Rejuvenating democracy

Financial SuStainability

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this paper sets out a new financial model that would give people a meaningful say over local taxation, spending and borrowing. it is a radical alternative – where money raised locally is spent locally, where public services prevent problems rather than deal with them and where growth is incentivised and rewarded.

it requires central government to release control not just of local taxes, but to allow communities the option to raise new sources of funding and adjust national taxes to invest in public services and growth or promote economic activity.

SummarySummary 1

Key propositions 2

introduction 3

Policy principles 4

Detailed discussion 5

background and what people have said 9

Propositions in more detail 11

conclusion 14

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Give people back a meaningful local vote on a wide range of tax and spending decisions, and create a local treasury for local services including:

• self-funded local government through council tax, business rates and other taxes. With local control over council tax and business rates, the right to determine new local taxes and to set fees and charges which fully recover costs

• a five-year funding agreement tied to the life of the Parliament for any services that remain funded by central government to allow greater innovation and pursuit of longer term objectives.

re-create the thriving market in municipal bonds which England once had and most other countries still have:

• free local government borrowing from Treasury restrictions because it already complies with appropriate prudential rules

• allow access to alternative sources of finance including the creation of a local government bond agency and the right to develop earn-back deals. These would allow places to reinvest the proceeds of additional growth in local services and measures to promote further growth.

Drive local public service effectiveness and end waste and red tape at all levels by bringing local services and decisions together in one place, for each place, for issues ranging from economic development to health and law and order. including:

• a place-base public service budget approach to the integration of public services in every place providing fluidity between currently protected and non-protected budgets to support locally agreed outcomes

• financial incentives for government departments to overcome inertia to place-based funding reforms, to integrate services and to focus on people and places.

Share money fairly around England by taking financial distribution out of the hands of ministers and replacing it with an agreement across English local government.

This PaPeR seTs ouT a neW financial model ThaT Would give PeoPle

a meaningful say oveR local TaxaTion, sPending and boRRoWing

KEy ProPoSitionS

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introDuctionlocal government finance is at a crossroads. the system has been creaking for some time and has defied incremental reform.

now, as resources shrink, it is evident that people’s needs are no longer met by a top-down approach to distributing a finite pot of resources to local authorities and other agencies based on crude national formulae. local governments has a vital role to play in economic recovery and delivering better outcomes for people. However, to do this we need a system that incentivises growth, tackles waste and inefficiency across public services and reinvigorates local accountability.

if local areas can be energised and enabled to grow local economies and to provide better outcomes at less cost, local government finance need not be a zero-sum game. the current government has shown an appetite for reforming local government finance through, for example, the introduction of business rate retention and piloting place-base public service budgets. Some of these new arrangements do not yet devolve decisions fully to local people. nevertheless the underlying principle to make localities more financial independent is the right one.

nearly 40 years on from the layfield report, local government leaders feel that the current arrangements have two major drawbacks:

- central government can cut (and is cutting) its grants and do so at a higher rate than other public services

- The electorate is highly sensitive to changes in a dominant, single local tax – the council tax.

With the demand for and cost of services increasing, by 2019/20 – subject to the June 2013 spending round – there could be a funding gap of more than £14 billion1. on current trajectories, projecting forward income and expenditure, the shortfall is such that local councils will have to withdraw from and reduce some services.

in 2018/19 on current projections, council tax and business rates will total more than local government spending on services excluding schools. this illustrates that we are close to a point where central grant making would be obsolete and a self-funded, localised model based on local taxes could be implemented.

against that background, council leaders propose a move away from dependency on central government grants, and local taxes set and controlled in Whitehall, towards financial independence.

1* this report went to print before the 2015/16 Spending round was announced

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WiTh The demand foR and cosT of seRvices incReasing, by 2019/20, subjecT To The

june 2013 sPending Round, TheRe could be a funding gaP of moRe Than £14 billion*.

2010

/11

2011

/12

2012

/13

2013

/14

2014

/15

2015

/16

2016

/17

2017

/18

2018

/19

2019

/20

Total council tax and business rate revenue will surpass total local government funding in 2018/19

Fund

ing

/ ex

pend

iture

/ ta

x re

venu

e, £

bn

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Democratic accountability and revival local electors’ votes will matter more if locally elected leaders determine the way in which local services are funded.

Promoting growth local areas should be able to use local borrowing and tax varying powers to invest in infrastructure and tackle the issues that stand in the way of economic growth.

Sustainable public services Place-base public service budgets should be used to deliver services that are financially sustainable, tackle waste and inefficiency and focus on prevention.

Fairness Variation in local tax bases and community needs requires a system of re-distribution to fund those areas that cannot be self-sustaining from local taxation. these arrangements should be determined by local government acting collectively.

PolicyPrinciPlES

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the public agencies that deliver services to our residents are all, to one degree or another, subject to central control. local authorities are perhaps more independent than most, but even here a high degree of financial control is exercised.

the balance of funding between central and local government has varied over the years, but even after the introduction of business rates retention, the proportion of funding raised locally is only 37 per cent, compared with 58 per cent in 1989.

council tax is subject to limitations, from capping subject to referendums. bandings are set by statute, despite the fact that housing values mean the average band varies between areas.

business rates (or non-domestic rates) are linked to the rate of inflation (the retail price index). Partial business rates retention will mean that councils will get some reward for growing their business rates tax base, but they still have no powers to increase the multiplier.

yet, for ten years under the Prudential borrowing system, local government has shown its can be trusted to set prudent and affordable budgets. rather, as we have seen, it is the need for central government to respond to global forces that have created the greatest risk to national prosperity and put local services in jeopardy, not the risk that a small number of local authorities may act imprudently.

DiScuSSionDEtailED

Chart 1. real terms reduction in expenditure over the Spending round period

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the current government has pursued two main policy objectives in relation to local finance:

• Firstly, reductions in spending above the level of other public services to help reduce the deficit. local government is experiencing cuts in grant funding of 33 per cent in real terms. this is significantly above the average for all government spending, even when the protected departments are excluded.

• Secondly, a shift away from funding based on deprivation towards funding incentives based on growth in the local economy through business rates and the new Homes bonus. relative need formula-based funding now accounts for just 21 per cent of the total ‘revenue Spending Power’ as measured by government. Just three years ago this stood at 48 per cent. the Government says that the emphasis is now on councils to build housing and facilitate economic growth to increase council tax, business rates and new homes bonus receipts generated in their area.

Chart 2. composition of revenue Spending Power over the Spending round period

2010/11 2011/12 2012/13 2013/14 2014/15

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reform of local finance faces four major challenges:

• tax and spending decisions in relation to local services are taken by different parts of government, with local politicians having only limited control over tax rates. local finance is over complicated and poorly understood by the wider public.

• Different places have different capacity to grow and some may never be self-sustaining. any movement towards greater local revenue raising requires re-distribution to take account of the wide variation in local tax bases and factors such as the vibrancy of the local housing market.

• the treasury treats local government like a government department subject to a control total, in-year re-allocations, top slices, short-term and late settlements and all the other devices it historically relies on to maintain public spending control. However, there is sufficient control within the current legislative framework that says the council must deliver a balanced budget.

• any concrete proposals for financial reform would create winners and losers amongst councils and local communities, making it difficult to establish consensus. they would also shift control and risk between national and local levels making it difficult to get political agreement between national and local leaders.

TheRe Was also a cleaR WaRning fRom councils. local goveRnmenT is

one of The feW PaRTs of The Public secToR ThaT PRomoTes economic gRoWTh.

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anD WHat PEoPlEHaVE SaiDlocal leaders, who know the system well, have said loud and clear that the current funding arrangements need reforming. they are frustrated to watch local services they care about at risk due to circumstances beyond their control. Far from holding out the begging bowl for more funds, local leaders tell us they need levers to pull and powers to act.

there is genuine concern that the current funding arrangements will restrict local choice about local services, and will – on their current trajectory – result in local government shrinking in the next few years to a core purpose of protecting the vulnerable.

there is anxiety about service withdrawal and service reductions. Services that local people care about will be lost. as a consequence local government will become less relevant and people will engage even less in the democratic process.

councils’ ability to promote growth will be compromised too. in some places, the reductions have been greater than the average (33 per cent in real terms between 2011 and 2015). there is a genuine concern about a tipping point in 2015/16.

Further reform of the local finance system will not of course take place immediately. Whilst central government continues to make grants, it needs to provide stable funding in the medium to long term to enable better financial planning.

bacKGrounD

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the way towards financial sustainability is seen as pivoting on three issues:

Growth local councils see promoting growth as core business. they would like to see more of the proceeds of growth retained locally, to be re-invested in the local economy and local services. this is seen as ambitious but achievable, given that Greater manchester secured an earn-back deal as part of its city Deal.

Public service reform Public services need to become more efficient. integration and early intervention are seen as the answers – across public services and in local government. Place-base public service budgeting is identified as the mechanism but there is frustration about the pace of implementation and central government inertia.

Financial independence Financial autonomy commands strong support. independent local taxation is seen as risky – ways will need to be found to manage extra volatility and to allow places without access to strong local taxbase to function. it is agreed that local government could find and manage its own solution.

Public seRvices need To moRe efficienT. inTegRaTion and eaRly

inTeRvenTion aRe seen as The ansWeRs – acRoss Public seRvices and in local goveRnmenT.

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in morE DEtailProPoSitionS

Give people back a meaningful local vote on a wide range of tax and spending decisions, to establish a level of decision-making that allows each place to act as its own local treasury, managing local tax and spend and driving growth. Including:

Self-funded local government through council tax, business rates and other taxes – with local control over council tax and business rates, the right to determine new local taxes and to set fees and charges which fully recover costs.

this could include, for example:

• De-regulating council tax discounts, local control over rates and full localisation of business rates including removal of the cap on the local share and local setting of the rates multiplier. a locally-led system of distribution could also involve, for example, devolved decisions on the timing of council tax and business rates revaluations.

• the ability to raise new taxes and set planning and licensing fees to give far greater flexibility or to nudge people away from (or towards) certain behaviours (such as increased recycling). Some communities could be attracted to levies on tourists; in other areas, the use of a local sales tax may make more sense than relying on local property taxes.

• the ability to vary national tax rates and reliefs with local democratic consent to generate additional funds to invest in growth and public services.

• Setting taxes at local level does not necessarily mean taxes will rise. in the past, a number of local authorities have actively reduced their council tax, in real terms or cash terms, as a matter of policy. Expanding decision-making at local level increases the extent to which authorities could choose to do this. making local treasuries responsible for their local economies means they have to take into account the level of taxation local taxpayers can afford.

• a five year funding agreement tied to the life of the Parliament for any services that remain funded by central government to allow greater innovation and pursuit of longer term objectives.

• Where central government continues to provide grant funding (and during transition to self-funded model), the predictability of a five year settlement would provide assurance that allows greater innovation and pursuit of longer term objectives, such as infrastructure investment funded by borrowing. there may need to be fall-back arrangements to deal with unforeseen events and national emergencies.

• re-create the thriving market in municipal bonds which England once had and most other countries still have.

• Free local government borrowing from treasury restrictions because it already complies with appropriate prudential rules.

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Place-base Public seRvice budgeTs need To become The defaulT

mechanism foR addRessing local seRvice RequiRemenTs

there remains no justification for borrowing caps given that local government has demonstrated its ability to borrow prudently. in Europe, local government borrowing does not sit on the national balance sheet allowing councils to demonstrate prudent financial borrowing and infrastructure investment.

• Enabling access to alternative sources of finance including the creation of a local government bond agency.

• Work is underway on the development of a collective agency for local authority bond finance, offering an alternative source of finance to the Public Works loan board. the treasury must promote and support this effort proactively and openly.

• the right to develop earn-back deals that allow places to reinvest the proceeds of additional growth in local services and measures to promote further growth.

• Earn-back deals are one way that localities could be allowed greater access to the fruits of national taxation as part of a structured system in which higher ‘fences’ must be negotiated in order to gain access to higher levels of retention.

End waste and red tape at all levels of public service by bringing local services and decisions together in one place, for each place, for issues from economic development to health and law and order.

• a place-base public service budget approach to the integration of public services in every place providing fluidity between currently protected and non-protected budgets to support locally agreed outcomes.

• Place-base public service budgets need to become the default mechanism for addressing local service requirements. under such a system, where working together to deliver shared outcomes is the norm, ringfencing becomes irrelevant.

• the use of place-base public service budgets can also facilitate not hinder the delivery of national policy objectives. Where all local agencies work together to ensure education and training makes people employable and more personally resilient, for example, the new welfare system is more likely to succeed.

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• Place-base public service budgets also have the potential to generate savings. For example, a more sustainable funding position for adult social care and children’s services would be brought about by enabling funding to move between protected health and education budgets and non-protected local government budgets to produce the same or better outcomes for less money.

• Financial incentives for government departments to overcome inertia to place-based funding reforms, to integrate services and to focus on people and places.

• Silo-based government in Whitehall has been identified as a blocker to place-base public service budgeting. the proposal to create an England office may weaken this barrier but will not necessarily remove it. Departments may need incentivising to allow earlier intervention and re-investment of savings in services wired around people and places. the 2015 Spending round could be the first such review to include a place-based element.

Share money fairly around England by taking financial distribution out of the hands of ministers and replacing it with an agreement across English local government.

the details of a fair distribution system depend upon how far government is prepared to go with devolving tax raising powers to local areas. an approach that successfully incentivised economic growth and delivered cost savings and efficiencies through place-base public service budgets would become more than just the ‘zero-sum game’ by which central government currently distributes a finite pot according to a national formula. a more modest approach would condemn both central and local decision-makers to the periodic round of ‘begging bowl’ politics. it is likely to be the case that some local authority areas will need support from the government or from their peers.

there are also a number of ways in which the system could be governed, although a much higher degree of local knowledge is required than the current system allows.

For these propositions to be implemented, local government needs:

• a new commitment to a mature and equal partnership from central government

• legislation to remove the central control of local finances

• engagement with local people that involves them in financial decision-making

• a willingness from local leaders to manage the consequences of financial independence including both volatility in tax yield and a fair re-distribution between areas.

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concluSionthe core objective of any finance system is to make sure that money gets to the places where it can add most value when it is most needed. the local finance system is broken because it no longer does this.

a rewired finance system needs to deliver economic growth and make a difference to the lives of local people. to do this it needs to incentivise decision-makers at national and local level to work together to deliver better outcomes at less cost. it needs to re-unite tax and spending decisions in a way that people can understand and that re-builds accountability. it needs to release the shackles on local spending and adopt a more realistic approach to managing economic risk.

these propositions would help revitalise local economies by enabling better targeting of investment in projects that will unlock growth potential and improve productivity – including house building, ending a top-down bidding culture and refocusing decision-making decisively on local employer-led priorities, and retaining and recycling the proceeds of growth, especially tax receipts, into local economies. they would also enable greater investment by councils in the provision of social housing, helping to de-risk the government’s welfare reform programme.

they would help make public services sustainable again by putting councils onto a self-financing footing. through the place-base public service budgets model, they would enable local public services collectively to find savings through removing duplication and inefficiency. by rewiring public services around people and places, they would allow investment in early intervention and reduce demand for services in the medium and long term.

the current financial position of most councils is unsustainable in the long term. unless something changes, councils will start to fail their communities solely because of financial instability. this is indicated by what we know from the preparations for the one year spending round in 2015/16 and the likely position of local government in the Spending round following the general election.

they would help rebuild local democracy by putting the vital link between tax and spending decisions at the centre of local democratic debate.

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