PAC report: Local Government Finance System: Overview and Challenges

Committee of Public Accounts

Local Government Finance System: Overview and Challenges

Conclusions and recommendations

1. The sector is facing a wide range of risks that have built up during the period of sustained financial pressure on local authorities. After steep funding reductions between 2010–11 and 2019–20, local government went into the pandemic with planned core funding down by 26% in real terms. Even factoring in other income sources, local government income was £8.4 billion less than in 2010–11 in real terms at the start of the pandemic. In our previous report into Local Government Finance, we set out the limitations the pandemic had exposed in the data that the Department normally collects from local authorities, and how this might result in Government not having a proper picture of local finance resilience, particularly the impact of major spending reductions on many services, sharply reduced resources to support governance, a severely fragile market for adult social care, at least £7.6 billion of recently purchased commercial property and, for too many authorities, the absence of audited information to manage their finances. It is also concerning that four local authorities have highlighted a risk of an unbalanced budget or other unlawful financial matters since 2018 and been issued a section 114 notice. At the same time the Department has been planning to stop its COVID-19 financial impact monitoring at the end of 2021. The Department needs to oversee local authority financial sustainability while recovering itself from the demands the pandemic has placed on its organisational resilience and delivering its new departmental responsibilities, such as levelling up. We will revisit this issue the next time the Department appears before the Committee.

Recommendation: In its response to this report: • The Department must set out what changes it has made to improve the quality of the local government financial data it collects, what requirements it will carry over from its monthly COVID-19 monitoring, and whether it now has the capacity to adequately oversee the risks to local authority finances and services.

2. Too often the Department has failed to act with sufficient urgency to address risks to financial sustainability in the sector, leading to problems becoming entrenched. This Committee warned in 2016 that the local capital finance framework might not be able to cope with changes in local authority activity, particularly in relation to investment in commercial property. The Department reacted by changing the guidance on local authority investments and on setting aside money to repay debts, but these proved ineffective in addressing key risks. Disappointingly, it took until 2020 before the Treasury took action to restrict borrowing for commercial investment, allowing billions of pounds to be borrowed and spent in the intervening period. In November 2021, the Department started consulting on legislative change to ensure all authorities act prudently and ensure they have the money to repay debts in future.

The Department’s consultation was in response to local authority practices which were not fully compliant with the duty to make prudent revenue provision for borrowing. For example, some local authorities excluded a proportion of their debt when calculating their Minimum Revenue Provision (MRP); and some local authorities had used capital receipts instead of revenue resources for MRP. Meanwhile some local authorities have set aside much too little money, and they now cannot make up the difference promptly without threatening their financial position. In addition, current proposals to continue to use just guidance to encourage local authority audit committees to have an independent member, rather than make it compulsory, suggest the Department is still over-optimistic about the ability of such ‘soft’ changes to address risks.

Recommendation: In its response to this report:

• The Department needs to identify key areas of concern regarding the sustainability of local government finance and explain how these will be addressed as part of its stewardship role.

• The Department should set out a clear timetable for responding to and implementing any changes as a result of its consultation; and

• HM Treasury and the Department should seriously consider extending their recently introduced conditions for local authority borrowing to require that a compliant policy is always in place for new loans and what action might be taken for existing loans where no MRP does exist, so that prudent levels of MRP are built into the authorities financial planning in the future.

3. The Department did not act with sufficient urgency, nor has it set out an overarching plan and timetable, to address the severe and pressing problems with the local government audit market. Significantly delayed audits are a serious gap in local authorities’ accountability to taxpayers and risk undermining public confidence and trust in local government finances. Just 9% of 2020–21 local government body audits were completed in time for audited accounts to be published by the extended deadline of 30 September 2021 and too many audits for 2019–20 and 2018–19 remain outstanding, putting further pressure on the local audit system. Previously this Committee recommended the Department set out a detailed plan and timetable for getting local audit timeliness back on track. We also recommended the Department explain how it intended to work with the Department for Business, Energy and Industrial Strategy to set up the new system leader for local government audit, the Auditing, Reporting and Governance Authority (ARGA), and how it would address the pressing need for effective leadership while ARGA was being established. The Department agreed with our recommendations however their initial response lacked detail. While we welcome the measures to address the urgent issues in local audit the Department has recently announced these will take time to finalise and implement.

Recommendation: Alongside its Treasury Minute Response, The Department should provide a detailed timetable and overarching plan that draws together the existing and recently proposed short- and long-term actions to address the problems with local government audit. This should include a clear timetable for finalising the local audit functions of ARGA, the transition arrangements and a mechanism to keep this committee updated on progress.

4. The Department is making some welcome improvements to its oversight of the sector although it remains to be seen what concrete difference these changes will make. Over time the Department has improved its analysis of financial risk and its engagement with local authorities: the sector praised Departmental engagement during the pandemic highly. However, while we do not expect the Department to micro-manage local authorities, there is clearly more it can do as part of its stewardship role. The Department recognises the gaps and plans to collect more detailed information on local authority reserves from the next financial year. It will also start collecting data on local authority holdings of commercial property, companies, and financial investments regularly. These changes, which we recommended in 2016, are welcome but we will only be fully reassured when we see the Department taking decisive and effective action where this new data reveals pressing risks.

Recommendation: Alongside its Treasury Minute response to this report, the Department should write with more detail about its new data collections and how it plans to use these data, including those relating to borrowing and investment.

5. We are concerned the Department is worryingly complacent in its view that the spending review will put local services on a sustainable footing. The spending review provided an extra £4.8 billion, £1.6 billion per year for the period 2022– 23 to 2024–25, along with assumed council tax rises (although lower rises than in recent years). These plus assumed growth in business rates will need to provide the “business as usual” funding for adult social care. The Department’s view is that this funding leaves the sector in a sustainable position, enabling local authorities to improve services and meet the rising demand and cost pressures they are facing. It is confident there will be no need to go back to the Treasury to ask for additional pots of short-term funding, as in previous years. Yet we remain sceptical when neither the Department nor the Treasury can explain how the adult and children’s social care pressures are built into the spending review settlement, council tax is rising by less than inflation this year and the pandemic means business rates growth is even more uncertain than usual.

Recommendation: Alongside its Treasury Minute response to this report the Department should write with more detailed assurance on the expected impact of the spending review on services and, working with other government departments, set out its plans to keep this under review.

6. The sector is still facing uncertainty and stop-gap financial arrangements until such time as the longer-term reforms are put in place. The sector is once again faced with a single-year settlement for the 2022–23 finance year. It has now had three one-year settlements, preceded by a four year settlement full of short-term funding initiatives. The government has proposed six major updates or reforms that could significantly alter the business rates retained by local authorities, business rates themselves, the way funding is distributed and the cost of providing adult social care - the service local authorities spend most on. While the spending review provided a final decision and a clear timescale for business rates revaluation, the remaining reforms are subject to further consideration by Ministers in the Department, the Treasury or the Department of Health and Social Care and will require public consultation. We understand that some support for adult social care will start to flow from April 2022, but it seems clear to us no other changes will be delivered before April 2023 at the very earliest. This prolongs the damaging uncertainty for local government. Although the government needs to take time to 8 Local Government Finance System: Overview and Challenges get the reforms right and ensure alignment with the levelling up agenda and other Ministerial priorities, we have previously recommended that a multi-year settlement be established, nonetheless. This would provide a stable funding environment and act as a bridging mechanism while the Department works on long-term reforms. Unfortunately the Department has again missed this opportunity and will also continue to be hindered by severely outdated funding formulae and its lack of information on services.

Recommendation: Alongside its Treasury Minute response to this report, the Department should write to us setting out its plans to support the sector through this interim period.

7. It is still not clear how the government will take a strategic, cross-government approach to rationalising local authority funding, which is particularly important for cross-cutting priorities like net zero and levelling up. Responding to concerns about the burden of bidding for multiple funding pots, the recently-appointed Secretary of State for local government has recognised the need to simplify and rationalise the funding available to local authorities. This is welcome recognition that the current situation does not represent value for money. Sector analysis has previously highlighted the numerous grants available to local authorities in any one year. During 2020–21, twenty-two grant funds were available for net zero work alone, many of which local authorities had to compete with each other for. While competing for funding can allow funding to be prioritised for those areas where it can be most effective, it also has the potential to create winners and losers with local people missing out. The Department is considering whether to review its approach to rationalising grants within the levelling up funds for which it is directly responsible. However, we have highlighted the need for better cross-government coordination many times before and we lack confidence that central government will join up to ensure local government funding decisions take account of the overall role of, and burdens on, local government.

Recommendation: In its response to this report, the Department and the Treasury should set out what changes will be required to deliver a strategic, crossgovernment approach to rationalising funding for local government, especially for major strategic priorities. Local Government Finance System: Overview and Challeng