How are English local councils funded?

Michela Palese, former Research and Policy Officer

Posted on the 30th March 2022

While you might think that local councils are wholly funded by council tax, in fact, local government in England is funded by a combination of central government grants and local taxes.

What are the problems with local government funding?

There are three main problems with the way local councils in England are funded. First, funding is often short-term and uncertain, meaning that authorities cannot effectively plan for the long term and ensure the sustainability of their finances and the essential services they deliver. Secondly, it is fragmented across services and departments, and central government put a lot of restrictions on how it is used. Thirdly, councils often have to engage in competitive bidding for grants issued by central government, which may not be successful, placing an additional cost on councils trying to obtain funding.

The impact of austerity

On top of these issues, austerity completely reshaped local government finances, ‘shrinking the capacity of the local state, increasing inequality between local governments and exacerbating territorial injustice.

The highly centralised system of national government in England, combined with weak local government, meant that austerity measures could be imposed from the centre onto local areas in England, unlike in the other parts of the UK. According to an analysis by the Institute for Government, since austerity began, spending on local government fell in England by 21 percent between 2010–11 and 2018–19. This is over ten percentage points more than in Scotland and Wales, which were able to prevent some of the worst cuts as they have a greater degree of autonomy over spending than councils in England.

The impact of the pandemic

Even before the pandemic began, councils had seen a significant reduction in core funding and were facing a 6.5 billion funding gap by 2024–2025. The covid-19 outbreak thus only served to expose the already precarious situation of local government finances, with the National Audit Office finding that, if the government had not provided emergency cash, there was the potential for system-wide financial failure. Some councils declared bankruptcy, while others had to ask the government for a bailout. Twenty-five councils were at acute or high risk of financial failure, with 92 at medium risk of insolvency. Because of cuts to local government finances, councils were less resilient and flexible in dealing with the impacts of the pandemic.

Current proposals for funding local government

In 2018–19, 50 percent of council funding came from central government grants, 31 percent from council tax, 18 percent from business rate revenues (collected locally but redistributed via a nationally-run system), and one percent from council reserves.

The reliance on central government funding, combined with the impact of austerity on local finances, means that local government funding in England is in need of reform. But the government seems to be continuing the top-down, centralised approach to local government funding, leaving councils with little say over the funding they receive.

Most of the government’s flagship levelling up policies, including the Towns and Levelling Up funds, allocate funding based on bids submitted by individual local areas. Central government retains full discretion to determine which projects are eligible and how funding will ultimately be allocated, rather than giving each area the autonomy to decide for itself how best to spend money to boost local growth.

The Towns Fund has already been subject to controversy due to the lack of transparency around the criteria used for determining the 100 towns which were to be invited to bid. The House of Commons Public Accounts Committee questioned the government’s approach in selecting the towns, stating that it was ‘not convinced by the rationales for selecting some towns and not others’, and has raised ‘concerns over the decisions being politically motivated’. A report from the National Audit Office had previously set out how, for some towns, ministers deviated from the recommendations of officials, and the Permanent Secretary at the Ministry of Housing, Communities and Local Government confirmed that ministers applied ‘their own qualitative assessment of those towns and their eligibility for funding’.

Further, it emerged that the towns invited to apply were ‘disproportionately drawn from marginal Conservative-held constituencies, and that the scheme might therefore benefit the Conservatives in any future election.’ This is particularly concerning given the nature of Westminster’s First Past the Post voting system and the key role played by marginal seats, with elections won and lost on a handful of seats changing hands. Focusing investment on these areas is a clear example of ‘pork barrel politics’ and has the potential to influence election results, and thus who forms the government. Due to First Past the Post, who wins these marginal seats can manufacture a large majority for a single party on a plurality of the vote. Further, it contributes to the neglect of and underinvestment in areas considered to be ‘safe’ from an electoral standpoint and thus not ‘worthy’ of political attention or funding.

What can be done about local government funding?

Compared to other countries in the Organisation for Economic Co-operation and Development (OECD), the UK has one of the most centralised local government funding systems, with little local autonomy and control over fiscal decisions around spending and taxation. For example, 30 percent of tax revenue is taken at the sub-national level in Germany, compared to under five percent in the UK, while spending by sub-national government is 2.5 times higher per capita in Germany than in the UK.

There is strong and growing consensus around the need to ensure fiscal autonomy for local government in England. In our new report, Democracy Made in England, we join the calls for financial and fiscal devolution to be among the powers available to English localities, depending on their need and capacity. This will allow areas to take on additional autonomy from central government and make long-term decisions for their specific area, while not precluding additional redistributive measures to ensure areas with lower revenue-raising capacity are not left behind.

We need to move away from Whitehall’s command and control approach to local government and ensure people and places are the heart of local decision-making.

Find out more about English local government and how it can be reformed, in the latest ERS report Democracy Made in England.

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