so in the first ten years the owner will save 25% of the construction cost in corporation tax (assuming the main rate goes up to 25% soon).

3. Business Rates average out at about one-third of what a tenant is prepared to pay in rent. Although the tenant-occupier has the legal liability to pay them, they are borne by the landowner, so a landlord has to accept one-third lower rents. So for five years, the landowner will be able to collect that one-third in higher rents. This is exactly what has always happened in “Enterprise Zones”.

These effects all reinforce each other, so it’s a massive hand-out for whoever happens to own land in the new freeports at the time the tax breaks were announced.

Let’s start with a empty site before the announcement:

– The annual gross rental value of a finished building on it would be £150,000. At present a landlord would be able to collect £100,000 of that (£50,000 goes in Business Rates). Capitalised at 5%, the finished building is worth £2 million. The building costs £1 million to build, so a potential purchaser/landlord is prepared to pay £950,000 (£1 million gross less £50,000 SDLT) for the empty site.

– The site is now included in a freeport zone and the calculation changes. The annual gross rental value is unchanged at £150,000 and net present value of the future rental income (less Business Rates) is £2 million (as before), plus £250,000 extra rent during the five year Business Rates holiday = £2.25 million. The building has a net cost after tax of £750,000 (contruction is a competitive industry, so prices will not change). This means that a potential purchaser/landlord would be prepared to pay £1.5 million for the site (without a reduction for SDLT).

So in this example, the selling price of land in the new freeport area has jumped by over 50% overnight. Happy times for everybody who anticipated this and held onto or bought land there! Future tenants or owner-occupier businesses will see no benefit whatsoever.

It would have made far more sense for the government to declare any large area of land it still owns to be freeports (with all the tax exemptions you can throw at it) and just rent it out. The chances are that the extra rental income will be as much as the ‘cost’ of the tax breaks, with zero administration/compliance costs or deadweight costs.

Physiocrat has made this video on the subject.