House of Commons - Office of the Deputy Prime Minister: Housing, Planning, Local Government and the Regions

Select Committee on Office of the Deputy Prime Minister: Housing, Planning, Local Government and the Regions Ninth Report

2 What is the role and purpose of government grant?

17. The system of paying grants from central government revenues to local authorities has developed over the past 150 years, or so, in a piecemeal manner and for different reasons. Primarily, grants of various sorts have been made in recognition of the inability of the local domestic and business tax base to support a desired level of local authority spending: in other words, to use central tax revenues to support local services, particularly those which are provided as part of national policies or in accordance with statutory obligations decided at a national level. Grants have also been made as a means compensating local authorities for differences in resources arising from differences in local taxable capacity and differences in spending needs: those with the lowest tax base may well have the highest spending needs. In recent decades the grant system has become an instrument of influence or control over the level of spending by local authorities, in aggregate and in each authority, and over the relative level of spending on particular services.

18. Central government gave £40 billion in 2004-05 to local authorities in England, consisting of £27 billion in general Revenue Support Grant and £13 billion in specific grant. This represents 53% of total local government income. A further £15 billion was distributed from National Non-Domestic Rate income on a per capita basis.[7] Therefore in sum the Government distributed a total £55 billion in 2004-05, constituting 73% of total local government income. The evidence that the Committee received on the role and purpose of central government grant focused on two areas; equalisation and control.

Equalisation

19. Equalisation of differences in local authorities need and their ability to raise money locally was the most commonly cited purpose of grant in the evidence we received. Somerset County Council's evidence argued that 'In any fair society, government grant should be used to distribute funding fairly between authorities, taking account of differences in need and available resources'.[8] These views were echoed in much of the evidence received including the submissions from the Chartered Institute for Public Finance and Accountability (CIPFA) and the Special Interest Group of Municipal Authorities (SIGOMA):

"In CIPFA's view, the overriding objective of grant distribution should be to distribute funding fairly between authorities, taking account of differences in need and available resources."[9]

"SIGOMA believes that it is the role and purpose of Government Grant to ensure that equalisation of resources is achieved. It is extremely unlikely that full equalisation can be achieved without government grant or intervention in one form or another."[10]

Evidence from the ODPM said that Government grant is needed to supplement council tax and income from business rates and has a crucial role in equalisation for resources and needs.[11]

How the local government finance system achieves equalisation

20. The principle behind the system of local government finance is that it should equalise for differences in needs (costs) and resources. The formula grant system sets spending totals which, in theory, take account of the costs faced by local authorities in providing local services. If all authorities of the same type were to spend at the level of their Formula Spending Shares, they would all, in theory, be able to set the same level of council tax. Business rate income is distributed evenly across the country on a per capita basis. Revenue Support grant is then distributed in order to equalise for differences in both needs and resources.

21. The balance of funding at individual local authority level and the ratio of income raised nationally to locally inevitably varies across the country because of these grant calculations. Based on local authority budgets in 2004-05 the proportion of income raised locally varies hugely, from 13% to 69%.[12]

22. The grant system only equalises for differences in needs and resources at one point - i.e. where spending equals the Formula Spending Share (FSS) that the Government calculate for each authority. If authorities spend at the formula totals and collect the assumed proportion of council tax, then the distribution of government grant is such that band D council tax rates would be the same across the country (the Assumed National Council Tax). If a local authority budgets to spend at a level above its FSS, the whole of the extra spending falls on the local taxpayer. If a local authority budgets to spend below the level of its FSS the whole of the 'saving' is passed on to the local taxpayer. Council tax rates vary across the country mainly because of local spending decisions.

23. Policy Exchange commented that the current equalisation system was too precise.[13] This view was shared by Professor Tony Travers: "[…] we in Britain have by international standards ferociously complex equalisation arrangements that seek to create much greater degrees of precision than I think many other systems do. I am not sure we need to spend quite the level of time and effort […] achieving quite that level of precision".[14]

Control

24. Grants give central government the power to exert control over local government: directly though ring-fencing where certain grants are separated from general (unhypothecated) income and can only be used for a specific purpose, and indirectly because it controls such a high proportion of local authority income and hence spending levels. We consider ring-fencing and passporting - how the grant is given rather than how much - in paragraphs 71 to 83 below.

What is the appropriate proportion of government grant?

25. There is no magic formula which can dictate the "right" balance between central and local funding of local authority services. Equalisation between the different needs and resources of different authorities could in theory be achieved without any central grant: the "rich" authorities would simply hand over some of their resources to the "poor" authorities. Conversely, local authorities could be 100% funded from central funds, as local agencies of central government. Nor does the problem of "gearing" discussed below suggest a particular balance: merely that the balance is a crucial factor in the way people pay for locally determined expenditure.

26. The sense that the current 75:25 central:local balance is "wrong" arises from a shared perception about the role and functions of local government, that the main responsibility for local services and local spending should lie with local authorities. From this it follows that local government should be responsible for raising much of the money it spends: and in any reasonable interpretation that means not less than half. It also follows that there should be no more controls on the levels of local taxation or local spending, nor on the end-use of central government grants, than are essential for overwhelming reasons of national policy.

Gearing

27. The "gearing" effect refers to the ratio of two different percentages: the percentage change in local authority expenditure, and the percentage change in council tax required as a result. It is the product of the balance of funding and has been cited as one of the main causes of the large increase in council tax in 2003-04 and the subsequent increased opposition to council tax.

28. The gearing ratio determines the effect an authority's decision on its budget requirement on the percentage increase (or decrease) in its council tax bills. If a local authority financed all of its spending from council tax, a 1% increase in spending would require a 1% increase in council tax. In this case the gearing ratio is 1:1. But the typical local authority finances 25% of its spending from council tax and receives the remaining 75% of its income from central Government. Local authorities' grant from central government is determined before authorities set their budgets and is not affected by local spending decisions. If a local authority with a formula spending share of £100 million receives £75 million from central Government, it would need to raise £25 million in council tax. If it wished to increase its spending by 1% (£1 million), it would have to increase council tax receipts by £1million to £26 million - an increase of 4%. In this case the gearing ratio is 4:1 (the percentage increase in council tax is four times the percentage increase in spending) - approximately the national average level. The higher the percentage of an authority's income which comes from central government, the higher the gearing ratio and, in turn, the more sensitive council tax levels are to decisions to local spending decisions.

29. The chart below illustrates the operation of gearing for England as a whole in 2003-04 when the average gearing ratio was 3.9:1.[15] There are three stages: (1) The Government increased grant by 5.8% (adjusted). (2) Local authorities set budgets which needed an extra £3.3 billion in council tax to meet spending levels. This represented a 3.6% increase compared to total income in 2002-03. (3) All this has to be raised from council tax. Multiplying 3.6% by the gearing ratio of 3.9 gives the average increase in income raised from council tax bills in 2003-04, 13.8%. The actual increase in the average in Band D rate was less than this at 12.9% because an increase in dwellings meant that the council tax rises were spread out over a greater number of domestic properties.

Problems associated with gearing

30. Mr Shostak, from the Public Services Directorate of the Treasury explained the importance of gearing for the balance of funding review:

"Gearing is inevitably one of the big issues that the Balance of Funding Review is looking at […] Because of the gearing we know (and in a sense that was part of the rationale behind the Balance of Funding Review at the off) that there is lack of clarity in terms of issues about accountability, there is lack of transparency, there is a range of other problems in terms of its impact in terms of council tax and so on."[16]

31. Other evidence the Committee received focused on the problems associated with accountability and transparency. Mr Woods from the Association of North East Councils said:

"There is the misunderstanding of increases in council tax because of the gearing effect, the four to one effect of a 1% on expenditure, resulting in a 4% increase in tax. I think, if we could change the local government finance system, which has a more buoyant form of income coming to local government, and if we could look at changing the gearing to something below 50%, it would mean that the council tax increases should reflect more some of the changes in the council's own expenditure and in the services. It is not going to mirror it directly, because you have not got a one-to-one relationship, but it is going to be more reflecting [...]"[17]

He added:

"I think gearing has an effect in terms of expenditure. One of the key considerations in forward planning is to look at the potential tax level which will be charged. […] We have got to look at the Government grant coming in to make that assessment, but effectively it gives us a budget bottom line and then the council must look at the sorts of services it can provide for that resource. The decision the council faces then is can they live with the level of cuts in service, so the efficiency savings, which it identifies, and, if not, what are the other options for having a tax perhaps higher than the members otherwise would have wished. As you go through the budget process, you are constantly trading off the impact on services against the potential increase in the council tax."[18]

32. The Leader of Somerset County Council explained that:

"At the moment the effect of gearing is such that the withdrawal of central government grant, in order just to stay still the council tax has to go up 4% for every 1% increase in spending. That is a very difficult concept to get over to members of the public; very, very difficult."[19]

Mr Bilsland, the Corporate Director (Treasury) from Somerset, added:

"[…] I think 1% on council tax for the County Council is £1.8 million, 1% on the budget is £4.5 million. So obviously a 1% movement in the budget has a three fold impact on council tax, and members are very sensitive to that. That means, of course, that when you get such volatility in government grant, you get huge impacts on council tax, and it is impossible to explain that to council tax payers, why these relatively small percentage shifts at one end of the system result in quite big numbers at the other end."[20]

The New Local Government Network argued that:

"[…] in the current system the gearing is unfair, it makes it impossible for local authorities and I think the evidence to the Balance of Funding Review suggests it does not discipline local authorities to be more efficient."[21]

33. The Local Government Association said that gearing distorts accountability.[22] The Association of London Government agreed adding that it magnified errors in the funding system and was damaging to central and local government.[23] The Local Government Information Unit said that "Gearing levels clearly distorts accountability, and means that it is almost impossible for authorities to explain the relationship between spending and tax in a way that local people can fully understand".[24]

34. The Audit Commission produced a report on the large increases in council tax in 2003-04 which highlighted gearing as one of the two principal causes of these increases.[25] Evidence from the Audit Commission explained that:

"[…] the current balance of funding does not help. It is predicated on government decisions being the primary determinant of what has to be spent at a local level. And, by limiting the revenue raised locally, it:

- disguises the connection between what is spent locally and the taxes raised to fund this; and

- exaggerates the relationship between changes in spending and changes in the amount of funding that needs to be raised locally, most dramatically, through the gearing effect"[26]

35. The ODPM has suggested that the gearing effect may not be all bad. According to a paper it submitted to the Balance of Funding Review:

"Gearing may in fact have some advantages. In particular it encourages local authorities to increase their spending power by driving down costs rather than pushing up taxes. Gearing of course cuts both ways. If local authorities are able to increase spending by less than increases in grant, then those savings will translate into much larger percentage reductions in council tax. Percentage changes may capture the headlines, but grant allocations and council tax bills are finally about hard cash amounts."[27]

However, the view taken in its memorandum to the Committee was somewhat different:

"It has been argued that gearing could act as a spur to efficiency by encouraging councils to look at ways of driving down costs rather than pushing up taxes. This does not appear to be the case - research done for the Balance of Funding Review shows that highly geared authorities do not perform better than others. Also, it is clear that there is no obviously 'right' level of gearing, and that changing the balance of funding will only reduce gearing, not remove it."[28]

36. Mr Allberry, Head of Taxation, Valuation and General Policy Division at the ODPM, told the Committee:

"What the research showed, I think, was that you could not prove a correlation between different rates of gearing and different rates of efficiency. I do not think the research disproved that overall gearing does not provide a spur to efficiency in as much as more efficient councils can have more money to spend from what they raise from council tax on their services."[29]

He went on to explain why gearing could potentially be a good thing,

"Simply because the local authority picks up the political cost, if you like, of putting up council taxes to increase expenditure and if that increased expenditure is as a result of relative inefficiency […] then the local authority must pass that relative inefficiency to the local authority."[30]

37. The Minister for Local and Regional Government outlined the different views about gearing:

"On the one side there is the view that this is an imposition which creates unreasonable pressure on the council tax because authorities have to increase council tax disproportionately because of the gearing effect. The other point of view is that this is a good financial discipline which ensures that councils think very carefully and hard."[31]

38. The balance of funding, and so gearing ratios, vary greatly between authorities. These variations are part of a system aimed at promoting fairness, and would exist even if the balance of funding was radically altered at a national level. If it was altered towards greater local funding, the extreme cases would become less so. The balance of funding also varies between different types of authorities in similar areas. For instance in 2004/05 grant covered two-thirds of formula spending totals for shire counties, but just under half for shire districts.[32]

39. Evidence from the Association of London Government (among whose members the highest gearing ratios can be found) pointed out other problems where an authority receives a very high level of government grant.

"The Association is also concerned that the current balance gives rise to a form of 'dependency culture' which is not beneficial to either central or local government. The high proportion of local spending currently met from central government grant may encourage Ministers to intervene in the detail of decisions on service delivery or seek to micro-manage local services. This runs counter to the Government's growing emphasis on local flexibilities and devolved decision-making, highlighting a potential conflict between theory and practice. Similarly, the current funding arrangements may encourage local authorities, when faced with new service pressures or changing circumstances, to demand additional financial support from central government, rather than to look for local solutions."[33]

40. The Committee is convinced that gearing has a negative impact on local authorities by distorting accountability, magnifying any weaknesses in the formula grant system and making the entire system less clear. It was the major factor in the 12.9% average increase in council tax bills in 2003-04. The ODPM has confirmed that there is no evidence that gearing has any positive effects on efficiency.

Reducing the impact of gearing

41. Without directly controlling local authority spending there are two main technical ways to reduce or eliminate the effects of gearing: introducing variable grants levels and changing the balance of funding.

Variable grants

42. A system of variable grants was outlined to the Balance of Funding Review by Steve Freer from CIPFA.[34] Professor Bramley explained the advantages of variable grant levels to the Committee:

"The gearing problem is a product of fixed grants, it is the fact that the grants are fixed. If you are willing to go with a grant that is part way contingent on the budget decision of a local authority then you can create any relationship you like between a percentage increase in local taxation and a percentage increase in expenditure and at the same time you can equalise that for rich and poor authorities […] That was the system from 1948 until 1989. We lived with that system for 30 or 40 years. It got a little bit too complicated in the 1980s because the DoE insisted on trying to keep recalculating grant on outturn expenditure. They could have it fixed as Stephen Freers' paper to the Balance of Funding review makes clear, on Budget day before the year starts and then it is fixed. I think it is a workable compromise and I suggest in my paper that if there is one magic bullet in all this that solves two of your problems in one go without having to introduce a new local tax, it is that. I would take that proposal very seriously."[35]

43. Both the Economic Secretary to the Treasury and the Minister for Local and Regional Government saw problems with this proposal:

"[…] the concern was, and remains the same, that this is in a sense a perverse incentive to increase your spending. If your spending increases are matched by increases in grant, the more you spend the more grant you get. This has exactly the opposite effect to gearing: this provides an incentive to spend more. This may not be in the best interests of economy and efficiency and reductions in council tax demands."[36]

"If you study the CIPFA paper, and certainly it will be clear when the balance of funding review reports, there are several problems with that approach. The first is that it creates a degree of uncertainty across the piece, in that the amount of additional grants which central government needs to provide would be uncertain because there would be two rounds of grant making: the first round of grant and then the top-up grant which would depend on what budget the local authorities had set. The second is that there would be an incentive within that sort of system for local authorities perhaps to set higher budgets, because of course they would have a reduced responsibility, a reduced amount of the revenue which they would have to raise locally if they set a higher budget. The third concern really plays into the points which Mr Betts made. If one had a system like that, then the only real way for government in the end to exercise the degree of control on the total which I have tried to explain from the start we do have a legitimate interest in, in terms of the Treasury, would be through some form of fairly crude capping of local authorities' budgets. In a sense, we have been there before."[37]

44. While such a fix to the gearing effect is appealing, the problems of uncertainty about grant levels, possible effects on efficiency and the prospect of a return to universal budget capping are not. Moreover, it does little to improve clarity of the system. We therefore do not think variable grants are the best way to reduce the impact of the gearing effect.

Balance of Funding

45. Changing the balance of funding can reduce the impact of gearing, but not eliminate it; a system where local authorities raised all their income locally is neither practical nor desirable. National shifts in the balance will also be only part of the picture, since local rates will vary due to equalisation.

46. The Committee heard much evidence on the level to which central government grant could be reduced and still meet its purposes outlined above, and, given an additional source or sources of local income, what the resultant balance might be.

The Director of the Policy Exchange said:

"[…] Our suggestion is that all authorities and no doubt there may be two exceptions but there should not be more than that should be raising at least 50% of their expenditure through a locally determined taxation, and we can get into the question of whether council tax is really locally determined or not and many should be raising more than 75% and it should all be compatible with some broad equalisations. I look at the fact that Westminster, which must surely on any of our measures be one of the richest areas in the country, is not raising more than a minority of its expenditure through local taxation. Surely it should be possible to take equalisation to the point where Westminster is funding 100% of its expenditure through its own raised taxes and you have still got all of your capacity to equalise people who are poorer than the average because Westminster is clearly right at the top. I think you can aim for some quite brave figures and if you do not we will end up in exactly this spiral that we have been in for 40 years or more."[38]

The Leader of Somerset County Council stated that:

"I would think over 50%, between 50% and 75% is reasonable to be supported locally, but, as I have said before, it has to be affordable, especially relating it to the local householders."[39]

The Director of the New Local Government Network told the Committee:

"[…] People argue you have got to have a very high percentage of money coming from the centre to make sure that poorer authorities do okay. As I understand it the work that has been done suggests you do need to have a certain amount of central money, but it is not nearly as much as we have at the moment. You can go quite a long way and still hit both the things you want to."[40]

Mr Woods from the Association of North East Councils told the Committee:

"[…] The research which has been done internationally has shown that for the majority of local authority levels the funding is at 50% or less, and that is the majority of arrangements. We did have roughly 50/50 prior to 1990-91, when business rates were under local control. I think, from the Association's point of view, our evidence is that the balance of funding should be no more than 50/50, and possibly less than that, to give a greater degree of accountability […] I would look at trying to get 50/50 in most of the regions. Our region in the North East has the lowest level of council tax of any of the regions, basically. We have the highest level of gearing as a region, so it is particularly important for us. Certainly we want to get as close to 50/50 or better, which would mean that the average should be slightly better than 50/50 in local government's favour to achieve that."[41]

The Audit Commission agreed that grant could be cut, but added that other changes would also be necessary:

"In order to achieve a change in the balance of funding, the government would also need to devolve spending and funding decisions. Government grant would need to continue to be provided to allow equalisation for different needs and resources. It could - and should - have a much smaller role in ensuring adequacy of local revenue, but only if there is devolution of decision making on services."[42]

47. The County Councils Network argued that central government grant should be cut where possible to help taxpayers identify which services are provided by local authorities. This, they argue, would encourage greater engagement and accountability and provide an incentive for efficiency.[43] Sir Jeremy Beecham, former Chairman of the Local Government Association, explained:

"We are however united in wanting to see a shift in the balance of funding. We believe that the present imbalance has two significant effects. First, it limits the autonomy of local government; the dependence on central government funding has that effect. Second, it creates a system which people who pay current local taxes cannot understand. They cannot understand the relationship between local expenditure decisions and the local taxes they have to pay. If they cannot understand that then our accountability to them is much diminished. We think that it is absolutely essential to move from the present imbalance of funding to a better balanced system and it is not an option to remain where we are."[44]

He added:

"We have done some modelling which suggests that the gearing could be reduced pretty substantially across the piece and there would only be a relatively small number of authorities which would be either in negative grant or at the other end in the Newham position. Any system would require a measure of equalisation."[45]

Cllr Clarke, also from the Local Government Association said:

"[…] You have talked quite rightly about equalisation, but in fact the amount of funding needed for equalisation is £16 or £17 billion, whereas grants are £40 billion. So, in effect, transferring that difference across to locally set taxes rather than nationally set taxes would be a key part of moving the balance."[46]

48. When questioned about the proportion of their budget the Treasury was willing to allow local authorities to raise, the Economic Secretary to the Treasury told the Committee:

"The short answer to that is that there is no fixed figure, there is no fixed principle, beyond the first priority to safeguard our ability to manage the economy and public finances soundly. As I said in my opening remarks, some of the arguments for seeing greater decentralisation and devolution can be entirely consistent with that. As long as they are consistent with that, then the Treasury in principle is unlikely to have a problem."[47]

On further questioning he did indicate that some limits do exist:

"Ultimately there has to be some control of public spending, central and local and if we do not have some control of public spending, then we run severe risks with the economy, we run the risk of seeing our public finances run out of control. We have learned from bitter experience in the past the wider impact that can have and the one thing you will see and hear from the Chancellor is that above all he will not put in jeopardy the stability and the steady growth we have managed to establish in the economy over the last seven years."[48]

Total local government expenditure represents around 8% of GDP. If local authorities raised half of their expenditure locally, each percentage rise above that predicted by Government would involve expenditure of around £200 million, or 0.05% of GDP: in other words, of no real consequence to public finance.

49. The Minister for Local and Regional Government explained to the Committee that equalisation meant that the gearing effect would always be present:

"[…] the more grant is given to an individual authority in order to compensate it for the disadvantages it suffers, the greater the gearing effect. Currently, for example, a highly deprived authority such as Newham - I know it is not a SIGOMA member, but it is a very deprived area - only meets 10% of its spending from its own locally raised resources; 90% comes from government grant. Even if we were to change the balance of funding by 100% and change the gearing ratio by that amount nationally from 25:75 to 50:50, a huge change, even if we were to do that in Newham, the likely consequence, everything else being the same, would only be to change the gearing from 10:90 to 20:80 and they would still be subject to a very significant gearing effect. I am afraid to say that gearing is here to stay, if we are to have equalisation. The degree of gearing, yes, we can change and that can be altered if the balance of funding changes, but if it is our objective - and I believe it is our objective - to ensure that more deprived areas do receive compensating grant from government to help them meet their responsibilities, then there will always be a greater contribution from government sources in such areas and that is likely to have the gearing effect we have discussed."[49]

50. It is clear that Government grant can be significantly reduced from its present level and still fully meet its functions of equalisation and meeting national objectives through ring-fencing. Revenue Support Grant of £27 billion in 2004-05 is well above the level needed for equalisation. Plans to cut ring-fencing will mean a greater proportion of grant is paid through Revenue Support Grant. We conclude that the only purpose of keeping grant so much higher than necessary is to have a greater control of local authority expenditure, as a tool of macroeconomic policy. While economic stability is a legitimate goal, the relatively marginal effect of small changes in local authority expenditure within the context of the whole economy and negative impact of gearing on local authorities leads us to recommend that central Government should have control only over the grant it needs to meet the goals outlined above. Local authorities should have control over a much greater proportion of their income, at least 50%. Our proposals for the taxes which should fall under local government control are outlined later in this report. We accept the Minister for Local and Regional Government's argument that equalisation means that some gearing effect will always be part of the system, but the changes we propose aim to reduce this and its distorting effects. A shift in the balance of funding of the order of our recommendation would make the system significantly more acceptable and transparent.

51. On the 8th of July the Secretary of State for Education set out the Government's five year plan for Education. The statement did not make it clear exactly how schools would be financed in the future. We would be concerned if the Government were to seek to achieve the 50:50 central/local funding balance at a national level by transferring the funding of schools to central Government control and removing the funding for schools from the Aggregate of External Finance. However, we would be wholly opposed to a proposal to ringfence the funding for schools within the Aggregate of External Finance. The Government needs urgently to clarify its plans for funding for schools.

Other Grant Issues

Transparency over the basis of funding decisions

52. The Committee also received evidence about the lack of transparency in the current grant system: including the way in which the level of the formula spending share is determined for each of the service blocks, the Government's assumptions about the effects of inflation, and the effects of changes in demand for service.

Evidence from Wandsworth Borough Council argued that:

"[…] the Government should provide full transparency about its planning assumptions for inflation and growth in local authority expenditure and provide matching support by government grant".

They also called for the creation of an independent commission to promote improvements in simplicity, certainty, timeliness, transparency, accountability and intelligibility for all kinds of government grant.[50]

53. The evidence from the Audit Commission similarly called for more information about this process:

"Clarity and openness about the basis of national funding systems, and acceptance that these are not subject to short-term manipulation, are key to acceptance of outcomes from funding decisions. In our report on council tax increases in 2003/04, we suggested the government should be more transparent about the basis for funding decisions. A more radical option to increase transparency would be for an independent grants commission to allocate resources - after government had determined the total amount to be allocated"

They also said that accountability would be improved if there was clarity from national government about what it had allowed for in grant settlements.[51]

54. The so-called 'funding crisis' in education in 2003-04 was a particular example of a situation where, due to lack of clarity around the process, there was a heavily polarised debate between local education authorities and the Government about the generosity of the settlement. Peter Kenway, a Director of the New Policy Institute told the Committee:

"[…] The point I would stress is that I think the thing one is looking for is clarity, which is not easy to achieve, but when I think back to last year and the business around the shortage of funding to schools, who was to blame? Was it the school, was it the local authority or was it central government? We were asked this question. We are experts and I do not know the answer. The real issue is where you go if you are unhappy with an outcome."

The Minister for School Standards was asked about this and replied:

"I think I am right in saying that there was universal agreement that the increase in funding of about £2.7 billion exceeded the increase in costs by about £250 million. I do not think there is a dispute between central and local government about that. What was the case was that there were significant changes in the cost structure, notably in relation to pensions for example which ate up £500 to £600 million of that increase. I think that the diagnosis of what happened, the narrowness of the gap between costs and investment, is not actually very strongly disputed."[52]

55. However, taking £250 million as the 'real' increase in funding (after education specific costs) gives an increase of less than 1% across the country. This is much less than the 5% 'real' increase (compared to general inflation) in per pupil funding across the country set out in the Department's 2003 Annual Report.[53]

56. Lindsay Bell, the Director of Local Government Finance at the ODPM, confirmed that inflationary pressures are taken account of:

"[…] the totals are negotiated as part of the spending reviews individual departments look at the costs that they think will fall as a result of policies to local government, and inflation and pay and things are one element of what we look at for that."[54]

The Minister for Local and Regional Government explained how this system operates:

"We do operate the new burdens principle. I police it as best I can. I am well supported by the Treasury who support it. Our objective is to ensure that if additional burdens are placed on local government then an appropriate financial allowance is made in the spending review and that has been very much part of the work going on in the current spending review. This is something which involves the Local Government Association. We do involve them in it and I believe that is an entirely appropriate and constructive way of going about it. I would not like to say whether we could be more transparent than that."[55]

He went on to say:

"I could not possibly say it is adequately publicly available, because a lot of it is very arcane and involves lengthy and detailed discussions between technical experts and central and local government about the impact of particular new burdens. A lot of that would be very, very complex indeed to try to get into the public domain."[56]

57. Information about the cost pressures faced by local authorities in providing their local service would add an element of transparency to system of local government finance. This information is used at present within government to make vitally important decisions about local funding. It is not acceptable that the Minister for Local and Regional Government gives himself the role of 'policeman' over his own decisions. At present the complexity of the system and lack of this type of information means that it is perfectly possible for local authorities and central Government to make statements about the generosity of annual settlements that are diametrically opposed, without the public being about to judge which is more accurate. We are not suggesting that this lack of information always hides reductions in the real level of funding; only that simply comparing funding changes to general inflation is inadequate. In 200203 employment costs made up 60% of local authority service expenditure.[57] Average earnings are currently running around two percentage points above the Retail Price Index and public sector earnings are increasing faster than in the private sector.[58] These factors together mean that it is reasonable to assume that the costs of providing local services are increasing faster than the Retail Price Index, and make comparisons to general inflation unreliable or misleading.

58. Information of the sort we seek is only likely to be the starting point for debate about cost pressures between local and central Government; but it would be a better informed and more productive debate than at present. It would give council tax payers a better idea of why their bills have changed and who is responsible. We recommend that the ODPM publishes details of the estimated cost pressures for each local authority service. We accept that much of the detail is likely to be technical, but summary information could spell out at a national level what funding had increased by, what servicespecific inflation was predicted to be, what assumptions about efficiency improvements have been made and hence what remains for actual service improvements.

Three year budgets

59. On 3 May 2004 the Prime Minister made a speech to the National Association of Head Teachers announcing the Government's plan to introduce three year academic year budgets for schools:

"[…] One of the greatest difficulties for schools, as the last two years has shown, is to plan ahead not knowing year on year what the school budget will be. Subject of course to the proper financial systems and accountability, and as a result of this year's spending review settlement for education, I can tell you today that it is our intention, in the education department's future programme in July, to set out a move to three yearly, not yearly, budgets for schools, with assured funding to underpin them. And we would like these budgets to be aligned to the school year, not the financial year, reflecting the way you do business as school managers."[59]

On 8 July 2004 the Secretary of State for Education and Skills announced to the House his plans to introduce "guaranteed three-year budgets for every school from 2006" as part of the Government's five-year strategy.[60] The Minister for School Standards told the Committee that the benefits of this would be "huge":

"When head teachers say it is very difficult for them to plan with confidence on the basis of year on year changes to budgets, they are absolutely right. So the benefits are obvious, the benefits to local government as well as to central government are obvious. We are now working with colleagues in government and around the school system, including local government, to put it into practice and we are determined to do so. The current spending review runs up to 2005-06 and we are working hard on an implementation timetable which meets the need, but is also practical and prudential."[61]

60. The Minister for Local and Regional Government said:

"This was a general wish and it is not limited either to schools or to local government, to try to move towards greater financial certainty. The institution of the spending review programme with three-year indications of funding is part of that process."[62]

He also listed some of the potential problems:

"[…] there are problems, particularly in areas where there are fluctuations in either pupil numbers or in other demographic trends which impact on the cost of delivering local authority service. If you lock people in to particular levels of funding for a three-year period, without the scope to vary to take account of significant rises in cost pressures, driven by demographics which are entirely outside the authority's or the school's control, you could be creating a different problem. There are issues there which need to be addressed, but the concept and the principle of a greater degree of certainty, so that people can plan ahead, whether it is at the school level or the local authority level, must be right."[63]

61. There was also support from the Local Government Association for this proposal. Sir Jeremy Beecham said he welcomed the proposal so long as it was extended to the rest of local government. He added "There will need to be an element of flexibility; a minimum guarantee, as it were, should be available to councils and within that context it would be feasible to plan for schools and other services."[64]

62. There would be obvious advantage in a three year rolling programme of grants for local authorities. It would enable authorities to publish at least indicative budgets for the same period, and associated local tax rates. The Spending Review system in central Government already provides this element of certainty and predictability. A similar scheme already operates in Scotland. We would in principle like to see the practice of three year assured funding proposed for school budgets extended to all local service funding. If this is not done it is important that the ODPM and Dfes explain the relationship between education and other local authority spending and whether all education funding is effectively going to be ringfenced. We recommend that ODPM inquire into the lessons to be learned from Scotland, and investigate appropriate safeguards for its introduction in England.

7 www.local.odpm.gov.uk Back

8 Ev 43 HC 402-II [Somerset County Council] Back

9 Ev 35 HC 402-II [Chartered Institute Public Finance and Accountancy] Back

10 Ev 40 HC 402-II [Special Interest Group Of Municipal Authorities] Back

11 Ev 1 HC 402-II [Office of the Deputy Prime Minister] Back

12 Budget returns data 2004-05, ODPM. These figures are not consistent with the usual national balance of funding ration of 75:25 because they exclude specific grants. Back

13 Ev 119 HC 402-III [Policy Exchange] Back

14 Q 71[Professor Travers, London School of Economics] Back

15 Audit Commission 2004 'Council tax increases 2003/04 Why were they so high?' Back

16 Q 150 [Mr Shostak, Public Services Directorate, HM Treasury] Back

17 Q 517 [Mr Woods, City Treasurer, Newcastle-upon-Tyne City Council and Finance Officer, Association of North East Councils] Back

18 Q 543 [Mr Woods, City Treasurer, Newcastle-upon-Tyne City Council and Finance Officer, Association of North East Councils] Back