In recent years, the financial sustainability of local government has faced successive challenges, including increased demand for services, especially social care, changes to the level of funding equalisation between councils and, most recently, the covid-19 pandemic. In some instances, councils have been in such acute financial trouble that they have approached the Ministry of Housing, Communities and Local Government for financial assistance; three of these—Northamptonshire in 2018, Croydon in late 2020 and Slough in July 2021—issued section 114 notices, essentially declaring they had run out of money. Our inquiry has sought to identify the most serious threats facing local councils’ finances. In light of the various factors we consider in the report, including the somewhat delayed Fairer Funding Review, renewed discussion about property taxes and the need to reform funding for social care, the time is right to consider a more radical review of local government finances—and our report makes various recommendations about how this should be done. We also consider what happened at Croydon—which prompted us to look at the section 114 regime—in the annex to our report.
The failure of successive Governments to properly fund social care, which consumes up to 70% of top-tier councils’ budgets, is currently the most serious spending pressure on local government. A solution to the funding crisis alone could largely restore local government financial resilience. We are also concerned about the cuts to more discretionary services arising from councils’ need to prioritise social care provision. We will consider these issues further in our inquiry into funding of adult social care.
The introduction of the Business Rates Retention Scheme (BRRS) in 2013 altered how councils were funded and was central to the Government’s objective of making councils more self-sufficient. This trend is also evident in the increasing proportion of overall funding derived from council tax.
We support the principle of encouraging councils to be more self-sufficient, alongside devolving more powers to them, which we will explore in our upcoming report on devolution in England. Given the narrowness of the funding base of local government, we recommend that the Government devolve more revenue-raising powers to councils. With greater fiscal autonomy should also come more control over spending. Furthermore, we suggest that options be explored for reforming council tax and for reforming business rates, as the Government has promised, possibly by replacing them with a proportional property tax.
We note, however, that councils can never be wholly self-sufficient, as this would disadvantage councils in more deprived areas, and that therefore some funding equalisation will always be necessary. Plans to reform the BRRS through a “reset”, which would result in more money being redistributed to councils with lower rates bases, and a reassessment of need, known as the Fair Funding Review, have been twice delayed. We recommend that both be completed as soon as possible. We also recommend that the Government allow councils to retain 75% of business rates from 2022, but so that this represents a net increase in funding, we urge it not to impose commensurate cuts to grant funding. The additional funding should then be put towards equalisation in a separate grant designed for this purpose. We urge the Government to clarify what level of funding equalisation it considers to be appropriate for local government.
The Government’s short-term approach to funding local government has aggravated councils’ financial instability. The last two spending reviews have been one-year settlements, and while we appreciate the reasons for this, it means local government has not had a multi-year settlement since 2015. Councils cannot manage their spending and borrowing without the medium-term funding certainty that multi-year funding settlements bring. We conclude that the next settlement must be a multi-year settlement.
The pandemic has placed an enormous additional burden on local government finances in the last year. The Government responded with substantial financial support that, according to some estimates broadly covers all covid-19 pressures for 2020–21, although doubt remains about the Government’s commitment to covering future costs. We commend the Government for responding to this unprecedented crisis with such significant emergency funding. The effects of the pandemic will be felt for many years, however, and we recommend that the Government provide greater certainty about what future costs it intends to cover.
In recent years, some councils have sought to generate alternative sources of revenue by borrowing to invest in commercial property. Despite concerns that councils could become too dependent on such uncertain revenue streams, it is our view that commercial investment poses no obvious threat to local government financial resilience overall and that, where it has contributed to financial instability, the councils concerned must bear ultimate responsibility. In understanding local authorities’ use of commercial investment, we must acknowledge that previous Governments encouraged councils to be more commercial.
Since the abolition of the Audit Commission, which had become overly bureaucratic and expensive, responsibility for local audit has become fragmented. Last year, the Redmond Review also concluded that the local audit market was deeply flawed and recommended a new regulator to oversee the sector. In response, the Government has proposed establishing a standalone unit, to act as a “system leader”, within the new regulator of corporate audit, the Audit, Reporting and Governance Authority. We are pleased the Government has published its proposals for a new system leader, but it is not clear if the new unit will be able to join up individual auditor findings with a view to identifying systemic issues across local government. We also are not persuaded that a standalone unit within ARGA can provide the necessary specialism that local authority audit requires. Without a central body responsible for oversight of the sector, we see no way of ensuring a robust and transparent regime of local audit. We recommend the Government remove the ability of local authorities to choose their own auditors.
Under the Local Government Finance Act 1988, a Chief Finance Office must issue a report, known as a section 114 notice, if they conclude the council cannot balance its budget in-year. At that point, spending on all but essential services must stop. It is a statement that the council is in deep financial stress and requires assistance from central government. We conclude that the regime lacks intermediary measures that councils can use to flag up concerns. The Government should introduce an intermediary “yellow card” measure that a Chief Financial Officer could apply to force a council to confront much sooner the seriousness of its financial position. We also recommend that Chief Financial Officers report to both the Executive and appropriate scrutiny committees on a quarterly basis on the state of local authority finances and, in particular, draw attention to potential serious financial problems.