England & Wales Covid-19 , Finance

The impact of Covid-19 on English council finances: funding gaps, revenue losses, service implications

Summary

Covid-19 is having a huge impact on council income and spending. A recent report by the Institute for Fiscal Studies examines the extent of gaps in funding for the current year and future years, ahead of the Spending Review on 25 November. 

Briefing in full

Introduction

The (IFS) report: Covid-19 and English council funding: what is the medium-term outlook? examines  the major issues as local authorities seek to make in-year savings and prepare their budgets for 2021-22.

The briefing broadly follows the structure of the IFS report and looks at:

  • the falls in local revenues since the start of the pandemic including the impact on council taxes, fees and charges and business rates
  • the government’s financial support to local authorities
  • the outlook for council revenues, spending pressures and funding for 2021-21 and beyond on the basis of “upper”, “middle” and “lower” scenarios.

The main findings of the report are that the funding gap between what councils need to spend and what they receive in funding and income is likely to be around £2 billion this year, and between £2 billion and just over £3 billion a year over the next four years. Although these figures are high they are well-evidenced and probably more realistic than more apocalyptic estimates suggested by some other commentators.

The impact of the pandemic on local revenues

Council tax

Council tax is the largest revenue stream for councils. In 2020-21 council tax was budgeted to raise just over half of total adjusted revenue expenditure (£33.1 billion including precepts for police, fire and combined authorities). In the last few years, councils’ in-year collection rates have been consistently high, typically around 98 per cent, but for 2020-21 the report quotes evidence that amounts collected are likely to fall. In the first quarter of 2020-21 councils raised £707 million less than expected and, in total, councils are expecting to collect £1,410 million less than they budgeted for at the start of the year. The report breaks this down as follows:

  • £812 million in payment failures, through more council tax payers falling into arrears
  • £475 million in additional support through local council tax support (LCTS) as more households see their incomes fall and become eligible for LCTS discounts. In total councils are estimating that the number of claimants will rise from 2.32 million in 2019-20 to 2.66 million in 2020-21.
  • Other unidentified losses of £123 million, which the report suggests will result from tax bases being lower than anticipated (as house-building slows down) and losses through payments being delayed until 2021-22.

In their “middle scenario”, the researchers suggest that 12.8 per cent of delayed loss through payment failures is likely to be eventually written off – around double the proportion for 2019-20.

In March 2020 the government provided an extra £500 million to councils to reduce bills for those receiving LCTS by a further £150 and to fund additional discounts at councils’ discretion. The report notes that many councils expect to exhaust this funding as claimant numbers rise.

Accounting rules require council taxes to be paid into a Collection Fund, from which councils receive payments equal to the amount they budgeted for at the start of the year. That protects councils from in-year council tax losses, but those losses then form the deficit that has to be taken into account the following year. Thus, the losses incurred in 2020-21 would need to be taken into account when setting the budget for 2021-22. In order to reduce that effect, the Government has indicated that councils will be able to spread their 2020-21 losses over three years, although the details of how this will operate are still awaited. IFS’s middle estimate is that there will be a total deficit of £493 million in 2020-21 which will reduce council tax revenues by around £164 million a year over the next three years.

Business rates

Councils were expecting to collect around £25.6 billion of business rates in 2020-21. Unlike council taxes, around 50 per cent of business rates go straight to the government as “the central share”. After taking account of relief grants and tariffs and top-ups, councils’ income from business rates was forecast to be about £14 billion in 2020-21 – enough to fund 25.2 per cent of their net spending.

The report finds that between April and July councils collected £5.3 billion less than anticipated. At first sight this is a huge shortfall, but it must be remembered that the government is fully funding additional reliefs this year for the retail, hospitality and leisure sectors that total £10.4 billion. Even so, the report forecasts significant losses from business failures caused directly by the pandemic and from businesses that already had arrears being “tipped over the edge”. The report also suggests that businesses may be able to apply to the Valuation Office Agency for reductions in rateable value on the basis that the pandemic has affected their profitability. That is by no means certain, and IFS do not try to quantify the effect, but if reductions do result it would reduce business rate receipts still further.

Leaving aside rateable value reductions, IFS’s middle estimate is that the total business rate deficit on the Collection Fund will be around £602 million, which, like the council tax deficit will be able to be spread over the next three years and reduce potential revenues by £201 million each year.

Other spending and income pressures

Although the effect of council tax and businesses losses will be deferred to future years, there are other income losses and spending pressures that are affecting council finances immediately. The report suggests that these in-year effects were already being revised upwards, even before the second wave of the pandemic began to take hold. IFS’s latest analysis suggests that councils will spend almost £5 billion more than anticipated this year, with adult social care increasing by almost £2.2 billion. Large increases are also expected in spending on housing, homelessness and, unsurprisingly, public health.

Coupled with that, councils now expect to lose around £2.1 billion in sales, fees and charges during 2020-21 with the biggest proportionate losses relating to culture and leisure (59.5 per cent) and public transport and parking (32.6 per cent).  Further losses, totalling £794 million, are expected from reductions in commercial activities and other income sources. The total from additional spending and non-tax losses in 2020-21 is therefore estimated at £7.9 billion.

The report finds that different councils are being affected in different ways depending on their demographic profiles and local economies. In general, shire districts appear to be hit hardest, seemingly because of their greater reliance on income from sales, fees and charges. In contrast, county councils appear to be suffering least, with London boroughs, unitaries and shire counties fairly close together in the middle.

Government financial support

The government has provided a number of additional grants to help councils cope with the Covid-19 pandemic. The majority of these have been to help offset general spending pressures and losses in income, but others are to fund new activities, and it is important to distinguish the two. The report concentrates on grants for existing activities which can be summarised as follows:

  • General purpose grant funding – across three tranches (but excluding funding allocated to fire authorities and the GLA) – £3,634 million
  • Infection Control Fund – the 25 per cent available to support domiciliary care. (The additional £546 million announced on 17 Sept to “help the care sector restrict the movement of staff between care homes” is not included) – £150 million
  • Local authority Test and Trace service support grant – to cover local authority public health responsibilities in militating against and managing local outbreaks – £300 million
  • Active Travel Fund – the proportion allocated to local authorities (in areas where they are also local transport authorities). The £180 million “for longer-term projects” is not included – £20 million
  • Local Authority Emergency Assistant Grant for Food and Essential Supplies – £63 million
  • Reopening High Streets Safely Fund – to establish safe trading environments for businesses and customers – £50 million
  • Emergency rough-sleeping funding – £3 million

That adds up to total grant support of £4,221 million.

Two other grants (Interim accommodation and immediate support (£92 million) and Home-to-school transport funding) have been excluded because they were allocated after councils were required to submit their latest expenditure survey returns.

Further support to councils is being provided through:

  • the furlough scheme (estimated at £35 million)
  • funding from NHS clinical commissioning groups for adult social care (£486 million)
  • a safety net for sales, fees and charges (SFC) income (75p in the £ if income falls below 95 per cent of what was planned before the pandemic) (£1,059 million)
  • the welfare system – costs incurred that will be ultimately met by central government through housing benefit and universal credit (£46 million)

In total, IFS estimate that non-grant support to councils will add up to £1.6 billion, bringing total support up to £5.8 billion. Comparing this with in-year spending pressures and non-tax income losses which total £7.9 billion leaves a budget shortfall for 2020-21 of £2 billion. However, the report warns that this estimate is based on analysis of income and spending for only the first four months of the year, and that further restrictions and lockdown may make the final figure higher.

The Outlook for 2021-22 to 204-25

The report models the outlook for income and expenditure for the next three years using three possible scenarios. The main assumptions underlying the model are that:

  • council tax increases will be limited to 2.0 per cent for all councils but that the current 2 per cent adult social care precept will not continue
  • council tax bases increase in line with forecast increases in housing stock, having allowed for the slowdown in construction during 2020-21
  • costs of LCTS will increase in line with Office of Responsibility projections for unemployment
  • council tax and business rate deficits for 2020-21 will be spread over three years
  • the 50% business rate retention scheme remains in place and business rate growth is in line with Office for Business Responsibility projections
  • government grants increase in line with the GDP deflator
  • demand for adult social care increases by 2.2 per cent per year
  • demand for children’s social care increases by between 1.44 per cent and 2.6 per cent depending upon scenario
  • demand for other services increases in line with population projections
  • productivity changes by between –0.5 per cent and +0.5 per cent depending upon scenario
  • unit costs increase in line with a weighted average of average earnings and inflation
  • salary costs increase in line with average earnings, taking full account of changes to the National Living Wage and that differentials are maintained
  • Covid-related costs either reduce or abate altogether depending upon scenario

On the basis of these assumptions, the report’s middle scenario projects that:

  • spending needs will increase by almost 11 per cent in real terms between 2019-20 and 2024-25, driven by a 16 per cent real-terms increase for adult social care and a 7 per cent increase for other services.
  • revenues will increase by just 4 per cent in real-terms over the same period

In monetary terms, the real-term funding gaps projected by the three scenarios are:

                                  Lower           Middle          Upper

                                  £bn                £bn                  £bn

2021-22                  -0.35              2.44                 5.14

2022-23                  -0.33              2.11                 5.13

2023-24                  0.32                2.89                6.39

2024-25                  0.42                3.39                7.28

 

The slight drop between 2021-22 and 2022-23 reflects the projected reduction in costs attributable to Covid-19.

If estimates of the pre-existing gaps between what councils pay for adult social care and what benchmarks imply providers need are added in, the gaps increase substantially. To give just one example, in the middle scenario, the gap for 2024-25 rises from £3.4 billion to between £4.6 billion and £4.9 billion.

The report concludes with a short discussion on what central government could do to reduce these funding gaps. One option discussed is the relaxation of constraints on council tax increases. Using IFS’s middle scenario, to fully close the gap would require annual council tax increases of 4.6 per cent, increasing the average Band D council tax from £1,818 in 2020-21 to £2,171 in 2024-25. However, encouraging higher council tax increases tends to benefit more affluent areas with higher tax bases so the report favours increasing and targeting grant funding help close the gaps. The pros and cons of tourist taxes and local income taxes are discussed briefly, but the former would only make a marginal difference, and the latter would take years to implement and be complex to operate.

As the economic outlook is so uncertain, the report suggests we should view the forthcoming Spending Review as a chance to set baseline allocations and a direction of travel which can be varied as more evidence on councils’ revenues and spending needs and on central government’s public finances becomes available.

Other emerging evidence

In their November Budget Survey, the County Councils Network found that only one in five county councils is confident that it can deliver a balanced budget in 2021-22 and confidence drops further for 2022-23. Only one county council expects to be able to invest in adult social care without extra funding, and over half are expecting to reduce access to care packages and/or introduce new charges for some adult services. There is less scope for reducing children’s social care but over a quarter of counties expect to implement moderate or severe reductions to services for children in care. About a third are planning moderate to severe cuts to libraries and a similar proportion are planning moderate or severe reductions to road repairs. In total, 60 per cent of councils said that service reductions and council tax increases will result in economic hardship for residents next year.

In its Spending Review submission, the Special Interest Group of Metropolitan Authorities (SIGOMA) warns that member councils are expecting average budget shortfalls of £14 million this year and a further £18 million a year in future years. SIGOMA argues that the focus in funding allocations needs to move away from incentivising growth and towards funding service needs.

The Association of London Councils, in its Spending Review submission, argues that the financial challenge facing London local government is unprecedented and that “Boroughs need immediate funding to close the £1.4 billion gap caused by the pandemic”. Elsewhere in the submission ALC states that London Boroughs need help to “close their £2 billion budget gap through annual above inflation [grant] increases…”

Other groupings, such as the District Councils’ Network and the Local Government Association itself, as well as individual councils are raising similar concerns both about the situation in 2020-21, and the prospects for future years.

Comment

The IFS report provides a measured and very detailed commentary on the challenges facing English councils as they seek to minimise their in-year deficits and prepare realistic budgets for 2021-22. The financial impact of the Covid-19 pandemic has been unprecedented and the consequences will, at best, be with us for several years. Some of the figures that have been mentioned are quite frightening. The LGA has said that councils “will face a £4 billion funding gap next year just to keep services running at today’s levels“, and Grant Thornton have suggested that the funding gap could be in excess of £10 billion in 2021/22.  In that context, IFS’s middle estimate of funding gaps of between £2 and just over £3 billion over the next few years comes almost as a relief.

Whatever the true figures, local government is in a very difficult position. The Spending Review will now only map out central government priorities for one year, and it will need to integrate with four major reviews, none of which have concluded. They are: devolution in England (on which a White Paper is awaited), the Fair Funding Review which will introduce a new mechanism for distributing funding between councils, the “fundamental” review of business rates (on which the Treasury is currently analysing consultation feedback), and the future funding and organisation of adult social care where, again, we are waiting for a delayed White Paper.

It appears English councils will have to prepare their budgets against a backdrop of considerable uncertainty, whilst planning to reduce staff and cut services, but that is nothing new. The difference this time is that the pandemic has changed everything and the years of austerity have made the room for manoeuvre more limited. There are no easy solutions; whichever commentator you believe, without more support from central government, it seems inevitable that councils will be forced to make deep service cuts that will affect all our lives.

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?

 

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