Financial sustainability of local authorities Contents

Conclusions and recommendations

1.Seven years of funding reductions have left an increasing number of local authorities in a worrying financial position. The spending power (government funding plus council tax) of local authorities as a whole has fallen 28.6% since 2010–11. This has coincided with a growth in demand in key services, such as a 14.3% increase in the estimated population aged 65 and over in need of social care, and a 10.9% increase in the number of children looked after. Signs of financial pressure are now present amongst local authorities, particularly those with social care responsibilities. Nearly two thirds of these local authorities drew on their funding reserves in 2016–17 to support their spending and over 80% overspent their social care budgets. Some of these local authorities are rapidly depleting their reserves: more than one in ten local authorities with social care responsibilities will have completely exhausted their reserves within three years if they continue to use them at the rate they did in 2016–17. In February 2018, the statutory financial officer for Northamptonshire County Council issued a section 114 notice indicating that the authority was at risk of spending more in the financial year than the resources it had available, which would have been unlawful. Despite this evidence of financial pressure, the Department’s view is that the local authority sector is sustainable.

Recommendation: The Department should, by the end of September 2018, write to the Committee to explain why it believes that the local authority sector is sustainable in the current spending review period, and detailing what it is doing to minimise the risk of financial failure in authorities currently on its risk register.

2.The Department is overly reliant on the next Spending Review, which is now under greater pressure following the announcement on NHS funding, to address the financial challenges currently facing local authorities. The Department told us that it was starting to prepare for the 2019 Spending Review so that it could provide the Treasury and other government departments with a clear picture of the pressures being faced by local authorities. The Department recognises the current pattern where authorities rely on their reserves in order to balance their books would not be a sustainable outcome from the 2019 Spending Review. However, we are concerned that the Department lacks the information or ability to provide a sufficiently compelling evidence to make a case for the levels of local authority funding needed. The Department told us that it took expected increases in demand for services, demographic changes and rising homelessness into account as part of its bid for the previous Spending Review, although it would not provide us with details. Yet in 2016–17, the first year of the 2015 Spending Review period, local authorities with social care responsibilities overspent their service budgets by over £1 billion and used £858 million of their reserves. The Department had to introduce a range of additional funding measures to support the sector in the short term. The Department recognises that it needs to improve its evidence base and improve engagement with other departments to avoid this situation happening again during the next Spending Review period. If the Department is not able to secure sufficient funding for local authorities from the Spending Review, alternative means of ensuring that local authorities remain financially sustainable will be needed.

Recommendation: The Department should write to the Committee within the next six months setting out how it is planning to work with other departments effectively and make the case to HM Treasury for local authority funding persuasively at the next Spending Review; and in addition to securing funding at the next Spending Review, what steps it will take to support the sector in meeting its funding and demand challenges.

3.The Department does not have a consistent and transparent method to assess financial risk in local authorities. The Department uses a range of data and information to assess sustainability in the local authority sector on an ongoing basis but does not share its methodology with the sector or publish the outputs of its work. There is therefore no shared definition of what financial sustainability means in practice in the local authority sector. In particular, the Department is not able to say at what specific point it would have a concern either about individual local authorities or the sector as a whole. This lack of information on the Department’s understanding of financial risk amongst local authorities complicates both assessing risk in the local authority sector and holding the Department to account. It also raises a concern that the Department lacks a clear methodology for assessing risk on a consistent basis. Similarly, the Department does not make public any of the work underlying its bid as part of the government’s 2015 Spending Review, which determined how much money the Department will have over the following four years, and how much government funding local authorities will receive. This evidence is vital to make the case to Treasury for more funding particularly at a time when there are so many competing calls for increased funding across Whitehall. The next Spending Review is due in 2019 and will determine funding levels for 2020–21 and beyond. Both the Department and representatives from the local authority sector recognise that there needs to be more data and analysis on financial risk in the sector and greater transparency on the findings.

Recommendation: The Department should:

4.Increased pressure on funding from social care is limiting spend across other service areas, and the implications of this for service users and taxpayers are unclear. Local authorities are spending a greater proportion of their funding on social care services. The share of local authorities’ service spend devoted to adult and children’s social care grew from 45.3% in 2010–11 to 54.4% in 2016–17. This results from a combination of a 3% real-terms reduction in social care spend and a 32.6% reduction in spend outside social care. Some service areas have seen very substantial reductions. Spend on planning and development has fallen by 52.8%, housing services by 45.6%, and highways and transport by 37.1%. Council tax rates are increasing and much of the additional income is being used to fill the gap in funding for social care. In many cases there is insufficient data to assess the impact of these funding reductions on service users. There is also no single point within government that monitors the impact of spending reductions on services. This means that the Department may not know if pressures in one service area quickly transfer to others or the extent of the risk that this poses to local authorities or service users.

Recommendation: The Department should write to the Committee by the end of September 2018 setting out how it will work with other relevant departments on an ongoing basis to ensure that it properly understands local authorities’ performance across the full range of local services they deliver, the extent to which pressures in some service areas are affecting others, and any service areas where departments have any areas of concern. The results from this work should be published on a regular basis.

5.The lack of a long-term funding plan for local authorities is a risk to value for taxpayers’ money. A series of significant changes to the funding of local government and the scale of funding will come into force in 2021. These are the 2019 Spending Review, the Fair Funding Review and the introduction of 75% local retention of business rates (up from 50% retention). The Spending Review will set the total amount of government funding available for local authorities, the Fair Funding Review will set the framework for distributing funding between authorities, and increased business rates retention will affect the size of fluctuations in local income (depending on precisely how increased retention is implemented). Local authorities will not know the cumulative outcome of these changes until late in 2019, by which stage they will be well into the process of setting their budgets for 202021. The government is considering making changes to funding arrangements for adult social care too, although both the timing and the impact of these is uncertain. The lack of clarity over the design of the new funding framework and the potential scale of changes to their funding means that authorities are not able to manage their financial planning within their normal three to five year medium-term financial strategies, and will have to take a short-term approach. This makes it more difficult for local authorities to take a considered, long-term approach to delivering savings and making investments. This is a risk both to the value-for-money of local authority spending and also to their financial sustainability.

Recommendation: In order to support authorities’ financial planning:

6.Arrangements covering accountability for, and scrutiny of, local authority spending may not be sufficiently robust given the level of financial pressure local authorities face. Local authorities are audited by independent external audit firms. Most authorities also have an internal scrutiny function that holds the executive to account. Both audit and scrutiny form an important part of the framework to support financial sustainability in local authorities. However, there are weaknesses in aspects of the current arrangements. We were told by local authority stakeholders that there was a risk that the role of the external auditor was becoming reduced to that of purely financial audit and meeting regulatory requirements, rather than scrutinising the financial standing of the authority. The willingness and capacity of authorities’ audit committees to respond to external auditors’ findings is also a concern and was a factor in the issues faced by Northamptonshire County Council. Scrutiny committees also support local arrangements to secure financial sustainability, but stakeholder bodies questioned whether their level of resourcing was adequate and whether they received sufficient independent advice.

Recommendation: The Department should, by May 2019, review the way audit committees and scrutiny functions operate in examining and challenging local risks to financial sustainability.

7.The introduction of IFRS nine poses a risk to good financial management and planning in local authorities, including council tax levels. New international accounting requirements for the treatment of gains and losses from investments have the potential to add significant volatility to local authorities’ general funds. Fluctuations in the market value of some investments may now be reflected in the accounts as if these changes were actual income or spending. This notional income or spending could in turn have implications for local authorities’ reserves and their council tax rates. Previously, changes in the value of asset or investment only affected the council’s overall finances when the asset was sold and the value of the gain or loss compared to the original price was confirmed. Stakeholder organisations have proposed that the Department should exercise its powers to introduce a statutory override to the new arrangements to better protect local authorities’ finances.

Recommendation: The Department should introduce a statutory override for the requirement under IFRS 9 for local authorities to account for gains and losses from investments in their general funds, in order to prevent any distorting effects on local government financial management.

Published: 4 July 2018