Department for Transport,
Local Government and the Regions

Modernising Local Government Finance: A Green Paper

Part 3:
Reforming the revenue grant system

The case for reform

3.1 The current grant system has been in place for the last decade. It has a single explicit objective: to ensure that council tax bills of properties in the same council tax band could be the same everywhere in England, if every authority budgeted to spend in line with its SSA. The system has been able to cope with substantial changes in the structure and responsibilities of local authorities. But, like its predecessors, it has also attracted much criticism from local government.

3.2 The objective of the grant system is very narrow, compared with the aims of a good finance system set out in paragraph 1.3. The SSA formulae on which the grant distribution heavily depends are widely criticised as unfair, both by local authorities and other stakeholders. The grant distribution has become increasingly difficult to understand and to explain. Four weaknesses in particular have been apparent:

3.3 The present grant system obscures accountability. Ministers are answerable for the overall level of grant and for the method of distribution. But how much an individual authority gets is the result of applying a formula, rather than a specific decision by Ministers in respect of that authority. The system is designed to provide needs-based assessment and avoid individual local authority influence over the outcome. It distances Ministers from the outcome too, since there has been no place for any ministerial decision to depart from the amount the formula determines for an individual authority. This longstanding aspect of the grant system is intended to reflect the nature of the central–local government relationship.

The building blocks of reform

3.4 The Government recognises that there is unlikely to be a grant system that will provide everything that both central and local government might want from it. But in tackling the weaknesses of the present system and delivering as far as possible the aims set out in paragraph 1.3, it is possible to build in several features which, used in combination, can produce a grant system that is both fairer and more transparent. There is further discussion of the features summarised at annex A.

Predictability and stability

3.5 The Government has already introduced reforms that bring greater predictability and stability to local authority funding. In place of the old annual public expenditure rounds, the 1998 comprehensive spending review introduced two-yearly spending reviews, which set firm funding figures for the two coming years and an indicative figure for the third year. The 2000 spending review has extended the spending review period to three years, including three-year plans for at least 85 per cent of total capital resources provided to local authorities. In future, the Government will also announce the majority of specific grants on a three-year basis together with information on how they will be distributed.

3.6 The Government has implemented a moratorium on SSA formula changes while it reviews the grant system. It has also introduced central support protection grant (CSPG). This guarantees that no authority in England will have its grant reduced from one year to the next, and that authorities responsible for education and social services receive a minimum grant increase of 1.5 per cent.

3.7 Local authorities have welcomed these reforms and responded positively to them. They have enabled them to strengthen their forward planning. Some have extended the benefit of predictability and stability to schools and other budget-holders and to taxpayers. The Government wants to encourage these trends. There might be advantage in giving individual local authorities more specific indications of the grant they would receive over a three-year period. Where grant is allocated by formula, the formulae could be revised every two or four years (to a timetable aligned with the spending review); client population data could be updated annually, and we could explore with local government the scope for ‘smoothing’ the more volatile data changes.

Floors and ceilings

3.8 The CSPG ‘floor’ has also had widespread support. So there might be advantage in making it a permanent feature of the grant distribution system. It might provide that no local authority in England would get an annual increase in general grant that was less than the ‘floor’. This rule could be made to override all others. There might be a good case for a grant ‘ceiling’ under some circumstances too, especially if grant were to be allocated on the basis of authorities’ own assessments and plans.

3.9 ‘Floors’ and ‘ceilings’ might be set for a three-year period, possibly by reference to the Government’s inflation target. The level of the floor would depend on the overall funding available. With continuing economic growth, we would expect to give all authorities a grant increase. But the higher the floor is set, the less is available for distribution reflecting specific local factors.

3.10 Floors and ceilings would ensure that authorities’ grant revenue would not change dramatically as a result of introducing a new grant system. We could also consider other ways of making change to a new system gradual, including measures leading up to the full introduction of a new system. Floors and ceilings could also help local authorities decide what level of borrowing they can prudently sustain. We would need to discuss the detailed design of the scheme with local government.

Other building blocks

3.11 The reforms above can help fulfil our aim of a more predictable and stable local government finance system. But we need to consider how revenue grant distribution can be reformed in line with the other aims set out in paragraph 1.3 as well.

Formulae

3.12 Formulae could continue to play a role under any approach to grant distribution. They could be used to distribute general grant in its entirety, as at present, or restricted to allocation of the grant that remained above a floor. New formulaic approaches will need to be easier to understand, avoiding the mechanical application of statistical analysis that characterises the current system. In the future it may also be possible to take account of wider evidence, including the targets which both we and local government are trying to achieve.

3.13 There is a wide range of options for distributing general grant on the basis of formulae. At its simplest, this could be a formula based on the number of people for whom a service is provided (a ‘client indicator’). This could allow for deprivation and higher wage costs. We could distribute a fixed percentage of grant on a client indicator and the remainder on the basis of indicators that are particularly strong in certain authorities – such as urban or rural deprivation (drawing on an approach used in France). Or we could use a wide evidence base to inform the development of fairly complex judgmental formulae (drawing on an approach used in the Netherlands).

3.14 If we retained an approach that analysed what authorities spend, we could develop formulae that distinguished clearly between fixed costs and the costs that vary according to the number of people for whom a service is provided.

3.15 There is no direct interaction between the grant distribution system and the new Best Value regime at present. But this could change. Best Value will generate new, hard data on the cost of providing services and should also result in a convergence of costs among groups of similar authorities. Such data could be used as a check on the validity of grant allocations generated by formulae. In time, it may also be possible to develop formulae based on the actual cost of service provision. Best Value will also generate a body of informed opinion, based on independent audit and inspection, which will enable an assessment to be made of how much an authority needs to improve, and what it would cost.

Safety Valves

3.16 We recognise that any formula-based system is bound to have limitations. We could remedy this by allowing authorities to apply for further funding via a ‘safety valve’ mechanism. This would allow us to pay additional non-ringfenced grant to authorities that appear to be underfunded. They would need to demonstrate that problems such as high council tax levels, low service standards or gaps in service provision, were due to underfunding, rather than inefficiency. To keep the system manageable and focused on the most deserving cases, local authorities might need to meet certain criteria before central government could consider an application for safety valve grant.

Specific and other forms of grant

3.17 We can also continue to use ring-fenced grant to target resources in a way that the present system cannot. The special grant for asylum seekers targets the money directly where the costs arise. The specific grant to reduce class sizes ensures that schools get the money they need. These are important national priorities, which we pursue on behalf of those who use and pay for local services. New forms of ring-fenced funding may still be necessary where we wish to start or pilot new initiatives. But we will want to ensure that these grants do not proliferate to the point where they seriously erode local financial freedom.

3.18 New forms of funding can also be targeted without being ringfenced. The Neighbourhood Renewal Fund announced in the 2000 spending review is focussed on authorities covering the most deprived areas and the achievement of new targets for education, crime, employment, health and housing in those areas. Authorities will work with new local strategic partnerships to draw up local deprivation strategies spelling out how they will use the additional funding to help renew communities and promote closer co-operation with the police, health and other local services. But the funding itself will not be hypothecated to particular services.

Local Public Service Agreements (PSAs)

3.19 Local PSAs link funding to service delivery. Building on the foundation provided by Best Value, they give local authorities financial incentives to achieve stretching targets on a range of outcomes that matter to local people and to the Government. We will run a pilot with around 20 authorities for 2001/02, ahead of a planned wider rollout in 2002/03. As they roll out, they will supply a lot of information about how to incentivise and deliver modernisation. We will be evaluating their success and will want to consider whether incentives can and should be built into the main grant distribution system.

Local authority plans

3.20 Local authorities are already required to produce a variety of different plans for different purposes, including Best Value Performance Plans (BVPPs) which bring together quality and financial targets for future years. The Local Government Act 2000 similarly requires authorities to develop community strategies which bring together key partners in delivering local sustainable development. The performance targets need to be grounded in the authority’s corporate and financial planning framework.

3.21 Such corporate plans might look three to five years ahead and cover all sources of funding, all forms of expenditure and how funding is linked to services. They could also form a basis for consultation on budget and council tax increases and the supplementary business rate. Many local authorities already produce such plans and some best practice was highlighted in last year’s Audit Commission report Planning to Succeed.

3.22 The information contained in corporate plans could also provide the basis of a case for revenue funding from central government based on the unique circumstances of the individual authority. They would need to incorporate the target outcomes set out in local PSAs and in their BVPPs.

Box 1: An example of a grant system with several discrete elements

The first element would be a floor on grant increases which would, for example, guarantee every authority a year on year increase in grant equal to inflation plus X per cent. There might also be a ceiling which meant that no authority would receive a year on year increase of more than Y per cent.
The second element would be a formula which would determine whether an authority received a grant top-up between the floor and ceiling. The formula might both reflect the local costs of providing local authority services and the resources which the authority had at its disposal. The costs formula would be based on the number of people for whom a service is provided with top-ups for factors like deprivation and labour costs. It would be established on a judgemental basis in the light of Best Value information and other evidence on unit costs. If the formula calculation gave an authority more grant than the floor, the authority would receive a commensurate top up.
The third element would be the voluntary local PSA. The Government would pay incentive grant when authorities met their targets (or milestones to those targets). In a mature system, an authority regularly achieving new stretching targets could expect to get some incentive grant every year.
The fourth element would involve Ministers exercising discretion in individual cases over a financial top-up grant or ‘safety valve’. Authorities could apply for this if they felt that other elements of the grant system did not provide adequate funding for the standard of services to which they aspired. Consideration of an authority’s case could be based on an assessment of their corporate planning proposals.
A fifth element would be the continued use of ring fenced grants to finance activities which are a national priority or which are distributed unevenly between local authorities.

Options for reform

3.23 We have identified several different potential components of a new revenue grant distribution system: formulae, floors and ceilings, local PSAs, safety valves, targeted grant and corporate plans. We need to consider which of these building blocks we put together to create a coherent revenue grant distribution system that delivers our aims.

3.24 In principle, each of these components could operate separately – starting with the application of floors and ceilings, followed by a formula, and then adding a safety valve and targeted grant. Incentives would be built in through local PSAs. Or we could try to create an ‘all in one’ package by considering corporate plans framed between an all-encompassing floor and ceiling. Boxes 1 and 2 give examples of such packages. There could be many variations on them.

3.25 How we put these ideas together will determine how we clarify accountability for grant decisions. If we continue to use formulae derived from regression analysis of historic expenditure alone, then there will be no scope for using discretion. A more judgemental approach to formulae could allow some discretion, but this might not be sufficient to take account of local variations in performance.

3.26 Safety valves would also allow Ministers to take some account of the circumstances of individual authorities. If authorities plans were to be considered in the round by central government then grant could be tailored to local circumstances and to authorities’ plans for dealing with them. But such a change to a plan-led system (as in Box 2) would represent a significant shift in the relationship between central and local government. It might be preferable to meet paragraph 1.3’s aims without such a far-reaching shift, by adding safety valves, targeted grant and local PSAs onto formulae that were simpler and more intelligible than SSA.

Box 2: An example of a plan-led system
The Government would need to draw up clear guidance on the production of corporate plans and on how they would be appraised in consultation with local government. It might well require local authorities to show what they would do if they secured a ‘floor’ increase in grant and what additional benefits they could deliver if they secured a ‘ceiling’ increase or a point in between.
In appraising plans, the first priority would be to ensure that authorities have sufficient funding to meet the net cost of maintaining existing services, implementing their local BVPPs including meeting national top-quartile Best Value targets for improving services and reducing costs. The Government would need to be satisfied about the realism of authorities’ cost and revenue forecasts without becoming embroiled in the detail.
Once these first calls on funding had been met, local authorities’ additional spending proposals would be considered.
The Government would be willing to consider different types of funding proposals. Proposals might be made to tackle problems arising from historic underfunding; for service improvements or efficiency gains that Best Value reviews indicate are achievable but constrained by current resource levels; or to meet local demand for new or improved services or facilities.
Obviously, not all proposals would be affordable. No local authority would get a grant increase above the ‘ceiling’ and some would have to make do with an increase at or close to the ‘floor’. The final decision on an authority’s increase would ultimately be a matter of judgement. Councils would have the opportunity of putting their case to a minister face-to-face before ministers made their grant allocation recommendations to Parliament. Authorities would receive an informal debriefing and formal statements of the reasons for the grant decision. The corporate plan would also include key outcome targets and be used to recognise and reward their achievement.

Extending the existing SSA ‘freeze’

3.27 The three-year moratorium on SSA formula changes is due to end in 2001/02. But the earliest possible date for introducing a new regime backed by legislation would be 2003/04 and such legislation would need to be judged against other priorities. This points to an extension of the moratorium to 2002/03 while we concentrate on building a better system with local government. We would welcome views on this.

Explaining revenue grant distribution

3.28 We are clear that we will need to do more under any future approach to grant distribution to explain the system and the decisions it produces to authorities and other stakeholders. This is not an issue for the Government alone. We need to work together with local authorities to make revenue grant distribution more intelligible.

[ Part2 ] [ Contents ] [ Part4 ]

Published 19 September 2000
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