Any plans for devolution need to be accompanied by updates to English councils' hideously outdated funding allocations.
Ten days into her job, the Deputy Prime Minister Angela Rayner wrote to local government leaders promising ‘the most ambitious programme of devolution this country [England] has ever seen'. The new government plans to devolve powers over, and funding for, transport, skills, housing, planning and employment support, that some of the mayors of combined authorities have, to more areas of England. It also plans for more areas to receive funding for such responsibilities via a ‘single pot' that they are free to allocate as they see fit, rather than use a plethora of ring-fenced grants as is now usually the case. More generally, all councils will benefit from multi-year as opposed to single-year funding settlements.
These plans can be described as ambitious only in the context of England's highly centralised governance arrangements: local governments in other large, developed economies often have more flexibility over spending and particularly revenue than their English counterparts. But they are a start. And a growing number of voices are calling for the devolution of additional revenue streams to accompany these changes on the spending side of the budget. These include voices within local government (such as the Northern Powerhouse and London Finance Commission) and think tanks (such as the Centre for Cities and LGIU).
The aims of devolution are both democratic and economic. Greater local autonomy can allow councils to better reflect the preferences and needs of local residents, if their greater proximity to local residents means they better understand those preferences and needs, and given they are accountable specifically to local voters. Some also argue that better decision-making, the ability to join up services locally, and the stronger financial incentives for growth that fiscal devolution can bring may improve services and boost economic performance. Both the government and others cite cross-country research by the OECD which shows that greater decentralisation of tax and spending is associated with higher levels of national income and potentially lower inequality between places. However, as the Institute for Government has noted, the evidence is actually fairly mixed and suggests that impacts depend crucially on what is devolved, to what places, and the funding and redistribution arrangements that accompany devolution.
Why funding reform matters too - and why it should come first
In the excitement about devolution, it is therefore important not to forget another big issue facing England: the lack of a proper system for allocating funding between councils, which means the amount of funding different councils receive is now essentially arbitrary. This follows ill-advised changes in the late 2000s, designed to obfuscate rather than illuminate the distributional choices being made by the government, and the ending of annual assessments of councils' spending needs and revenue-raising capacities in 2013. As recent research at IFS has shown, this has resulted in big discrepancies between assessments of the funding different areas need and the amount they actually receive. Population has grown over 15% in 19 council areas while falling in 11 others since 2013 - something which has not been properly accounted for. Poor areas, in particular, lose out, with councils in the most deprived fifth of areas in England receiving a share of funding that is 10% below updated assessments of their share of needs, while the least deprived receive a share that is 13% higher, as shown in Figure 1. Current funding allocations are therefore helping entrench rather than tackle inequalities in health, well-being and life chances across England.
Figure 1. Gap between councils' estimated share of funding and share of assessed spending needs if all councils set the average Band D tax rate, 2022-23
Source: Appendix figure B.25, Ogden, Phillips and Warner (2023).
This situation also means funding is less predictable for councils, with the allocation of funding between councils being decided on a year-by-year, ad-hoc basis by the government, rather than determined by a set of well-articulated principles and rules - although in some years the government has just chosen to roll over the previous year's funding, this cannot be taken for granted. Uncertainty about future funding makes it more difficult to plan investment and service delivery, with potential adverse impacts on performance and value-for-money.
Ploughing ahead with substantial devolution, particularly of major new sources of revenue, without addressing these problems risks entrenching them and undermining some of the purported benefits of devolution. It is likely to be even more politically difficult to redistribute newly-devolved revenue streams that councils come to see as their own - especially if such redistribution has not been foreshadowed at the outset - than to redistribute councils' existing funding sources.
In addition, reaping the full rewards of devolution will depend on the capacity of local councils to take on any additional powers and responsibilities. Researchfinds that the potential benefits of devolution are unlikely to be realised if the local government units to which powers are devolved are not funded sufficiently to deliver what is asked of them. Given that existing assessments of spending needs suggest deprived areas are currently relatively underfunded for their existing responsibilities, devolution without funding reform risks further increasing rather than reducing geographical inequalities.
An effective system of redistribution that is at least partially updated to account for changes in needs and revenue-raising capacities over time can also help reduce incentives for potentially damaging tax competition between areas as they compete for mobile tax bases (the choice of what revenue streams to devolve is also important here).
Putting in place a system to update councils' funding to account for differences in and changes in their needs and revenue-raising capacities is therefore an important accompaniment or precursor to substantial further devolution, especially of additional revenue streams.
Could packaging with devolution finally unblock funding reform?
The lack of an effective system in England for allocating funding between councils has long been known, with a recent call for action by the House of Commons Housing, Communities and Local Government Committee echoing the findings of inquiries from 2020 and 2019. At IFS, our recent reports follow on from earlier analysis of the issues and potential solutions in 2015, 2016, 2018and 2019. Indeed, under the Cameron and May Conservative governments, significant progress was made in updating spending needs assessments and designing a new system of redistribution, in consultation with the local government sector: the so-called ‘Fair Funding Review'. But no resulting changes have been implemented. With the problems known, potential solutions identified and a fair chunk of the technical work done, why has the current unsatisfactory situation been allowed to persist?
In part, events. First, Brexit undoubtedly reduced the bandwidth of the May administration to push other policies forward. Second, the COVID-19 pandemic meant that delaying reforms at that stage due to take effect in April 2021 almost certainly did make sense: the government and councils had a lot of other challenges on their plates. But key too is the political difficulty of redistributing funding between areas, creating losers as well as winners. Put simply, the losers are likely to make more noise than the winners, especially if overall funding levels are tightly constrained, making the losses more painful, and even the winners feel like they are still struggling to meet spending pressures. Such reasoning may explain why following the pandemic, the last government kicked reform into the post-election long grass for the next government to deal with.
The political challenges will not have gone away, especially given the tricky fiscal outlook. But a new government, with a large majority in Parliament, and a clearly stated intention to take ‘tough decisions' on the public finances, may be the best placed to deliver much-needed change to the way councils are funded. Packaging reforms to funding allocations along with the devolution of additional powers and revenue sources to local government would also give councils more flexibility to respond to any changes in their funding. In other words, not only is updating the system for allocating funding an important precursor to substantial further devolution but, if properly coordinated, devolution may also make such an update easier to finally implement.
A truly ambitious government could go further still, by throwing changes to England's property taxes, which are also ripe for reform, into the mix. This could include a revalued and less-regressive council tax, a reformed system of business property tax which does not penalise investment, and reducing or ideally abolishing stamp duty land tax. The Welsh Labour government has just legislated for regular council tax revaluations in Wales, and the UK Labour party has long promised to replace the existing business rates system.
Alongside a new way of funding local government, such a package could empower local decision-makers, help tackle geographical inequalities, free up the housing market and encourage investment, and in turn boost growth. But funding (and tax) reform as well as devolution is key to this ‘grand bargain'. Indeed, putting in place a proper system for allocating funding between councils is an important first step for such a plan - not least because major changes to council tax and business rates will inevitably change councils' revenue-raising capacities in different ways. Other funding will need to be redistributed to areas seeing lower tax bills and taxbases. Reform of the council funding system therefore should not be delayed until the full details of any tax reforms are decided - work should begin now.
The next step is to agree the principles of reform
With the aforementioned work undertaken by the Cameron and May governments, the new government does not need to start from scratch when it comes to reforming the way councils' funding is allocated - although some updates to work now six or more years old is probably sensible. But it does need to work out what it is trying to achieve with devolution and funding reform, including how it wishes to balance sometimes competing objectives.
IFS researchers will discuss the issues and options for both a new system to allocate funding between councils and devolution in depth in a forthcoming IFS report, to be published this autumn (2024) and funded by the Health Foundation. Our report will emphasise that there is not one single best way forward for either funding allocations or devolution: the best approach depends on how different legitimate objectives - such as local discretion and financial accountability, versus national standards and equity - are balanced. Our analysis will be guided by the importance of two factors though: flexibility and transparency.
Flexibility in any future system is important as different governments may make different trade-offs between objectives, and it would be useful if these could be accommodated within the broad system adopted going forwards. Recalibration is preferable to wholesale reform every few years. A new system should also be able to accommodate revaluations and reforms to local taxes that may necessitate updates to how other funding is allocated. Transparency is important so that the trade-offs governments are making are clear and can be subjected to proper scrutiny.
Both these factors suggest a role for grant-funding or clearly labelled transfers between councils (such as the tariffs and top-ups that operate in the business rates retention scheme) as the main way to redistribute between councils. In contrast, some other suggestions, such as undertaking redistribution through allowing councils in different parts of the country to retain different proportions of local tax revenues, are likely to be both less flexible and less transparent. The government should avoid these.
Using the Spending Review process to drive progress
The government should coordinate its work on these issues with the Spending Review process. This cannot get into the detail of how funding is allocated between councils, but it will provide a funding envelope for local government as a whole. And it provides an opportunity for the government to set its direction of travel on local government funding reform, devolution and potentially the property tax system.
It is likely too late to agree the full set of changes to councils' funding before 2025-26, so instead the government should aim to start rolling out funding reforms and potential devolution arrangements from 2026-27 onwards. This is the first year of a planned multi-year cross-government Spending Review and potentially the first year of multi-year funding settlements for councils too (the 2025-26 Spending Review is planned as a one-year stopgap).
If the government wanted to consult on reforms next summer in advance of rolling them out from 2026-27, this gives it approximately nine months to develop more detailed plans, building on work done by previous administrations and inputs from the local government sector and other stakeholders. IFS researchers will update the IFS-CIPFA Local Government Finance Model to look at the potential long-term impacts of any proposals the government does bring forward.
Lots of work to do then. Civil servants (and IFS researchers) will need to crunch the numbers. Councils and other stakeholders will need to consider the proposals and provide their feedback. And Ministers will need to make the final calls on inevitably tricky questions. Time to get cracking.