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Now is the time to look at alternatives to the existing capital financing system, argues James Odling-Smee, of the ...
Now is the time to look at alternatives to the existing capital financing system, argues James Odling-Smee, of the Local Government Information Unit.

Rita Hale is right (LGC, 14 January) - if local government wants to influence future reforms of the local government finance system, we need to be putting forward concrete ideas and do it before the consultation papers appear in the next few months.

One area where there appears to be a genuine possibility of positive change is that of investment. The current capital finance system is highly centralised and restrictive.

The growth of competitive bidding has meant there has been a shift away from capital allocations based on needs assessment and there is more ministerial discretion. The system has also undermined sound investment strategies - new investment has been restricted even when it is needed to protect assets or when it could provide an income stream to fund further investment.

The DETR is considering what could be radical changes to capital financing. There are indications that the government could move away from the current system of capital controls to one that enables councils to borrow subject to prudential accounting limits. This would clearly increase the potential for capital investment and allow for greater decision making at a local level. Local government should be encouraging this change.

The basic rationale for restrictions on capital investment needs to be challenged. Central government's control of borrowing for capital purposes mainly stems from its concerns over the public sector borrowing requirement. Uniquely in the UK, public spending, other than what can be met from taxation, is counted as a deficit, to be met from borrowing.

Proposals to invest are judged primarily against whether they count against the PSBR, not whether the investment is needed. We end up with the situation that desperately needed investment in major public infrastructure projects is delayed, does not happen at all or can only happen if there is privatisation or semi-privatisation.

The current debates about London Underground and the future of council housing illustrate this graphically.

A large number of economists have been advocating a switch from the public sector notional credit requirement(which replaced the PSBR in 1998) to the general government financial deficit, as the primary measure of budget deficits.

The GGFD excludes net borrowing by public corporations and allows a more flexible treatment of self-financed public sector investment. It would facilitate the development of new models of investment in local government, where councils could invest in assets on the basis of their value and revenue stream.

We should also follow the lead of other European countries in allowing borrowing from the European Investment Bank and the European Investment Fund not to count against the PSBR (see New dimensions to European finance, Stuart Holland, Local Government Information Unit, 1999).

Thirteen of the EU member states do not count borrowing from the EIB or EIF against the PSBR, the GGFD or its equivalent as they argue that they have not been formally called upon to guarantee the loans. In these countries, local and regional government can take advantage of the preferential terms under which finance is made available for a variety of capital projects, including raising educational standards, urban renewal and regeneration and housing.

The private finance initiative is increasingly being seen as the primary means of raising capital in the public sector, including local government. PFI is highly complex, not suitable for every type of project and raises issues of accountability and control. Where PFI is not appropriate, desperately needed investment will often not go ahead under the current system.

The government needs to consider alternative and innovative ways of delivering investment, such as the issuing of bonds where there is a revenue stream that can cover or partly cover them or the establishment of 'quasi-corporations' where the charges are economically significant. These models would become available under the GGFD.

If the current system is replaced by one of prudential indicators, there will be less reliance on PFI, greater opportunities for councils to invest and an increase in local accountability. Coupled with changes to public accounting, this would mean a radical and welcome change to the present system that clearly is not delivering on either local or national government objectives.

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