Northamptonshire’s section 114 notice last month brought into sharp focus questions about the financial viability of local authorities, and about the viability of the sector as a whole.
Stark range of reserve levels revealed as finances feel the pressure
Councils are said to be on the “brink of viability” and to be facing a “looming catastrophe”. But there is very little published data to show whether all authorities are close to the financial edge, or whether this is more true for some than others.
At Pixel Financial Management, we wanted to gather and analyse data that could provide evidence and to help answer some fundamental questions such as:
- What do local authorities’ accounts and financial practices tell us about the financial health of the sector (and individual authorities)?
- Are some types of local authority under more pressure than others, and if so what might the reasons be?
- What does this analysis tell us about the overall funding requirements for local government and how funding should be reallocated in the forthcoming fair funding review?
Assessing financial health
A s114 notice has to be issued by an authority when expenditure for the year exceeds income. In practice, this occurs when an authority has no more usable reserves to fund its revenue expenditure for the year. So the level – and direction of travel – of usable reserves for every authority tells us much about how close an authority might be to running out of resources, and having to issue a s114 notice.
Traditionally, the analysis of local authority reserves has focused on the general fund reserves, or unallocated balances. Unfortunately the unallocated balances only tell part of the story. When under severe financial pressure, local authorities will use every source of funding to balance their budget and to fend off the potential for a s144 statement. And this includes squeezing earmarked reserves and ultimately capital reserves.
What we see from the data is that reserves of all types have been reducing since 2015, the high point for the level of reserves for England as a whole. Usable reserves are now very low and falling very quickly in a worryingly large number of authorities. The pace of reductions is very clearly increasing, and reserves are falling in all classes of local authority. The level of usable revenue reserves has declined by 9% in aggregate across upper-tier authorities and in each type of upper-tier authority between 2015 and 2017.
Click on image for interactive chart
When we dig beneath the surface we see that reserves of all types are falling, including earmarked reserves. If earmarked reserves were left entirely for their stated purpose, and not used to fund general expenditure, then we wouldn’t see these falling, at least not consistently across the sector. It is evident that many authorities are using both general and earmarked reserves to fund spending pressures.
Of more concern is the extent to which authorities are using capital resources to support their revenue budgets. Government gave green light to this in 2015-16 when it extended the ability of authorities to capitalise transformation expenditure. In theory this was a good idea: it gave authorities the scope to make much more radical changes in services than their in-year revenue resources would allow. Unfortunately it has also opened the door for authorities to hide the true extent of their financial pressures by capitalising large amounts of revenue spending that qualifies for the capitalisation scheme.
Yes, this expenditure has to be signed-off by the external auditor, but the evidence suggests that authorities are starting to make very significant capitalisations indeed.
Including capital reserves, which have more conditions attached, in the analysis might overstate the usable reserves councils have.
In many cases authorities are using capital receipts to fund qualifying revenue expenditure. And if authorities continue in this direction, they will increasingly become dependent on achieving specific asset sales to balance their revenue budgets.
The evidence demonstrates that the sector is in a very serious financial position: usable reserves of all types are falling both nationwide and in each class of authority.
Stark range of reserve levels revealed as finances feel the pressure
Under financial pressure
Analysis of each type of council shows us the average level of reserves, and reveals the systemic pressures on each class. These include demographic pressures (particularly of over-65s), changes in government funding, ability to raise council tax income, and service pressures. It is unlikely that there will be efficiency differences between different classes: these are likely to be ironed-out when we look at the overall class data.
What is clear is that usable reserves (as a proportion of net revenue expenditure, or NRE) are highest in Inner London boroughs, followed by outer London boroughs. And the level of usable reserves is by far the lowest in the shire counties. Shire counties will point to this as very clear evidence that they are experiencing greater financial pressures than other types of authority, principally because they are more exposed to adult social care pressures, and particularly from older age groups.
We expected metropolitan districts to be faring much less well than appears to be the case because they have suffered the greatest cuts in core spending power since 2010-11. Although their usable reserves are lower than those in London and the Unitaries, they are still higher than those in shire counties. The huge funding cuts in metropolitan districts have taken their toll on finances, but that they have managed to retain higher levels of reserves than counties might indicate that they are less exposed to demographic pressures.
Usable reserves are sky-high in inner-London boroughs, no doubt from a combination of parking revenue, new homes bonus, business rates (in some boroughs) and large asset sales. These boroughs also have some of the lowest council taxes in the country. In 2015, inner London authorities had twice the levels of reserves than did shire counties when expressed as a proportion of net revenue expenditure. Even in Inner London, though, usable reserves are now starting to fall.
Our analysis does not show district councils but reserves for these authorities have increased between 2015 and 2017, and are at a much higher level than for upper-tier authorities. This leads us to the conclusion that it is the demand-led nature of upper-tier authorities which is putting the strain on reserve levels. This is not to say that district councils are having an easy time of it – they have experienced the largest reduction in government funding since 2016-17 and some of the build-up in reserves is no doubt in readiness for funding losses in 2020-21.
Stark range of reserve levels revealed as finances feel the pressure
Counting down the days
The range in usable balances is enormous across local government, with some councils having sufficient reserves to cover more than 18 months of spending, whilst others have enough for a couple of weeks. This is an important part of the analysis: many of the headlines talk about the sector being in financial crisis, but the evidence shows that that crisis is being felt much more severely in some authorities than others. This is important both for understanding what is happening, and to inform the solution to the problem: i.e. funding needs to be directed very carefully to where it is needed.
A handful of councils’ usable reserves (revenue and capital) are both less than 10% of net revenue expenditure, and have fallen by more than 50% over 3 years. The analysis that we saw at class level plays out for individual authorities: again we can see that shire counties are being very badly affected by a combination of funding cuts and spending pressures, and most of those with the highest usable reserves are in inner London. Some counties have above-average amounts of reserves, so it might not all be about the “county experience” – some of these will have specific circumstances – but there are no shire counties in the top quartile.
We would very much encourage the debate to remain at the national and the class level. At this level the evidence gives some very strong messages about the financial health of the sector, and about the relative financial strength of different types of authority.
Following Northamptonshire’s s114 statement, the short term question for government is whether there are more authorities which are likely to issue s114 statements in the near future, and particularly before the new spending review and fair funding review are implemented in 2020-21. If financial failure amongst local authorities remain few and far between, then the government can deal with these failures as isolated cases: inspectors, rescue plans, interim funding. A larger number of s114s will press the case for a wider financial rescue package, particularly as these are much more likely to be upper-tier authorities with social care responsibilities.
At the moment, although the evidence from usable reserves is ringing alarm bells all over the country, the depth of local authority balance sheets, and the willingness of local authority directors of finance to take all available measures before issuing a section 114 notice, suggests that near-term financial failures will continue to be few and far between. It is likely, in our opinion, that the big questions about the financial resilience of the overall sector and individual classes of authority will have to be addressed in the spending and fair funding reviews.
If usable reserves are to be used to influence the fair funding review, it will require some care to unpick the evidence, and to understand how various factors have affected usable reserves. Some initial thoughts along these lines are:
- Funding needs to be more responsive to demographic change
- Funding needs to be more focussed on social care, including children’s and adults’ social care
- Other sources of income might need to be taken into account
While the sector as a whole is under financial pressure, further short-term financial support might be required in places to ward off any other financial failures.
The overall funding package for local government from 2020-21 needs to be much better than it has been in the past two spending reviews. Continued cash-terms cuts in funding from central government will result in more s114 notices, with all the disruption to authorities and services that this brings.
More controversially, funding in future will have to be much more carefully directed towards authorities with the greatest financial pressures. Adult social care – and children’s services – are overwhelmingly the greatest drivers of financial “need”. The fair funding review is going to have to show that it is making a priority of those authorities and those areas where the financial pressures are greatest.
Usable reserves expressed in days of a council’s net revenue expenditure
The numbers in the graph below show how many days a council’s services could run for if it had to solely rely on its use of reserves to fund them. A breakdown of the amount held in revenue and capital reserves is displayed in an information box when you hover the cursor of your mouse over each column in the graph.
Getting the evidence: How the research was conducted
Using annual accounts, data on usable reserves between 2014-15 and 2016-17 from every English council was collected and compared. Usable revenue reserves include general fund reserves (unallocated balances), earmarked reserves and capital reserves. Specific authorities are not named. This is not due to lack of confidence in the data, but because the ensuing debate generates more heat than light especially as some councils might be able to explain why their finances are healthier than they look.
Paul Honeyben, London Councils
The fair funding review will not and should not take account of reserve levels, which reflect an authority’s past and current financial strategy rather than its relative need to spend on services. London boroughs are increasingly drawing on revenue reserves to set balanced budgets. In 2016-17, London boroughs reduced earmarked and unallocated reserves by more than any other type of authority and plan to reduce earmarked reserves by a further 40% over the next four years, whilst making £2.2bn of savings. Clearly, this is not sustainable in the long term in the face of continued funding reductions and growing demand for services, with London’s population growing twice as fast as that of the rest of the country. The government must fund local government appropriately in the 2019 Spending Review and ensure the whole sector is put on a stable financial footing for the future.”
Paul Honeyben, strategic lead for finance, performance and procurement, London Councils
Simon Edwards, County Councils Network
Counties face a toxic cocktail of rising demand, historical underfunding, and are seeing their core government grants dipping faster than other councils. Taken together, as well as the additional costs of delivering services in rural areas, these issues are unparalleled across local government. This explains why counties have had little choice to draw down on reserves to protect frontline services. There is also an argument to say the funding system in two-tier areas is unbalanced, with incentive-based funding not going to the service areas that need it the most. Counties and districts need to work together to ensure all extra resource in an area goes into the services under the most pressure.”
Simon Edwards, director, County Councils Network