How is coronavirus affecting local government finances?

The public health and economic effects of the Covid-19 crisis are creating a perfect storm for councils’ finances, simultaneously increasing spending and reducing incomes. The precise scale of this impact remains highly uncertain though, and will depend on how both the public health and economic situation evolves over time.

Evidence on the potential impact comes mostly from data collected by the Ministry of Housing, Communities and Local Government (MHCLG) on estimates and forecasts by councils in England of the financial consequences of the crisis. These suggest that councils will spend £4.4 billion more than initially planned this year and see their income from sales, fees and charges (SFCs) and commercial activities fall by £2.8 billion.

On top of this combined £7.2 billion hit to their budgets this year, shortfalls in the council tax and business rates collected this year will need to be accounted for in next year’s budgets. This could cost a further £1.9 billion, assuming councils’ success in chasing up missed payments holds up – or more if it doesn’t.

The government has provided extra funding and other support to help councils to address these financial pressures. But the pressures forecast by councils in England exceed this by £2 billion, with a further funding gap in the coming years. Without additional funding support, some councils will face a tricky trade-off between significantly depleting their reserves and making in-year cuts to services already stretched by the Covid-19 crisis. Councils in other parts of the UK are likely to be facing similar issues.

If the government wanted to ease this trade-off, several options are available. This includes further increases in funding, more targeted support for councils facing particular financial difficulties, and giving councils greater flexibility to borrow over the next few years so that they can spread costs themselves. Each option comes with pros and cons.

In what ways is the Covid-19 crisis affecting councils’ finances?

Local councils deliver a wide range of services to local people, such as social care and waste collections, and provide local amenities like leisure centres and libraries. They fund their spending mainly through taxes on local businesses and households (business rates and council tax), fees that they charge for some services, and grants that they receive from central government. The Covid-19 crisis is both increasing councils’ spending and reducing the income that they can raise themselves (Local Government Association, 2020).

Rising spending reflects a mix of additional costs, growing demand and new responsibilities. For example, the need to provide personal protective equipment (PPE) and comply with social distancing requirements has increased the costs of delivering a range of existing services. This is particularly true for adult social care, where many service users are vulnerable to the health effects of Covid-19. During the crisis, councils have also taken on additional responsibilities to house rough sleepers, support those who were shielding at home, and help with the testing, tracing and control of Covid-19 outbreaks.

On the income side, the wider economic effects of the crisis are hitting councils’ various income sources as households and businesses radically change their behaviour and struggle to pay tax bills, rents and service charges. Particularly affected are SFCs from parking, and culture and leisure services, driven by a decline in visits to high streets, leisure centres and tourist attractions – although recent weeks have seen some recovery (Springboard, 2020).

What is the scale of the financial impact?

Just how big the financial impact of the Covid-19 crisis will be for councils remains highly uncertain. This reflects uncertainty about how the public health and economic effects of the crisis will evolve over the coming months and years.

The best evidence currently available comes from data collected by the MHCLG on councils’ own forecasts of the spending and income pressures resulting from the crisis, although it only covers England (MHCLG, 2020a). A recent study uses the June wave of this data to look at the scale of these pressures and the financial resources that councils have to address them (Ogden and Phillips, 2020a).

The data show that councils were forecasting spending to increase by £4.4 billion and non-tax income to fall by £2.8 billion in 2020/21 relative to pre-crisis forecasts. This represents a combined pressure on council budgets of £7.2 billion this year, equivalent to around 13% of councils’ pre-crisis expenditure.

In addition, councils were forecasting that they would collect £12.2 billion less in business rates and £1.8 billion less in council tax this year than they were initially planning. Recently published quarterly revenue figures suggest a shortfall of around £4 billion and £0.5 billion, respectively, between April and June (MHCLG, 2020b, 2020c).

More than 80% of the reduction in business rates reflects the impact of waivers granted by the government to the retail, hospitality and leisure sectors this year (Ogden and Phillips, 2020b). Half of business rates revenues are usually paid over to central government, so central government will bear half of the remaining losses in business rates. And councils are likely to recoup some of the missed business rates and council tax payments later, in part through enforcement action.

Taking this into account, another recent study suggests that falls in business rates revenues this year will ultimately cost councils £1 billion, with falls in council tax revenues ultimately costing £0.8 billion (Geraghty, 2020). Accounting rules mean that councils only need to reflect this in their budgets from next year.

So far, there is limited evidence on potential costs and reductions in income in 2021/22 and beyond. Assuming a similar increase in the number of claimants of council tax support (which helps low-income households pay their council tax) as in the late 2000s recession, one study suggests a further hit to council tax revenues of around £2.5 billion between 2021/22 and 2024/25 (Geraghty, 2020). This figure is best considered indicative though, and other pressures could also persist.

Are all councils being hit to the same extent?

While the crisis is hitting councils across England (and elsewhere in the UK), evidence strongly suggests big differences in how exposed different councils are, and how able they are to manage this pressure. Even before the crisis, councils varied in their financial resilience (CIPFA, 2020).

Using council-level financial and socio-economic data, two recent studies find significant differences in Covid-19-related risks and resilience across councils (Davenport et al, 2020; Ogden and Phillips, 2020c). The extent to which councils rely on at-risk income sources such as SFCs from parking, and culture and leisure services varies substantially, as do the financial reserves held by councils. Urban and, perhaps surprisingly, more affluent areas look at greatest risk of significant income losses given that they rely more on income from SFCs and council tax (more deprived areas rely more on government grants).

Some parts of England have two-tiers of local government: lower-tier shire districts; and upper-tier shire counties – with the latter responsible for the costliest services like schools, social care and public health. In these areas, lower-tier shire districts rely much more on at-risk income streams, but hold substantially higher reserves, on average.

These patterns of risk and resilience are largely borne out in councils’ own forecasts (Ogden and Phillips, 2020a). As illustrated in Figure 1, lower-tier shire districts forecast non-tax income pressures that amount to a much larger share of their pre-crisis expenditure than other types of councils, particularly compared with upper-tier shire counties. Forecast spending pressures are more evenly distributed across different types of councils.

Figure 1: Forecast pressures by council type (percentage of their pre-crisis expenditure)

Source: Ogden and Phillips, 2020a

There is even bigger variation in forecast pressures at the level of individual councils. For example, while almost one-in-three councils forecast non-tax income losses equivalent to less than 5% of their pre-crisis expenditure, another one-in-six forecast pressures of at least 20%. In general, patterns align with councils’ exposure to at-risk income sources, such as SFCs from parking, culture and leisure facilities, and commercial and investment activities.

But differences in councils’ forecasts will also reflect differences in the assumptions that they have made about the future path for the public health and economic crisis. This seems to be particularly true for forecasts of spending pressures, where the correlation between councils’ estimates of costs between April and June and over the full year is only around 63%. In contrast, on the income side, the correlation is almost 90%.

How reliable is the evidence?

As highlighted already, the size of the financial hit and how this will vary across councils are still subject to significant uncertainty. This reflects the uncertain path of the public health crisis (will there be a second wave or more local lockdowns?) and the economic recovery (how quickly will consumer spending and business investment recover?).

Any estimates of the full-year impact of the crisis on council finances are very sensitive to the assumptions that councils have made about how quickly things will return to normal. Councils estimated that they incurred £1.8 billion of extra spending and £1.3 billion of non-tax income losses between April and June, so this three-month period accounts for more than 40% of the pressures that they are forecasting for the full year.

These figures imply that councils have assumed that monthly pressures from July onwards will be less than half of what they were from April to June. If on the other hand, these pressures turned out to be two-thirds as large, the pressure on council budgets this year would rise from £7.2 billion to £9.3 billion.

Different councils will also have made different assumptions and may have interpreted some questions asked of them differently. Close inspection of the data that councils have provided to the MHCLG also suggests some confusion and mistakes by councils as they attempted to answer the questions. Use of these data to identify specific councils at risk is therefore challenging and would need to be backed up by further information requests.

But these data remain the most up-to-date and comprehensive source of information available on the impact of the crisis on council finances. Councils’ estimates for the April-June period should be more robust than their full-year forecasts, as they will have been able to base their figures on actual spending and income outturns.

Reassuringly, reported pressures for April to June are comparable to costs in Wales, where funding for councils is distributed on the basis of claims for verifiable costs (BBC, 2020). And patterns across councils align with the risk factors – such as particular reliance on SFCs and commercial income – identified in earlier work. This suggests that there is genuine and valuable information in the data.

What is the government doing to help councils?

The government has provided additional financial support to councils to help them to address the Covid-19 crisis (MHCLG, 2020d). This includes £3.6 billion of additional general purpose grant funding, ring-fenced funding for particular services like adult social care and public health, and a new ‘safety net’ scheme that compensates councils for particularly large falls in their income from SFCs.

All told, councils are estimated to be receiving £5.2 billion of additional funding and support to help meet the £7.2 billion of spending and non-tax income pressures that they are facing this year. That leaves an estimated shortfall of £2 billion, as shown in Figure 2 (Ogden and Phillips, 2020a), although there is a wide degree of uncertainty around this.

Figure 2: Baseline forecast of unmet spending and non-tax income pressures in 2020/21, England

Note: Baseline scenario, which takes councils’ forecasts of spending and income pressures as given. ‘Non-tax income loss’ excludes council tax and business rates (losses of which will affect councils’ main budgets next year). ‘Grant funding’ includes general-purpose and specific grants. ‘Other non-grant support’ refers to cost-sharing with NHS Clinical Commissioning Groups and council claims through the Coronavirus Job Retention Scheme (furloughing staff).

Source: Ogden and Phillips, 2020a

In aggregate, councils hold reserves of £17.5 billion: much higher than this shortfall. But reserves levels vary widely across councils, and those forecasting the greatest pressures are not always the same as those with the greatest reserves. And the reserves that councils have which could actually be used to meet the pressures this year are much lower for several reasons:

• First, some will have been put aside to meet definite spending commitments and are therefore not usable.
• Second, some will represent saving by councils in advance of major investments, and so while not committed per se, there could be costs involved in changing plans.
• Third, holding reserves is one of the few ways for councils to prepare to meet further shortfalls or unexpected shocks in future years.

The data do not tell us how much of councils’ reserves are in fact usable, but it is possible to examine how the fraction of councils with ‘low’ reserves levels would be affected if they had to meet all remaining pressures from reserves. This shows that given the £2 billion forecast shortfall, the proportion of councils where the ratio of reserves to spending is less than 33% of the pre-crisis average would increase from one-in-16 to one-in-seven.

Some councils therefore face a tricky trade-off between significantly depleting their reserves – putting them at greater financial risk in the future – or making in-year cuts to services. A number of councils hit particularly hard by the crisis, including Luton, Croydon and Walsall, have already announced job losses and/or cuts to services to help to address anticipated funding shortfalls.

If it wanted to ease this trade-off, the government has several options (Ogden and Phillips, 2020a):

• The simplest approach would be to increase the general grant funding it gives to councils. But ensuring that those councils facing the greatest pressures receive sufficient funding would mean other councils receiving ‘too much’ if existing funding formulas were used.
• More targeted support could be much cheaper, but would need checks on the claims submitted by councils. This is the approach being taken with the ‘safety net’ scheme for SFCs.
• The government could also temporarily relax rules that prevent councils from borrowing to cover day-to-day spending. This borrowing would need to be repaid later, although this would help to spread the pressure over several years and it would mean that councils could avoid needing to make immediate cuts to balance their budgets. Government would have the option of reimbursing at least part of the borrowing costs incurred. Similar rules have been relaxed in parts of Europe, and the OECD has identified such changes as a sensible way to give local areas more flexibility to respond to the crisis as they see fit (OECD, 2020).

The governments of Wales and Scotland have also been providing additional support to councils in their nations. In Wales, this now amounts to £500 million, and is paid over to councils on the basis of claims for additional costs and losses of income (Welsh Government, 2020). In Scotland, the Scottish Government has provided councils with an additional £700 million (COSLA, 2020).

In both cases though, this includes extra money for education, which has been provided directly to schools in England. Unfortunately, forecasts of the costs facing councils in these nations have not been published by local or central government, although an investigation by BBC Wales suggests a similar scale of costs in Wales as in England (BBC, 2020).

What more do we need to know?

As time progresses and more months of actual outturns data become available, uncertainty about the full-year impact of the Covid-19 crisis on councils’ finances should abate. Quarterly data for council tax and business rates revenues are published with a lag of around six weeks, but the collection of quarterly data on spending has been delayed this year to ease the administrative burden on councils. Outturns data for the full financial year are not expected until Autumn 2021.

Future work will also need to examine:

• How the financial effects of the Covid-19 crisis may evolve over the next few years.
• The policy decisions taken by local government and the extent to which this has driven differences in spending and income pressures they are facing.
• How local lockdowns may affect the income and spending of councils.

Addressing these questions will require further data to be collected from councils and collaboration between researchers and the local government sector.

Where can I find out more?

• COVID-19 and English council funding: how are budgets being hit in 2020–21? This Institute for Fiscal Studies (IFS) report by Kate Ogden and David Phillips looks at in-year financial impacts based on councils’ forecasts as reported to the MHCLG.
• Local Government Dashboard: Coronavirus risk and resilience indicators for local government collated by the IFS.
• Local authority COVID-19 financial impact monitoring information: GOV.UK summary of data collected from councils on their forecasts of the financial impact of Covid-19.
• Coronavirus: UK councils fear bankruptcy amid Covid-19 costs: BBC report from late June on councils’ forecasts of the financial impact of Covid-19 (NB figures across councils may include different types of costs/losses, so may not be comparable).

Who are experts on this question?

• David Phillips (Institute for Fiscal Studies)
• Tony Travers (London School of Economics)
• Lee Geraghty (LG Futures)

Authors: Kate Ogden and David Phillips