Conclusions and recommendations
1.We are concerned that the Department for Communities and Local Government (the Department) appears complacent about the risks to local authority finances, council tax payers and local service users resulting from local authorities increasingly acting as property developers and commercial landlords with the primary aim of generating income. There is growing activity among local authorities aimed at generating revenue income from capital investment in properties and businesses. For example, developing houses and commercial units for rent or sale at market rates. Local authorities can finance these investments through borrowing and can invest outside the authority’s own area. The Department does not have a good understanding of the scale and nature of these activities. It suggests that they are predominantly an extension of long-standing council activities and not necessarily more risky. However new and additional risks come from authorities purchasing properties to lease to businesses or developing houses for market rent, as authorities themselves recognise. Some authorities are also adopting these strategies in order to provide significant elements of their future revenue income. We do not share the Department’s confidence that the increased commercial acitivity in the sector adds no particular risk to the Department’s own work. We are also concerned that some authorities might lack the necessary commercial skills and experience amongst both members and officers. If commercial decisions go wrong, council tax payers will end up footing the bill and other services will be under threat.
Recommendations:
By summer 2017 the Department should send an update to the Committee setting out how it is strengthening its understanding of the scale and nature of authorities’ commercial activities, focussing in particular on the scale of risk across the sector and the types of authorities placing themselves at greatest risk.
Working with partners in the sector, the Department should review the level of commercial skills across both officers and members in different types of authorities.
2.Neither the Department nor HM Treasury understand why local authority investments on deposit are now at record levels. Local authority investments on deposit grew to £26.1 billion in 2015–16, compared to £18.5 billion in 2010–11. Deposits with commercial banks and most other institutions are not risk-free. However, the Department was not able to explain to us the factors underlying the growth in these deposits. HM Treasury’s understanding was equally limited and appeared to be based on supposition rather than evidence collected from authorities. In particular, HM Treasury’s views that the changes in early repayment terms to Public Works Loan Board loans have not played a role in the build up of deposits is at odds with evidence from the Local Government Association that the changes made had a clear effect on the choices open to local authorities.
Recommendation: In its update to us in summer 2017, the Department and HM Treasury should explain clearly the causes of, and risks associated with, the build-up of investment cash held on deposit by local authorities based on both analysis of data and direct engagement with local authorities.
3.The Department does not have a good enough understanding of the extent to which revenue pressures are affecting local authorities’ capital spending and resourcing activities. Local authorities are under sustained revenue pressure, with reductions in government funding leading to a 13.8% real terms reduction in revenue service spend from 2010–11 to 2014–15. A significant number of local authorities have to use more than 10% of their revenue spending to service debt incurred to finance capital spending. Authorities cite revenue pressures as the main factor that shapes their capital programmes; for example by making them reluctant to increase external borrowing and causing them to prioritise capital spending that reduces revenue costs or generates additional income. Accordingly, capital spending on a commercial property portfolio could replace some capital spending on libraries or youth centres. The Department accepts that local authority capital programmes are being shaped by decisions made in the light of tight revenue budgets. However, the Department’s work for the last Spending Review was focused on revenue pressures and did not include a full analysis of the capital side. While the Department’s policy, through 100% localisation of business rates, is that authorities should become more self-sufficient and entrepreneurial, it has not yet considered the implications for capital expenditure and resourcing.
Recommendation: The Department should ensure that the interactions between revenue spending, capital spending and borrowing and the resulting pressures on local authority capital programmes are considered fully in future spending reviews and in the design for the 100% business rates retention scheme. The Department needs to set out plans to do this in its summer 2017 update to us.
4.The Department lacks a cumulative picture of capital risks and pressures across the sector. Local authorities have a great deal of freedom to decide on borrowing and capital spending without central control. The Department relies on a devolved framework that gives it assurance about the short-term sustainability of individual authorities, but the framework does not identify issues across the sector. Despite this, the Department does not use the data it collects effectively to build its own system-wide picture of trends across the sector and carries out limited analysis related to capital. The Department’s current understanding of risks across the sector, such as the deteriorating condition of capital assets, is not sufficient. The Department accepts that in future it needs to monitor trends and developments in the sector more actively and to be more intelligent in the way that it identifies trends in the sector.
Recommendation: The Department’s update note should set out how it intends to strengthen its use of quantitative data and other information to ensure it has a clear understanding of trends and risks across the sector relating to capital spending and resourcing.
5.The Department’s figures for capital spending in the sector do not provide sufficient detail to identify significant changes in its purpose and objectives. In the Department’s statistics, three-quarters of capital spending is grouped into a single category called ‘new construction, conversion and renovation’. This is broad enough to hide the marked changes in investment strategy ongoing in the sector including a switch to invest to save and commercial schemes away from long-term asset management. The Department agreed to look at how it could improve the usefulness and quality of such data. The rest of government relies on the Department’s data and analysis to understand local government and HM Treasury supported the need for more detail. Furthermore, significant levels of funding are now being granted to Local Enterprise Partnerships and there has been some double counting when the funding is transferred from accountable authorities to other authorities.
Recommendation: In the update note for summer 2017 the Department should set out what measures it has introduced to ensure that the purpose and geographical location of capital spending can be ascertained and what specific steps it has taken to remove double counting from its figures.
6.There is a risk that the local capital finance framework might not be able to cope with the current, rapidly changing and uncertain institutional and economic environment. The nature and purpose of local authority capital spending is changing in response to continued revenue funding reductions. The Department is also considering further significant changes to the funding of local authorities, such as to the New Homes Bonus and business rates retention. The Department is still gathering and analysing evidence about implications of Brexit for local authorities. New questions about transparency and accountability are being raised by progress with devolution deals and the developing role of combined authorities. The Chartered Institute of Public Finance and Accountancy (CIPFA), which the Department relies on for information and expertise, has accepted the need for the capital framework to be reviewed. However, we are not convinced that the Department is being sufficiently pro-active in reviewing the capital framework itself; seemingly content to take assurance from the framework’s existence rather than from evidence that it is working properly or that it is robust enough for the current turbulent times.
Recommendation: Working with CIPFA, the Department should ensure that the local government capital finance framework remains current and continues to reflect developments in the sector, alongside wider institutional and economic changes.
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16 November 2016