Local government finance: five key trends for the next five years

When Wales elected its last cohort of councillors in 2017, government funding for local authorities was nearing its nadir. The revenue settlement stood 14% below its 2010−11 peak in real terms.

Over the following years, funding levels stabilised as the UK government loosened its fiscal policy and the Welsh Government started offering “stand-still” (after inflation) settlements to local government.

When the pandemic hit, funding arrangements were uprooted once again. The Welsh Government set up a bespoke hardship fund to compensate local authorities for most additional costs and income losses incurred in 2020−21 and 2021−22. Almost overnight, government funding for local authorities reached levels not seen in a decade.

Though most pandemic-related support has since elapsed, this year’s increase in the settlement is the largest since the advent of devolution (even when adjusted for inflation – which is approaching a 40-year high).

As election day approaches, this Wales Fiscal Analysis blog post sets out the funding and spending context for local authorities over the next five years.

1. The funding outlook marks a step-change from the austerity years, but the settlement will remain below its 2010−11 peak in real terms.

After a record increase of 9.4% this year, Aggregate External Finance (the sum of the non-ringfenced Revenue Support Grant and re-distributed Non-Domestic Rates) will grow by 3.6% in 2023−24, and 2.4% in 2024−25 (1.1% and 0.6% in real terms). The slowdown is attributable to the profile of UK spending plans announced in October 2021, which front-loaded most of the spending increases to aid with the immediate recovery from the pandemic.

No firm spending plans are in place beyond 2024−25. But by assuming that NHS spending continues its post-2018 trajectory and non-NHS spending grows in line with all other spending, we can project the associated consequentials for the Welsh Government during the following two years. Together with the latest devolved tax forecasts, these assumptions imply that the local government settlement grows by 3.3% a year on average in 2025−26 and 2026−27 (1.3% in real terms).

If these projections are correct, the next five years will mark the first electoral term since 2004–08 when funding grows in each year, having adjusted for inflation.

And yet, these annual increases are expected to be relatively modest compared to those seen during the first decade of devolution. Funding grew nearly three times as fast in the five-year period following the 1999 Local Elections.

Even towards the end of the next electoral term, government funding for local authorities is expected to remain below its 2010−11 peak.

2. Local authorities’ spending requirements will continue to exceed revenues owing to a combination of inflationary, demographic, and other demand-related pressure.

Despite a growing budget, spending pressures are still likely to exceed councils’ revenue over the coming years. Even with annual council tax increases of 4%, maintaining services at their 2022−23 levels would leave councils faced with a projected funding shortfall of £80 million next year, £145 million in the following year – and similar amounts thereafter.

In the near-term, record energy prices and surging inflation have contributed to rising input costs for public sector providers. The UK government has resisted calls to top up its spending plans in response to higher inflation – which has already wiped out nearly a third of the planned real increase announced in October 2021.

In the absence of new funding, curbing inflationary pressures by holding down nominal pay awards may be an option.

But this might not always be possible, let alone desirable.

Not only is there a clear need to recruit and retain staff to aid with the pandemic recovery, but the Welsh Government has already committed to a substantial increase in the starting salary for new teachers and uplifting care workers’ pay in line with the cost-of-living-indexed Real Living Wage.

In the medium-term, social services will continue to account for a majority of spending pressures, reflecting demographic patterns and the attrition of other local government services in the face of austerity.

For every £2 in additional funding received by local authorities in 2026−27, more than £1.10 will need to go to social services department to meet pressures.

3. Council tax reform and/or revaluation might be on the cards for the first time in two decades.

The big increase in the local government settlement meant that average council tax increases across Wales this year have been kept at their lowest level since 2012 and well below increases seen over recent years.

These smaller increases will help with immediate cost-of-living pressures.

However, given the budgetary outlook, further increases will likely be required in the medium-term.

Local authorities in Wales have increased council tax levels at a faster rate than English and Scottish authorities for much of the past decade, which means council tax now accounts for a much larger share of the overall tax burden in Wales. Although this has mitigated further cuts to local services during years of austerity, it has increased pressures on Welsh household budgets in a broadly regressive manner.

This strengthens the case for reforming the local tax system to make it fairer, which is a commitment in the Welsh Government’s Programme for Government as well as the Co-operation Agreement with Plaid Cymru. A consultation is planned next year with initial reforms due in this Senedd term.

Therefore, alongside further increases in council tax levels, expect to see some council tax reforms during the next electoral term, be it revaluation, adjustment of the bands, or changes to the Council Tax Reduction Scheme and other discounts.

4. Local authorities will have an increasingly important role to play in bidding for economic development funding from UK-wide funds.

Over coming years, Welsh local authorities will need to bid and access a plethora of new UK-wide funds which have recently been set up.

The lack of a formal role for the Welsh Government in these economic development funds represents a major change in governance structures compared to the EU structural funding system.

Welsh local authorities made 165 successful bids (alongside 27 unsuccessful bids) to the UK government’s Community Renewal Fund (worth £47 million). Six Welsh local authorities also made successful bids for funding from the first round of the Levelling Up Fund, worth £121 million.

On top of the agenda for incoming local administrations will be the need to feed into, and submit investment plans to the UK government in order to access the £585 million worth of funding allocated to Welsh areas through the Shared Prosperity Fund (SPF) for the years 2022−23 to 2024−25.[1] The window for submissions will close on 1 August.

£101 million of the SPF funding will need to be allocated towards Multiply interventions, the UK government’s programme to improve numeracy in the adult population. As with other funding streams, local authorities will need to be wary of duplicating other existing approaches and schemes in such devolved areas.

5. Expect further reform of taxation and council services

Council tax might not be the only tax to be reformed.

The Welsh Government has already communicated its plans to adopt a shorter, three-year revaluation cycle for Non-Domestic Rates, with similar plans afoot in England. And as the last of the pandemic-related reliefs come to an end, there will be further questions about the Welsh Government’s long-term plans for this tax.

Expect further debate around the use of council tax premiums. The maximum charge that councils can levy on second homes and long-term empty properties was recently increased from 100% to 300% of the regular council tax amount. The Co-operation Agreement between the Welsh Government and Plaid Cymru also includes a commitment to introducing a local tourism tax.

Though these taxes would only bring in small amounts of revenue, they do raise an important question about the role of taxation – not only as a means of funding public services, but also as a tool to influence and curb certain behaviours to achieve a government’s desired policy aims.

The next cohort of councillors will also be responsible for implementing several reforms of council services. This year’s settlement included funding to begin the roll out of universal Free School Meals for primary students and expand the free childcare offer.

The Welsh Government is also consulting on its long-awaited plans for social care reform and a National Care Service. An implementation plan is expected to be unveiled by the end of 2023, but the government has already clarified that social care will remain the responsibility of local authorities.

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The next five years are unlikely to be as tumultuous as the past 24 months, but planned taxation and other service reforms could nevertheless substantively change the role and responsibility of local government. A growing budget will provide welcome relief for councils, but as demand and inflationary pressures mount, budgetary trade-offs will continue.

[1] Although the spending profile of this allocation across the years 2022−23 to 2024−25 is not publicly available, we estimate the fund will be worth £340 million a year in 2024−25, given the UK-wide spending profile.