Local authority funding in England has undergone considerable upheaval in the 2010s. Central government grant funding has been substantially reduced; after falling in real terms to 2015, council tax has begun to rise; and new grants have been introduced in response to claims of a ‘crisis’ in social care funding.

Since 2013, business rate retention has also rewarded councils with a share of growth in business rate revenues. In February 2016, the Government complemented these changes with the announcement of a ‘fair funding review’, followed by consultations in July 2016 and December 2017.

The Fair Funding Review

The Fair Funding Review will affect how funding is allocated and redistributed between local authorities from 2020 onwards. It is expected to use three main ‘cost drivers’: population, deprivation and sparsity, together with additional cost drivers related to specific local authority services.

How this will be done is the subject of further consultation between now and mid-2019; and it will also be influenced by discussions within a number of joint working groups between the Ministry of Housing, Communities and Local Government (MHCLG) and the Local Government Association (LGA). ‘Indicative numbers’ for funding allocations to individual councils are to be available by spring-summer 2019, and the review is to be implemented in April 2020. These dates are based on evidence given by the Minister, Rishi Sunak MP, to the Housing, Communities and Local Government Committee on 24 April 2018.

Changes to business rates

This consultation period might be expected to be critically important for councils’ long-term funding, but whilst it will have an effect, there are many other moving parts within local authority funding which could overshadow it.

First, the Fair Funding Review will not apply to funding that sits outside the local government finance settlement. For instance, it will not affect funding of schools, health services and the police, each of which have their own funding formulae.

Second, the review will not consist of a formula for distributing a pot of grant money from central to local government. General grants will be few and far between after 2020. This is because in 2020 the proportion of local business rate retention will rise from 50% to 75%. Several grants are to be ended at this point, in order to prevent this change causing a ‘windfall’ for local government.

Instead, the review will be used to change business rate baselines. These provide each council’s starting point for the business rate retention system. New baselines will be applied in 2020 – but not reviewed annually. This will mean that in the years after 2020, individual councils’ incomes will diverge from the baseline, as their business rate revenues grow by different amounts. This is a deliberate outcome of rate retention: it is intended to encourage councils to try to increase their rate revenues instead of being dependent on the Government for funds.

The factors at play

The implication is that the effects of the review on councils’ financial health could be relatively muted. If a council successfully increases its business rate revenue, within a few years this could, in principle, overshadow any change made by the review. However, this is not clear cut (even leaving aside what happens to councils which do not increase their rate revenue). The consultancy LG Futures has suggested that relatively small changes in how a council’s baseline is set could have more effect on its revenue levels, over a five-year period, than revenue growth itself.

Whether this is true will depend critically on technical decisions within rate retention: for instance, how to set the baseline, how long before the next review and how to divide rate revenue between counties and districts (‘tier splits’). These are all still subject to the consultation process.

Furthermore, councils have other sources of income and are not totally dependent on the funding affected by the review. Council tax will continue to provide a large proportion of local authorities’ funding and some councils are pursuing increasing revenue returns from commercial property. It is likely that a number of small ‘tied’ government grants (for adult social care, for instance) will remain in place after 2020, which councils will be able to spend on specific purposes.

Every income counts

The key question for councils is whether their total funding available will keep pace with need. The LGA has consistently said that it will not and predicts a £5.8 billion ‘funding gap’ (between projected needs and funding) by 2020. The LGA has urged the Government to allow local authorities to use the additional 25% of rate revenue that they will obtain in 2020 to meet current spending needs. As things stand, that extra money is to be offset by abolishing various central grants.

In short, how the Fair Funding Review is implemented, and how rate retention subsequently works, are assuming substantial importance for local government due to the spending pressures councils currently face.

Even if the bulk of the changes brought by the review, and by rate retention, are relatively small, every income source matters for local authorities. This will be even more true after 2020, when the changes to business rates retention mean that the majority of funding that is freely available to local authorities will be raised by local government.

Thus, councils will want to keep a close eye on the progress of the Government consultations and the MHCLG-LGA working groups. The issues are technical and complex, but could have significant influence by the early-mid 2020s.

Further reading

Library briefing: Reviewing and reforming local government finance

Library briefing: Business rates

Mark Sandford is a House of Commons Library researcher. He specialises in devolution in England and local government.