Response to ‘Local authority funding reform: objectives and principles’ consultation by MHCLG

Preface

1. This is a response by David Phillips and Kate Ogden to the Ministry of Housing, Communities and Local Government’s consultation on ‘Local authority funding reform: objectives and principles’. David Phillips is an Associate Director at the Institute for Fiscal Studies (IFS) and leads its work on devolved and local government finances, while Kate Ogden is a Senior Research Economist at the IFS also working on local government finance issues. However, the IFS has no corporate views on the issues covered in this response (or indeed any other issue): all views are those of David and Kate alone, and they are solely responsible for any errors or omissions.
2. David is also a member of the Local Government Funding Reform Strategic Group convened by the Ministry of Housing, Communities and Local Government (MHCLG) to share views and foster collaboration between various stakeholders as reforms to the local government finance system are developed, consulted upon, and implemented. The views expressed in this inquiry submission are not necessarily representative of the views of MHCLG Ministers or Officials or other members of the Strategic Group, who have had no part in drafting this submission.
3. This response deals with aspects of the following questions in the inquiry’s terms of references:
   1. Question 1. Do you agree with the government’s objective to allocate grant and retained business rates income in a way which accounts for differences between local authorities in demand for services, the cost of delivering them and ability to raise Council Tax locally?
   2. Question 2. In addition to the areas included in this consultation, are there elements of the local government finance system that are not fit for purpose and require improvement and reform? If so, please provide information on what reforms are required and why.
   3. Question 3. Do you agree that the suggested principles should inform our approach to updating local authority funding allocations?
   4. Question 4. Do you agree with our proposal to use the best available evidence and most up-to-date data in the assessment of need, including using the most recent census data?
   5. Question 5.Do you agree with our proposal to simplify the assessment by reducing the number of Relative Needs Formulae? If you disagree, please explain why and which service areas you are concerned about.
   6. Question 9. Do you agree that (other than locally retained business rates) we should only adjust for Council Tax when assessing local resources? If you do not agree, please include details of what other sources of income you think should be included (if any), and how the government should adjust for them.
   7. Question 10. Do you agree that we should measure Council Tax income by making uniform assumptions on the Level of Council Tax charged by local authorities and factors which determine their ability to raise Council Tax?
   8. Question 12. Do you agree Transitional Arrangements should account for a Business Rates Reset? If not, please explain why.
   9. Question 14. What measures should we use to support local authorities to move to their updated funding allocations?
   10. Question 15. Do you agree we should keep funding allocations up-to-date dynamically by using the most up-to-date data possible? If so, how?
   11. Question 18. Do you agree or disagree that the government should provide local authorities with greater control over Sales, Fees and Charges?

Our responses draw on previous research undertaken by ourselves and others and published by the IFS. This includes recent reports on the design of the local government finance system (Ogden et al, 2023; Phillips, 2024), as well as previous more in-depth looks at spending needs and revenue capacity assessment (Amin-Smith and Phillips, 2018; Harris and Phillips, 2018), and responses to previous consultations by MHCLG on funding reform (Amin-Smith et al, 2019; Amin-Smith and Phillips, 2019).  

4. The corresponding author for this response is David Phillips:

   Email: @email

   Phone: 020 7291 4800

   Address: 3^rd floor, 7 Ridgmount Street, London, WC1E 7AE.

Summary of our overall response 

5. It is welcome that the government proposes to introduce a funding system that accounts, at least in part, for differences between local authorities’ demands for services, delivery costs and council tax revenue-raising capacity. Putting in place such a funding system does not necessarily mean funding should be fully and immediately adjusted to account for all differences in needs, costs, and resources though. There is a trade-off between redistribution and insuring areas against needs/costs/resource shocks on the one hand, and financial incentives (to tackle needs and boost tax bases) as well as certainty of grant funding on the other. The government, in consultation with stakeholders, needs to determine how to trade off these objectives, and be transparent about the decision taken and why. It should make sure its wider objectives for service delivery are consistent with these decisions around the funding system.
6. There are a number of other issues with the funding of local services that have been raised by stakeholders which are not directly addressed in this consultation. These include that:
   1. Councils have a limited degree of revenue-raising power compared with local governments in other countries. Removing or reforming council tax referendum limits is a priority for some stakeholders and could help facilitate broader local government finance reform.
   2. The main devolved tax, council tax, is over a third of a century out-of-date, highly regressive with respect to property value, and unnecessarily distortive with respect to who occupies which properties.
   3. Councils have limited financial incentives to improve local socio-economic outcomes.
   4. Financial and political accountability is confused, with the remits and responsibilities of local government and central government not clearly understood by the public, in part due to actions of central government.
   5. The weak institutional status of local government may lead to systematic under-funding by central government.

The consultation does not address these important questions, but the government should consider them. If it decides no changes will be made in relation to these issues, it should explain why.

7. The technical detail of how spending needs and (unavoidable) differences in input costs are assessed, as well as how revenue-raising capacity is measured, will be of material significance. Proposals to use spending needs formulas based on sub-council level data analysis for social care services, to refresh the data used in all spending needs formulas, and to measure revenue-raising capacity using a common tax base and notional tax rate, are all sensible. It will be important to consult on the technical detail with sufficient time both for stakeholders to respond, and importantly, for additional analysis to be undertaken by independent researchers and consultants to inform stakeholders’ responses.
8. For the foundation formula that will be used to assess needs for most services outside social care, sub-council level data analysis is unlikely to be feasible. In this case it is important to realise that basing a spending needs formula on the most recent correlations between actual spending and local area characteristics is not necessarily the best way to assess needs. That is because such patterns will to a large extent reflect past funding allocations (rather than underlying needs). Instead, judgement will need to be used either to determine the formula directly or to identify a past year (or set of years) when funding patterns are deemed to be closest to ‘fair’. This is an inherently subjective matter.
9. Updating funding allocations each year based on actual changes in local area characteristics that affect needs, costs, and revenue-raising capacity, would make it difficult to provide funding certainty, and would blunt councils’ incentives to tackle needs and boost revenue-raising capacity. To avoid this, funding could be reallocated on a periodic basis after several years, or ideally on a rolling basis, which would allow a multi-year funding horizon for councils. In between these resets, it is still possible to use projected changes in characteristics (e.g., population) as part of the funding allocation process. Because these projections can be fixed in advance, they do not affect the certainty of funding or the incentives that councils face. If the projections are sufficiently strongly positively correlated with actual changes in needs or revenue-raising capacity between resets, using projections would help reduce the amount of funding that needs to be redistributed at future resets – reducing uncertainty at that point. If they are not sufficiently strongly positively correlated with actual changes though, they can worsen problems. MHCLG should therefore examine this issue carefully, undertaking or commissioning appropriate statistical analysis.

Question 1. Do you agree with the government’s objective to allocate grant and retained business rates income in a way which accounts for differences between local authorities in demand for services, the cost of delivering them and ability to raise Council Tax locally?

10. The clearest shortcoming with the English local government finance system is the arbitrary nature with which most funding is allocated between councils. It is therefore welcome that the government proposes to introduce an updated funding system from 2026–27 onwards. The details of what is proposed will matter, and the government should be clear about what it is trying to achieve with its new system.
11. Historically, there was a complex but broadly sensible approach to assessing councils’ spending needs (based on various local area characteristics) and their capacities to raise revenues (via local taxes, for example). These assessments were used to allocate central government funding in a way that offset differences. Ill-advised reforms in the mid-2000s saw this system become unnecessarily opaque and subject to potential manipulation and misrepresentation by Ministers, before efforts to comprehensively assess spending needs and revenue-raising capacities were abandoned in 2013–14.
12. Since then, ad hoc year-on-year changes in funding have in some years consisted of equal percentage cuts to grant funding. taking no account of councils’ own revenue-raising capacity, and more generally have not accounted for differential population growth, let alone other changes in local area characteristics. Together, this has meant that councils’ funding allocations have become essentially arbitrary with respect to their current circumstances. In turn, this means that current funding allocations are likely to be both unfair and inefficient, with negative consequences for overall value for money and the potential to exacerbate geographic inequalities. Inappropriate funding allocations have also been highlighted by combined authorities as adversely affecting their collaboration with councils, undermining the potential benefits of their devolved powers.
13. Our analysis, based on the formulas used to assess spending needs prior to 2013–14 but plugging in more recent data, suggests that more deprived areas receive a lower share of funding than their share of assessed needs, while more affluent areas receive a higher share of funding than their share of assessed needs. These differences amounted to around -10% and +10% for the most and least deprived fifth of areas in 2022–23 (Ogden et al, 2023). However, as well as updating data on council characteristics, the formulas themselves should also be updated. Given substantial changes in the last 10-20 years in the nature of what councils provide and how they deliver services, this should include updating which area characteristics are included and the weights applied to them. Updating the formulae (as well as the data) may give somewhat different patterns from those we have previously estimated.    
14. At a minimum, there is a pressing need to put in place a local government funding system that can properly account for variations in local spending needs and revenue-raising capacity, and to allocate funding accordingly. This is what the government has said it will do, which is welcome. But this is not without its technical challenges, and it is important to acknowledge that no approach is fully objective – subjective, political judgements on the level and quality of services councils are expected to deliver, and on what constitutes ‘need’, cannot be avoided. In particular:
    1. Expectations over the level and quality of services councils should provide (or be funded to provide) will affect the absolute levels of funding required, but also the relative spending needs of different councils. For example, with higher funding and an expectation of more universal services, needs may not be so concentrated in the most-deprived areas. This means that a clear view of the range and quality of services expected from councils is needed, as are realistic assessments of how much it would cost to fund these.
    2. Does ‘need’ mean only accounting for differences in demands for and costs of services between areas, or is additional support to high-need or disadvantaged areas also deemed desirable, in an effort to reduce underlying inequalities or address unmet needs? The latter approach is used to allocate NHS funding and is worth considering for local government if the government places a high priority on tackling geographical socio-economic inequalities.
15. Putting in place a proper system for allocating funding does not necessarily mean that funding should fully adjust for differences in assessed spending needs and revenue-raising capacity. Full adjustment would allow for the same range and quality of services to be delivered in all parts of the country, if all areas made the same choices around levels of local taxation. But there is a trade-off between redistribution and the provision of financial incentives for councils, such as to improve local outcomes or reduce needs drivers. Reforms during the 2010s – such as the introduction of the New Homes Bonus, and then business rate retention –placed an increased emphasis on incentives relative to redistribution, with particular behaviours from local authorities encouraged in return for additional revenue.
16. While evidence on how financial incentives affect council behaviour and socio-economic outcomes is limited, this does not mean that such incentives do not matter. It is important that a reformed system makes clear how much priority is being placed on redistribution versus incentives, and ideally should allow this balance to be shifted if the priority placed on these objectives changes. In other words, a reformed system of redistribution should be both transparent and have a degree of flexibility, so that governments do not feel the need to tear up the system and start again if their priorities are not being met.
17. In our view, the present consultation is not sufficiently explicit about this trade-off between redistribution and incentives. When developing more specific proposals for further consultation, MHCLG should be clear about how it is balancing redistribution and incentives, both at the point of introduction of a new system, and dynamically as funding allocations are updated to account for further evolution in assessed spending needs and revenue-raising capacity.

Question 2. In addition to the areas included in this consultation, are there elements of the local government finance system that are not fit for purpose and require improvement and reform? If so, please provide information on what reforms are required and why.

18. In a recent report (Phillips, 2024), IFS researchers have reviewed the range of issues that have been raised with the current local government finance system not otherwise discussed in this consultation. These include:
    1. First, that councils in England have a limited degree of revenue-raising power compared with local governments in other countries. Councils can vary the headline council tax rate charged, but increases above a certain percentage or amount have first to be passed by a local referendum. Councils have significant discretion to reduce business rates but very limited discretion to increase them. And the wider array of revenue-raising options available in many other high-income countries (from specific levies, such as tourism taxes, to broader-based taxes, such as local income taxes) are not available to English local government.
    2. Second, and related to this, some commentators have suggested that English local government has insufficient financial incentive to improve local socio-economic outcomes. Those incentives that are present (via business rates retention, for example) relate mainly to the development of new property. However, there is little financial incentive for councils to support residents to increase their earnings, especially if that involves remote work or commuting to other areas.
    3. Third, financial and political accountability can be confused, with the remits and responsibilities of local and central government overlapping and little understood by voters and other stakeholders. It is not possible to demarcate responsibilities fully, but frequent changes in the duties of or restrictions placed on local government, ‘unfunded burdens’, and a plethora of ad hoc deal-based devolution arrangements make such problems worse.
    4. The institutional status of local government is relatively weak compared with many other countries. The lack of an overarching constitutional framework for assigning responsibilities and powers between tiers of government in England means that, in effect, central government can relatively easily and unilaterally add or remove them. Alongside accountability concerns, it has also been argued that councils’ weak institutional status leads to the systematic underfunding of local services. And while central government has engaged with local government on the design of the finance system, there is no statutory basis for co-designing the system as in many other countries.
19. The aforementioned IFS research concludes that a number of reforms are worthy of serious consideration:
    1. Further fiscal devolution to local government should be carefully considered. The empirical evidence that the incentives, discretion and learning opportunities provided by devolution has a positive impact on growth is weaker than would be suggested by the apparent consensus that this is true. However, on the revenue side of their budget, English councils’ powers are highly constrained compared with many similar countries, so it is worth considering the case for providing some further revenue-raising options. A detailed discussion of the principles for assessing specific options and the resulting good and bad candidates for devolution can be found in Phillips (2024) and Amin-Smith et al (2019).
    2. Issues around financial incentives should be considered both as part of the review of councils’ needs and resources and any new fiscal powers being considered for devolution to local government.
    3. In relation to accountability, the government must be clearer about the range and quality of services it expects councils to provide, and how much it would reasonably cost to deliver these. In the absence of estimates of how much it costs to deliver the expected range and quality of services, it is harder for voters to hold the appropriate politicians to account for poor services: is it due to a lack of available resources, or poor local delivery. In addition, it is not possible to properly assess what share of funding should go to each council without assumptions about the level of service provision: the relative needs of deprived and affluent areas will depend on the extent to which the services they are expected to provide are more universal or targeted in nature, for example.
    4. Some have suggested setting up an independent institution to assess councils’ spending needs and revenue-raising capacities, and in turn determine funding allocations. An institution playing an advisory role in these matters may be beneficial. But the inherently subjective issues at the heart of spending needs assessment and funding allocation processes means that these would need to make recommendations on the basis of clear mandates from government/parliament and government/parliament would need to make the final decisions.
    5. Related to this, any new legal mandates for engagement with local government in the design of these processes should also recognise that reaching a consensus on specific proposals is likely to be difficult (as within a fixed envelope, more funding for some councils means less for others). Again, final decision-making will have to lie with central government or parliament, where democratic accountability for national distributional issues lies.  

    6. Some have suggested legally guaranteeing local government as a whole a proportion of the national revenues from particular taxes in order to increase local government’s bargaining power relative to central government. But the revenues from a given basket of taxes and the spending needs of councils and other parts of the public sector may well evolve differently over time. This would make ‘hard’ hypothecation – with local government funded entirely through these revenues – unappealing, while a ‘softer’ version of hypothecation (with funding topped up from other revenues) would leave central government with substantial discretion and bargaining power. A rule allocating a share of particular taxes to councils could limit the government’s options in raising taxes to fund other services (such as the NHS), and lead to greater reliance on more economically damaging taxes.

       A better alternative to tax hypothecation would be to expand the ‘new burdens’ doctrine to cover existing burdens, and potentially put it on a statutory basis, perhaps with the aforementioned independent institution assessing whether funding is sufficient to deliver expected services. Germany’s principles of funding adequacy, set out in its financial constitution, are an example of such an approach. This states that centrally imposed tasks must be accompanied by a sufficient amount of central funding and allows municipalities to challenge the Länder or federal government in constitutional courts if they believe sufficient funding is not provided. In an English context, it is probably not feasible to require centrally imposed duties to be fully grant-funded: a large part of spending on such duties is currently funded via local tax revenues. But central government could be required to ensure that funding available to local government, including from some notional level of council tax, is sufficient to deliver the range and quality of statutory duties expected of councils. If this were the case, the government would need to set out clearly the assumed level of council tax.

20. In earlier work (Adam et al, 2020), IFS researchers have also identified the council tax system as in need of major reform. This is because it is currently very out of date (using property values assessed as of 1991), highly regressive with respect to property values (those in band H face a gross tax bill that is roughly one fifth as large as a share of property value, on average, as those in band A), and distortive with respect to who occupies which property (with the design of the single person discount being the biggest issue).
21. An improved council tax system would require the following elements:
    1. At a bare minimum, a revaluation should take place, and a cycle of regular future revaluations should be legislated for. Currently, households occupying properties with the same current value in the same council area can pay bills many hundreds of pounds different from each other just because their properties used to be worth different amounts 34 years ago. That is patently unfair. We would not tax people’s incomes based on the relative salaries of their jobs 34 years ago – but that is akin to what we do with the home they live in.
    2. Ideally, there would be broader reforms, including increasing the number of council tax bands (or moving to a continuous system as in Northern Ireland), and potentially reducing the regressivity of the current system. In addition, reforms to the operation of the single person discount (and potentially other discounts, exemptions and premiums) should be made to break the link between the value of the discount and the band a property is in. The current 25% discount makes it relatively cheaper for single adults to live in high-band (large) properties, and more expensive for multi-adult households. This contributes to both the under-occupation and over-crowding of homes.
    3. Revaluation and reform would change councils’ tax bases, but on their own, would leave each council needing to raise as much council tax as it does now if it wanted to maintain its spending. This would see each area charging the same average tax bill as now; this would redistribute tax bills within council areas, but not across council areas. If local government grants and retained business rates were also adjusted to account for changes in tax bases, then council tax bills could be redistributed around the country to reflect the latest property values and tax structure. The re-introduction of an assessment of needs, costs and revenue-raising capacity proposed in this consultation would therefore be a key building block allowing future revaluation and reform of council tax to make it fairer across areas, as well as within them.
    4. A system of transitional reliefs when council tax is revalued and reformed would be needed to slowly phase in changes in bills. Longer-term mitigation measures for groups with low incomes might also be beneficial. This could include expanding eligibility, generosity or take-up of means-tested council tax reduction schemes. For those who own their homes but have low incomes, a deferral scheme could allow bills to be deferred (with interest) to the point of sale, death, or some fixed date, e.g. 10 years after the reform. Such schemes operate in Ireland, and parts of Canada and the US.

Question 3. Do you agree that the suggested principles should inform our approach to updating local authority funding allocations?

22. The principles outlined by the government (simplicity, transparency, dynamism, sustainability, robustness, stability, and accountability) are all reasonable objectives for a funding system. However, it is important to recognize there are trade-offs between these principles and the government must be clear how it is prioritizing different principles, and why.
23. For example, there is a trade-off between dynamism and stability: a fully dynamic system would update funding assessments to account for the latest data as soon as possible (e.g., annually); but stability and a commitment to multi-year settlements would preclude such an approach. A sensible compromise may be to align the updating of the data used in needs and resource assessments with the government’s cycle of spending reviews (for example, every 3 or 6 years), which will determine the quantum of funding for distribution.
24. There may be a trade-off between simplicity and robustness. A system based solely on population is very simple but is unlikely to satisfy ‘robustness’ (or ‘sustainability’ as it has been defined). We are pleased that this trade-off is explicitly recognized in the consultation. In our view, transparency is likely to be a better guiding principle than simplicity: the local government finance system is a sufficiently niche topic that those engaged in the detail can be expected to deal with a fair degree of complexity. However, transparency over objectives, methods, data, and outcomes is important for all stakeholders, including technical experts. The additional scrutiny that transparency allows may support, rather than conflict with, the ‘robustness’ principle, as well as supporting accountability.
25. The ‘sustainability’ principle as defined implies that consideration must be given to not just the relative distribution of funding between councils but also the absolute allocations given to councils. This links up with comments in paragraphs 14a and 19c, that the government should be clearer about service expectations and move towards trying to assess absolute as well as relative spending needs. As discussed in paragraph 19c, that might also help achieve the principle of accountability, by making it clearer whether service shortcomings are due to underfunding or poor performance locally.
26. The principle of accountability, in addition to the political dimensions highlighted, also has a financial dimension. Systems which assess revenue-raising capacity using notional rather than actual council tax levels ensure councils properly gain and lose from decisions over council tax levels. And systems which do not fully and immediately redistribute funding when needs and revenue-capacities change help ensure councils are financially accountable for their actions.

Question 4. Do you agree with our proposal to use the best available evidence and most up-to-date data in the assessment of need, including using the most recent census data?

27. The question in fact conflates two related but different issues: one needs to first consider which data should be used for the estimation of spending needs formulas; and secondly, one needs to decide which data to plug into those formulas when one wishes to actually allocate funding. In both cases, it would sometimes be preferable to use the most up-to-date data, but not always: the most up-to-date data is not always the ‘best available evidence’ and using it can blunt financial incentives and accountability.
28. For estimating spending needs formulas, if one is able to control for other factors that affect patterns of spending other than needs, using the most up-to-date data is probably preferable. That is because the relationship between local characteristics and spending needs can change over time as, for example, technology changes. One is more likely to be able to control for other factors if it is possible to use sub-council level data to estimate spending needs formulas, as is the case for new Adult Social Care and Children’s Social Care formulas that have been developed.
29. For the Foundation Formula, it is unlikely that it will be possible to use sub-council level data to estimate spending needs, and it is therefore less likely that just using the most recent data is appropriate.
    1. To see this, suppose, for example, that the government previously chose to allocate more funding to council areas with high levels of deprivation and high levels of ill-health. If the resulting pattern of spending across council areas was used to estimate a spending needs formula, this would show a positive relationship between deprivation and ill-health and spending levels. But this formula would largely reflect these past funding allocations and reveal little about the relative spending needs of different areas. Similar issues may arise when looking at service utilisation rather than spending – patterns of service usage may pick up where past funding has created the capacity to provide services, rather than the underlying need (and unmet need) for the services.
    2. In such circumstances, it is particularly important to not just use the latest available data as the patterns in those data will, to a large extent, reflect how funding was allocated in the latest year. Instead, one needs to use a combination of judgement and analysis of the variation in service access and quality across places to identify a year in which funding most closely aligns with a particular conception of need. This will inevitably be somewhat subjective.
    3. Harris and Phillips (2018) show that, given big changes in how funding was distributed across councils during the 2010s, the year chosen to estimate spending needs formulas could make a big difference to the resulting spending needs formulas and, in particular, to the weight placed on factors such as deprivation. Choosing a year after the big cuts to funding for councils in more deprived areas in effect bakes in those cuts to future spending needs assessments. Choosing an earlier year would, over time, act to undo the cuts, but would lead to a bigger redistribution of funding towards deprived areas and therefore have to be phased in more slowly.
30. Even for formulas estimated using sub-council level analysis, an element of judgement is required as to whether to adjust relationships between spending and local characteristics estimated using the most recent data. For example, will future funding mean that councils are able to provide a wider range of better-quality services, or will it necessitate further cutbacks in provision? Both of these may result in patterns of relative need across the country differing from that in the year used for estimating the formulas.
31. Once a particular formula has been chosen, if one wants funding allocations to reflect changes in assessed needs as quickly as possible, then plugging the most up-to-date data into that formula would be preferable. But as we discuss in paragraphs (15), (23) and (51), there is a trade-off between such immediate updates and other objectives, such as stability, financial incentives, and accountability.
32. Updating data with a lag – for instance, so that funding in year t depends on local area characteristics in year t-4 – would mean that funding would eventually be redistributed to account for changes in needs, but not immediately. That would allow some degree of stability or certainty in funding (councils could know a few years in advance how their funding will change given this depends on past characteristics). It would also leave councils with some financial incentive to tackle factors that drive spending needs, as their funding wouldn’t be adjusted downwards as a result of having lower assessed needs for several years.
33. Therefore, while there may be benefits in using the most up to date data available, this must be assessed on a case-by-case basis. The potential for data revisions, and the cost of collecting data rapidly, should also be considered.

Question 5.Do you agree with our proposal to simplify the assessment by reducing the number of Relative Needs Formulae? If you disagree, please explain why and which service areas you are concerned about.

34. We neither agree nor disagree with this suggestion. However, we would point out the trade-off between the simplicity of having fewer and/or simpler needs formulas, and the potential reduction in robustness and sustainability this could entail.
35. Note that it is not necessarily the case that having fewer needs formulas leads to a simplification, if it means either: (a), those formulas that still exist have additional variables added to them to try to capture variation in needs for a wider range of services; and/or (b) additional grants are provided outside the main revenue support grant to reflect the fact there is no bespoke recognition of a particular service or need in the main relative needs formulas.

Question 9. Do you agree that (other than locally retained business rates) we should only adjust for Council Tax when assessing local resources? If you do not agree, please include details of what other sources of income you think should be included (if any), and how the government should adjust for them.

36. As it stands, income from sales, fees and charges (SFCs) is accounted for implicitly as a resource by assessing councils’ needs for net rather than gross expenditure. This could continue to be the case – and we believe this is the case for the adult social care formulas developed in 2018 using 2012–13 data. Alternatively, separate formulas with separate sets of variables could be used to estimate gross spending needs and SFCs income. This would likely increase complexity but would only improve robustness if the factors that would be included in the spending and SFCs formulas differed significantly.
37. Commercial and investment income – which has grown significantly over the last decade – has not historically been accounted for when assessing revenue-raising capacity. To the extent that differences in commercial and investment income reflect differences in how proactive, entrepreneurial or risk-taking different councils have been, this may be appropriate: it may be deemed unfair and distortive to redistribute these revenues. But differences may also reflect the differingopportunities available to different councils: for example, councils in areas with larger or richer populations may have scope for more profitable commercial operations. In the longer-term, consideration should therefore be given to whether it is possible to assess ‘commercial opportunities’ in a meaningful way.

Question 10. Do you agree that we should measure Council Tax income by making uniform assumptions on the Level of Council Tax charged by local authorities and factors which determine their ability to raise Council Tax?

38. When assessing councils’ ability to raise revenue through local taxation, the key thing is to do this using a benchmark tax system – a common set of tax rules such as rates, exemptions and reliefs – applied to all areas. This avoids incentivising local policymakers with tax-setting powers to cut taxes in order to be assessed as having a lower revenue-raising capacity.
39. Estimating revenues for English local government under a common benchmark tax system has become harder over the last 15 years. In particular, since April 2013, councils must design and fund their own means-tested council tax reduction schemes (CTRS) to provide discounts to low-income households. These schemes differ across councils and there is no easy way, given available data, to calculate exactly how much a common benchmark scheme would cost to operate in each council area.The options to address this are discussed in Amin-Smith, Harris and Phillips (2019). The most feasible option may be to undertake statistical analysis of the factors driving the cost of council tax support schemes, including the characteristics of the schemes (such as minimum payments). The estimates of the impact of CTRS characteristics on costs could then be stripped out of each council’s CTRS cost to approximate costs under a chosen benchmark system.
40. It is also important to recognize that councils’ powers to set council tax rates have long been constrained. As discussed in Phillips (2024), there is a case to remove referendum requirements. If referendum requirements are retained, the common percentage limits for council of each type could be replaced with limits based on either a percentage or cash-terms increase, whichever was the higher (as has been the case for shire district councils in recent years). There could also be a council tax ‘floor’ set, below which no referendum limit would apply. Such changes would allow councils that historically set very low council tax rates to raise rates and revenues closer to the national average. Such councils will likely see their funding reduced under an updated system based on assessing revenue-raising capacity using a common notional tax rate; such changes to referendum rules would give them more flexibility to respond.
41. The assumed or notional council tax level has a big impact on the overall distribution of funding – it is perhaps the single most important decision that needs to be taken. A higher notional level of council tax means the system takes more account of differences in the relative amounts of council tax that areas are able to raise, and benefits councils that have a relatively higher share of assessed spending needs than their share of the council tax base. Conversely, a lower notional level of council tax benefits councils that have a relatively higher share of the council tax base than assessed spending needs.
42. Once a decision is made about the notional tax level to use, a further decision needs to be taken on whether, and if so how, to update it over time. Councils tend not to favour this updating because they feel it sets a ‘target’ council tax increase and most feel they would ‘lose out’ if they did not increase their council tax by the same percentage or more. That is not true on average; instead, there are winners and losers, as there would be from not updating the assumed council tax level over time.
    1. Not updating the notional council tax level means that those councils that have a higher share of assessed need than their share of the tax base will lose out over time. That is because they can raise relatively little from increases in council tax, and holding the notional council tax level constant means this is not being fully accounted for. Over time, that would lead overall funding (grant plus council tax) to grow by less in percentage terms in areas with high needs relative to their tax bases. As deprived areas tend to have higher needs and relatively low taxbases, councils serving deprived areas would lose out if notional council tax levels were not updated.
    2. The government is already likely to be assessing how much council tax increases will contribute to the overall quantum of local government funding when it decides how much grant funding to provide. Indeed, its core spending power projections currently assume all councils increase their council tax by the maximum allowed without a referendum. It is not tenable that the government would ignore councils’ own ability to raise revenues when deciding how to allocate funding between councils and other public services (such as the NHS or prisons) which do not have their own major revenue-raising powers.
    3. Given the government will already be assessing how much of a contribution to the overall quantum of funding council tax revenues will make, it would be sensible to also account for this when allocating funding between councils by updating the notional council tax level over time. This would avoid more deprived areas losing out. Certainty could still be provided to councils by fixing the notional council tax increases for the duration of a multi-year finance settlement. This could be set at forecast inflation, reflect agreed referendum limits (if they remain in place) or be based on some other factor.

Question 12. Do you agree Transitional Arrangements should account for a Business Rates Reset? If not, please explain why.

43. Transitional arrangements will be important in general because of the scale of funding changes some councils will see, given the amount of retained business rates growth that has accumulated since 2012–13 and after nearly 20 years without a properly functioning local government finance system (as discussed in Amin-Smith et al, 2016, the ‘four block model’ in place between 2006–07 and 2013–14 was anything but well-functioning). This means transitional arrangements should account for a business rates reset if one takes place, as is planned.
44. Such transitional arrangements are likely to be particularly important for shire district councils, for whom above baseline business rates growth often represents a particularly large share of their funding. We estimate that above baseline growth was worth around £1.4 billion in 2023-24. For shire districts, such revenues were equivalent to around 19% of their core spending power in 2023-24 on average, and to at least a quarter of their core spending power for fifty shire districts.

Question 14. What measures should we use to support local authorities to move to their updated funding allocations?

45. The consultation suggests a blended approach for moving to new allocations. This would be relatively straightforward but could lead to very large changes in 2026–27 if done over a single 3-year spending review and settlement period. Such an approach would fund the slow phasing in of funding cuts by also phasing in increases slowly.
46. This approach could be accompanied by (or replaced with) a system based on pace-of-change rules, capping the % cuts in grant and business rates or overall funding. That would avoid the largest percentage cuts. This could be funded by capping the % increases in funding too, or by a top-sliced ‘transitional protection fund’ (potentially funded by part of retained business rates growth, and/or the planned abolition of the UK Shared Prosperity Fund, which Budget documentation suggests will be redeployed to other local government funding). Such a system would prevent areas from facing large and rapid changes in their relative funding levels, necessitating rapid cutbacks in services or risking inefficient use of very large funding increases.
47. However, these mechanisms would make funding systems less responsive to changes in local areas’ circumstances; this is discussed in Ogden et al (2022) in relation to NHS, public health and local government funding. We might only expect funding allocations to converge towards target if assessed spending needs are not changing too rapidly and if overall funding is growing relatively rapidly. When overall funding is growing slowly (or declining), floors and ceilings tend to be more binding, so that pace-of-change rules can prevent funding from being redistributed to areas with rising assessed needs. This is precisely when one may be most concerned that funding is going to the areas that need it most.
48. As discussed above (paragraph 40), giving councils greater flexibility to adjust their council tax levels would likely be beneficial for those facing large reductions in grant / business rates funding – especially if they currently set council tax levels that are significantly below average, as is the case for some shire districts and inner London boroughs.

Question 15. Do you agree we should keep funding allocations up-to-date dynamically by using the most up-to-date data possible? If so, how?

49. This depends on the priority the government places on the different objectives it is trying to achieve. Immediately updating funding allocations by plugging new data on local area characteristics into spending needs formulas and up-to-date tax bases into resource assessments would align allocations most closely with assessed spending needs. But this would make it difficult to provide much clarity about funding beyond one year to councils, making multi-year funding settlements impossible. Such rapid updating would also severely blunt financial incentives to tackle needs and boost revenue-raising capacity, as such efforts would see councils’ funding reduced.
50. As discussed in paragraph (9), a sensible compromise may be to update the actual data on a periodic or ideally rolling basis aligned with the multi-year Spending Review and settlements.
    1. It is important to recognise that even this approach could not provide full multi-year funding certainty for councils. Settlements for later years should not be completely fixed, because it would be counterproductive to try to provide full certainty over cash-terms budgets – not least because inflation may turn out higher or lower than expected. Instead, settlements could be used to provide a baseline cash-terms budget that would not be reduced except in exceptional circumstances (for example, a government debt crisis). The government could also provide information about how decisions on any subsequent increases in funding would be made – for example, in response to changes in expected cost pressures (e.g., due to inflation and wage growth) and demand pressures. In setting out this information, the government should carefully choose indicators that reflect the pressures facing local government, but which are not easily manipulatable by councils themselves. For example, it would be preferable to base decisions to diverge from planned funding on changes in forecast economy-wide earnings growth and the National Living Wage, instead of using increases in wages negotiated between councils and employees’ unions.
    2. It would also be difficult for the government to provide councils with rolling 3-year settlements with any certainty. That is because the government intends for UK Spending Reviews to cover 3-year periods and to take place every two years. For example, the 2025 Spending Review will cover 2026–27 to 2028–29, and so a 3-year settlement will be possible in 2026–27. However, the next Spending Review covering the years 2028–29 to 2030–31 will not take place until after the 2027–28 settlement. This means the 2027-28 settlement could only cover the period up to 2028–29 (2 years ahead, instead of 3). The figures for 2028–29 would also potentially be subject to more significant revision at the 2027 Spending Review. The only way to provide rolling 3-year settlements to councils would be to do this outside the wider Spending Review process, which would probably be unwise from a wider public sector financial management perspective.
51. While it is not possible to provide much in the way of clarity and stability to councils if funding is updated to account for actual changes in characteristics each year, it is possible to use pre-determined projections of changes in characteristics, while still providing clarity and stability to councils. The most obvious candidate for using projections in between any periodic or rolling reset is population. Doing so can, under certain circumstances, ease the trade-offs between redistribution / sustainability on the one hand, and stability and incentives on the other.
    1. Councils could still have certainty between resets because the population projections used could be fixed until the next reset (which one would probably want to undertake based on population estimates, not projections).
    2. As well as certainty, one of the main benefits of not updating funding immediately for changes in local circumstances is so that councils reap the rewards of boosting tax bases and tackling the drivers of spending needs. Using population projections would not distort councils’ financial incentives between resets). Again, that is because until the next reset, councils’ funding would be updated based on pre-determined projections (which councils’ behaviour cannot affect) instead of changes in actual circumstances (which is what councils’ behaviour will affect.
    3. Provided that (i) population is a major driver of spending needs and is not significantly negatively correlated with other needs drivers and (ii) population projections are sufficiently strongly positively correlated with actual population growth, then accounting for projected population growth would mean funding allocations track what is actually happening to councils’ spending needs more closely between resets. For (i), it would be possible to test the correlation between population projections and other needs drivers, and between population projections and actual populations, in historic data – MHCLG should do this. For (ii), by ‘sufficiently strongly positively correlated’, we mean that each 1 percentage point increase in projected population growth must be associated with, on average, at least a 0.5 percentage point increase in actual population growth. If the association were weaker than that, using the population projections might push funding allocations further from the actual evolution of spending needs than failing to accounting for population projections. MHCLG should undertake or commission statistical analysis of the relationship between population projections and actual populations historically to help inform its decision-making.
52. If population projections are not used to assess spending needs between resets, the implicit assumption is that populations are fixed or growing at the same rate everywhere. This is not a neutral assumption. It would penalise councils whose populations are growing faster than average, and benefit councils whose populations are growing less quickly than average. One could make a case that this is a reasonable outcome: that fast-growing areas doing well economically and so can afford to see their funding per resident fall a bit; and slower-growing areas may be struggling and may benefit from an increase in funding per resident. But if that is the intention, this should be made explicit.
53. A further potential benefit of using population projections – if they are sufficiently positively correlated with actual population growth, and population is a key driver of spending needs – is that this could help reduce the pressure on transitional protections at resets. Under these circumstances, using projections between resets will mean the change in funding at the following reset will, on average, be smaller than if projections were not used. Smaller changes in funding at resets would reduce the degree of uncertainty councils face as they approach a reset and would help reduce the cost and complexity of transitional arrangements.
54. If conditions (i) and (ii) described in paragraph 51c were satisfied, we think there would be a reasonably strong case for accounting for projected population growth in between resets. There would be value in engaging with local government to explain the impact that doing this (or not doing it) would have for areas with different population growth trajectories. Exemplifications are often useful.
55. If, on the other hand, these conditions are not satisfied, then MHCLG should not use population projections in between resets as doing so would both reduce the fairness of allocations between resets and mean bigger changes at resets, on average. If these conditions are only marginally met, it may also not make sense to take account of population projections if local government stakeholders have concerns about their usage.
56. If projected population growth is accounted for on the spending needs side, there is a strong case for also accounting for some projected elements of council tax base growth (for example, using official household projections, fixed for a multi-year period). If this is not done, those councils projected to see faster population growth would see their allocations of grants and retained business rates increased to account for their increasing share of spending needs and they would also retain in full any increases in council tax associated with that faster-than-average population growth. That would mean a “double win” for areas seeing fast population growth, and a “double loss” for areas seeing slower population growth.
57. However, such an approach could be rationalised if the government wanted to provide a financial incentive/reward for areas seeing population growth. Compensating areas for their higher needs via grant / retained business rates allocations and letting them retain the full proceeds of council tax base growth (at least until the next reset) would provide a financial reward for new housing developments that boost population.

Question 18. Do you agree or disagree that the government should provide local authorities with greater control over Sales, Fees and Charges?

58. We neither agree nor disagree with this statement, but instead highlight some considerations which should determine which, if any, sales, fees, and charges (SFCs) councils are given more power over.
59. Currently, rules prevent councils themselves from charging fees for most services that are higher than necessary for cost recovery, although ‘cost recovery’ is broadly defined. These rules could be relaxed to allow councils to set SFCs to generate a surplus. Fees for certain services, such as planning and building control applications, are capped nationally. These caps could be increased, or powers to set fees subject to a cap at self-defined cost recovery could be devolved to councils. Decisions on whether to relax rules in these ways should be made on a case-by-case basis, taking account of the features of the ‘market’ for specific services. On the one hand, where councils face competition for the provision of services from the private sector (such as for gym facilities or pest control services), such competition should constrain councils from setting excessive fee levels without the need for restrictions, allowing councils to more easily explore the scope for income generation. On the other hand, where councils have a formal monopoly on the provision of services (such as licensing and planning fees), continued regulation is sensible to avoid excessive fees. This is particularly the case where a large portion of such fees may be charged to only a small subset of residents or non-residents (and hence non-voters), such that normal democratic accountability mechanisms may be ineffective.
60. Councils are able to set up separate companies to provide non-mandatory services to residents, businesses and other public sector bodies for a profit, in turn generating dividends for the council. Given these existing flexibilities, it is not clear what impact relaxing rules for non-mandatory services provided or commissioned by councils would actually have. This will depend in part on the actual or perceived costs of setting up a separate company under current rules.