Four ways Labour could fix the crisis in local council finances

England’s councils are in serious financial trouble. Six including Birmingham, Nottingham and Croydon have effectively announced their bankruptcy, in the form of “section 114 notices”, since 2020.

A cross-political party enquiry has also just indicated that government must plug a £4 billion funding gap across the board.

It might be tempting for a new reforming government to regard local authority financial failures as a minor inconvenience that can be tolerated when there are bigger fish to fry.

However, as Will Hutton recently argued, England is discovering that the local is political, that society begins with good access to social care and regular bin collections.

Councils are critical delivery partners for any UK government. If financial difficulties hobble their capacity to act, the government loses time and capacity too.

Alternative viewpoints should therefore be considered alongside a more inclusive dialogue around council financing: a recent international study of resilient local government finance systems (In Germany, Italy, and Japan) suggests four proposals for turning around the fortunes of local government finance in England.

Proposal 1: Rework the local government needs assessment [the Fair Funding Review].

Germany, Italy, and Japan all have a mature and detailed process of relative needs assessment. In England, needs assessment has been suspended since the introduction of business rate retention in 2013.

The government launched a ‘fair funding review’ in 2016, but this has not progressed since a consultation in 2018. Not having this in place in England makes it a significant outlier in the international community, gradually untethering the distribution of local government finance from local need and resource.

The Fair Funding Review should be reopened and delivered, paving the way for yearly needs assessments and longer-term funding settlements.

The reach of the Fair Funding Review could also be extended to apply it to specific grants within the Local Government Finance Settlement (LGFS) as well as the Revenue Support Grant (RSG) and the Settlement Funding Assessment (SFA).

The general grants listed in DLUHC’s local growth and place fund registercould also be included. This would also provide a platform for further pooling of funding along the lines envisaged by the Total Place and Our Place programmes.

Proposal 2: Establish a systematic form of territorial equalisation between local authorities.

England is an outlier in not having a systematic form of territorial equalisation, that ensures solidarity and parity in needs-based revenue between location.

Germany, Italy, and Japan all utilise forms of vertical (central to local) and horizontal (between location) redistributions of major income streams (including elements of personal, company, consumption, and asset taxes) that ensure that all locations have access to sufficient resources and the ability to deliver minimum service standards.

Importantly, the funding provided through the equalisation systems in Germany, Japan and Italy is not ringfenced. This results in individual local authorities having significant discretion over the income they receive.

Proposal 3: Establish a standing commission, akin to the ‘English Devolution Council’ proposed by the Institute for Government.

Discussions between councils and the government about local financial pressures, distribution of funds, or the impact of national policies are haphazard and often adversarial. To strengthen this relationship, we propose a one-stop, statutory body to provide discussion forum for local authority representatives and the government.

Germany, Italy, and Japan all have comparable institutions that are well-resourced, embedded, and respected.

The commission would provide a route to building trust by normalising central consultation with local authorities and exposing both sides to one another’s preoccupations – central demands for financial certainty and local demands for discretion.

Scotland’s recent Verity House agreement provides an interesting example close to home, while Australia and New Zealand are going through similar processes of review and settlement at the time of writing.

The commission could also provide a forum to discuss moving towards a light-touch system of assessing local government performance against outcomes, to complement entirely un-ringfenced funding for local authorities.

The statutory body would enable this to be negotiated rather than imposed – and therefore likely more effective. An assessment system could consist of a small number of sophisticated and clearly thought-out outcome metrics and could be managed by a future, independent iteration of the Office for Local Government (OFLOG).

Proposal 4: Develop a long-term programme exploring assigning national tax revenues to local authorities.

Germany, Italy, and Japan all have access to revenues from a range of taxes. However, most of this comes from ‘assigned revenues’, not from local rights to set tax rates.

For instance, in Germany 25% of national VAT revenues are assigned to the local government sector and distributed amongst local authorities according to a needs assessment.

A fixed percentage of the revenue from one or more national taxes could be assigned to local government as a whole. Taxes that could be considered in this regard include income tax, VAT, employers’ NI, corporation tax, vehicle excise duty, and stamp duty.

The revenue could then be distributed according to the needs assessment developed in Proposal 1. This would counter the problem faced by many proposals for fiscal devolution: that richer areas raise more money, increasing inequality. The Local Allocation Tax in Japan demonstrates how this proposal could work in practice.

Implementation

Italy and Japan show that reform can happen. Both countries have moved away from a strongly centralised culture in the last 20 years, in part through broadening the financial options available to their local authorities.

Inspiration can be taken from the Trinity Reform in Japan during the early 000s that laid out the legislative framework for reworking the Japanese local government finance system around principles of sub-national financing.

Taken together, these principles indicate how financial resilience, meaningful discretion, and autonomy can be embedded in local government working.