How Is Local Government Funded?

This page sets out how local government is funded in England today. We do not expect to go into these matters in much detail during the Assembly, but you might find that the information provided here gives useful background for discussions.

Sources of local government funding

Local councils have four main sources of funding:

  • Central government grants
  • Business rates
  • Council tax
  • Fees and charges

There are also a wide range of additional central government grants for local bodies which sit outside local council control. Some of these go to local councils, but the councils are required to pass them directly on to others (e.g. funding for primary and secondary schools), or can only spend them in line with national requirements (e.g. housing benefit).

Other national funds are spent locally without any involvement from councils: for instance, NHS funding; funding for further education colleges; and funding for trunk roads and motorways.

For many decades, the bulk of councils’ income (on average) came from a combination of government grants and business rate income, the latter being redistributed by the government to take some account of need. Because of large reductions in government grants since 2010, this is no longer as true as it was.

Under the existing system, as a general rule, the less deprived an area, the less government grant it is likely to receive. That is because richer areas can raise more funding via council tax and business rates. This is not an exact link, but it is a useful rule of thumb. For many decades, all governments used the grant to ensure as far as possible that local councils could provide an equal level of service across the whole country. However, since 2010, on average, deprived areas have seen their grants cut more than less deprived areas.

The following sections explain how the four sources of funding work.

Central government grants

Central government grants for local councils are set each financial year in an annual funding round (the ‘Local Government Finance Settlement’). Since 2010, grants have been cut dramatically – by 37% across England between 2010 and 2015.

There is no clear ‘formula’ that can be used to explain how much money an individual council gets, or should get, in grant – though there are formulas for some elements of it. The annual funding round takes the previous year as its starting point, so grant levels result from the build-up of different decisions, large and small, over many years.

Business rates

Business rates are paid by businesses to their local councils.

Before 2013, all of the income from business rates went to the government, which then redistributed it to councils, taking some account of individual councils’ needs. Business rate revenue under this system was indistinguishable from government grant.

Since 2013, councils have been allowed to keep half of the money gathered through business rates in their area. The idea of this change was to give councils an incentive to encourage new businesses to set up locally.

Earlier in October, the government announced that, by 2020, this will be extended so that councils will keep all the money raised in business rates in their area. Councils will be allowed to cut business rates. Places with a ‘devolution deal’ and an elected mayor will also be able to raise rates by a small amount.

The Local Government Association welcomed this. But critics worry it will make it harder to redistribute money from richer to poorer areas. There are also concerns about a ‘race to the bottom’, as councils try to attract businesses to their area by cutting the tax.

Council tax

Council tax funding is collected by district councils and unitary authorities. County councils also set an amount (a ‘precept’) that is collected alongside this as part of council tax. Police and fire authorities, and transport authorities, also collect shares. Each council keeps all of the council tax revenue that it collects (none is redistributed between councils).

Since 2012, councils have not been able to raise council tax by more than a set level each year without a referendum approving the rise. In the last three years this level has been 2%. Before this, there was a system called ‘capping’, where the government would decide each year to stop particular councils increasing their council tax by too much.

Fees and Charges

Fees and charges can be put on a large number of local council services. Some fee levels are fixed by the government – such as planning and licensing fees – whilst councils have control over others, such as parking charges and leisure centre charges. There are a small number of services for which they are not allowed to charge – for instance, school education, elections and libraries. Some councils (usually small districts) make more from fees and charges than they do from council tax.

How do councils spend this money?

Most of the money from these four sources is brought together into a single funding pool and can be spent as the council wishes. There are a few small exceptions to this. This is known as ‘ring-fenced’ or ‘hypothecated’ funding. For instance, the government provides a Public Health Grant, which has to be spent on public health. But other grants can be spent more freely (even if they have names that suggest they are supposed to be spent on a specific function).

Councils can borrow money for capital investment projects – e.g. to build a new road or a new leisure centre. But they can’t borrow in order to plug gaps in their everyday spending on services. They can borrow money from the government, from banks, or by issuing bonds. The main limit on council borrowing is how far they can guarantee future income to pay off the debt. This means that how much councils can borrow is closely linked to the amount they bring in through council tax and business rates.

How could councils obtain more money?

Councils today have, on average, less money available than in 2010. Most have much less: between 20% and 40% (see figures for local areas). Many people within the council sector have called for councils to have more ways of raising their own money. This is known in the jargon as ‘fiscal devolution’. The main ways in which this could be done are as follows:

  • More government grant funding. Councils are expected to see their grants go down by at least 15% by 2020, on top of the 37% reduction since 2010. The reductions have been greatest for councils in urban and deprived areas. So increased government grant is unlikely in the near future.
  • Raising more council tax. In real terms, council tax has been reduced by 10% since 2010 thanks to the referendum law (mentioned above). Councils have called for this to be removed.
  • Higher council tax bands. New, higher council tax bands could be introduced for more valuable properties. This could cause unhappiness amongst those paying more; but, depending on how it was done, bills for smaller and medium-sized houses could go down. Wealthy areas, with large numbers of valuable properties, could gain a lot more income if this were done.
  • Business rates. By 2020, the government says that councils will retain all of the revenue from business rates in their area. But this will increase funds available to councils only if grants from central government are not cut.
  • Fees and charges. Councils could be given more control over the levels of fees and charges. Many of these are fixed by the government. Some councils complain that in some cases, the fixed fees do not cover the costs of providing the service (e.g. planning fees). On the other hand, this could lead to some types of fee rising considerably.
  • New local taxes. Small local taxes, such as a tax on hotel beds, could be introduced. This type of tax probably would not raise much money.
  • Investment. Some councils, e.g. Eastleigh Borough Council, have built up a property portfolio and can now use the income from it to supplement their other sources of income. In 2011, Eastleigh owned £188m of commercial property, giving a net annual profit of £2.5m (in the context of an overall budget of about £14m).
  • Local income tax or VAT. The Scottish Parliament is to have the power to set its own income tax and to retain a percentage of VAT receipts (VAT cannot be devolved, under European Union law). In the past, some academics have proposed giving councils the power either to retain some income tax locally, or to set an extra income tax rate locally. The best estimates are that it would take 4–5 years to change the income tax system so that this could be done. As with council tax above, the prospect of higher taxes is likely to be unpopular amongst the public; and wealthier areas would raise more revenue than less wealthy areas.

Any proposals to give councils more means of raising money would inevitably be described, in the media and political debate, as potential tax rises. This discourages politicians from taking action. For instance, council tax bands are still based on house prices in 1991 in England. This means a lot of property valuations will be a long way out of line with the current value of the property. If a new valuation took place, some people’s council tax bills would fall and some would rise, in line with movements in property values since 1991.

Do Combined Authorities have more funding?

As we set out, there have been moves in recent years to establish ‘combined authorities’ that pool certain activities across several local councils.

So far, where combined authorities have been offered extra powers by the government, they have taken on the funding to go with these extra powers. This has taken the form of government grants. However, there is no guarantee that the same amount of funding will be available in future years. No formula exists to guarantee a certain level of government funding year after year, for any local services or councils.

The government is currently seeking to pass a new law (the Cities and Local Government Devolution Bill) that will make it possible for combined authorities to receive new powers. Under these arrangements, combined authorities will have the power to set their own share of council tax (the ‘precept’), but only if they have a mayor, as in Greater Manchester.

There is also the possibility of ‘pooling budgets’. This is going to happen in Greater Manchester with the devolving of the National Health Service. There, local health bodies will combine their budgets with councils’ social care spending. The idea is that sharing budgets will make it easier to coordinate services across health and social services, with less spending on administrative costs and less duplication. We don’t know, however, how much money, if any, could be saved in this way.

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