England & Wales Covid-19 , Finance

Local government finance in the pandemic

Summary

The recent NAO report on local government finance during the pandemic is sobering but not unexpected. It calls on the government to focus on service sustainability, to continue to provide additional financial support and warns of the risks of financial failure should that support not be forthcoming.

Briefing in full

The National Audit Office has recently published a very informative but sobering report: Local government finance in the pandemic that examines the current state of English local government finances and their future sustainability. The report explores the extent to which the Ministry of Housing, Communities and Local Government (MHCLG) has been able to assess and fund the costs of the new services local authorities have been asked to deliver during the pandemic, and whether the Department has been able to secure financial sustainability across the sector. The report is in four parts:

  • Part One looks at the financial health of the sector before the pandemic and its financial impact over the last year
  • Part Two examines the actions taken to support local government during 2020-21
  • Part Three assesses how successful government measures have been in supporting local government during the pandemic
  • Part Four examines the steps taken by government to ensure the sector’s financial sustainability in future years

The main findings of the report are that:

  • Even before the pandemic took hold, the financial sustainability of local government was under threat
  • The funding gap for local authorities as a direct result of the pandemic is estimated at £600 million
  • The impact on individual local authorities varies considerably – for some the impact is well over 5 per cent of their revenue budgets
  • Many county councils and single-tier authorities have identified “material overspends” for 2020-21 and around 81 per cent are planning to use reserves to balance their budgets
  • Large funding gaps and low reserves mean that some authorities are at risk of financial failure
  • Many authorities are planning budgets in 2021-22 that will be balanced through cuts in services and further use of reserves
  • The financial effects of the pandemic are expected to be long-term – less than 20 per cent of authorities anticipate their finances returning to normal within two years.

The remainder of this briefing looks in more detail at the four sections of the report and the recommendations that the report makes to MHCLG.

Part 1: Financial impact

We all know that the decade before the pandemic was a period of retrenchment for local government, but the report’s analysis sets out the scale of financial cutbacks all too clearly. After adjusting for changes in responsibilities, the report shows that council spending power fell every year from 2010-11 to 2019-20, with a slight upturn in 2020-21 but, in real terms, spending power in 2021-21 was still only 73.7 per cent of its 2010-11 level. This reduction has been accompanied by a significant shift in where funding comes from. Direct government support for spending power fell by 55 per cent between 2010-11 and 2019-20 with the rest having to be generated locally. By 2019-20 82.6 per cent of local authority income was generated through council tax, retained business rates and sales, fees and charges, whereas in 2010-11 the equivalent figure was just 48.6 per cent.

But this remarkable shift from central to local funding obscures a deeper problem. Councils are not created equal; some have much more buoyant council tax and business rates tax bases, and can generate more from sales, fees and charges than their more impoverished neighbours.  Consequently, councils entered the pandemic in very different financial positions with some, like East Sussex, in relatively sound financial health and others like Croydon and Wirral already planning for significant savings in 2020-21.

A further issue has been the lack of any long-term (or even medium-term) funding strategy for local government. For too long the funding landscape has been characterised by one-off and short-term funding initiatives. Councils had to budget for 2020-21 in an atmosphere of uncertainty, on the basis of a one-year financial settlement with long-awaited reforms to the funding regime and business rates apparently as far away as ever.

So, even at the start of the pandemic, many councils were already facing significant financial challenges and those have become more acute as the year has progressed. The monthly monitoring surveys introduced by MHCLG early in the pandemic show that councils are forecasting Covid-19 spending pressures totalling £6.9 billion for 2020-21.  The report calculates that this is equivalent to 12.5 per cent of 2019-20 revenue expenditure, although there are very large differences between different types of council. Cost pressures for county councils have been highest, around 14.3 per cent, followed by unitary authorities (12.7 per cent), metropolitan districts (12.6 per cent), London boroughs (11.5 per cent) and district councils (7.1 per cent).

Not surprisingly, the services with the highest cost pressures have been adult social care and public health, but other services have been hit too, often through increased use of temporary staff to deal with increased social distancing, illness, self-isolation and shielding.

Councils’ ability to generate income has also been seriously affected by the pandemic. Accounting rules mean that the impact of reductions in council tax and business rates will not be felt until 2021-22, but income lost through restrictions on council-owned facilities, less car parking and lower rent receipts had an immediate effect. Losses from non-tax income in 2020-21 are forecast to be £2.8 billion (equivalent to 5.2 per cent of 2019-20 revenue expenditure), but as with costs, losses vary between different tiers and individual councils.

Taking non-tax income loses and cost pressures together, the impact on the sector as a whole is forecast to be £9.7 billion (equivalent to 17.6 per cent of 2019-20 revenue expenditure). Total financial pressures are highest for district councils and lowest for county councils but there are considerable variations between authorities in each class.

Part 2: Government response to the pandemic

Ministers’ approach to supporting local government during the pandemic has been to provide funding that, in the Chancellor’s words, is “timely, targeted and temporary”, but without any blanket guarantees of support. MHCLG officials have told NAO that there is a clear expectation that local government would bear some of the cost of the pandemic and that government support “was always intended to be sufficient to give the sector confidence so the leadership … is not distracted from its Covid 19 response by having to address the prospect of financial failure”.

It is evident that MHCLG did not have a stable strategic framework in the early stages of the pandemic, and that the speed and scale of the economic impact exceeded the economic shock modelled in previous desktop stress testing. However, drawing on discussions with the Local Government Association (LGA) and treasurers’ societies, the Department very quickly developed a monthly survey to gather data about funding already given and inform decisions about future funding. There have been some data quality issues, but guidance has been repeatedly updated to improve the quality and consistency of reporting, and any direct relationship between data at the individual authority level and funding has been avoided so that there are no incentives that could put pressure on data quality.

MHCLG officials have also engaged intensively, holding regular meetings with the LGA and treasurers’ societies, attending a wide range of sector events, providing regularly updated FAQs and engaging directly with more than one-third of councils. NAO has received very positive feedback about MHCLG’s engagement both from local government representatives and individual councils. The sector has been less engaged in the design of schemes by other departments, which has led to some criticisms, including lack of advance notice, impractical or burdensome implementation arrangements and unrealistic expectations.

The report classifies the support given to local authorities during the pandemic between general funding, specific funding, exceptional support and other support:

General Funding – MHCLG allocated four tranches of un-ringfenced funding totalling £4.55 billion and introduced a sales, fees and charges scheme to compensate councils for three-quarters of their losses against budgeted income for 2021. The first tranche of funding was allocated using relative needs data from 2012-13, the second tranche on a per capita basis and the third and fourth tranches using a new relative needs formula, based on the monthly survey data. The fourth tranche was also used to retrospectively correct for over and under-funding in the first two tranches. The report identifies several issues with the arrangements including:

  • Lack of clarity with the new allocation formula
  • Lack of clarity over objectives, at least for the first two tranches
  • Incrementalism, in that between tranches councils did not know if or when additional support would be provided, or how it would be shared out
  • Lack of support for commercial income losses, e.g. from airports and shop rents

Specific funding – a number of specific funding pots have been provided during the year. These include the Local Council Hardship Fund (£500 million), the Contain Outbreak Management Fund (£978 million), the Next Steps Accommodation Programme (£166 million), the National Leisure Recovery Fund (£100 million) and the Covid Winter Grant Scheme (£170 million). Whilst these funding streams have been generally welcomed, the report finds that some concerns have been raised about bidding requirements, assurance requirements and disproportionate constraints on how funding is used. Support offered via different routes has sometimes been seen as confusing, incoherent or unfair.

Exceptional support – the report notes that MHCLG is providing exceptional support to councils facing immediate unmanageable financial pressures, most commonly through capitalisation directions that allow borrowing or the use of capital receipts to support revenue spending. The report argues that the number of authorities seeking exceptional support would be a useful indicator of stress in the sector, but the Department has declined to share that data because it would invite unhelpful speculation on the identities of the authorities involved. Although not identified in the report, the MHCLG website lists five authorities for which capitalisation directions have been issued due to pandemic pressures: Bexley, Eastbourne, Luton, Peterborough and Wirral.

Other support – the report identifies a number of non-financial support measures including extending reporting deadlines, greater flexibilities and relaxation of some specific legal duties.

Part 3: Outcomes for the sector in 2020-21

The report identifies forecast cost pressures totalling £6.87 billion for English local authorities for 2020-21. Non-tax income losses estimated at £2.85 billion push the total financial pressures to £9.72 billion.  These pressures have been offset by government support through un-ringfenced grants (£4.55 billion), other funding (£3.33 billion) and sales, fees and charges compensation (estimated at £1.23 billion) leaving a gap of £586 million. Further analysis shows that the funding gap is not shared equally. 252 authorities (74.8 per cent) have been underfunded, but 85 authorities seem to have been overfunded.

District councils seem to be faring worst with 84 per cent being underfunded (50 per cent by more than 5 per cent of their 2020-21 revenue expenditure).  At the other end of the scale, only 56 per cent of county councils appear to have been underfunded and, of those that are, the underfunding is less than 2.5 per cent of 2020-21 revenue expenditure.

Surveys conducted in preparation for the report have revealed that more than half of respondents have made unplanned savings on their 2020-21 service budgets in response to the pandemic. Around 73 per cent of respondents from district councils and 46 per cent from single tier and county councils said they had already or were planning to use reserves to help balance their 2020-21 budgets.

More worryingly, 31.5 per cent of authorities reported a funding gap that exceeded their level of available reserves and 20.3 per cent said that they had no reserves available to address financial pressures due to the pandemic. This does not however give the full picture, because authorities usually have unallocated reserves that are larger than the levels of reserves they consider to be available.  But even looking at unallocated reserves, the situation is still not encouraging; 16.5 per cent of district councils and 10.7 per cent of county and single-tier authorities reported pressures exceeding their unallocated reserves as of 1st April 2020.

Even against that backdrop, the report estimates that only 1.5 per cent of authorities are at acute risk of financial failure. However, a further 5.9 per cent are in the high risk category and 27.3 per cent are at medium risk. Such high percentages are an ominous sign of just how fragile local government finances have become.

Part 4: Local authority finances in 2021-22 and beyond

As mentioned earlier, in-year tax losses do not have a direct impact on local authorities until the following year, so losses in 2020-21 due to the pandemic will not affect budgets until 2021-22. As of December 2020, authorities forecast that business rates collected in 2020-21 would be £1.6 billion lower than budgeted and council tax £1.3 billion lower. Some of this income will be delayed rather than lost permanently, but deficits this large would have a huge impact upon 2021-22 budgets. Fortunately, the government has allowed 2020-21 deficits to be spread over three years and has confirmed that losses that ultimately prove to be irrecoverable will be 75 per cent funded. A more long-lasting problem may be a reduction in tax bases as the shock of the pandemic affects local labour markets and economies.

Other challenges for local authorities identified in the report are:

  • The ongoing cost and demand pressures of the pandemic
  • How to replenish depleted reserves
  • Restarting delayed savings programmes
  • Dealing with increased demand for welfare and business support resulting from the economic downturn
  • Dealing with losses in sales, fees and charges

The report notes that the Spending Review was not announced until 25 November and the local government finance settlement not until 17 December. Late announcements of government funding are nothing new, but this year finance directors felt more than ever that they were having to plan in a vacuum. Examples of the impact of uncertainty included:

  • Elected members delaying difficult decisions in the hope the finance settlement would be more positive than expected
  • Insufficient time to review savings options to make good rather than quick decisions
  • A tendency to be overly cautious and cut services rather than plan efficiencies
  • Building up reserves in-year in the expectation they will be needed to balance the next budget

The settlement itself provided:

  • A further tranche of un-ringfenced funding (£1.55 billion)
  • A continuation of the sales, fees and charges income compensation scheme for the first quarter of 2021-22
  • A commitment to meet 75 per cent of authorities’ irrecoverable tax losses from 2020-21
  • A £670 million grant to authorities to support households least able to afford council tax costs. The Department has used this funding to justify not adjusting its assumption that the council tax base growth will continue in line with the recent trend.

NAO surveys carried out immediately after the settlement revealed that most authorities were expecting to be able to set balanced budgets for 2021-22 but, not surprisingly, over 80 per cent of respondents said the process would be more challenging than usual. There was also a widespread acknowledgement of greater risk associated with budget plans. Again not surprisingly, 94 per cent of respondents from single tier and county councils and 81 per cent of district councils said that they would need to make cuts in service budgets for 2021-22.

In the longer term, the report suggests that authorities finance will be scarred and, rather than returning to normal once the pandemic recedes, it is likely that programmes of financial recovery will be needed. The majority of respondents indicated their desire to build up reserves but only a small proportion were confident that they would be able to do so. A significant minority of respondents were unsure about when their finances might return to pre-pandemic levels, with the majority not expecting recovery until 2023-24 at the earliest.

Report recommendations

The report makes a number of recommendations to government:

  • MHCLG should continue with intensive sector engagement, improved monitoring and un-ringfenced general grants until the pandemic is over
  • Other departments, should improve their links with, and understanding of, local authorities
  • MHCLG and HM Treasury should explore how to provide the sector with greater clarity over future funding both during the pandemic and as the economy recovers
  • MHCLG should continue its offer of exceptional financial support and maintain capacity to ensure timely consideration of requests. It should also consider how it can share information about levels of financial stress without undermining engagement with individual authorities
  • MHCLG, supported by the rest of government, should carry out a review of the lessons from the pandemic in order to understand better the information it needs to manage financial risk and ensure sustainability
  • MHCLG and HM Treasury should produce a long-term financial plan that explains when the delayed financial reforms programme will be restarted and what further steps will be needed to support authorities to recover from financial scarring caused by the pandemic.
  • Government needs to establish an emergency financial response framework and to improve resilience to a future pandemic or similar crisis

Comment

The NAO has produced a very helpful and timely analysis of the effect of the pandemic on English councils that includes a wealth of useful background information and rewards careful reading. The tone is measured and restrained but many of the findings give cause for concern.

Government responded to the pandemic by quickly engaging with local authorities and by providing unprecedented extra financial support – the extra £9.11 billion provided in 2020-21 is equivalent to 18.5 per cent of the sector’s entire core spending power for the year – but the report reveals that it was not enough. Councils started 2020-21 in a difficult position, having seen only a slight easing of their finances after a decade of austerity and becoming ever more reliant on above-inflation council tax increases to keep them afloat. The extra burdens of the pandemic have left a gap in their finances of around £600 million, but the problem is compounded because the pain has not been spread equally. District councils seem to have suffered the worst with 13 per cent facing pressures of 10 per cent or more of their annual revenue expenditure, and 30 per cent of all councils seeing pressures of 5 per cent or more.

Councils have responded by in year service cuts and by raiding their reserves – there was no time to implement efficiency programmes – and it is not surprising that cases of councils needing extra intervention are beginning to emerge. Perhaps it is a sign of the effectiveness and tenacity of the sector that so far there have been so few.

Local government is teetering on the edge. Long-awaited reforms to business rates, the funding regime and adult social care seem no nearer, in many cases, statutory services are operating at their bare minimum, and reserves are severely depleted. If widespread financial failure is to be avoided, it is vital that government provides ongoing financial support to councils and that ministers take heed of the recommendations in this report.

Related Briefings  

The IFS 2020 Green Budget

Local government financial governance in the light of Covid-19: briefing update

Finance round up: Government support for local authorities during Covid-19: is it enough?

Spending Review 2020 – what it means for English councils

Swift Read: Provisional Local Government Finance Settlement 2021-22

Budget 2021 – key announcements for local government

Swift Read: Budget 2021 – a wasted opportunity for local government?

 

For more information about this, or any other LGiU member briefing, please contact Janet Sillett, Head of Briefings, on janet.sillett@lgiu.org.uk