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IFS: Finance reforms could 'exacerbate inequalities'

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The move to fund councils through business rates retention and council tax revenue could exacerbate inequalities, analysis by the Institute of Fiscal Studies has found.

The analysis also found there to be no correlation between changes in councils’ business rates bases and shifts in productivity and employment.

The IFS’ report, published today, found a “negative correlation” between individual councils’ capacity to raise revenue and the amount they need to spend to meet local needs.

The IFS said this results in revenue per person being lower where spending needs per person are higher, creating the requirement for a mechanism for resources to be shared across the country.

The report adds: “Without significant redistribution of tax revenue capacity between councils, their ability to fund local public services would vary greatly, potentially exacerbating geographical (and socio-economic) inequalities.”

The government has announced its intention to introduce 75% business rates retention by 2020-21, while a number of areas are piloting 100% retention.

However, it remains unclear how funding will be redistributed to meet councils’ particular circumstances.

The report says the government’s aim to give councils strong financial incentives to grow their local economies and tackle the drivers of demand means there is greater potential for revenues to diverge from spending needs.

The report examined how revenue from local tax and spending needs changed between 2006-07 and 2013-14, when data for both was most recently available.

This was used to model how relative levels of funding for different councils may have evolved if versions of 100% retention had been in place during this period.

This found assessed spending needs per person varied significantly across councils, with one-in-10 councils needing 15% less than the national average spending per person, while another one-in-10 needing 25% more than the average.

Spending needs were assessed to be higher for London boroughs and councils in northern regions – particularly in urban rather than suburban or rural areas - than for councils in the south and east of England.

The report added: “In large part, this reflects that the existing needs assessment places a significant weight on levels of socio-economic deprivation: 60% of the variation in assessed needs per person can be accounted for by variation in councils’ average scores on the index of multiple deprivation.”

The IFS said spending needs between these two groups of councils converged “a little” during the period. The reports added this can be explained by areas with high levels of needs in 2006-7 seeing a fall in relative levels of deprivation compared to the rest of the country, while they also experienced slower growth in the proportion of their population that was elderly.

“This latter trend is likely to continue, which could lead to a further narrowing of the gap in spending needs per person between high- and low-needs areas,” the report said.

The report said changes in population size over the period can explain 39% of variations in councils’ ability to raise council tax revenue during the period, but these population changes explain only 3% of the variation in capacity to raise revenue through business rates.

“This suggests that increasing the extent to which councils rely on business rates for their revenues will increase the potential for large changes in their revenues per person over time,” it added.

The analysis also found no correlation between changes in councils’ business rates bases and shifts in productivity and employment over the period. The report said in the recent past “there has not been a clear link between the measure of business rates revenues councils are incentivised to grow and broader local economic growth.”

Responding to the report, chair of the Local Government Association’s resources board Claire Kober (Lab) said “first and foremost” councils must be able to use extra business rates income to plug an overall funding gap that will exceed £5bn by 2020.

She added: “A fairer system of distributing funding between councils is urgently needed and this distribution mechanism, along with the way the new system of business rates retention is set up, should take into account issues such as those identified in the IFS report.

“No council should see its funding reduce as a result of this new system.”

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