Funding reforms pose a ‘threat’ to financial planning while some councils benefit

Picture by Pippa Fowles / No 10 Downing Street, Flickr

Funding reforms are on the way. Adrian Jenkins surveys the landscape government and councils will need to chart.

Local authorities are currently fully engaged in dealing with Covid and its financial fall-out. Over the horizon, though, is the prospect of the long-awaited implementation of local government funding reforms. These will be the most significant changes to the funding of local authorities since at least 2013-14 when the current business rate retention system was introduced.

Whilst we have some idea about the type of changes that ministers will make, we do not have any certainty about whether they will be implemented in 2022-23. This is now becoming a hugely important question for local authorities because it will change funding allocations and significantly so in many cases.

There are many changes within the proposed reform package. Firstly, the fair funding review will give every authority a “needs assessment”. These assessments were last updated in 2013-14 but there has been nothing like the current review for well over a decade. Indeed, some of the “needs assessments” have been in use since the start of the century.

Secondly, council tax assumptions will be updated (a process called council tax equalisation). And thirdly, ministers have consistently promised a full business rates baseline reset. This effectively creates a new business rates “target” for every authority.

There are many hurdles to get across if the government is going to deliver in 2022-23. And getting over these hurdles is made more difficult by Covid, which has had an impact on capacity within MHCLG and it will continue to do so for weeks or months to come.

And these are only the headline changes. We also expect a replacement for new homes bonus, fundamental changes in business rates, and changes to a range of specific grants. One change now looking less likely is the increase in the local share in the business rates system from 50% to 75%.

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Consequences

Of course, any changes will have significant distributional consequences. The winners and losers will depend on a complicated interaction of factors. To take a few examples, the changes in “needs assessments” are likely to shift funding from London towards lower-need counties.

But offsetting that is the effect of council tax equalisation, which negatively affects many high-taxbase counties, and gives more to high-need metropolitan councils. Many districts are likely to lose heavily from the baseline reset and the ending of new homes bonus.

The sector has been waiting for these changes for a long time. The government’s official position is that all this is going to happen in 2022-23.
These changes have been delayed from 2019-20 so, even if government hits 2022-23, the reforms will be four years late. And still the government is not entirely sure that it will be ready in time for 2022-23.

In a response to a question in the House of Commons (17 December 2020), Robert Jenrick could only say there would be an “opportunity” to implement the funding reforms in 2022-23. Not exactly a cast-iron commitment.

There are many hurdles to get across if the government is going to deliver in 2022-23. And getting over these hurdles is made more difficult by Covid, which has had an impact on capacity within MHCLG and it will continue to do so for weeks or months to come.

If there are going to be major funding reforms in 2022-23, then we would expect a consultation paper published in July 2021. It would be difficult to start consulting on fundamental funding changes after the summer, barely a few months before a provisional settlement in December.

A pre-summer consultation is not a requirement, but major change would be difficult without it. That leaves little time between the end of the settlement process (February 2021) and a pre-summer consultation. Preparations for reforms have been furloughed since early 2020, and it might be hard to revive them quickly. The technical working groups have largely not met since autumn 2019.

Treasury

The spending review is an added difficulty. We don’t know when it is: it might be before the summer (July 2021?) but it might not be until the autumn (September or even October 2021?), and we don’t know which period it will cover (one year only or up to 2024-25?).

In theory, reform of local government funding would naturally follow a spending review. But there are complicated interactions between a review and proposed reforms. For instance, the spending review will make decisions about the funding available for local government, the reliance on council tax, and whether the Treasury will fund “damping”. An earlier spending review will make reforms easier to manage because MHCLG will know local government’s funding envelope.

We would certainly expect the baseline reset and fair funding review to happen alongside each other. It is difficult to see either happening in isolation. Both these changes will create major winners and losers

The Treasury is likely to push for the funding reforms to be delivered in 2022-23, particularly the business rates baseline reset. We expect the Treasury will want to use accumulated business rates growth to fund growth in core services and, or, to support damping and transition. There could easily be well over £1bn that can be diverted into social care grants.

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Re-setting business rates baselines in 2022-23 in a sustainable way will be almost impossible. Business rates income will not have settled after the pandemic and may not until 2023-24, too late to use for a reset later this year.

It might be necessary to fall-back on an interim solution, with temporary resets. This is feasible but potentially messy. There is an added complication with business rate revaluation in 2023.

We would certainly expect the baseline reset and fair funding review to happen alongside each other. It is difficult to see either happening in isolation. Both these changes will create major winners and losers, and easier to handle both together rather than in different years. Other changes in funding can be handled separately, or at a later date, such as the increase to 75% retention.

Planning

Despite the many reasons that could delay funding reform, we are still assuming that it will happen in 2022-23. There is no real evidence that it will be later, and the government’s policy remains that it will be 2022-23. If it is delayed again, it is not clear that it would be more likely to happen in 2023-24 than, say, 2024-25.

The structure of the reforms is already largely laid out and we can make reasonable assumptions about key aspects. For instance, the “needs assessments” will move towards a simpler approach and there will be a continued commitment to full baseline reset.
There are still big questions though, not least how to reset baselines when business rates income has not settled down after the pandemic.

Funding changes always create winners and losers; some of the changes will be large indeed. Ministers will want to manage any disruption but the proposals do indicate some big swings. The most substantial changes are likely to be those with the highest growth from business rates and council tax, many of which are district councils.

Other major losers are likely to be inner London boroughs. In our modelling, we have made assumptions about “damping” and transitional arrangements, but these are still speculative. In short, gainers should be prudent about planning on gains; losers should be aware of losses and plan for changes in the first available year.

There is a considerable threat to financial planning (and financial viability) for many authorities. For others, the increase in resources will be very welcome and could help stave-off their financial pressures.

But for all authorities, the uncertainty is enormous: how can authorities make plans for next year if they do not even know when major changes will take place—still less what those changes will be?

Adrian Jenkins leads the funding advisory service at Pixel Financial Management.

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