English councils’ finances held up much better during the first year of the COVID-19 pandemic than previously thought, according to a new report published by the Institute for Fiscal Studies (IFS), with potentially significant implications for local government funding policy in the coming year, the think tank warns.

Official expenditure and income data published last month shows that councils’ net spending during 2020-21 was £4.1bn more than would have been expected in the absence of the pandemic – a much smaller, although still sizeable, increase than the £7.8bn reported in the latest available government survey of councils about the financial impact of the pandemic on non-education services spend.

Since the pandemic started, the government has been surveying councils about its financial impact, but that survey asked councils to highlight areas where spending was higher and income lower as a result of the pandemic – and not areas where spending was lower, for example due to temporary closures of services or reductions in demand.

There is no suggestion that councils were purposefully overestimating the costs of the COVID-19 pandemic in their survey responses, however councils did have an incentive to err on the higher side when estimating the likely financial impacts given that the surveys were used to inform how much funding the government provided to local government, the IFS says.

This link between survey-based estimates and the funding provided to local government also means that overall English councils received billions more in funding than their increases to net expenditure, at least in the first year of the pandemic to March 2021. While some councils had to draw down their reserves and seven had to ask for special temporary borrowing powers from the government in 2020-21, councils were overall able to add substantially more into their reserves last year than had been anticipated prior to the pandemic.

Kate Ogden, a Research Economist at IFS and one of the authors of the report, said: “The fact councils as a whole were able to build up reserves in 2020-21 means that the sector’s financial position was not quite as precarious going into this year as is sometimes claimed. And it means the government’s decision not to meet this year’s reported financial pressures in full is not unreasonable.

However, Ogden warned that this approach may not work for all councils, some of which have been particularly hard hit and faced real financial difficulties as a result of the pandemic. At a time when the sector as a whole appears to have been more financially robust than expected, net expenditure varied substantially across councils – and especially across smaller shire district councils; while just over one in 10 shire districts saw their reported net spending fall, one in four saw it increase by 40% or more.

“The government shouldn’t be too sanguine about the longer-run picture for council funding. As our previous work has shown, with rising demands and costs for adults’ and children’s social care in particular, councils will struggle to raise enough themselves via council tax in the coming years, especially in poorer parts of the country,” Ogden said.

Alison Ring, Director for Public Sector and Taxation at ICAEW, commented: “While a fuller story of the pandemic won’t become apparent until after the end of this financial year, there are lessons to learn from the way central government responded to the initially desperate financial situation facing many local authorities. Better financial information would have helped, as well as more flexible grant funding mechanisms to allow for money to be reallocated to where it is needed.

“As the Institute for Fiscal Studies report highlights, the longer-term financial situation for local authorities is much less rosy than that shown at this halfway point, with the growing costs of adult social care continuing to put pressure on the budgets for local public services and investment in local economies. Greater certainty around future funding would really help, with the long-awaited Levelling Up White Paper key to supporting councils in delivering for their local communities.”

The fact that councils’ spending increased by less than expected and they were able to pay into reserves in 2020-21 may explain why the government has so far been unwilling to fully fund councils’ reported financial pressures this year. And it may feel that they could draw down the additional reserves accumulated in 2020-21 to meet any unmet pressures that do exist.

The findings of the IFS analysis, funded by the Economic and Social Research Council, could change the way the government chooses to respond if councils face another extreme adverse shock in future, the IFS warns. It suggests that the government may not see councils’ survey responses as a reliable guide to the net spending pressures being faced.