IFS - Even after the COVID-19 crisis, councils will need billions of extra funding to address a growing funding gap

24 Sep 2020 10:11 AM

English councils are facing a financial double whammy, with increases in costs and losses in income as a result of the COVID-19 crisis coming on top of underlying upwards pressures on spending, especially for adults’ and children’s social care services. 

A new report from IFS researchers – funded by the Economic and Social Research Council and the Local Government Association – finds that even before the recent surge in COVID-19 cases, forecasts by councils implied that COVID-19 spending and overall revenue pressures arising this year could exceed the additional funding made available so far by around £3.1 billion. £2.0 billion of this will hit budgets this year, but accounting rules mean that the £1.1 billion of it that relates to falls in local tax revenues can be spread over the next three years. Given councils made their forecasts before most local lockdowns came into force, and before more stringent national restrictions were announced, there is a significant risk the final shortfall could be higher.

COVID-19-related pressures should abate over time, but councils also face underlying financial pressures. To analyse these, the report looks at three scenarios for revenues and spending over the period to 2024–25. Under its middle scenario, if council tax is increased by 2% a year – the current default limit without a local referendum on bigger increases – English councils would need a further £3.2 billion of funding in real terms in 2024–25 to maintain services at their pre-COVID-crisis levels. This assumes a modest long-term hit to business rates and income from parking and transport services as a result of the COVID-19 crisis, but no additional long-term demands for council services. 

Without additional funding, councils would have to further reduce the range and quality of services that they provide – following cuts of 40% to many services in the decade between 2010–11 and 2019–20. Reserves could help address shortfalls for many councils this year but once used cannot be used again and so are not a viable source of funding to address the longer-term financial challenges facing councils – which would continue growing after 2024–25.

Looking in more detail at the medium-term outlook, it is very likely that councils will face a funding gap if council tax is increased by 2% a year:

• In our middle scenario, councils’ revenues are projected to grow by 4% in real terms between 2019–20 and 2024–25, but spending needs are projected to grow by 11%. Key factors pushing up spending needs are increases in demand for adults’ and children’s social care services (projected to be 2.2% and 2.0% a year), and increases in wage costs, partly as a result of increases in the National Living Wage. 
• Councils would need an extra £3.2 billion in real-terms funding in 2024–25 to keep pace with rising spending needs and maintain services at their 2019–20 level. They would also need between £2 billion and £3 billion in each of the next three years, even assuming most extra costs and falls in fee and commercial income as a result of the COVID-19 crisis abate by April 2021.
• Uncertainty about both underlying spending pressures and the impact of the COVID-19 crisis means the eventual figure could differ by billions of pounds though. In our upper scenario, for instance, an additional £7.3 billion would be required in 2024–25. This situation could arise if economic recovery is slower, more of the cost increases and income falls associated with the COVID-19 crisis persist, and underlying spending pressures are 1 percentage point a year higher than under our middle scenario. 

There are also three further factors that could create additional pressures on top of those included in our main scenarios:

• A lack of data means that none of our scenarios incorporates any long-term increases in demand for council services as a result of the COVID-19 crisis. However, a range of evidence suggests that some increase in demand could be expected, potentially further pushing up spending needs. Recent research suggests some people who recover from the acute phase of COVID-19 face new long-term health problems, and shows an increase in mental ill health more generally. Past research shows recessions and unemployment are associated with increases in ill health and child abuse.  
• Councils might also need to increase their pension contributions from April 2023. Falls in the value of pension fund investments could see an increase in annual pension contribution costs of between £0.3 billion and £1.2 billion in real terms. And if lower investment returns persist in the longer term – e.g. due to slower economic growth in coming decades than previously forecast – the increase may need to be even larger.   
• There may have been a pre-existing shortfall in funding for adult social care services even before the COVID-19 crisis. Comparing how much councils pay for adult social care services with minimum benchmark levels that providers need suggests a shortfall of between £1.2 billion and £1.4 billion in 2018–19. Trends in adult social care spending suggest this could increase to between £1.4 billion and £1.7 billion in real terms by 2024–25.

There are several options for addressing funding shortfalls, which could be used separately or in combination:

• The referendum limit on council tax increases could be raised or scrapped, with each additional 1 percentage point increase each year raising approximately £1.2 billion by 2024–25. However, councils serving more affluent areas can raise more from council tax than those serving more deprived areas. This means that unless there were redistribution of existing funding, reliance on council tax increases to meet rising spending needs would see increasing inequalities between more affluent and more deprived areas.
• Increasing grant funding would allow central government to target funding at more affluent or more deprived areas as it saw fit by varying the formula used to allocate the grants. However, such an approach would mean less discretion over tax and spend levels by councils, and require higher taxes, lower spending or more borrowing by central government.
• Councils could be given additional tax-raising powers. Powers to set local tourism taxes would raise worthwhile amounts for a few councils, but would do relatively little to address funding gaps at a national level. Of the taxes that could raise large sums, a local income tax – in addition to council tax – would be the most sensible option but, as with council tax, would require significant redistribution across the country. 

Kate Ogden, a research economist at IFS and an author of the report, said:

‘Increases in the cost of discounts to households with low incomes and in the number of households being unable or unwilling to pay their bills mean council tax will raise less than councils had budgeted for. And even putting to one side the business rates holiday for many businesses, councils are also collecting less in business rates, with businesses arranging to defer bills or failing to pay up. 

‘Our middle scenario suggests councils could ultimately lose out on £1.1 billion as a result of falls in tax collections this year. The government has said it will look at ways it could take on a share of these costs though, with an announcement expected in the Spending Review.’

David Phillips, an associate director at IFS and another author of the report, said: 

‘Our middle scenario implies that councils will need an extra £3.2 billion in real-terms funding by the mid 2020s to meet rising spending needs. But this figure is highly uncertain and could be billions higher or lower, depending on what happens to underlying demands and costs, and the scale and duration of ongoing impacts of the COVID-19 crisis.

‘This uncertainty, combined with the myriad of policy reviews that could impact on local government funding – including those of adult social care services and business rates – means that it would be unwise to expect the Spending Review to set firm and fixed funding allocations for councils. Instead, it may be better to consider the Spending Review as a chance to set baseline allocations. These could then be varied as more evidence on councils’ revenues and spending needs, and the overall economic and public finance outlook, becomes available over time.’

COVID-19 and English council funding: what is the medium-term outlook?