Local government finance Background slide pack May 2014 www.local.gov.uk
Local government Finance Introduction Local government finance is frequently seen as complex. This may be because it covers councils of many sorts and a variety of different services and sources of funding. This background slide pack has been prepared to give members of the Commission a background briefing in the main local government finance issues. Each section contains an introduction and some key facts and figures – mostly in chart form. It has been prepared from a local government perspective. It does not seek to describe the system from the point of view of, for example, users of services. It is also descriptive rather than analytical. A further piece of work could be to show how particular outcomes are the result of given policy choices and to test what could be the outcome from other policy choices. An example of this is the government decision to incentivise councils keep council tax down, and the effect on council service quality. Please contact firstname.lastname@example.org any additional clarification.
Local government finance Index 1) Local government spendingslide 4 2) Funding slide 11 3) Grantsslide 17 4) Business ratesslide 25 5) Council taxslide 47 6) Revenue spending powerslide 56 7) Incentivisation slide 60 8) Other sources of incomeslide 64 9) Roles of central and local governmentslide 69 10) Distribution and equalisationslide 77 11) Reserves slide 97 12) Housingslide 102 13) Capitalslide 108 14) Place Based Financeslide 112 15) Further informationslide 122
1) Local government spending The first section concerns local government spending. We present the DCLG definition of spending (slide 5) and explain why it differs from the definition of “controllable expenditure” used for the LGA’s Future Funding Outlook work (slide 6). We then present the LGA’s spending outlook projections (slide 7) This is followed by slides on the main spending pressures (health and social care - slide 8, children’s social care – slide 9 and waste – slide 10)
Local government spending There are a variety of different definitions used for local government spending. This initial section shows how they are reconciled. Net Current Expenditure - includes all local government services including police - £117bn budgeted to be spent in 2013-14. Source: Local Government Revenue Expenditure and Financing; Budget 2013-14 England https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/225884/RA_Budget_2013-14_Statistical_Release_-_FINAL__2_.pdf
From net current to ‘controllable’ expenditure • The LGA’s work excludes the following which are funded by ringfenced or other service specific grants • Schools - Education funded by the Dedicated Schools Grant (around £40bn) • Police – now provided through Police and Crime and Commissioners • Housing Benefit • In total net controllable expenditure is £51.1 bn in 2013-14
Summary net controllable expenditure Projected figures for 2019/20 are taken from the Local Government Association’s Future Funding Outlook model, and are based on the need and ability to cut expenditure to balance to projected funding reductions. The following slides explain how the main spending pressures have been modelled.
Spending pressures – Health and Adult Social care • Demographic growth. Service usage is projected based on the change in either over 65 (for older people services) or working age (for other services) population in each local authority area. • Unavoidable cost rises. Health and social care unit costs remain constant in real terms to 2015 and then rise by 2% per year in real terms (but non-labour non-capital costs remain constant in real terms). This follows the approach taken by the PSSRU when modelling future social care costs for the Dilnot report. Overall this adds up to unavoidable growth in cash terms in required spending on Adult social care over 6 year period shown on slide 7. The calculation takes account of the funding provided by the Better Care Fund from 2015/16, but not any additional burdens arising from the Care Bill (the Dilnot reforms) as these have not yet been accurately estimated.
Spending pressures – children’s social care • Unavoidable cost rises. Health and social care unit costs remain constant in real terms to 2015 and then rise by 2% per year in real terms (but non-labour non-capital costs remain constant in real terms). This is intended to reflect key unquantifiable cost drivers such as changes to the length of time spent in care, increase in referrals, use of agency staff, complexity of care needs, etc. • Service usage is projected based on the change in child population in each local authority area. • The Children and Family Court Advisory and Support Service also report that there has been a sustained increase in the number of councils applying to the courts for Care Order since the Baby P case, but the numbers are still too volatile for a trend to be predicted and the average costs for councils leading up to a court application have not been accurately determined. Overall this adds up to unavoidable growth in cash terms in required spending on Children social care over 6 year period shown on slide 7.
Spending pressures - Waste • Cost of landfill: Based on DEFRA modelling that overall waste arisings will decrease and the amount of waste landfilled will decrease. Landfill tax will remain at £80 per tonne from 2015/16 and landfill gate fees will increase with inflation only. • Cost of Energy From Waste: Based on DEFRA modelling that overall waste arisings will decrease, but the proportion of waste arisings sent as EFW will increase. EFW gate fees will increase with inflation only. • Cost of composting gate fees (organics): Based on DEFRA modelling that overall waste arisings will decrease and the proportion of waste arisings composted will remain constant. Composting gate fees will increase with inflation only. Overall, adds up to unavoidable cost pressures to maintain / slightly increase spending on waste over 6 year period as shown on slide 7.
2) Funding The second section looks at the main sources of funding. Slide 12 presents an overview of the main sources of funding; these are explained more fully in later sections of the pack. Again we present the DCLG definition (slide 13) and show how controllable expenditure differs (slide 14). We then show the path of future funding (slide 15). Slide 16 shows the squeeze on service expenditure which results from these projections.
Overview – where does funding come from? • Government grants • Ringfenced grants inside Aggregate External Finance (e.g. Dedicated Schools Grant, public health) • Revenue Support Grant • Other unringfenced grants • Grants for hypothecated spending outside Aggregate External Finance (e.g. Housing Benefit subsidy) • Business rates revenue • Council tax revenue • Fees and charges (£11.3bn in 2012/13) • Income from other organisations in shared service arrangements etc • Investment income
Local government funding Net Revenue Expenditure is a narrower definition. It does not include grants outside AEF (mainly housing benefit) but it does include capital financing costs and capital expenditure funded from revenue. In 2013-14 budget: Revenue Expenditure (£102bn) = Net Current Expenditure (£117bn) less grants outside AEF (£22bn) plus capital financing costs and capital expenditure funded from revenue (£8bn) less smaller adjustments (net £1bn) • Source: Local Government Revenue Expenditure and Financing; Budget 2013-14 England • https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/225884/RA_Budget_2013-14_Statistical_Release_-_FINAL__2_.pdf
Net controllable expenditure in councils 2013/14 = £51 billion • Net revenue expenditure of local government is £102 billion (see slide 13) • Subtract grants inside AEF £44 billion (most are ringfenced eg Dedicated Schools Grant, Housing Benefit subsidy) • Add back new homes bonus, public health and other non-ringfenced grants £6.7 billion • Subtract all “other” authorities: police and fire, parks, waste and transport authorities £14 billion • Add investment income £0.4 billion • Total controllable expenditure in councils 2013/14 = £51 billion
Total funding £50.8 billion in 2010/11 (the last year before the austerity measures of CSR2010) • Total funding projected to fall to £43.4 billion by 2019/20 • This includes £3.1 billion of Public Health funding which carries with it a new responsibility • All figures are in cash terms PH funding not new money as it comes with a new burden The path of future funding Negative reserves figures when councils underspend and contribute to reserves
The squeeze on service expenditure • When we account for inflation and demographic pressures in waste management and social care, the money available for all other services (blue) shrinks from £26.6 bn to £15.1 bn (and £3.1 bn of this is for new Public Health responsibilities)
3) Grants This section presents an overview of the main grants to local government. Slide 18 shows that including schools funding most grant income is ringfenced – this is a result of the decision to ringfence schools funding which came into effect in 2006-07. Slide 19 presents the main specific grants in 2013-14, both those within and without ‘aggregate external finance’. Most non-hypothecated grant is bound up with both the business rates and council tax systems. Up to 2012-13 redistributed business rates and revenue support grant were known as formula grant. Slide 20 shows the composition of formula grant up to 2012-13; following schools ringfencing, the majority of this income came from redistributed business rates. Slide 21 explains the different definitions of Revenue Support Grant. Following the introduction of business rates retention, formula grant, along with a number of other income streams, was incorporated into a new settlement funding assessment (known as start-up funding assessment in 2013-14). Slide 22 shows the split in how this is financed between locally retained business rates and revenue support grant and reflects the fall in revenue support grant shown in slide 15. Finally slides 23 and 24 contain more material on hypothecated and specific grants. The business rates system is covered in section 4 below.
Grants to local government within Aggregate External Finance (AEF) - most grants are ringfenced Settlement funding in 2013-14 includes retained business rates and revenue support grant. Before then it consists of formula grant and revenue support grant. The 2013-14 figures are not comparable with previous years – they include transfers including council tax support and public health
Specific grants in 2013-14 • Source: Local Government Revenue Expenditure and Financing; Budget 2013-14 England • https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/225884/RA_Budget_2013-14_Statistical_Release_-_FINAL__2_.pdf
Composition of formula grant up to 2012-13, £bn In 2006, schools funding was taken out of the general grant to councils to form the ringfenced Dedicated Schools Grant – hence the significant reduction in total formula grant.
Grants – revenue support grant • Before April 2013, revenue support grant (RSG) was a grant paid in addition to the redistributed amount of business rates. Following the introduction of the ringfenced Dedicated Schools Grant in 2006-07 RSG was reduced (see slide 20) • Since April 2013, it represents that element of settlement funding which is not funded through retained business rates. It is funded through the central share of business rates and through grant funding. (See slide 22) • In 2013/14 it was worth £14.5bn, but it is reducing sharply, down to £8.7bn in 2015/16. If the current trend continues, our modelling estimates it will be worth £2.2bn by 2019/20.
Grants – hypothecated • Local government acts as an ‘agent’ for implementation of several national policies and transfer of related funding • As a result, it receives grant funding that gets passed on to the intended recipients • The main examples include: • Dedicated Schools Grant (DSG) (£31.3bn). It is a ringfenced source of funding for schools. Councils act as agents for the government in transferring the funding, however there are some powers retained locally over how the funding is distributed among individual schools. • Housing benefit (£19.9bn). Councils administer this benefit on behalf of government and receive a hypothecated grant to fund the welfare payments, alongside a separate grant for administration costs (which can be influenced) • Treatment of these grants accounts for most of the polemic difference over the size of council spending
Grants – other specific grants • Specific grants are provided by the government with the intention of them being spent for their particular purpose, or being awarded on a particular criterion • Many of these grants have been rolled into the business rate retention system to form part of the new RSG, but a few remain outside the framework • Some are unringfenced: • Efficiency support grant (awarded to councils with largest reductions in spending power) • Housing benefit administration grant • Council tax freeze grant • New homes bonus • Local welfare provision grant • Education services grant • Some are ringfenced: • Public health grant • NHS funding to support social care (Better Care Fund from 2015/16)
4) Business rates Section 4 concerns business rates. Slide 26 introduces how the business rates system works. Slide 27 shows the historic yield of business rates. Slide 28 provides further detail on how the business rates bill is set . Slide 29 introduces the business rates retention system which was implemented in April 2013. Slide 30 shows how this is compatible with the reduction in resources shown in slide 15. Business rates retention is then considered in further detail. Slides 32-35, taken from the DCLG Practitioners Guide explain the basics of the system. Slides 37-42 explain various aspects of business rates retention with case studies taken from different councils. Slides 37-38 concern how the top-ups and tariffs system equalises the starting point, slides 39-40 concern growth and slides 41-42 concern risk. Slide 43 concerns pooling and slide 44 other aspects of the business rates system. Slides 45-46 concern the impact on business and current discussions around the Treasury / DCLG Business Rates Administration Review.
Business rates • Business rates are a tax on non-domestic property. • The business rate bill for a business is worked out by taking the rateable value and multiplying by a fixed multiplier (2014/15 - 48.2p in the pound, with smaller premises paying a reduced rate of 47.1p). The national multiplier was introduced in 1990 • The multiplier is normally uprated by RPI annually (exceptionally the increase has been capped in 2014/15 at 2 per cent) • Rateable value – broadly – reflects the annual rent for which the property could be let on the open market – currently (2014/15) this reflects 2008 rents. • Councils do not have any control over the system (except for the ability to provide discretionary relief) and act as issuers and collectors of bills. However, from April 2013 they retain up to 50% of real terms growth in their business rate revenue • Total yield in 2014/15 is worth £22.4bn (after allowances for mandatory, discretionary and transitional relief, allowances for losses in collection and the cost of collection and amounts retained outside the rates retention scheme e.g. revenue from enterprise zones)
Business rates – setting the bill • The value of premises is subject to regular reassessment: • If there is an appeal about the valuation raised by the council or ratepayer, the result of the appeal may change the value • There are overall revaluations taking place every five years (with the exception of this cycle where there will be 7 years between revaluations) • At every planned revaluation, the total amount raised from business rates is fixed – the revaluation is intended to deliver a constant yield, so when the total rateable value changes, the multiplier is changed accordingly • This still creates winners and losers among businesses and councils. A business can see its bill change even if rateable value hasn’t • However, businesses with major changes to bills receive transitional relief. This sets limits to how fast bills can increase and decrease. See https://www.gov.uk/apply-for-business-rate-relief/transitional-rate-relief
Business rates – retention system • Before April 2013, business rates were collected by billing authorities and transferred to the exchequer.The government redistributed the majority of rates in the form of Formula grant (see slide 20) • Since April 2013, councils keep 50% of locally collected business rates (the local share), with the other half transferred to central government to be used to finance grants (the central share) • Legally business rates have to be used by the government to fund local government activity. • The only grant financed through the central share is currently (2014-15) RSG, but this is likely to change as RSG reduces to less than what is collected through the central share. At this point, other grants should be financed with the remainder. It is predicted that in 2015-16 there will be a gap of £3.2bn between RSG and the central share • The following slides describe the mechanics of the system in more detail
As time passes other grants may start getting funded by business rates Central share of collected business rates Local share of collected business rates
Business rates retention – aggregates (1) from spending review control total to the local share and RSG https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/78786/130206_Business_rates_retention_and_the_local_government_finance_settlement_-_A_practitioner_s_guide.pdf p9
Business rates retention – aggregates (2)Individual authority level https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/78786/130206_Business_rates_retention_and_the_local_government_finance_settlement_-_A_practitioner_s_guide.pdfp13
Business rates retention – proportionate shares and business rates baselines https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/78786/130206_Business_rates_retention_and_the_local_government_finance_settlement_-_A_practitioner_s_guide.pdfp14
Business rates retention – top-ups and tariffs https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/78786/130206_Business_rates_retention_and_the_local_government_finance_settlement_-_A_practitioner_s_guide.pdfp15
Business rates retention: equalisation • At the outset of business rate retention, the government calculated two measures for each council: • The local business rates baseline (the local share of business rates collected in an area, after taking into account how they would be split between various tiers of local government in that area) and • The funding baseline (how much a council would receive if the total English local share would be distributed according to need) • Authorities where need was greater than yield received a top-up to match the difference, paid for by the tariffs from those councils that ‘collected more than needed’. • These top-ups and tariffs are annually updated by RPI, alongside the rateable value of businesses to keep the system in balance. Top-ups and tariffs are a self-financing system • RSG is – broadly – distributed on the same basis as the funding baseline • However, the system is not sensitive to changes in relative need as formulae are not updated annually as before.
Business rate retention – case study (1/3)Calculating top-ups and tariffs • The top-up and tariff mechanism is intended to provide a ‘level playing field’ in year 1 of the system. • As Hillingdon is estimated to collect more than it needs, at the start of the system it is assigned a ‘tariff’ it has to give up every year. It is fixed but uprated by inflation annually. • As Wigan is estimated to collect less than it needs, at the start of the system it is assigned a ‘top-up’ it will receive every year. It is fixed but uprated by inflation annually. • The end result is that, at the start of the system, both councils see their local business rates adjusted to match need. From this point on, the changes to business rate income in comparison to the baseline affect the level of locally retained income.
Business rates retention: growth • From April 2013, local authorities keep 50% of business rates collected in their areas (there are splits between different tiers and standalone fire authorities also get a share) • However, revenue support grant is reduced to take into account that there is annual RPI growth, effectively ensuring that councils only benefit from taxbase growth • ‘Tariff’ authorities are also liable to pay a levy on this retained growth, this is the government’s way to take into account that areas with more proactive economies (i.e. with BR receipts higher than needs) would otherwise benefit more from equivalent levels of growth than top-up authorities. • The rule of thumb is that post-levy growth in rateable value of 1% in above inflation results in 1% more income retained after tariff.
Business rate retention – case study (2/3)Business rate growth • In this scenario, both councils collect more in business rates than their respective baseline. This amounts to £5m in both cases, 4.9% of Hillingdon’s and 13.3% of Wigan’s initially estimated business rate income. • Hillingdon is a tariff authority and as such has to pay a levy on growth. The levy rate is individually determined – the bigger the relative size of the tariff, the bigger the levy, but this is capped at 50%, benefitting authorities with very high tariffs. • Levy income is used to fund the safety net mechanism – see part 3 • Wigan is a top-up authority, which means that no levy is applicable • Revenue support grant is reduced by the level of total inflationary growth in the local share, so if the funding in the local share grows by less than inflation, a council may see its total funding reduce – even if business rate income has grown
Business rates retention: risk • With business rate retention, councils have a more direct stake in income collected in their area. Some of these risks are difficult to manage as the levers are retained centrally: • Business rate appeals. • Business rate avoidance and evasion. • Economic contraction. • The safety net mechanism is intended to protect councils from their post-top-up or post-tariff income falling by more than 7.5% • It is intended to be funded by the levy on growth described earlier, but the impact of appeals in 2013/14 made this impossible • As a result, settlement funding is being topsliced to pay for the remainder of likely safety net payments. This topslice was £25m in 2013-14 and will be £120m in 2014-15. The topslice is taken from RSG
Business rate retention – case study (3/3)Business rate decline • In this scenario, both councils collect less in business rates than their baseline, a £0.7m loss. • The loss could have arisen from businesses shrinking or closing down, successful appeals or avoidance. • As a result, after paying over the tariff Dartford loses retained income worth 30% of the funding baseline. The safety net mechanism limits losses to 7.5%, so it receives protection funded by levy payments of other councils in the system or a topslice from overall council funding. • Southampton also loses the same amount but it’s only 1.5% of its funding baseline so the safety net mechanism is not triggered.
Business rates – pooling • Local authorities are allowed to enter into business rate pooling agreements • For the purposes of calculating the growth levy and the amount of business rates retained the authorities in a pool are treated as a single entity • There are two main benefits • The risk of reduction in income is shared among participants • For tariff authorities, the levy on growth can reduce if paired with top-up authorities • The pool makes its own agreement for how locally retained business rate income is shared • There are 18 pools in operation in 2014/15, an increase from 13 last year • Some pools have not been continued after the first year.
Business rates – other • There are a number of smaller schemes which allow councils to retain 100% of business rate revenue: • Enterprise zones • Renewable energy • (Not yet confirmed) Fracking • There are two ways for local authorities to implement an additional business rate charge, fully retained locally • Business Improvement Districts (BIDs). Businesses in local areas such as town centres etc. can enter into a voluntary agreement with the council, ratified by referendum, to pay a top-up on the business rate bill, to be used to improve the area’s prospects for growth. • Business Rate Supplements (BRSs). Local authorities can levy BRSs on larger businesses in the entirety of their area in order to finance projects which improve growth prospects for the LA area as a whole. The only BRS in operation is levied by the GLA for Crossrail.
Business rates – impact on businesses • Councils do not have rate-setting powers – they were taken away in 1989 in favour of a uniform, national rate • Business rates bills are based on the rateable (imputed rental) value of commercial property at a particular point in time, so there is no direct connection with actual profitability or sales • As a result, businesses of comparable size and performance can have very different business rate bills depending on where in the country they are based, provided that rental market conditions are different • Properties are revalued all at once every 5 years (with the exception of the 2010-2017 cycle), however this is done in a way that does not change the total amount raised nationally • In practice, this means that the tax rate is increased if, overall, property values drop, or decreased if, overall, property values rise • So if a business does not see any significant change in its rateable value, it can still see its bill rise or fall, depending on what the national trend is • Councils have powers to grant discretionary relief to businesses, but this must be done from their own resources
Business rates – current discussions • Various groups, some representing businesses (such as the British Retail Consortium) have called for the business rate system to be reviewed • Suggestions include: • Tying business rates to corporation tax to reflect profitability • Using a different taxbase(emissions) • Discounts for employment growth • Replacement with a land value tax • The government is undertaking two simultaneous reviews of aspects of the system: • Business rate appeals. The government has consulted on ways to change the appeal system and to make billing information clearer in order to reduce the burden on the Valuation Office Agency and increase certainty to councils and businesses, reducing the number of appeals. • Wider business rate administration concerns. The government has consulted on various other aspects of the system, such as revaluations, introducing value bands as opposed to current (2014/15) individual valuations, business rate enforcement and others. • The government has also recently introduced a number of measures aimed at reducing the rate burden on businesses: • A cap on the annual increase in rateable value (and hence the bill) of 2%, as opposed to inflation of 3.2% • extension of the small business relief scheme originally established in 2010 • A series of further reliefs aimed at smaller retail businesses to reduce their business rate bill
5) Council tax This section concerns council tax, which is the main source of local revenue. Slide 48 presents the basics of council tax. Slide 49 outlines how the tax is set including the council tax referendum provisions. Slide 50 shows how the average level of Band D council tax has changed through the years. Slide 51 contains more detail on the taxbase. Slide 52 shows the values which are used for the different bands based on 1991 property values. Slide 53 shows the modal average in various areas. Slide 54 concerns council tax support which replaced council tax benefit in April 2013. Finally slide 55 shows how as funding for council tax support is reduced one result is that the system becomes more regressive.
Council tax - basics • Introduced in 1993, it is a banded tax related to the estimated value of a domestic property. It is the only tax fully retained by local authorities. • Councils set the council tax for Band D, with tax for other bands calculated according to fixed proportions (e.g. Band A tax will be worth 6/9 of Band D tax). Average Band D tax in 2014/15 is £1468 • Council power to increase tax is limited by the requirement to hold a referendum on rises above a certain threshold, set annually by the government • There is a set of discounts, prescribed nationally but administered locally. Over 90% of discounts (by value) are for single adults in a household – a discount of 25% (known as the Single Person Discount) • The poorest taxpayers are supported through locally determined and administered council tax support schemes • The next 4 slides describe the system in more detail
Council tax – setting the tax • Council tax is set annually based on the ‘council tax requirement’ which is expressed as the difference between revenue expenditure and other income such as grant income • Band D council tax is defined as the council tax requirement divided by the taxbase (see slide 30) • However, councils are in practice limited in terms of the changes they can make to household bills, especially when it comes to increases. • Since 2011-12 the government have paid a ‘council tax freeze grant’ to councils which freeze their council tax. In 2014-15 this is worth the equivalent of a 1% increase in council tax requirement • The government has established a requirement for councils to hold a local referendum should they wish to increase council tax by more than a nationally set, annually reviewed threshold (‘principle’). This is 2% for 2013-14 and 2014-15 • To date, no referenda have been triggered
Band D council tax from 1993 (£) – flat since 2010-11 despite decreasing grant yield shown against inflation (RPI)