Local authority financial sustainability

When a local authority runs into financial difficulties, alarming headlines quickly follow. ‘Tipping points’, ‘one-off measures’ and ‘unsustainable’ are just some of the warnings that  have been issued by councils from Torbay to Lancashire, while the budgetary crisis in Northamptonshire saw the county council prohibit any spending except on what was deemed a legal requirement.[1] Nearly a decade of austerity has clearly hit local finances.

But it is somewhat tricky to assess local authorities’ overall financial health. Because local authorities (just as police forces[2] and schools[3]) cannot borrow to finance day-to-day spending* and hold money in reserve in case of unexpected, unbudgeted cost, headline financial indicators for local authorities always look healthy and do not display obvious signs of pressure. But performance indicators that are not specific to any one service offer telling insight.

There are some  signs that local authorities are in a worse financial position than they were in 2010. After Northamptonshire County Council ran into financial difficulties, several local authority chief executives publicly  expressed concerns about their own financial sustainability:

  • The chief executive of Torbay Council has said that funding cuts have meant that it has had to “significantly reduce [its operations] to statutory services only”.[4]
  • The chief executive of East Sussex  County Council has said it will have to cut services to the “legal minimum”.[5]
  • The chief executive of Surrey County Council has said that the council  has “only managed to balance its budget in recent years by using one-off measures”.[6]
  • Lancashire County Council’s auditors publicly  stated that the council’s finances are at a “tipping  point” and its use of reserves was “unsustainable”.[7]

The Public Accounts Committee (PAC) and the Institute for Fiscal Studies (IFS) have expressed similar concerns.[8],[9] The following analysis assesses the evidence for financial sustainability on two key indicators: local authority reserves** and property investments.

* They can borrow for capital investment. See CIPFA, CIPFA Briefing: English local authority reserves, 2015, p. 1.

** Police are also partially locally funded through a levy on council tax, the police  precept, and funding for maintained schools flows through local authorities. We exclude schools and police  from our analysis of local authority financial sustainability because local authority school reserves are ringfenced, and police  forces hold reserves separately. We analyse police  and schools’ financial sustainability in Chapters 8 and 9 respectively.

Have local authorities’ reserves reduced – and if so, does that indicate that local authorities are less financially sustainable?

Over the past decade, local authorities have been forced to adjust to an increasingly difficult financial reality. The coalition, Cameron, and May governments cut grants to local authorities by almost half  (49.1%) between 2010/11 and 2017/18.[10] Cuts were accompanied by substantial uncertainty about future funding, which has made it difficult for local authorities to plan ahead. The 2019 spending round did not resolve this uncertainty and in fact delayed implementing business rates retention and the Fair Funding review  – both  of which will change how much money individual local authorities will have – until 2020.[11]

To understand how local authorities have responded, we look at their levels  of reserves, which are a key indicator of their ability to absorb future financial shocks. The appropriate level of reserves for any individual local authority to hold should reflect a judgment on the specific risks they face, and how much it is prudent to keep.[12] Trends in total reserves held by all local authorities indicate whether authorities overall  are balancing their budgets each  year – or whether they are drawing  on one-off sources of money.

Local authority usable reserves as a percentage of annual spending

In response to ongoing financial uncertainty, both  district authorities (councils responsible for some  local services) and social care authorities (councils  responsible for local services including social care)* have faced similar uncertainty about their finances. While district authorities have continued to increase their reserves, social care authorities have kept their reserves broadly flat.

This suggests that social care authorities have found it harder to increase reserves. Some have had to use their reserves to meet pressures in adult and children’s social care. Almost 40% drew down their reserves between 2017/18 and 2018/19,[13] and there was an overall fall in social care authorities’ reserves between 2015/16 and 2016/17.

The total reserves held by social care authorities increased by £1.5 billion (bn) between 2016/17 and 2018/19, but this does not mean  they are more financially sustainable. This increase happened at a time when  central government gave local authorities an additional £3.2bn for adult  social care – through the improved Better Care Fund, adult  social care support and winter  pressures grants – and local authorities raised an extra £2.5bn through the council  tax precept for social care.

Without these one-off grants and the additional social care precept, more social care authorities may well have drawn down from reserves between 2016/17 and 2018/19.

Unallocated reserves – money that local authorities are not holding for any specific purpose and so can use it to cushion unexpected in-year  financial pressures – in social care authorities fell from 9.4% of annual spending in 2014/15 to 8.8% in 2018/19. The unallocated reserves that social care authorities now hold are lower in real terms than they were in 2013/14. In contrast, district authorities increased their unallocated reserves, from 30.3% (2014/15) to 33.1% (2018/19).

Using reserves is not always a sign of distress. Local authorities can use reserves prudently by spending on one-off ‘invest-to-save’ projects, such as investing in road maintenance to reduce later insurance claims.[14] Local authorities do not report what they spend their reserves on in national data  returns, so we cannot say whether overall use of reserves has been prudent. We can, however, see  how local authorities’ actual use of reserves compares to their planned use at the start of the financial year.

The National Audit Office calculates that unplanned withdrawals from reserves – where local authorities either use reserves without budgeting for doing so, or use more than they budgeted for – rose from £114 million (m) in 2010/11 to £658m in 2016/17.[15] This suggests that local authorities are increasingly using reserves to top up day-to-day spending, having struggled to implement savings plans or manage costs.

Reserves can only be used once: local authorities who spend theirs to fund their regular activity will not be able to do so forever.

* For a full list of responsibilities, see Institute for Government, ‘Local government’, explainer, www.instituteforgovernment.org.uk/explainers/local-government

Has local authority spending on property changed – and if so, does that indicate that local authorities are less financially sustainable?

Local authorities’ investment in commercial property has also drawn much comment – particularly where this spending has been financed by borrowing.[16] Unlike day-to-day spending, local authorities can borrow  to finance capital investments as long as the purpose is not solely to generate a yield. But at least  part of local authorities’ motive for investing in commercial property has been to generate profits from rental income to fund stretched local public services.[17],[18]

Local authority spending to acquire land and existing buildings for trading services, £m

We do not know exactly how much local authorities spend on commercial property,* but local authority capital spending to acquire land and buildings for ‘trading services’ has risen rapidly over the past three years. Local authority trading services, which include commercial housing and real estate, is the closest comparable category in recorded data  to commercial property investment.

In real terms, annual local authority spending on acquiring land and buildings for trading services is now almost 20 times higher than it was 2009/10. Spending rose particularly quickly after 2015/16, reportedly in response[19] to the government’s announcement that it intended to make local authorities financially  self-sufficient by the end of that Parliament.[20]**

The rise in spending reflects both  an increase in the number of authorities acquiring land and buildings for trading services, and the amount that they are individually spending. This appears to be the result of a small number of authorities making very large investments.***

Local authorities appear to have boosted commercial investments to generate profits to fund public services. But we do not know how successful this strategy has been, and without a clear understanding of the risks councils are taking – which cannot be gleaned from financial data**** – it is unclear if increased investment in commercial property has made councils more or less financially sustainable.

Increasing investment in commercial property may generate revenue but it also exposes authorities to different financial risks that they may not be able to manage:[21] for example, rental income will fluctuate with economic activity[22] while changing consumer trends can affect retail businesses.[23]

* Local authority capital spending statistics do not record spending on commercial property. The Public Works Loan Board – the main lender to local authorities – does not record the purpose of the loans it makes  to local authorities. The Ministry of Housing, Communities and Local Government is working with local authorities to develop a new capital spending category to better reflect this change. See House  of Commons Library Briefing, Local Government: commercial property investments, 2018, p. 18.

** Some of the increase between 2016/17 and 2017/18 may be due to reclassifying some  commercial activity as trading services, which was previously classified under other headings. See Ministry of Housing, Communities, and Local Government, Local Authority Capital Expenditure and Receipts, England: 2017-18 Final Outturn, 2018, p. 9, www.gov.uk/government/statistics/local-authority-capital-expenditure-and-receipts-in-england-2017-to-2018-final-outturn

*** In 2018/19, three local authorities (0.8% of all authorities) accounted for 29.6% of trading services property spending. See Ministry of Housing, Communities, and Local Government, Local Authority Revenue Expenditure and Financing England: 2018 to 2019 individual local authority data – outturn, (no date), retrieved 30 October 2019, www.gov.uk/government/statistics/local-authority-revenue-expenditure-and-financing-england-2018-to-2019-individual-local-authority-data-outturn

**** The Ministry of Housing, Communities and Local Government has recognised this and has issued new guidance on transparency for local authorities. See https://assets.publishing.service.gov.uk/government/uploads/ system/uploads/attachment _data/file/678866/Guidance_on_local _government _investments.pdf