How local government finance works

How local government finance works – what is the outlook and implications for future capital schemes?

Since the austerity agenda that began with the Conservative – Lib Dem coalition government in 2010, local councils have become used to annual reductions in central government funding.

Steadily reducing grants have placed increasing financial pressure on councils, along with a requirement to balance budgets by progressively cutting local public services and undertaking activity to increase council tax and business rates income.

Combined with steadily increasing demand growth for adult and children’s social care services, pressures on council budgets have been very challenging. This has been a particular issue for councils in more deprived areas of the country, as revised government funding formula has created a more even distribution of resources, less influenced by deprivation levels.

Government has recognised pressures in social care, providing some dedicated social care grants and introducing the social care levy that has enabled councils to raise funds for adult social care through council tax.

Councils also played a key role in mitigating the impact of the Covid-19 pandemic at a local level, receiving significant Covid-19 grants over the last two years to help fund this activity. To a degree, this has protected councils from the ongoing financial pressures of reduced government grant.

As grant funding has reduced, councils have become increasingly focussed on raising funds through other sources including council tax and business rates. This has led to an increased focus on promoting housing development and attracting business investment. This is arguably a positive effect of the increased importance of council tax and business rates as a rising proportion of council funding. This development has seen councils increasingly interested in investing their own capital resources to support development, and borrowing to do so.

Council’s fund borrowing costs from their revenue budgets. Despite these budgets being under pressure, interest rates have been historically low, and councils have been able to borrow cheaply to support capital schemes on the basis they will support growth in business rates or council tax income. The Johnson government’s levelling up agenda saw councils providing significant match funding for developments through programmes such as the Levelling Up Fund and Town Deal.

The outlook for council revenue budgets remains challenging, as:

• Government grant continues to reduce.
• Specific Covid-19 grants are gone.
• Demand for social care services continues to grow, as the population ages and the socio-economic climate worsens.
• The social care levy has been limited to a 1% annual increase on council tax, down from 3% in previous years.
• The Government’s tax cutting agenda is likely to mean further cuts in government spending on public services from 2023.

Given the pressure on revenue budgets, and the increasing cost of borrowing, it is possible that council finance officers will become more reluctant to borrow to fund capital programmes. However, there will be a continuing need to protect overall council budgets by increasing income from council tax and business rates. It may be that the appetite for borrowing to support investment in business and housing will remain, but councils are likely to become more astute and more demanding of evidence that borrowing costs are outweighed by the benefits of increased council tax and business rates income.