Two papers, published by the IFS and funded by its Local Government Finance and Devolution Consortium, find that the government’s Fair Funding Review for councils could hit inner London boroughs like Westminster but help councils in more suburban and rural parts of England. This reflects likely changes to assessments of councils’ spending needs and revenue-raising capacity.

Inner London boroughs often set low tax rates. Westminster, for instance, sets the lowest Band D council tax rate in England – £415 – which reduces the revenues it raises itself. At the same time they often have high assessed spending needs. Westminster’s assessed spending need per resident for environmental, protective and cultural services (EPCS) is currently 2.5 times the national average.

The Review seems set to make councils who set low tax rates bear more of the cost themselves. It is also likely to lead to lower spending needs estimates for councils currently assessed to have the highest needs. This could mean high needs / low tax rate councils lose funding as a result of the Review. In practice, the government may feel the need to protect such councils from the full impact of updated needs and revenue assessments.

Councils that currently have high tax rates and low assessed spending needs could be set to gain. This could ease funding pressures a little in some suburban areas like Surrey.

However, it is worth remembering that the Fair Funding Review is about how to slice the funding pie, not the size of that pie. The upcoming Spending Review will be more important for the overall financial health of councils – and the sustainability of the services they provide.

A Briefing Note discusses how councils spending needs could be assessed:

Assessing councils’ spending needs based on the observed relationships between spending and councils’ characteristics is better than many alternative methods. But it can run into problems.

  • Since 2009–10, funding policy has led to much bigger cuts in the budgets of councils serving deprived areas than in those of councils serving less deprived areas. A funding formula based on recent spending patterns would therefore weight deprivation less highly when calculating councils’ spending needs than one based on 2009–10 spending patterns. It would bake in the effects of cuts to poorer areas.
  • The government’s proposals to use small-area and individual-level data to get around the worst of these problems when assessing spending needs for adult and children’s social services is therefore very welcome. But assessments will still rely on subjective judgements.

A report argues change is needed to the way council tax revenues are treated:

  • Since 2015–16, cuts in funding from central government have taken account of how much council tax each council raised in that year. This will need to change - funding cannot remain tied to what council tax revenues happened to be in the mid-2010s.
  •  Simply taking account of current tax revenues would be inappropriate. Councils setting low tax rates would be compensated via bigger grants or transfers from other councils. It could also undermine council tax as a revenue source if councils respond to this by cutting tax rates.
  • Funding should instead depend on how much councils would raise if they all set the same council tax rate. Councils setting higher or lower tax rates would therefore retain any extra revenues or bear any cost in full. Localisation of council tax benefit makes this more difficult than in the past. It could lead to councils being incentivised to offer bigger discounts to more households, hence undermining tax revenues.

That report also discusses how the funding system as a whole could operate:

The last formal system, the so-called Four Block Model in operation between 2006–07 and 2013–14, was complex, confusing and unstable. This made scrutiny of the government’s choices difficult.

  • We need a system where it is much clearer how assessments of spending needs and revenue-raising capacity affect final funding levels. The system should be designed in such a way as to give the government discretion over the extent of redistribution between councils, while also ensuring that discretion is exercised transparently.
  • Some degree of redistribution is necessary given the very different revenue-raising capacities and spending needs of different councils – Kensington, at the top end of the scale, has a council tax base per person more than three times larger than Nottingham, at the bottom. But there is a trade-off. The more redistribution there is the weaker are financial incentives to grow local tax bases and tackle the drivers of spending needs.

Neil Amin-Smith, Research Economist at the IFS, said: “Continuing to take account of councils’ actual council tax revenues when redistributing between councils isn’t a viable long term option. Moving back to a system where redistribution takes account of how much councils would raise if they all set the same tax rate would be better, but would create winners and losers.”

 “Councils with low tax rates, such as many in inner London, would lose as they would have to bear the costs themselves. The flipside is that councils with higher tax rates, including many county areas, would gain as they could keep the extra revenue to spend on better local services.”

Tom Harris, Research Officer at the IFS, said: “There is no objective answer to the question of how much money one council needs relative to another. Historically, allocations have been based on previous spending patterns. Funding for more urban and deprived areas has been cut most in recent years. So any analysis using current patterns of spending will lead to a funding formula which does less to redistribute to poorer areas than would an analysis based on spending patterns a decade ago. Empirical analysis of spending patterns is useful, but it cannot provide a set of objective figures for what different councils ‘need to spend’. In the end this is a political judgment.”

David Phillips, Associate Director at IFS, added: “With the outcomes of the Fair Funding Review potentially costing or benefiting individual councils to the tune of millions of pounds a year, it is vital this Review and the new funding system it results in are as transparent as possible.”

“The government has made a good start by involving councils in the process. But it needs to follow that up by showing clearly how different options will affect different councils, and by designing a system in which the amount of redistribution between councils is as clear as possible. The last system was so complex and opaque that the government could claim it was protecting the most grant-reliant and deprived councils, while actually doing the opposite.”