Fair funding review failing to consider councils’ capacity to raise revenue

29 Aug 18

The recalculation of local government funding allocations should take into account all the ways councils could bring in money, explains the IFS’s Neil Amin-Smith. 

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Much of the discussion surrounding the government’s ‘fair funding review’ has focused on how the relative needs of different councils should be assessed.

Less attention has been paid to the fact that the review is also considering how differences in councils’ resources should affect funding allocations.

However, decisions taken on the latter are likely to have just as large an effect on what councils get as the updated assessment of their needs.

Take council tax.

On average, council tax revenues represent around half of councils’ core spending power, but the amounts that individual councils are able to raise vary widely.

The area with the highest revenue per person, Surrey, raised £600 per person, nearly four times the £158 per person raised in the area with the lowest, Wandsworth, in 2016–17.

This comparison in fact also highlights one of the difficulties in taking account of such differences – Wandsworth may have low revenues, but this is largely because it sets tax rates at around a third of the national average.

Surely it shouldn’t receive extra funding simply because its residents choose to pay less council tax?

In a recent report we argued that councils should instead be compensated for differences in their capacity to raise revenues, measured in this case by differing council tax bases.


‘If councils were instead compensated, either partly or fully, for differences in realised revenues, this would mean compensating those councils choosing to set lower tax rates.’


If councils were instead compensated, either partly or fully, for differences in realised revenues, this would mean compensating those councils choosing to set lower tax rates.

This, in turn, would provide an incentive to all councils to reduce rates – since any council that did so could expect to be at least partly compensated by higher grants or transfers.

Councils also raise significant sums of money (almost £10 billion in 2016–17) from levying various fees and charges.

These include, among other things, co-payments for adult social care, parking charges and charges to use leisure facilities.

Unsurprisingly, there is once more substantial variation between councils in amounts raised.

Kensington and Chelsea and Westminster, for example, raised around £600 per person in 2016–17 from fees and charges, whilst in three councils (Wakefield, Thurrock, and Wolverhampton) less than £100 per person was raised.

However, unlike with council tax, there is no obvious way to measure a council’s capacity to raise revenues from fees and charges.

Simply accounting for their actual fees and charges income could incentivise them to cut their fees and charges – as once again they would be compensated for this by higher grants/transfers.

The current approach is thus statistical.

Fees and charges income is netted off councils’ gross expenditure on local services when statistical analysis is carried out to build spending needs formulas.

The drawback of this is that it only accounts for such income in so far as it varies in line with the local characteristics included in the spending needs formulas.

It may in future be sensible to include characteristics in the needs assessment that are chosen because they reflect capacity to raise revenues from fees and charges, even though they might not seem directly relevant to estimation of spending needs.

There is a third strand of council income that is currently not taken any account of in funding decisions.

This is the money councils are able to generate from commercial trading and investment activities.

It would, of course, be very difficult to assess councils’ differing abilities to generate such income, and basing any equalisation on realised incomes could leave councils with little incentive to grow them further.

However, taking no account of commercial income poses two potential problems.

The first stems from the fact that different councils may have very different opportunities to generate such revenues.

Taking no account of such differences means that areas without many opportunities may have to have higher rates of council tax or put up with lower quality services.

The second more complex problem is that councils might increasingly try to classify fees and charges income as commercial income.

The distinction is a fine one, and hinges on whether the services in question are being provided in order to make a profit, or on a cost-recovery basis as part of a council’s role in providing services.  


‘The statistical approach used for estimation of spending needs (net of fees and charges income) does mean that councils cannot directly impact their own funding allocation.’


The statistical approach used for estimation of spending needs (net of fees and charges income) does mean that councils cannot directly impact their own funding allocation.

This is because each council’s allocation depends on the relationships across all councils between net spending and local characteristics – and if an individual council shift’s income from sales/fees to trading income, this will have little effect on those relationships.

However, groups of councils (eg in Greater Manchester) could cooperate more closely to coordinate reclassification of fees and charges income, which may have more of an impact on those relationships, potentially distorting estimates of net spending needs.

As things stand, of course, such income is a relatively small component of councils’ overall funding – it is forecast to amount to less than 4% of fees and charges income in 2018–19.

However, in a tough public spending environment, many councils see ‘commercialisation’ as an opportunity to increase their revenues: this is an income source likely to grow in importance.

In many ways, the broad outlines of the approaches that should and will be taken to the equalisation of other income sources are fairly clear.

However, in the longer-term, commercial income may merit more careful attention.

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