Local government finance: the
status quo
3. Local authorities derive income to fund their
activities from four main sources:
- local residents via the council
tax;
- local businesses via the uniform business rate
(UBR) which is also known as the national non-domestic rate (NNDR);
- central government grant, and
- a variety of fees and charges.
The contribution made by central Government to local
government is in the form of 'formula grant' and other grants
that may or may not be tied to specific purposes. Formula grant
is made up of three elements—NNDR income, revenue support
grant (RSG) and police grant. Collectively formula grant and
specific grants are termed Aggregate External Finance (AEF).
In addition to AEF, central Government makes other special grant
payments to local authorities, usually referred to as special
grants outside AEF, some of which are related to mandatory payments
such as rent allowance payments. Others may be targeted but without
restrictions. In 2006-07, central government financed 76 per
cent of local government's gross revenue expenditure.[2]
4. Since the mid-1970s the RSG has been what is usually
known as an 'equalising grant'. This means that it has been distributed
between local authorities in such a way as to take account of
differences in their spending needs, as assessed by central government,
and their ability to raise money from local tax. In theory, if
each local authority were to spend at the level assessed by central
government each local authority of the same type—e.g. all
district councils—would be able to set the same rate of
council tax. Although local authorities and others have often
questioned the reliability of successive governments' methodology
for measuring spending need, there has been broad agreement over
the merits of having an equalising grant system.
5. Currently householders' liability for local taxation
is based upon the broad capital value of their property while
businesses' liability depends on the rental, or rateable, value
of the premises they occupy. Although the tradition of property
taxation in Britain dates back several centuries, local authorities'
powers to levy local taxes largely date from the nineteenth century.
Initially liability for a local 'rate' was aligned to the right
to vote, a right that was itself often determined on the basis
of property ownership or occupation. Thus both businesses and
residents became ratepayers. Debate over the basis of local taxation,
and aspects of its impact, has existed from the start. Politicians
from across the political spectrum, from the nineteenth century
Conservative Prime Minister Lord Salisbury to the radical thinker
Sydney Webb to former Labour leader George Lansbury who, as Mayor
of Poplar in 1921, led his local borough council in refusing to
forward the tax revenue it had collected, have questioned the
size of rate demands and the effect on individuals.
6. Local authority services have been subsidised
from central sources for more than a hundred years. In the wake
of the Second World War, local authorities played a significant
role in the development of the welfare state, with services such
as education, housing and social services being delivered, and
paid for, at the local level. Although the support given to local
authorities by central Government increased significantly to meet
these new demands, local rates increased in real terms. In the
1960s, the 'domestic element', a small subsidy from central Government,
was introduced to reduce the rate of increase in householders'
bills relative to other ratepayers but this did not compensate
fully for the combined effects of the high inflation in the early
1970s and the costs involved in the provision of an increasing
range of local services. Local taxation was consequently forced
up to levels far higher than previously. In 1974, the average
annual increase in local rates for all ratepayers—businesses
and householders alike—exceeded 30 per cent.[3]
7. Such huge rate rises provoked widespread dissatisfaction
and, in response, the Government appointed (later Sir) Frank Layfield
QC to lead the first of what was to become many modern inquiries
into local government finance. Reporting in 1976, the Layfield
Committee put forward two models for future funding. The first
effectively put central Government in control of local government
finance. The second option, favoured by a majority of the Committee,
envisaged much greater local autonomy and the introduction of
a new source of local revenue. In the event, neither proposal
was implemented and no reform of local taxation took place.
8. The post-1979 Conservative Government contemplated
significant reform, publishing a Green Paper in 1981, which considered
a range of alternatives to the domestic rates, including a local
income tax, local sales taxes and a poll tax. Again, no reform
followed. A further Green Paper in 1986 revived the idea of a
poll tax, now termed 'community charge'. The latter replaced domestic
rates in Scotland in 1989 and in England and Wales a year later.
At the same time direct central control over the revenue raised
from business was imposed and the NNDR became a nationally determined
'assigned revenue'. The community charge proved unworkable and
short-lived: in 1991, the Government reduced liability by £140
per head and simultaneously increased the rate of Value Added
Tax from 15 to 17.5 per cent to compensate. A further review of
local government revenue resulted in the replacement of the community
charge with council tax two years later. The NNDR remains in
place.
9. In January 2003 a further review of local government
finance was launched by the then Local Government Minister Rt
hon. Nick Raynsford MP, this time focusing on balance of funding
issues specifically. It reported in July 2004. Shortly beforehand
our own predecessor committee had reported on Local Government
Revenue, calling for a re-localisation of the business rate
and a severing of the link between increases in the business rate
and the Retail Price Index (RPI).[4]
At the same time, the Government asked Sir Michael Lyons, Director
of the Institute of Local Government and Professor of Public Policy
at the University Birmingham and a former chief executive of three
major local authorities, to undertake an independent review of
local government finance. His remit and timescale were extended
in 2005 to include the role and function of local government.
Sir Michael's final report, Place-shaping: a shared ambition
for the future of local government, was published alongside
the Budget in March 2007.
10. Like Sir Michael, we have found that many are
under the misapprehension that before 1990 local authorities were
free to reduce the burden of taxation on residents at the expense
of business ratepayers. This was never the case. Before the
abolition of the domestic rate and the 'nationalisation' of the
business rate in 1990, businesses and householders in principle
paid the same local tax at a rate set by the local authority.
Indeed, as Sir Michael Lyons notes, "business and domestic
rates were actually aspects of the same tax."[5]
In practice the 'domestic element' reduced the tax rate for householders
by 18p in the pound.
11. Following the 1990 transfer of the non-domestic
rate to central government and £140 reduction in the community
charge in 1991, the proportion of local authority resources raised
from local taxation fell to 20 per cent. Although this has since
increased slightly there is still a significant gearing problem
for local authorities: each one per cent increase in expenditure
leads to a council tax increase of some four to five per cent.
Over time successive Governments have encouraged local authority
expenditure to rise more steeply than the central funding supporting
that expenditure, meaning that the revenue required from council
tax, that is from householders, has risen far more sharply than
spending. At the same time increases to the NNDR have been capped
by a statutory linkage to the RPI, so the contribution made by
business has remained constant in real terms even though it has
declined as a proportion of overall local authority revenue.
12. The business rate is chargeable on all non-domestic
properties barring certain reliefs and a total exemption for agricultural
land or buildings dating from 1929. Although collected by local
government (district authorities in two-tier areas), a uniform
national rate is determined by central Government. Between 1990-91
and 2006-07, business rate receipts were paid into a national
pool and redistributed by central Government to local authorities
as a flat-rate grant according to the number of people resident
in an area and, from the introduction of council tax in 1993,
also taking into account the range of functions undertaken by
the local authority (different arrangements apply in the City
of London).
13. In 2006-07 the Government made a number of changes
to the grant distribution arrangements including removing schools
funding from the RSG and introducing a new, ring-fenced Dedicated
Schools Grant (DSG), new needs formulae and a new block grant
distribution mechanism. Most of the funding for the DSG came
from the RSG. The amount remaining for distribution fell from
£26.7 billion in 2005-06 to just £3.4 billion for 2006-07,
increasing the proportion of central government funding for local
authorities which is ring-fenced for specific purposes or targeted
from five per cent to 53 per cent (54 per cent in 2007-08).[6]
Having taken this decision, the Government was forced to use
income from the NNDR to equalise between local authorities in
terms of needs and resources purposes as there was insufficient
RSG remaining within the formula grant pot. Indeed NNDR income
has become essential to the equalisation process. Another consequence
of ring-fencing schools funding is that the gearing ratio has
been changed.
Our inquiry
14. Reforming the way in which local government is
funded is an urgent necessity if local authorities are to continue
to fulfil their duties to local residents, to take on the place-shaping
role set out by Sir Michael Lyons and to exploit fully, to the
benefit of the communities they serve, the devolutionary approach
set out by the Government in the local government White Paper,
Stronger and Prosperous Communities.[7]
Current funding arrangements, dominated by the will of central
government, inhibit such aspirations. We are conscious that,
despite the sterling work done in the series of reviews which
have taken place over the last 30 or so years, little has been
done to affect strategic, as opposed to reactive, reform of local
government finance in the round. Wishing to avoid any possibility
of causing a further delay in Government action, we have conducted
a short and pointed inquiry into Sir Michael's most significant
proposal relating to local government finance—the suggestion
that local authorities be given the power to raise a local supplement
to the NNDR. We have also examined concurrently and on a similar
timescale proposals to alleviate problems within the council tax
benefit system. A separate report is in preparation. The urgency
with which we have undertaken this work signifies the importance
we attach to these matters and our belief that persistent procrastination
by successive Governments over devolutionary reform, demonstrated
by the long history from Layfield onwards of ineffectual reviews
never fully implemented, is damaging both to communities and to
local government and is contrary to the principles of fair and
good governance. We started our inquiry in May 2007, just
11 weeks ago.
15. We have built upon, rather than duplicated, the
work undertaken by those who have examined local government finance
over the years. In this respect we owe a debt of gratitude not
only to Sir Michael Lyons and his team for their expertise, for
their interesting proposals, and for their willingness to share
the fruits of their labour with us, but also to those who contributed
to earlier reviews. We are particularly grateful to those individuals
and organisations who contributed to our inquiry directly through
written submissions or by answering our questions in person.
We would also like to extend our thanks to our specialist advisers
for this inquiry, Rita Hale OBE, former Director of Rita Hale
& Associates Ltd and a local government finance consultant,
and Professor Tony Travers, Director of the Greater London Group
at the London School of Economics, for their guidance, insight,
and willingness to work to our demanding schedule.
16. We regret
that, despite the series of reviews of local government finance
that have taken place over the last 30 years, from the Layfield
Committee onwards, there has under successive Governments been
little change designed to create a funding system that supports
and enables local authorities to fulfil their role as 'strategic
place-shapers'. We agree with Sir Michael Lyons that reforming
local government finance is a key component in empowering local
authorities. There is no excuse for the Government to squander
the opportunity to develop an agenda for change alongside its
response to the Lyons report, its implementation of the 2006 Local
Government White Paper and reforms contemplated in the recent
Green Paper, Governance of Britain.
1 Sir Michael Lyons, The Lyons Inquiry, Place-shaping:
a shared ambition for the future of local government (hereafter
'Lyons report'), March 2007, executive summary, paras 22-9 Back
2
House of Commons Library Standard Note, Local Government Finance
Settlement 2007-08, January 2007, page 4 Back
3
ODPM: Housing, Planning, Local Government and the Regions Committee,
Ninth Report of Session 2003-04, Local Government Revenue,
HC 402-I, para 3 Back
4
ODPM Committee: Housing, Planning, Local Government and the Regions
Committee, Ninth report of Session 2003-04, on Local Government
Revenue, HC 402-I, paras 155-160 Back
5
Lyons report, para 8.6 Back
6
House of Commons Standard Note: Local Government Finance Settlement
2007-08, January 2007, p. 3 Back
7
Department for Communities and Local Government, Stronger and
Prosperous Communities, October 2006, Cm 6939 Back
