The fiscal mood music of recent has been more than a little dissonant. The Prime Minister has warned that the upcoming Budget will be “painful”, while the Chancellor has said there will be “difficult” decisions on tax, spending and welfare, and reports suggest Ministers have been asked to identify cuts to investment plans. At the same time there will be “no return to austerity” and the Chancellor says it is time to count the benefits as well as the cost of public investment.
What to make of all this? And what does it mean for local government?
The new government has a difficult inheritance when it comes to the public finances and public services. Debt and the debt interest burden are high. Tax revenue, measured as a share of national income, is at its highest level outside World War II. And while public spending as a share of national income is well above pre-pandemic levels, public services are clearly struggling.
To address this, the last government pencilled in real-terms cuts to investment spending, and increases in overall-day-to-day spending that would almost certainly have necessitated cuts to a range of unprotected services outside the NHS, defence, overseas aid, childcare and schools – of perhaps 2 to 3% a year.
Labour’s manifesto pledged modest top-ups to these plans, funded by a number of tax rises – but far from enough to avoid cuts. It’s almost certain spending will be topped up further, with rumours suggesting that taxes on wealth and investment returns are likely to increase, and rules on debt redefined to free up more “headroom” to borrow for investment. However, a separate rule requiring the current budget to be in balance is likely to be more binding, limiting the scope for increases in public service spending. That’s particularly true if the Chancellor wants to retain some “headroom” against this rule too – which would be wise to avoid small changes in forecasts forcing changes to tax and spending plans, or further re-writing of the fiscal rules.
New IFS analysis suggests that delivering the specific pledges set out in Labour’s manifesto and funding public sector pay pressures will require inherited spending plans to be topped up by £20 billion in 2028–29. That should be doable.
Avoiding cuts to unprotected day-to-day spending would cost a further £16billion. And avoiding cuts to investment spending too would cost a further £4 billion. Together that means around a £40 billion top-up to planned departmental spending in 2028–29 would be needed to avoid having to make cuts to certain services and investments – one, intuitive, definition of “no austerity”.
That may be doable, with further increases in taxes, and if the Chancellor is willing to sail close to the wind on her fiscal rules. But the fiscal and spending outlook strongly suggests that the spending taps are unlikely to gush enough to avoid difficult choices.
What this means for local government depends on two key factors. First, what to do with grant funding in the context of pressures on services delivered by councils and elsewhere in the public sector, given limited overall funding. Even more important though is the level of council tax increases allowed by central government, and that councils feel comfortable with: council tax contributes around 4 times as much of core spending power as grant funding, overall. The last parliament saw increases of 4 – 5% a year, but given high inflation, council tax is no higher in real-terms this year than in 2019–20. Moreover, a freeze in the early 2010s means council tax is just 2% higher in real terms than in 2010. Continued increases of 4 – 5% a year would represent increases of 2 – 3% in real terms per year.
IFS analysis published in the summer showed that with council increases of 5% a year, and a real-terms freeze in grant funding, councils’ overall funding would increase by around 2.5% a year in real-terms over the next 4 years given current inflation forecasts. But with 3% a year increases in council tax, the increase in overall funding would be just half as much – 1.3% a year. In both cases, poorer areas with smaller tax bases would see smaller increases in overall funding, unless grant funding were redistributed to offset differences in revenue-raising capacity.
Each 1% cut in grant funding per year would reduce overall funding by about 0.15% per year on average across England, so with council tax increases, overall funding could increase at least somewhat in real terms even with quite hefty cuts in grants.
But analysis by the LGA suggests that if recent spending pressures were to persist, real terms increases in funding of over 4% a year would be needed to maintain service quality. Pressures are likely to slow but by how much and how quickly is far from certain. And concrete action to reform services and tackle demand and cost pressures is needed, as recently highlighted by the County Councils Network.
There are no magic bullets, but I discussed some ways central and local government could help make funding stretch further in a previous MJ article. Addressing soaring costs for temporary accommodation, specialist children’s placements, and residential care home placements is clearly vital, with market regulation, joint procurement and in-sourcing potentially parts of the equation. Upfront investment – in new children’s care facilities or housing, for example – could help save money in the longer-term. The government should therefore channel its capital funding to such efforts, not only the green transition and higher profile things such as roads, railways or hospitals. Councils that can should also consider channelling more of their reserves to core service transformation efforts.
With firm spending plans for 2026–27 onwards not due until next March’s Spending Review, the Chancellor could decide to avoid discussing these issues in this month’s Budget. But councils can’t wait until next year in the unlikely hope that substantial new funding will be forthcoming. Reforming services takes time. The time to double down on efforts is now.