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Funding shortfalls cause councils to use up their reserves

4 September: Local authorities are struggling to balance the books in the wake of COVID-19, as the gap between income and expenditure widens.

The pandemic has placed extraordinary financial demands upon local authorities in England despite billions in additional funding from central government. There is an increasing prospect of finance officers declaring bankruptcy by issuing s114 notices to suspend non-statutory spending. 

ICAEW’s Public Sector Team wrote about this in July, while a more recent study by the Institute for Fiscal Studies (IFS) underlines how stretched public sector finances in local government have become, with an average financial hit equal to 13% of pre-crisis expenditure.

Many councils are relying on their reserves to meet these unfunded financial pressures. While central government funding has been provided to cover some additional expenditures as a consequence of the pandemic, only 71% of certain lost income streams is being replaced. This leaves 29% of those income shortfalls and 100% of other losses to be covered, including losses on commercial property investments.

For many, it is a trade-off between making in-year cuts in spending commitments or cuts in future years – especially where reserves have already been earmarked to fund specific projects. After a decade of austerity, many councils have already made significant cuts to balance their books, with above-inflation council tax rises in that time more than offset by reductions in central government funding. Many will find it difficult to find savings without making further reductions in the level of service provision they provide to local communities.

According to research carried out by the rating agency Moody’s, local authorities in the UK are experiencing higher fiscal pressures resulting from the coronavirus pandemic than other leading European countries. This is primarily because UK local authorities' pre-crisis fiscal performance was relatively weak, so they will face challenging decisions regarding spending cuts or the use of reserve balances to balance budgets this fiscal year.

Local authorities are funded directly by government and through locally raised council taxes and allocated business rates. Unlike central government, local authorities cannot borrow to finance revenue expenditure, while compared with other developed countries, they have very limited revenue-raising powers. An OECD report from 2014 shows that every other G7 country collected more taxes at either a local or regional level than England.

Croydon in south London is expected to be one of many councils looking for emergency financial help from the government. It has sought a ‘capitalisation directive’ to allow it to shift costs between its revenue and capital budgets, a relaxation of the normal principle that revenue costs should be funded entirely out of revenue income.

One option that could help reduce costs in the medium-term might be to merge local authorities to reduce back-office costs and obtain efficiencies of scale in the delivery of local services. Discussions to this end are underway in several counties that retain two-tier systems of county and district councils, with a recent report commissioned by the County Councils Network suggesting that up to £3bn could be saved over five years by replacing 213 county and district councils with 25 new unitary councils. 

There have also been discussions about merging some smaller unitary councils in other parts of the country for similar cost-saving reasons. Whether these savings are achievable remains to be seen, especially as council re-organisations can be expensive to implement successfully (and even more costly if implemented unsuccessfully). There are also significant objections to be overcome, with many district councils in particular expressing concern about whether much larger local authorities will be sufficiently close to the communities they serve. 

The Ministry of Housing, Communities and Local Government (MHCLG) says that it continues to monitor local authorities’ finances closely and has urged councils in difficulty to talk to them first.

Alison Ring, Director for Public Sector at ICAEW, said: “It is a worrying time for many local authority finance teams who will have to make difficult financial decisions as they get into the second half of this financial year and start working on budgets for 2021/22.

“Not one sector is immune from the impact of the pandemic and local authorities have borne heavy costs to keep their local communities afloat.”