Councils stare into a highly uncertain financial future

Last week saw significant political debate about the amount of extra funding being given to English councils moving into tier 3 (‘very high alert’) of the government’s COVID alert system. Most of the attention focused on funding to help pay for additional business support measures – such as grants for businesses legally able to open but facing big falls in demand – on top of those being funded directly by central government. This amounts to around £20 per person in those places that have moved into tier 3 so far, although the exact figure differs somewhat between places. As we highlighted at the time, how these figures have been calculated – and why they differ slightly between places – is far from transparent, especially considering the government has set out a simple formula for allocating similar funding to councils in tier 2 (‘high alert’) areas. 

For councils’ own budgets though, of more importance was the allocation of £919 million of additional general-purpose funding across England. As shown in Table 1, for each of the regions going into tier 3 restrictions so far, this additional general funding (column 1) is worth at least double the amount that they have received to help pay for extra test and trace and enforcement capacity (column 2) – with the exception of Warrington. And in Greater Manchester it is worth over three times as much.

Table 1. Additional funding for regions under tier 3 restrictions

Source: MHCLG (2020) COVID-19: funding allocations. Tier-3 funding from media reports and ministerial statements.

Our most recent analysis of councils’ forecasts found that the financial hit as a result of the COVID-19 crisis this year was expected to exceed the financial support provided by central government by £2 billion. the additional general-purpose funding – as well as a new £100 million fund to support council leisure centres – should therefore make a genuinely important contribution to addressing the financial pressures councils are facing.

The extra £919 million brings the total increase in general-purpose grant funding for councils’ COVID-19 pressures to £4.6 billion. Taking account of funding for infection control measures for adult social care providers (£1.1 billion), local Test and Trace schemes (£0.3 billion), homelessness services (£0.1 billion) and various smaller pots, means a total of £6.5 billion of extra grant funding has been provided to local government to help pay for higher spending and address at least some income losses.

A more sensible approach to allocating funding to address higher spending…

Three previous tranches of general-purpose grant funding had each been allocated using separate formulas. In particular, the first £1.6 billion was allocated largely on the basis of historic assessments of adult social care spending needs, while the second £1.6 billion was allocated on the basis of population. As more data on the effects of the COVID-19 crisis on councils’ actual and forecast spending become available, the third tranche (£0.5 billion) was allocated on the basis of a formula taking account of the relationship between those effects and population and deprivation levels.

This formula was a clear improvement on the much rougher formulas used for the first two tranches of funding. Unlike them, it takes account of observed relationships between actual and forecast spending and local characteristics. And unlike using each council’s own spending figures, it doesn’t provide a direct incentive to overspend or over-forecast.

But because until now it only applied to the third tranche – and not the £3.2 billion allocated in the first two tranches – overall funding allocations were still mostly based on the previous arbitrary formulas. To address this, the fourth tranche of £919 million has been allocated so that the combined total of all four tranches is allocated broadly in line with specially estimated formula based on population and deprivation. There is one small exception though: those typically smaller and more affluent councils that would have received less than a £100,000 increase in funding in tranche 4 have been given £100,000, with allocations for all other councils scaled down proportionately. The amounts involved are small – with those council areas losing out seeing 10p less funding per person, on average, than if the formula were applied without adjustment.

Moreover, as shown in Figure 4.1, the resulting allocations are still substantially higher for more deprived than less deprived areas. For example, the tenth of councils with the lowest levels of deprivation are receiving the equivalent of £62 per person in additional general-purpose grant funding overall, while the tenth with the highest levels of deprivation are receiving £109 per person, around 75% more.

Focusing on just the latest tranche of funding, the patterns are even more striking. The additional funding announced last week amounts to just £6 per person, on average, for the tenth of councils with the lowest levels of deprivation. But its equivalent to £34 per person, on average, for those with the highest levels of deprivation. This is because the allocation of the latest tranche of funding has had to offset the allocation of the second tranche as a flat per-person amount.

Figure 1. Total additional general-purpose grant funding, by council deprivation level

Source: MHCLG (2020) COVID-19: funding allocations. Deprivation deciles based on IMD 2019 at the upper-tier authority level.

The concentration of deprivation in urban areas, especially in the North of England means that many of the areas that have gone into tier-2 and tier-3 restrictions are receiving the highest levels of extra general-purpose grant funding. This includes Knowsley (£120 per person in total, of which £35 per person is in the latest tranche) and Liverpool (£119 and £38, respectively) in the Liverpool City Region, Manchester (£118 and £44, respectively), and Blackpool, Lancashire (£117 and £33, respectively). The areas that have received the lowest levels of funding per person are more rural or suburban places, mostly in the south, and include Wokingham (£54 and £6, respectively), Rutland (£57 and £2, respectively) and Buckinghamshire (£60 and £6, respectively).

Figure 2. Total additional general-purpose grant funding per person, by upper-tier council area

… but councils facing large income losses could lose out

A formula based on patterns of spending increases will clearly be much less well targeted at addressing reductions in councils’ income, especially as more affluent areas where spending is generally lower also typically rely more on incomes they generate themselves rather than funding from central government.

The government has already introduced a scheme to directly compensate councils seeing falls in their income from sales, fees and charges, covering 75% of their losses after the first 5% fall. And it has said that it will announce how it will support councils experiencing reductions in business rates and council tax revenues in the upcoming Spending Review.

But a number of councils rely significantly on investment and commercial income, including from facilities like airports (such as Luton and Manchester councils) and commercial property. As it stands neither the direct grant funding – which is allocated based on spending patterns – nor the income compensation schemes are targeted at these types of losses.

As reliance on commercial income varies so significantly across councils, is would probably be infeasible to try to allocate funding to address shortfalls via a formula. The government could also be concerned about incentivising risky behaviour if it stepped in and compensated councils directly for losses in commercial and investment income (although one could argue that the current situation is so unprecedented that it would be possible to treat associated financial losses more generously). As we have previously said, there is therefore a strong case to allow councils in this position to be able to borrow if necessary, to spread the cost of any falls in income over several years rather than having to make large short-term cuts to spending.

An uncertain future

Uncertainty about how the COVID-19 crisis will evolve, and the path for both national and local revenues and spending, mean councils’ financial outlook is highly uncertain.

The government has committed to providing £8 per person to any other regions entering tier 3 restrictions for additional test and trace and enforcement action, which would amount to around £450 million across England if all areas entered tier 3 (of which just under £60 million has been allocated to the regions already in tier 3). But it is likely to need to provide further general-purpose funding, perhaps even for the current financial year ending in March 2021, if COVID cases remain high and significant public health measures remain in place.

Initial plans for the next financial year, 2021-22, will be set out in the forthcoming Spending Review which is expected in late November and the following Local Government Finance Settlement. But given uncertainty about the path of the crisis – and hence how councils’ spending and incomes could evolve – these plans are likely to be far from final. Instead it may be sensible to set initial baseline allocations under the assumption that most of the impact on councils’ spending and income abates by April. To help councils plan how they would cope if this benign scenario does not come to pass, the government should at the same time plan continue collecting data from councils on the financial impact of COVID-19 and explain how it will respond if significant spending increases and income losses continue. This would likely mean, as in the current year, topping up funding as the ongoing effects of the COVID-19 crisis become clearer. To fund this central government could set aside additional funds in an enlarged contingency reserve.

Looking further ahead, local government had wanted a three-year Spending Review and settlement – things which would generally be very useful for medium-term financial planning. Of course, the government has now opted to set out budgets for one year only – which is sensible given the extreme uncertainty about the economic and fiscal outlook. However, there are two ways in which the government could provide some clarity to councils. First, if the government is able to set out in broad terms how it will respond to the evolving economic and fiscal environment – such as the extent to which borrowing, tax rises and spending cuts could be used to address the budget deficit in the medium-term –, councils will have a better understanding of how that evolution could affect their funding. Second, it could provide clarity on a range of policy reviews – such as for social care, business rates, and funding allocations – that will have big implications for councils’ funding in the years ahead.

Of course, like the rest of us, councils would still be largely in the dark about their financial future. But at least they would have some sense of how the government will respond to the evolving economic and fiscal landscape and its intentions with reform of local government.

David Phillips is associate director of the Institute for Fiscal Studies