Part 2:
How local government finance worksThe pattern of expenditure
2.1 In 1998/99, local authorities in England incurred £56 billion of revenue expenditure2and £7 billion of capital investment. Chart C shows what this money was spent on.
Chart C: Local Authority expenditure by service: 1998/ 99 
Explanatory notes and data sources for this chart can be found at www.local.dtlr.gov.uk
2.2 Revenue expenditure covers the day-to-day cost of running an authority and all the services it provides. It covers pay for the teachers, police, fire fighters, social workers, librarians and other staff who are employed by the authority. It covers the cost of running the buildings and vehicles they use. It covers the cost of maintaining parks and roads. It also covers the cost of payments to suppliers where services are contracted out, the cost of grants to bodies which the authority supports and the cost of partnerships in which it participates.
2.3 Capital investment covers large purchases that have benefits over many years, such as the cost of building a new school, road, library, leisure centre or waste-treatment facility. Local authorities can purchase such assets outright, but that is unusual. More commonly, they fund major investments by borrowing or by entering into leasing arrangements or private finance deals. In each of these cases, the capital cost of the new asset is met by a series of payments, spread over many years, which are a call on the revenue account. So, capital investment and revenue expenditure are linked.
Chart D: Local authority income by source: 1998/ 99 
Explanatory notes and data sources for this chart can be found at www.local.dtlr.gov.uk
Sources of funding
2.4 Chart D shows the main sources from which local authorities fund revenue expenditure and finance capital investment.
2.5 Internal sources account for about a third of their revenue funding. The largest of these is council tax. Others include rents payable to the authority and the fees and charges it makes for some of the services it provides. These are all within the authority’s control.
2.6 External finance accounts for the remaining two thirds of local authorities’ revenue funding. It comprises:
An authority’s share of the yield from the business rate. Like council tax, the business rate is a tax on property. It is collected by local authorities, paid into a central pot, and redistributed on a simple per capita basis.
- Government grant. The Government provides general grant, which can be spent for any legitimate purpose. The main components are revenue support grant (RSG) and Police Grant. It also provides grant that is ring-fenced for a specific purpose. The largest scheme is the Standards Fund for education, but there are many smaller schemes, eg to deal with asylum seekers or promote regeneration. In 1999/2000, 91 per cent of Government grant was general grant and 9 per cent was ring-fenced.
2.7 Capital expenditure is financed through four main sources:
borrowing and credit arrangements, on the strength of credit approvals issued by central government;
central government capital grants;
spending of usable capital receipts; and
spending from revenue.
2.8 The balance between internal resources and external funding has been the dominant issue in past debates about local government finance. The Government set out its position very fully in response to a Select Committee report last year. Local authority work has national and local benefits. It is therefore right that it should be supported by national and local taxpayers, by businesses and householders. There is nothing sacrosanct about the present balance, but there is no evidence that shifting the balance would strengthen local accountability or enhance financial freedom. The Government is absolutely clear that theÊbalance cannot be shifted against the wishes of taxpayers.
2.9 In the Government’s view, the more serious issues are the balance between general and ring-fenced grant and the extent to which local authorities’ revenue expenditure, borrowings, taxes, fees and charges are constrained by legislation or ministerial decision.
Setting revenue budgets
2.10 In its spending reviews, the Government decides how much it can afford to spend, reviews its expenditure priorities and sets targets for the improvements which are to be delivered from additional funding. The spending review determines the total level of general grant to local authorities for the coming three years.
2.11 This grant is then allocated between authorities. The arrangements for allocating ring-fenced grant vary: some schemes use formulae or other rules on entitlement; others allocate funds on the basis of appraising bids. The general grant – revenue support grant (RSG) – is allocated among authorities by formula. RSG bridges the gap between the authority’s standard spending assessment (SSA) and the revenue the authority could raise by charging a standard rate of council tax, together with its share of the yield from business rates. If the total amount of business rate available for distribution is higher or lower than forecast, this is offset by a matching adjustment to the total RSG.
2.12 The Government also allocates credit approvals. These determine how much an authority is permitted to borrow. Local authorities are free to fund capital investment from their own resources. But, if they wish to borrow or use other forms of credit, they must by law get a credit approval.
2.13 Local authorities set their budget and council tax in the light of these Government decisions. They have to balance their spending priorities against their internal resources, the grant from Government and what they will be permitted to borrow. The key decision is what services and facilities local people want and what level of council tax they are prepared to pay. This lies at the heart of Best Value. In order to protect local people from excessive council tax increases, the Government has reserve powers to cap budget increases. But this is very much a reserve power. We hope it will not be necessary to use it.
How SSA works
2.14 The SSA plays a key role in the current local government finance system. It is therefore important to be clear what it is trying to do and how it works in practice.
2.15 The original aim of RSG was to allow local authorities to provide a standard level of service for a standard rate of council tax. This is done by constructing SSA formulae which attempt to reflect variations in the cost of providing services, and then making an adjustment to reflect the fact that revenue from council tax also varies, and that the authority gets a share of the business rates.
2.16 In practice, local authority spending levels can vary for three reasons. First, an authority may take a conscious decision to aim for a high or a low council tax or to give one service aÊhigher priority than another, reflecting the judgement of politicians about what local people want from their council. Second, some authorities are more efficient than others. Third, there are factors beyond the control of any individual authority. SSA seeks to identify this last group of factors. It does this primarily by looking for statistical correlations. It assumes that, if there is a strong correlation between the amount that different local authorities spend on a service and a given variable, this suggests that the variable has a real impact on the cost of providing the service.
2.17 The table below shows how SSA is structured and illustrates the linkage to regression analysis. The formula for secondary education illustrates the three main types of variable found in the SSA formulae:
- The size of the client population. An authority with 20,000 children to educate or 2,000 miles of road to maintain will inevitably face higher costs than an authority with 10,000 children or 1,000 miles or road. Most SSA formulae are based on a unit-cost approach like this.
- Input costs. Pay levels vary across the country. So do property prices and rents. These variations in cost are clearly beyond any individual authority’s control. They are reflected in the area cost adjustment. The case for this is clear-cut. But quantifying it is more difficult and contentious.
- Variations in the level of input needed to deliver the desired outcome. More staff are needed to provide a given number of meals-on-wheels in sparsely populated areas. Heavily used roads require more frequent maintenance. Children with learning problems demand more attention from teachers.
2.18 The council tax adjustment (referred to in paragraph 2.15) is based on the same principle. It ignores variations in the level of council tax set by different authorities and variations in the collection rate. It is based on the amount that different authorities would collect if they all set the same level of council tax and all succeeded in collecting 100 per cent of the tax due to them.
2.19 The distribution of general grant is determined wholly by the SSA formulae, the council tax adjustment and the authority’s share of business rates. There is no scope for varying grant to individual authorities to reflect local circumstances not reflected in the formulae. Up until 1999, the formulae were reviewed annually. Local authorities and Government proposed formula changes. The Government discussed them with local government, considered them, and announced its decisions, which were subject to the approval of Parliament. The data used in the formulae were also updated annually. Chart E shows the increases and decreases in SSA in 1999, distinguishing between the impact of formula and data changes. It shows that the impact of SSA changes on a small minority of authorities is very large. From 1999, the Government introduced a moratorium on formula-changes while we review the grant distribution system, but data is still updated annually.
Chart E: Range of changes in SSAs due to methodology and data 
2. The revenue figures (both expenditure and central government support) set out in the green paper cover local authority general fund spending and include expenditure financed by sales, fees and charges. They exclude expenditure on/support for council housing for which there are separate ring-fenced accounts. There is no corresponding ring-fence for capital so the figures given cover all capital expenditure/central government support for capital.
Published 19 September 2000
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