Council funding: how should the cake be cut?

UK local government funding has long been notorious for its complexity. The Government made a commitment to a ‘fair funding review’ in 2016, which aims to review and (if necessary) update the needs assessment underlying the distribution of funding.

The most recent consultation was published in February 2017. It will be challenging for the Government to design a system that satisfies a majority of local authorities and which is relatively transparent and simple.

How to assess local needs, and how to balance the different statistical indicators, is inevitably a matter of political judgement. To contribute to the debate, the Communities and Local Government Committee commissioned research that would explore some of the issues behind the decision-making, including:

  • Exploring how the existing needs assessment could be simplified
  • Simplifying the wider funding model which converts assessed needs into funding
  • Modelling the ‘business rates retention reset’ (a key element in determining how the needs assessment figure affects total funding for councils)

Putting needs assessment into practice

A relatively simple statistical approach can be used to reduce the number of indicators used in the needs assessment formula. They include data such as levels of educational qualifications, sparsity of population, and recipients of benefits. For five key services, the number of indicators could be reduced by almost half (removing 18 of 40) – this could be done whilst ensuring that half of all authorities would see their needs assessment result change by 1% or less. This would help to make the formula simpler and more transparent for local authorities. This method could be applied to any future set of indicators to try to reduce the numbers used.

A simplified system

There is a more influential way in which the Government’s funding system could be simplified. Since 2007, funding has been allocated/deducted based on each authority’s needs/resources relative to a benchmark authority – the authority with the smallest needs/council taxbase per head – instead of simply being allocated/deducted in direct proportion to assessed needs and council taxbase.

This was done to avoid the impression that the needs and resource assessment was setting spending/council tax targets for councils. But it also meant that the link between needs, resources and funding became hard for councils to understand, and it often exhibited unpredictable statistical quirks. A government seeking simplicity and transparency for the funding system could consider allocating funds to councils proportionately to their needs and resources.

The worries about inadvertently creating spending targets for councils should be less acute under today’s system. The new business rates retention system, introduced in 2013, means that the ‘fair funding review’ will only set the starting point for councils’ funding. Their funding will then diverge from this starting point, because councils will be able to increase their business rates revenue through local policy decisions.

How often should the business rates retention system be reset?

Rate retention was introduced to encourage local authorities to grow the local economy, and to benefit financially from doing this via additional business rates revenues.

The researchers modelled scenarios for how often the rates retention scheme should be reassessed or “reset”.  This was last done in 2013, with a reset pencilled in for 2020.

The business rates retention system allows councils’ funding to diverge from the levels set by the needs assessment over time. The longer the time between resets, the greater this potential divergence would be, with councils being rewarded for a longer period for increasing their business rates income.

However, the research found that the reset itself had more effect on individual councils’ funding than the extra rates revenue that they generated. Individual councils had material gains and losses as a result of the reset methodology. If these gains and losses are “locked in” to the system for a prolonged period, this reduces the influence of needs assessment and rates retention.

The research found that more frequent resets would allow more up-to-date data to be used and help councils’ funding to track assessed need more closely. The trade-off over more frequent resets would be the increased complexity they would bring to the system and the smaller incentive for councils to increase their business rates income.

The Government’s February 2017 consultation suggested that councils could keep some of their rates revenue growth permanently (as a long-term reward for their policy decisions) by excluding certain income from the reset.

What next?

In summary, it would be possible to simplify the needs assessment process relatively painlessly. This is true regardless of how it is used to determine funding outcomes.

The question of how often to reassess the business rates retention scheme, via the reset, has no easy answer. Different options have different consequences, and this will ultimately be a matter of judgement for the Government.

One option to increase incentives, whilst allowing a significant role for needs assessment, would be to revive the idea of ‘local growth zones’. These featured in the Local Government Finance Bill 2016-17 (which was lost due to the 2017 General Election). They would allow councils to exclude certain local areas from the reset and receive the full reward of business rates increases in those areas.

Thanks to Jude Ranasinghe and Lee Geraghty, from the LG Futures research team, for comments on early versions of this piece.

The CLG Committee’s research is published on Parliament’s website.

The basic principles of business rate retention are outlined in our research briefing Reviewing and reforming business rates.

Picture credit: Victorian Houses, Nottingham by Natesh RamasamyCreative Commons Attribution 2.0 Generic (CC by 2.0)