Anthony Breach is a Senior Analyst at Centre for Cities, where he leads on housing and planning.
It’s never a good sign when local council finances make it into the headlines. A trickle of effectively bankrupt councils has become a stream, and risks turning into a flood without reform of England’s highly centralised funding system.
The problem is bigger than a few cases of financial mismanagement. The Government concedes this when it consults on letting councils sell their assets to plug local revenue gaps – granting councils the freedom to eat their own seed corn.
Cuts to government grants are only half of the story though. The other half is that council tax increases are capped by central government, preventing the county and unitary councils that provide the bulk of services from closing their funding gaps.
After over a decade squeezed between these two forces, councils across England and of all colours are now struggling to providing more than the statutory minimum. Below this, there is nothing left to cut without the disintegration of core public services and local state capacity.
One response might be that this is unimportant, as only a small number of people use the remaining services. But almost everyone pays council tax, which despite being the public’s least favoured tax for increases, is now being hiked to the hilt of five per cent (and beyond it, up to 15 per cent in councils that have financially failed) to meet these statutory needs. Delivering on the desire to cut council tax bills is now more difficult than ever due to the funding crisis.
There are, though, two separate problems to consider. The first is the lack of resource in the local funding system, and the second is the design of that funding system.
The funding system is highly centralised, meaning councils rely on grants to pay the bills. As a consequence, councils not only see little increase to their revenues if they grow their tax base, but because grants are weighted towards poorer areas, councils that support the success of their local private sector are punished with lower amounts of grant.
Councils are understandably focused on securing an emergency injection of grants from central government, as they need to solve that first problem in the short-term. But more grant is not a long-term solution, as it does nothing to address the second problem. And even if the money could be found by this Government or the next to secure big increases to grant, the one after could simply cut them again.
It is not hard to see that the damage the centralised local finance system does to incentives, combined with the powers councils have over planning and new infrastructure plus ‘Nimby’ voters all adds up to a serious bottleneck on both the national economy and ‘levelling up’. Reforms to local finance should therefore aim over the medium-term to both strengthen the local and national economies, and use that to provide the funding for local services.
Fiscal devolution, which would shift local finance away from central grants and towards more local control of taxation, is the key to this as by allowing councils to keep more of the proceeds of growth would give them better incentives to generate revenues, if the following principles were met.
First, grants must be distributed to councils on a simple per head basis. Councils should get external funding to help finance the services Parliament has required they provide in statute, grants should incentivise expansion, not deprivation.
Second, business rates must be returned to local control. Although they are seen as a local tax, they are actually set and largely flow to central government to feed the grant machine. Giving councils back control of business rates would also ensure councils are incentivised to listen to businesses and provide land for new factories, offices, and shops.
Third, as these changes to grant and business rates would entail less national redistribution, fiscal devolution must entail more local redistribution. Council tax could be cut for a majority of households in every borough if it was made more flexible, but only if the base was broadened by allowing councils to shift from its regressive to a flat or progressive local council tax rate. Greater flexibility would also make council tax more ‘buoyant’, meaning revenues rise as the economy grows, strengthening the incentives councils face.
Fourth, to further compensate for any losses from changes to grant, and again further incentivise councils to pursue economic growth, the local tax base must be broadened from its narrow base in property with a slice of all locally generated income tax. This would also prevent local redistribution placing heavy tax burdens on asset-rich, cash-poor households such as pensioners.
And fifth, fiscal devolution must be delivered to local governments that match local economies. The American experience – where the affluent can gerrymander tiny ‘cities’ into existence and cut their taxes – must be avoided as it damages services for their less fortunate neighbours without any improvements for growth. Further reform of local government will therefore need to be part of the package by which fiscal devolution solves the local funding crisis.
Fiscal devolution does present challenges. Even though centralisation of the local funding system is harmful, change will have to proceed carefully to avoid unintended consequences.
One way of doing this would be to deliver fiscal devolution to a few select areas first before extending out to the rest of England. Centre for Cities, as part of the Economy 2030 inquiry, recently proposed such an approach based on the five principles above (alongside changes to powers and governance) in a revenue-neutral ‘triple deal’ for the mayors of London, Greater Manchester, and the West Midlands.
The triple deal would provide relief for local finance problems in each city by improving the rewards they gain from economic success. But it would also provide a stepping stone to extending fiscal devolution across all of England, improving local finances everywhere by improving local economies nationally.
Local finance is currently in a bad way though, and in the short term we will need to increase grants simply to keep the lights on in councils across England. But subsidies from central government are not a sustainable basis for local services and local growth. Only a redesign of the funding system through fiscal devolution can push local council finances back out of the headlines where they don’t belong.
Anthony Breach is a Senior Analyst at Centre for Cities, where he leads on housing and planning.
It’s never a good sign when local council finances make it into the headlines. A trickle of effectively bankrupt councils has become a stream, and risks turning into a flood without reform of England’s highly centralised funding system.
The problem is bigger than a few cases of financial mismanagement. The Government concedes this when it consults on letting councils sell their assets to plug local revenue gaps – granting councils the freedom to eat their own seed corn.
Cuts to government grants are only half of the story though. The other half is that council tax increases are capped by central government, preventing the county and unitary councils that provide the bulk of services from closing their funding gaps.
After over a decade squeezed between these two forces, councils across England and of all colours are now struggling to providing more than the statutory minimum. Below this, there is nothing left to cut without the disintegration of core public services and local state capacity.
One response might be that this is unimportant, as only a small number of people use the remaining services. But almost everyone pays council tax, which despite being the public’s least favoured tax for increases, is now being hiked to the hilt of five per cent (and beyond it, up to 15 per cent in councils that have financially failed) to meet these statutory needs. Delivering on the desire to cut council tax bills is now more difficult than ever due to the funding crisis.
There are, though, two separate problems to consider. The first is the lack of resource in the local funding system, and the second is the design of that funding system.
The funding system is highly centralised, meaning councils rely on grants to pay the bills. As a consequence, councils not only see little increase to their revenues if they grow their tax base, but because grants are weighted towards poorer areas, councils that support the success of their local private sector are punished with lower amounts of grant.
Councils are understandably focused on securing an emergency injection of grants from central government, as they need to solve that first problem in the short-term. But more grant is not a long-term solution, as it does nothing to address the second problem. And even if the money could be found by this Government or the next to secure big increases to grant, the one after could simply cut them again.
It is not hard to see that the damage the centralised local finance system does to incentives, combined with the powers councils have over planning and new infrastructure plus ‘Nimby’ voters all adds up to a serious bottleneck on both the national economy and ‘levelling up’. Reforms to local finance should therefore aim over the medium-term to both strengthen the local and national economies, and use that to provide the funding for local services.
Fiscal devolution, which would shift local finance away from central grants and towards more local control of taxation, is the key to this as by allowing councils to keep more of the proceeds of growth would give them better incentives to generate revenues, if the following principles were met.
First, grants must be distributed to councils on a simple per head basis. Councils should get external funding to help finance the services Parliament has required they provide in statute, grants should incentivise expansion, not deprivation.
Second, business rates must be returned to local control. Although they are seen as a local tax, they are actually set and largely flow to central government to feed the grant machine. Giving councils back control of business rates would also ensure councils are incentivised to listen to businesses and provide land for new factories, offices, and shops.
Third, as these changes to grant and business rates would entail less national redistribution, fiscal devolution must entail more local redistribution. Council tax could be cut for a majority of households in every borough if it was made more flexible, but only if the base was broadened by allowing councils to shift from its regressive to a flat or progressive local council tax rate. Greater flexibility would also make council tax more ‘buoyant’, meaning revenues rise as the economy grows, strengthening the incentives councils face.
Fourth, to further compensate for any losses from changes to grant, and again further incentivise councils to pursue economic growth, the local tax base must be broadened from its narrow base in property with a slice of all locally generated income tax. This would also prevent local redistribution placing heavy tax burdens on asset-rich, cash-poor households such as pensioners.
And fifth, fiscal devolution must be delivered to local governments that match local economies. The American experience – where the affluent can gerrymander tiny ‘cities’ into existence and cut their taxes – must be avoided as it damages services for their less fortunate neighbours without any improvements for growth. Further reform of local government will therefore need to be part of the package by which fiscal devolution solves the local funding crisis.
Fiscal devolution does present challenges. Even though centralisation of the local funding system is harmful, change will have to proceed carefully to avoid unintended consequences.
One way of doing this would be to deliver fiscal devolution to a few select areas first before extending out to the rest of England. Centre for Cities, as part of the Economy 2030 inquiry, recently proposed such an approach based on the five principles above (alongside changes to powers and governance) in a revenue-neutral ‘triple deal’ for the mayors of London, Greater Manchester, and the West Midlands.
The triple deal would provide relief for local finance problems in each city by improving the rewards they gain from economic success. But it would also provide a stepping stone to extending fiscal devolution across all of England, improving local finances everywhere by improving local economies nationally.
Local finance is currently in a bad way though, and in the short term we will need to increase grants simply to keep the lights on in councils across England. But subsidies from central government are not a sustainable basis for local services and local growth. Only a redesign of the funding system through fiscal devolution can push local council finances back out of the headlines where they don’t belong.