Financial distress in local authorities

Local authorities have seen significant reductions in their spending power coincide with increasing demand for their services and inflationary pressures exceeding those in the wider economy. Recent funding settlements, while increasing in cash terms, have not kept pace with these pressures leading to a downward spiral. The prospect of further real terms funding cuts is likely to exacerbate existing concerns about systemic underfunding, with the current funding gap already estimated at £4 billion.

The Government must include additional funding in the local government finance settlement for 2024–25 to ensure local authorities bridge their estimated £4 billion funding gap. The Government must set out which local authorities are being prioritised and why for this financial settlement. The Government must also set out what longer- term support will be provided to local authorities if the £4 billion funding gap is not fully met in the forthcoming financial settlement.

There is widespread agreement that Council tax is outdated, regressive, and long overdue for reform. The Government’s increasing reliance on council tax to fund local authorities is causing a disproportionately negative impact on funding levels for authorities in the most deprived areas of England. The Government’s imposition of referendum thresholds for increasing council tax is restricting local authorities’ abilities to raise sufficient funding to fulfil their statutory responsibilities, in response to reductions in central Government grants, increased demand for services, and inflationary pressures.

We repeat the recommendation made in our July 2021 report, Local Authority Financial Sustainability and the Section 114 Regime, and our November 2023 report, Council Tax Collection: namely, that: the Government must urgently reform council tax by undertaking a revaluation of properties and introducing additional council tax bands, and should consider options for wider reform of council tax.

Furthermore, in the short-term, the Government must raise the referendum threshold for council tax at least in line with a relevant measure of inflation. In the longer- term we recommend that the Government considers removing the threshold entirely.

We have previously recommended that the Government widens the funding base of local authorities and grants more flexibility over local taxes and other revenue raising powers. We therefore welcome the Government’s call for views on local authority capital flexibilities and believe that additional flexibilities may play a useful role in enabling local authorities to support themselves in times of financial distress.

However, local authorities’ use of capital funding for revenue expenditure is not sustainable and at best it can only be a temporary solution to short-term financial pressures. We have concerns that the Government, if it does grant these additional flexibilities, may delay its engagement with the more fundamental reforms to the Financial distress in local authorities 43 funding system which we believe are urgently required. There is a risk that local authorities, in using these flexibilities, are drawn into fire sales of local assets, or unsustainable borrowing, in attempts to bridge their chronic budget gaps. This could drive poor value for money for local authorities and their communities, and exacerbate existing financial distress.

The Government should ensure that the implications of any additional flexibilities it grants on capital funding are carefully considered. We recommend that these are limited to extending flexibilities over invest-to-save activity only. The Government must closely monitor local authorities’ uptake of these flexibilities and act quickly to work with local authorities in preventing unintended negative consequences. The use of capital funding for revenue expenditure must not become business as usual and is not a sufficient substitute for more fundamental reform of the funding system.

The business rates system is overly complex, outdated and in urgent need of reform. The baselines used in the business rates retention scheme are over 10 years out of date and their continued use is causing a significant misalignment between the level of funding distributed to local authorities and those authorities’ spending needs. There is a disproportionately negative impact on those authorities in the most deprived parts of the country. The Government committed to a Fair Funding Review for local government in 2016 but is still to deliver on this commitment and it is not clear to us that it will do so.

We renew our previous recommendation that the Government implements the business rates reset and Fair Funding Review. This should include transitional arrangements to ensure stability in funding levels after reset and review. The Government must commit to a fundamental long-term review of the business rates system to ensure business taxation is fit for a modern economy.

We agree with the Government that comprehensive reform of the children’s social care system is urgent and necessary. We are concerned, however, at the receding prospect of timely delivery of reforms and note that, despite the additional funding that the Government announced in autumn 2022, the Government’s plans do not provide sufficient short-term financial support to local authorities to enable them to maintain the quality of services that vulnerable people need and deserve. As the CMA has noted, there is a need to ensure profits made by private sector firms from public sector services are not “materially higher than” expected, and are appropriate and fair to the services provided.

The Government must work urgently with local authorities to better understand their short-term budgetary pressures in this area and work to develop a package of support and funding to enable continued service delivery while wider system reforms are implemented.

The Government should support local authorities by reviewing possible ways of facilitating greater collaboration across local authorities so that they can collectively deliver more children’s care services directly rather than through private suppliers.

While the additional funding announced in Autumn Statement 2022 has provided some brief respite for local authorities facing particularly acute pressures, a consistent and sustainable increase in funding is required. We have heard evidence of ongoing concerns about the continuing cost and demand pressures affecting adult social care. The absence of any additional funding announced in the Autumn Statement 2023, and the prospect of future real terms funding cuts, has exacerbated those concerns.

We reiterate the recommendation we made in our July 2022 report Long-term Funding of Adult Social Care, that the Government needs to recognise the need for more funding to local authorities for delivery of adult social care, in the order of several billions each year, and to plan a sustainable mechanism to deliver this funding, for example through the social care premium recommended by our predecessor committee in 2018.

We also reiterate the recommendation we made in our July 2022 report for the Government to publish a 10-year plan for implementing the reforms set out in its white paper People at the Heart of Care.

The rise in numbers of EHC plans following the Children and Families Act 2014 has significantly increased demand for more costly forms of SEND provision and home to school transport. The funding available to local authorities, through the Dedicated Schools Grant or otherwise, is far from sufficient to meet this demand.

The Government’s use of the statutory override and one-off ‘safety valve’ funding are temporary measures and do not address the underlying mismatch between demand, costs, and annual Dedicated Schools Grant funding. They will not prevent local authorities from accumulating further deficits until the underlying mismatch is resolved, and we do not believe it is realistic to expect local authorities to manage down deficits of the scale of many billions of pounds in total over a period of two or three years. Without significant additional funding via the DSG to match service demand and costs, or a further extension to the statutory override - which would, at most, offer a further period of temporary respite - the sector faces a cliff-edge of section 114 notices.

The Government has provided no clarity on whether it will fund, or it will expect local authorities to fund, deficits remaining when the statutory override ends in March 2026.

It is clear that the Government’s aim to improve existing mainstream and locally available special school provision will not be sufficient on its own to influence parents’ Financial distress in local authorities 45 or carers’ views on Education, Health and Care plans. The development of improved locally available provision will also take time to realise and is not likely to address the financial pressures affecting local authorities in the short-term.

The Government should provide clarity to local authorities on its specific expectations for resolving existing DSG budget deficits, and agree with local authorities a set of realistic and achievable steps, supplemented by sufficient additional funding, for eliminating these existing budget deficits. This should be done by 31 March 2024.

The Department should commission a cross-government independent review of Education, Health and Care Plans and consider fundamental reform of this system, to put SEND provision on a financially sustainable footing for local authorities whilst ensuring that all children and young people with SEND have access to the services that they need. This review should also address provision in mainstream and special schools. Furthermore, the Government, when considering future financial support for local authorities, should assess the future demand for SEND within the wider context of schools as part of the Dedicated Schools Grant funding.

Additional funding for home-to-school transport is necessary in the short-term. Therefore, the Government should assess the benefits of introducing new statutory guidance aimed at encouraging the use of less costly forms of shared transportation. In response to this Report, the Government should set out the results of this assessment in full.

We welcome the Government’s decision to increase Local Housing Allowance rates to the 30th percentile of local market rents from 1 April 2024. However, this is an urgent matter that required the Government’s immediate action. It is therefore disappointing that the Government did not implement this change with greater speed following the Autumn Statement in November 2023. We are concerned that this delay has failed to alleviate the increasing numbers of families unable to find suitable accommodation during the winter, with serious consequences for the health and wellbeing of those affected.

We recommend that the Government reconsider its position on re-freezing local housing allowance rates from 2025–26 onwards. Instead, the Government must maintain LHA rates at least at the 30th percentile of local market rents each year to ensure that those children and adults receiving benefits have sufficient access to rental properties and to prevent further escalation of pressure on local authorities’ homelessness services.

The Government elected in the next UK General Election is faced with the task of designing and implementing a series of fundamental reforms to the way in which local authorities are funded, the services that they are currently required to deliver, and the way in which these services are delivered. It is critical that the next Government prioritises this matter.

The next Government must embark on a fundamental review of the system of local authority funding and local taxation, exploring all options for removing its current regressive elements and bringing it into the 21st Century. This should include consideration of land value taxes, and of wider fiscal devolution including the option of granting local authorities a specific share of central taxation.

The next Government must ensure that it explores all options for fundamental reform of funding and delivery of social care services and implements reforms that address the underlying causes of the acute funding and delivery pressures that local authorities are currently facing. The Government should also explore how the structure of local authorities, including for example moving to unitary authorities, may alleviate financial pressures currently facing local authorities.