CHAPTER 4
How is the money spent? – capital spending and how it is financed
4.0.1 This chapter describes the pattern and trends in capital spending by local authorities and how that expenditure is financed. It is divided into the following sections:
- 4.1 Capital spending
- 4.2 Financing of capital spending - overview
- 4.3 Credit approvals, grants and contributions
- 4.4 Use of capital receipts
- 4.5 Private Finance Initiative
Additional detail on expenditure and receipts in 2004-05 and 2005-06 is given in Annex D.
4.1.1 Capital spending by local authorities is mainly for buying, constructing or improving physical assets such as:
- buildings – schools, houses, libraries and museums, police and fire stations etc;
- land – for development, roads, playing fields;
- vehicles, plant and machinery – including street lighting, road signs etc.
It also includes grants and advances made to the private sector or the rest of the public sector for capital purposes, such as advances to Registered Social Landlords.
4.1.2 Authorities finance this spending in a number of ways including use of their own revenue funds, capital receipts, borrowing or grants and contributions from elsewhere. Up until 31 March 2004 the capital finance system laid down in Part 4 of the Local Government and Housing Act 1989 (the “1989 Act”) provided the framework within which authorities were permitted to finance capital spending from sources other than revenue – that is by the use of borrowing, long-term credit or capital receipts.
4.1.3 The basic principle of the old system was that authorities could use borrowing and credit only up to the limits specified by the Government through the issue of credit approvals. From 1 April 2004, Part 1 of the Local Government Act 2003 (the “2003 Act”) implemented a completely new capital finance system. The key feature of this new Prudential capital finance system is that authorities no longer need government approval to finance capital spending by borrowing or credit. They continue to receive central government support for a major part of their capital programmes, but are now free to borrow to fund additional investment as long as they can afford to service the debt without extra government support.
4.1.4 The Prudential Code was specially prepared by CIPFA for the new system and sets out in broad terms how affordability is to be assessed. With regard to capital receipts they may, as before, be used to finance capital spending. However the former duty to set aside for debt redemption part of most housing receipts has been replaced by pooling, under which part of most housing receipts has to be paid to the Secretary of State.
4.1.5 The definition of capital spending under the Prudential system is now tied much more closely to the normal accounting concept, but this can be varied by regulations or by directions issued to individual authorities. Such directions allowing revenue spending to be treated as capital spending were formally issued under section 40(6) of the 1989 Act and from 1 April 2004, under sections 16(2)(b) and 20 of the 2003 Act. They have been issued, for example, in relation to spending on redundancy payments and pension fund contributions. They are issued only in cases of demonstrable financial difficulty.
- Local authority capital expenditure has risen every year since 2000-01.
- Spending in 2005-06 increased by 17%, slightly faster growth than in 2004-05.
- The forecast for 2006-07 is for much slower growth.
- In real terms capital spending increased by 80% between 2000-01 and 2005-06.
- New construction and conversion forms the major part of capital spending.
- Between 2000-01 and 2006-07 increases in education and transport expenditure have been the main contributors to increases in capital expenditure.
- As a result, the education sector’s share of capital spending has risen over this period from 19% to 21% and the transport sector’s share has risen from 17% to 21%. Housing remains the largest single sector.
- There is considerable regional variation in the level of capital spending per head of population. London has had the highest spending per head for many years, mainly through housing.
- The distribution of capital spending by class of authority shows a decline in the share of the shire districts, in part a reflection of the shift from housing into education.
4.1.6 The following tables provide final 2004-05 and 2005-06 outturn expenditure showing:
- service by economic category for both years;
- service by region (£ million and £ per head) for both years;
- service by class for both years.
4.2 Financing of capital spending – overview
4.2.1 Up until 31 March 2004, capital spending could be financed by:
- revenue resources – either the General Fund Revenue Account, the Housing Revenue Account (HRA) or the Major Repairs Reserve – but an authority could not charge council tenants for spending on general services, or spending on council houses to local taxpayers;
- borrowing or long-term credit as authorised by the credit approvals issued by central government. Credit approvals were normally accompanied by an element of Revenue Support Grant (RSG) covering most of the costs of borrowing;
- grants received from central government;
- contributions or grants from elsewhere – including the National Lottery and NDPBs such as the Sports Council, English Heritage and the Countryside Commission, as well as private sector partners;
- capital receipts (that is proceeds from the sale of land, buildings or other fixed assets);
- sums set aside as Provision for Credit Liabilities (PCL). This required the use of a credit approval, unless the authority was debt-free.
4.2.2 From 1 April 2004, capital spending can be financed in the same ways except that:
- central government no longer issues credit approvals to allow authorities to finance capital spending by borrowing. However, it continues to provide financial support in the usual way, via RSG or HRA subsidy, towards some capital spending financed by borrowing that is Supported Capital Expenditure (Revenue) – SCE(R);
- authorities are now free to finance capital spending by self-financed borrowing within limits of affordability set, having regard to the 2003 Act and the CIPFA Prudential Code;
- the concept of PCL has not been carried forward into the new system, although authorities which were debt-free and had a negative credit ceiling at the end of the old system could still spend amounts of PCL built up under the old rules.
- From 2001-02 onwards, credit approvals as a proportion were lower because a substantial part of housing provision was redirected as Major Repairs Allowance (MRA) and paid through the Housing Subsidy system.
- In 2005-06 capital expenditure of almost £2.3 billion was financed by unsupported borrowing, 13% of the total, and more than double the amount financed in 2004-05. Borrowing by the GLA for Transport for London’s investment programme and by Birmingham for the refinancing of the National Exhibition Centre account for 33% of the 2005-06 total.
- In 2001-02 credit approvals were the principal financing source for capital expenditure, accounting for 26% of the total. By 2005-06 government grants and Supported Capital Expenditure (Revenue) each accounted for 23% of the total financing.
4.3 Credit approvals, grants and contributions
4.3.1 Up until 31 March 2004, credit approvals made it possible to finance capital spending by borrowing or credit – and set upper limits to such spending. There were two types of credit approval:
- Basic Credit Approval (BCA) which could be used for any capital project that is not ring-fenced, but had to be spent in the one year;
- Supplementary Credit Approval (SCA) which was normally tied to a specific project and which could be spent normally over a two year period.
4.3.2 From 1 April 2004, local authorities have not required government approval to borrow, although central government continues to provide some support via Supported Capital Expenditure (Revenue) – SCE(R). It continues to do this by giving annual revenue grants or HRA subsidy to help meet the costs of such borrowing. In the past however, not all credit approvals attracted financial support for example trading SCAs which could be given for a project which would generate income to pay for the costs of the borrowing.
4.3.3 BCAs (using a formula applied to Annual Capital Guidelines (ACGs)) and now SCE(R)s are calculated to represent an authority’s relative need for capital expenditure in up to five sectors (education, transport, housing, social services and Environmental, Protective and Cultural services). Until 2002-03, the formula to calculate BCA was in two parts, so as to reflect the need for spending and ability to finance it from existing funds. This was achieved by deducting a proportion of an authority’s usable receipts (the RTIAs mechanism).
4.3.4 Capital grants have mainly been given only for specific projects or types of expenditure, although from 1 April 2004 a new power in the 2003 Act enables grants to be given for a wide range of purposes. Grants may be given by government departments, mainly for transport, housing or regeneration work.
4.3.5 SCE(R)s are also provided in connection with specific projects or outcomes.
4.3.6 Local authorities receive grants and contributions from other sources for example NDPBs and the National Lottery distributors as well as contributions from the private sector, for example for access roads or traffic management schemes.
4.4.1 A capital receipt is what is received by a local authority from the sale of a capital asset, such as a council house, or from the repayment of a grant or loan made by the authority to someone else to use for capital spending.
4.4.2 Until 31 March 2004, all capital receipts were divided into usable and reserved parts when they were received. Only the usable part could be used to fund new capital spending. The reserved part had to be set aside as provision to repay debt or meet other credit liabilities. From 1998 receipts from the sale of most non-housing assets were fully usable, but set-aside in relation to housing receipts (at 75% for council houses and 50% for other housing assets) continued until 31 March 2004.
4.4.3 From 1 April 2004, there is no requirement to set aside any part of a receipt, though authorities are still free to earmark all or some of their receipts for debt redemption if they wish. However, a new pooling system has been put in place requiring authorities to pay to the Government a proportion of their capital receipts from the sale of housing land and dwellings. Large and Small Scale Voluntary Transfers are excluded from this scheme.
- Most capital receipts are from the sale of assets (97% in 2005-06) and mainly fixed housing assets (59% in 2005-06).
4.5 Private Finance Initiative
4.5.1 The Private Finance Initiative (PFI) provides an additional and different route for local authorities to secure the use of a capital asset such as a building. It offers a form of public-private partnership under which local authorities can pay for the use of new or improved capital assets (and some associated services) rather than themselves borrowing to build or buy the assets. They do this by entering into a contract under which the private sector partner will design, build, finance and then operate or manage the asset. The essence of such contracts is that the authority’s regular payments to the contractor are linked to the latter’s operating performance. If, for example, the building is not cleaned or heated or maintained to the level specified in the contract, then the contractor’s remuneration is abated according to a formula specified in the contract. In this way, risk is transferred from the public to the private sector. If that risk transfer is significant, the overall transaction does not score on the public sector balance sheet.
4.5.2 The local authority PFI programme is the government’s way of providing financial support for local authority projects which meet an appropriate set of criteria. Departments receive allocations in each Spending Review which are intended to cover planned PFI activity over the Review period. The plans become reality when a PFI credit is issued to an authority once a contract for the project has been signed. The PFI credit measures the capital value of a project which government will support and in due course triggers an ongoing stream of revenue grant. This is similar to the revenue support issued to local authorities for the borrowing costs arising through their mainstream capital programmes.
4.5.3 Capital investment funded through PFI is excluded from the expenditure figures appearing in the rest of this chapter.
- Education accounts for about half of the local authority PFI programme compared with only 21% of traditional capital spending.
- In 2000-01 transport did not feature in the local authority PFI programme; by way of contrast, in 2004-05 it accounted for 10.3% of the PFI programme, and 18.4% in 2005-06.
