Financial sustainability of local authorities Contents

1Local authority risks and impacts

1.On the basis of a report by the Comptroller and Auditor General, we took evidence from the Department for Communities and Local Government (the Department) and HM Treasury. Our evidence session was also informed by an update memorandum from the National Audit Office.1

2. There are 353 local authorities in England, which use capital spending to invest in assets such as roads, leisure centres, libraries and the offices that they use in delivering services. In 2013–14, local authorities collectively held assets worth £168.5 billion (excluding education). In 2014–15, local authority capital spending was £12.3 billion (excluding education).2

3.Between 2010–11 and 2015–16, local authority capital spending increased by 13.6% in real terms. This is in contrast to day-to-day spending on services, such as meeting staff costs, which is classed as revenue spending and fell by 13.8% over the same period.3 Understanding the ways that revenue and capital interact is necessary to get a full picture of the financial challenges facing local authorities and the ways in which they can respond. For example, authorities can borrow to finance capital spending but then interest costs and repayments will represent a fixed cost to revenue, reducing their room for manoeuvre.4

4.The Department is responsible for the local government finance system within government. This responsibility covers both revenue and capital spending. The Department operates a devolved accountability framework for capital; more so than for revenue. However, the Department remains responsible to Parliament for assurance about the financial sustainability of local authorities and the way in which local authorities use their resources.5

5.HM Treasury approves decisions taken by the Department that could have an impact on the national finances. It also sets the framework under which local authorities can borrow from the Public Works Loan Board.6

Commercial capital investments

6.Local authorities are increasingly making commercial capital investments aimed at generating revenue income, for example by purchasing properties to lease to businesses, developing houses for market rent, and developing commercial units. South Norfolk Council told us that its capital programme includes making “new property investments to generate income above the returns being earned on cash investments to ensure we can deliver those services that residents value the most” and “to help our aim of moving closer to financial independence”. This type of activity is growing: the National Audit Office found that many councils are in the early stages of setting up such schemes.7

7.For some authorities, these investments are specifically intended to replace income from reducing government grants. Government policy is for “the sector to be largely self-financing” and the Department told us that “a degree of entrepreneurialism is part of the picture”.8 Despite this recognition, the Department’s data does not capture this change and the Department has not fully engaged with the changes taking place in the sector or the potential for increased risks for council tax payers and local service users. When we asked the Department about its awareness of the risks involved, it told us that “a lot of the time, the commercial structures that local authorities are putting in place are new ways of operating existing services” and that out-of-area activity involved selling council services to other authorities and so “are not necessarily more risky”. The Department also argued that commercial investments did not add risk to council finances since they were no more risky than managing social care demand pressures.9

8.However, local authorities are increasingly acting as property developers and commercial landlords with the primary aim of generating income. These investments can be outside their own authority and they can be financed by borrowing. Furthermore, in some cases these activities have been designed to replace lost government funding and can represent significant elements of authorities’ income. These developments are substantially different to the types of smaller scale commercial ventures undertaken previously. Authorities themselves recognise that such activities bring new risks to their finances.10

9.Oversight of these new commercial activities will require skills of elected members that may be in short supply in some authorities. Already some authorities are less confident than others about members’ ability to provide strategic oversight of the sustainability of capital programmes. Members receive support from officers but these new ventures may require specialist skills and experience that have not been needed by officers in the past. The market value of the commercial skills and experience required is not a good fit with local authority pay scales. Authorities in straitened circumstances could struggle to fill these gaps.11

Local authority “investments on deposit”

10.The amount of local authority money deposited with banks and other financial institutions (investments on deposit) has grown by £7.6 billion since 2010–11, reaching £26.1 billion at the end of the 2015–16 financial year. This level is higher than the previous peak of £25.0 billion in 2007–08.12

11.Deposits with commercial banks and most other institutions are exposed to ‘counterparty’ risk as it is possible for the institution to fail and the money to be lost. For this reason, the Department issues statutory guidance on local authority investments that requires them to manage such risks. It told us that this guidance requires authorities to prioritise security and was strengthened in April 2010; this followed the report of an inquiry prompted by the local authority investments on deposit put at risk following the collapse of Icelandic financial institutions in 2008.13

12.When asked to give more detail on the cause of the recent increase in deposits, the Department’s response did not lead us to believe that it had a strong grasp of the issues.14 The only explanation the Department gave us for the increase in the level of deposits was the need for local authorities to “make minimum revenue provisions in order to repay their debts primarily to the Public Works Loan Board”. Local authorities repay money borrowed from the Public Works Loan Board in a lump sum at the end of the loan.15 However, local authority borrowing, requiring such provisions, has steadily risen during a period while the level of deposits has risen, fallen and risen again.16 This suggests that there are likely to be other factors in addition to minimum revenue provision charges.

13.The National Audit Office reported that some local authorities felt that changes to the early repayment terms of Public Works Loan Board debt meant that early repayment was no longer seen as value for money. In the past, local authorities have repaid loans to the Public Works Loan Board early using money that might otherwise be held on deposit but early repayment has fallen significantly in recent years.17 When we asked HM Treasury about the impact of changes they made to Public Works Loan Board early repayment terms, we were told that the change in interest rates is “the major driver of that behaviour” rather than the Treasury changes. But HM Treasury told us this without referring to any detailed analysis of the issue or to the views of local authorities.18 In contrast, local authorities told the National Audit Office that the changes were a significant factor irrespective of the change in interest rates, while the Local Government Association said that the early repayment route for local authorities has “effectively been closed” by the changes to Public Works Loan Board terms.19

Impact of revenue pressures

14.The Local Government Association told us that “local government remains under significant financial strain”.20 The Department told us that, where they have had concerns about the financial risks to individual local authorities, these concerns have arisen from “the overall budgetary pressures on the revenue side”.21 Revenue spending power (income from government grants and council tax) fell by 25.2% from 2010–11 to 2015–16 and is expected to fall by a further 7.8% in real terms by 2019–20.22

15.Local authorities can finance capital spending by borrowing but must then bear the cost of interest and repayments from their revenue resources. With falling revenue income, the impact of debt servicing costs has become substantial for many authorities. For example, more than a quarter of metropolitan district councils spent more than 10% of their revenue spending on debt servicing in 2015–16.23 Debt servicing costs are effectively fixed costs for an authority, competing for the revenue resources needed to meet its statutory service obligations in areas such as children’s and adult social care.24

16.The National Audit Office reported that the main issue facing authorities was making sure their capital programmes put less pressure on revenue spending. Some capital spending can reduce revenue costs, for example if a new office costs less to heat than the space it is replacing, while other capital investments can generate income.25 The Department said that authorities are making sensible decisions about capital investments in the light of tight budgets.26 Authorities have prioritised capital spending that reduces revenue costs, generates additional income or supports local growth. However, along with an understandable general reluctance to increase debt servicing costs any further, this has left less room for spending on services like youth centres and libraries.27 It also leads to risks that the condition of important capital assets will deteriorate. For instance, the National Audit Office reported that authorities have reduced or are delaying long-term capital investment in capital works and asset management as this was becoming increasingly difficult to resource. Authorities are increasingly reluctant to borrow to resource this type of investment as it is not able to generate savings or income to cover the costs of borrowing.28

17.The Department focused its efforts in the most recent spending review on revenue pressures. It did, however, recognise that it needed “to pay more attention to the capital side in future”.29 It also recognised that the position of capital needed to be considered as the sector moves to financial self-sufficiency by 2020 with the introduction of 100% business rates retention. But the Department still expects that the core revenue budget will be where the “big debate needs to be”.30 However, the National Audit Office report has demonstrated the significant and growing interactions between both capital and revenue; servicing debt represents a significant element of revenue expenditure and capital programmes are now increasingly shaped by a desire to reduce revenue pressures or generate revenue incomes.31 Capital and revenue cannot be seen as separate and distinct elements of authorities’ financial and service sustainability and need to be considered side-by-side by the Department on a consistent basis.32

1 C&AG’s Report, Financial sustainability of local authorities: capital expenditure and resourcing, Session 2016–17, HC 234, 15 June 2016; and National Audit Office memorandum for the House of Commons Committee of Public Accounts, Update to Financial sustainability of local authorities: capital expenditure and resourcing, October 2016

2 C&AG’s Report, paragraphs 1.2 to 1.4, figure 2 and Appendix 1. For this report local authorities include London borough councils, metropolitan district councils, unitary authorities and district councils

3 Update memorandum, paragraphs 2.1 and 2.2. C&AG’s report, paragraph 1.2 and figure 2

4 C&AG’s Report, summary paragraph 3 and paragraphs 1.12 and 1.17

5 C&AG’s report, paragraphs 3.1, 3.3, 3.4 and 3.20

6 C&AG’s Report, paragraphs 1.34, 3.21 and figure 16

7 C&AG’s Report, paragraphs 2.20 and 2.21; South Norfolk Council, (FLA0002)

8 Q 15; C&AG’s Report, paragraph 2.20

9 Qq 9, 11, 33, 37; C&AG’s Report, paragraphs 2.27 and 2.28

10 Q 4; C&AG’s Report, paragraphs 2.14 and 2.20 to 2.22; South Norfolk Council, (FLA0002)

11 Qq 7, 38; C&AG’s Report, paragraph 3.26

12 C&AG’s Report, figure 9 and update memorandum, paragraph 1.7

13 Q 42; C&AG’s Report, paragraph 1.54 and figure 16; House of Commons Communities and Local Government Committee, Local authority investments, seventh report of 2008–09, HC 164, 11 June 2009

14 Qq 70–74

15 Q 42

16 C&AG’s Report, figures 8 and 9

17 C&AG’s Report, paragraphs 1.32 to 1.35

18 Qq 17–19

19 C&AG’s Report, paragraph 1.35 and Local Government Association, (FLA0001), p. 3

20 Local Government Association, (FLA0001), p. 1

21 Q 32

22 C&AG’s Report, paragraph 1.52

23 C&AG’s Report, paragraphs 1.12 and 1.17; update memorandum, paragraphs 1.9 and 1.10, and figure 2

24 C&AG’s Report, paragraphs 5 and 2.11

25 C&AG’s Report, paragraphs 1.15 and 2.16 to 2.22