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Spending Review leaves inflationary sting in local authorities

Author: ICAEW Insights

Published: 29 Oct 2021

A relatively large increase in central government funding for local authorities is likely to be offset by a below-inflation council tax rise next year. Further cuts may be needed to balance the books in local authorities facing rising costs on top of low reserves.

The apparently generous local government settlement in the Autumn Budget and Spending Review 2021 will not be leading to champagne corks popping in most local authorities, despite the Autumn Budget cut in the duties on sparkling wine.

Instead, a below inflation council tax rise in 2022-23 will be causing headaches for councils across England looking to make up for uncompensated losses incurred over the course of the pandemic. This is in a situation where many have run down their reserves over the last decade of higher spending on adult social care and cuts in funding for most other local services.

Improved economic forecasts allowed the Chancellor of the Exchequer to increase spending for all departments, including an eye-catching 9.4% average annual real-terms increase in resource expenditure funding for local government over three years. This takes the settlement up from £8.5bn in the current financial year to £11.7bn in 2022-23, £12.1bn in 2023-24 and £12.8bn in 2024-25.

The 9.4% rise is the highest of any department but this headline number masks a continuing squeeze on the core spending power of local government, which HM Treasury estimates will increase by a much lower rate of 3% in real terms each year over the Spending Review period. This is because the majority of council funding does not come from central government grants but instead comes from council tax and an allocation of business rates.

The Budget Red Book says local authorities in England will only be allowed to raise council tax by 2% each year without a referendum and the social care precept by 1% (compared to 3% in recent years).

With inflation potentially as high as 5% this year, this implies a real-term cut in local authority council tax receipts, offsetting some of the increase in grant funding in the coming year.

Analysis by the Institute for Fiscal Studies (IFS) concludes that once the money allocated for social care reforms is excluded, the increase in core spending power is actually only 1.8%, compared to an average of 3.3% for other departments. With councils facing rising costs, including an increase in payroll taxes due to the new health and social care levy, and further analysis from the IFS suggesting the money from that levy allocated to pay for social care reforms is likely to be insufficient, the IFS concludes that councils may be forced to cut services without further funding announcements.

Despite a less generous financial settlement than at first sight, the Spending Review 2021 should in theory provide a level of “stable funding” that will allow local authorities to plan ahead over the next three years, as called for in ICAEW’s letter to the Chief Secretary to the Treasury.

Local authority funding cannot yet however be described as “stable” as each individual local authority will not know its funding until the Department for Levelling Up, Housing and Communities (DLUHC) determines new formulas for allocating grants and business rates funding in the next couple of months. There could be significant changes if the government implements the much delayed “Fair Funding Review” to update the methodology allocating funding between councils.

If the government chooses to continue to allocate funds based on 2013 population statistics, this will cause some councils significant financial difficulties in dealing with demographic changes that have occurred since then, while cushioning those local authorities which have done better on a relative basis.

The tight settlement and financial uncertainty raises concerns about how local authorities can play their role in ensuring the government achieves all of its five priority outcomes set out alongside the budget including levelling up and net zero. A recent NAO report found that piecemeal and inconsistent funding had hindered the government’s approach to working with local authorities on net zero.

ICAEW’s letter also called for the government to rationalise the funding streams for local authorities. The government’s recently published Net Zero Strategy seemed to suggest that this was the direction of travel as it stated that “longer term and more co-ordinated funding streams can enhance innovation and investment, reduce bureaucracy, and encourage more efficient and integrated decision making”. However, the Spending Review did not address this and we await the local government funding settlement to see if this message will be addressed or not.

The Spending Review does address ICAEW’s call for for more investment in financial capability in local government, with £34.5m of funding committed to specifically strengthen “local delivery and transparency”. This includes “the sector’s procurement and commercial capacity, establish the Audit Reporting and Governance Authority as the new local audit systems leader, and help local councils meet new transparency requirements”. This is a positive move, although the amounts involved (less per annum than the £15m one-off funding provided specifically to cover new audit requirements in 2021-22) may not be enough on its own, leaving councils to find further savings elsewhere if they are to improve effectiveness and transparency of their finances.

Alison Ring, Director for Public Sector and Taxation at ICAEW, commented: “Local authorities in England will welcome the additional grant funding provided in the Spending Review and the government’s commitment to cover the cost of business rates relief”, commented Alison Ring, Director for Public Sector and Taxation at ICAEW. “However, higher inflation will erode the value of council tax receipts in the coming financial year, and reforming the funding formula remains a key priority for many local authorities.

“Either way, council budgets remain under severe pressure following the pandemic, with many local authorities operating with very low levels of financial reserves. Further funding may be needed to recapitalise councils if they are to ensure they can continue to provide local services adequately.”

Oliver Simms, Manager for Public Sector Audit & Assurance at ICAEW, said: “ICAEW’s response to the MHCLG consultation on the local audit framework called for the government to provide funding for local authorities to pay audit fees that enable high quality audit, and we are pleased that some funding was provided as part of the Spending Review.

“This is unlikely to be sufficient on its own, and it is important than council leaders and officers make investing in their financial teams, processes and systems a priority if they are to provide the transparency that is needed to ensure the best decisions are made over how to spend public money.”

ICAEW’s virtual public sector sustainability conference on 10 December will include a panel discussion on how central government can better work with local government to help achieve net zero. You can register for the conference here.

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