Local Government Finance

LOCAL GOVERNMENT FINANCE

Contents:

Scope

Key Points

Background

Responsibilities

Best Value

Local Government Finance Settlement

Total Revenue Support

Local Authority Self-Financed Expenditure

New Burdens

Distribution of Local Government Finance Settlement

Loan & Leasing Charges & Support for Early PPP Projects

Grant Aided Expenditure - Pre-Spending Review 2007

Client Group Approach

Revenue Funding Distribution - Post-Spending Review 2007

Review of Distribution

Council Tax Equalisation

3 Year Settlements & Minimum Grant Floor

Revenue Capping Powers

Council Tax Benefit Subsidy Limitation

Capital Expenditure

Annex: Housing Revenue Account


Scope

1. This section gives guidance about the structure and operation of the local government finance system. The guidance is aimed primarily at the core Scottish Government (SG) and the other constituent parts of the Scottish Administration.


Key Points

2. Where SG business areas consider that a policy initiative or legislative change might place a new burden on local authorities they should contact Local Government Finance Unit at the earliest possible stage and discussions must take place with COSLA before any public announcement is made.

3. The relationship between the SG and local government changed fundamentally on 14 November 2007 with the signing of the Concordat which sets out the terms of the new relationship between central and local government based on mutual respect and partnership. The Concordat recognises that it is the responsibility of each local authority to allocate the total financial resources available to it (excluding ring-fenced resources) on the basis of local needs and priorities having first fulfilled its statutory obligations and the jointly agreed set of national and local priorities including the SG's key strategic objectives.

4. Support for the 3 year revenue grant settlements is determined through negotiation between Scottish Ministers and the Convention of Scottish Local Authorities (COSLA) as part of the spending review process which takes place every 2 or 3 years depending on the corresponding spending review timetable of the UK Government. The total revenue support is made up of 3 components: specific ring-fenced grants, non-domestic rate income (NDRI) and general revenue grant (GRG).

5. Total revenue funding is distributed between Scotland's local authorities using a "needs-based" grant distribution system. In addition, to ensure a stable and fair distribution of grant, the grant distribution system includes a minimum grant "floor" within the settlement calculation, to ensure that all councils receive at least a minimum guaranteed increase in revenue funding for each year when there is an overall increase in revenue funding or a maximum guaranteed decrease in those years where overall revenue funding decreases.

6. Total revenue funding supports around 85% of local authority net revenue expenditure, with the remainder met largely from the council tax. It is for each local authority to set its council tax level depending on its own spending decisions and in consultation with local electors. With the introduction of the Concordat the SG has provided additional funding to allow local authorities to freeze their council tax levels at 2007-08 levels pending the replacement of the council tax by a fairer local tax.

7. Scottish Ministers have retained reserve legislative powers to cap local authority expenditure, by imposing a reduced council tax level, where they consider an authority's expenditure or expenditure increase to be excessive

8. Capital investment by local authorities is largely funded through borrowing. The SG supports local authority capital investment in a number of ways: a) by funding the debt servicing costs (i.e. loan charges and redemption fees) of some of this borrowing, known as "supported borrowing", via general revenue grant, b) by the payment of specific ring-fenced capital grants and c) by payment of a general capital grant, which since the introduction of the Concordat now includes a number of former specific grants which have been rolled up. In addition, any unsupported borrowing, arranged under the prudential regime, is financed through local authorities own general resources. Local authorities are now free to make their own decisions about capital investments as long as their capital spending plans are prudent, affordable and sustainable.


Background

9. The local government finance system supports revenue expenditure on services and capital investment in infrastructure by Scotland's 32 local authorities across the full range of their non-housing responsibilities - including education, social work, environmental services, roads and transport, etc.

10. SG revenue support is paid to local authorities on a weekly basis under an Order made by Ministers under Schedule 12 of the Local Government Finance Act 1992. Where possible, councils are advised of their grant allocations for a 3 year period following each spending review but approval is required from the Scottish Parliament each year for the annual Local Government Finance (Scotland) Order. Schedule 12 also requires that Ministers consult "such associations of local authorities as they consider appropriate" before laying the annual Order. This requirement is fulfilled by the SG's consultation with COSLA which is normally undertaken towards the end of the calendar year preceding the start of the new financial year when the new budget will come into force

11. Capital investment by local authorities is largely funded through borrowing financed either by revenue grant "supported borrowing" or through local authorities own general resources, or by the SG's payment of specific ring-fenced or general capital grants. Entirely separate finance arrangements operate for local authority housing. These are described in the Annex to this section on the operation of the Housing Revenue Account.

12. The detail of the local government finance system can appear complex. In part, this reflects the variety of functions that it must fulfil, for example it must:

  • provide a stable and equitable allocation of revenue and capital grants between Scotland's 32 local authorities,
  • reflect councils' diverse characteristics and expenditure needs, including any changes in circumstances over time, such as population movement;
  • provide councils with the certainty to plan their future spending and investment;
  • reflect new financial pressures on councils as they arise, including new policy initiatives or transfers of responsibility between central and local government; and
  • acknowledge the wider impact of local authority expenditure and investment on public finances.

13. Not all of these aims are necessarily compatible, for example, pressure to reflect changes in councils' circumstances must be balanced against the need for stability, to allow councils to plan for changes in their expenditure and service provision. Ultimately, the system allocates resources from a fixed pot and as a consequence any adjustments usually impact on all councils. It is important, therefore, that the system is transparent and, as far as possible, commands broad agreement amongst local authorities. As a result the grant distribution methodology is kept under constant review to ensure that it is as fair and equitable as possible.


Responsibilities

14. Within the SG, responsibility for local government finance matters rests with the Cabinet Secretary for Finance, Employment and Sustainable Growth and the Minister for Local Government and Planning. However, many of the elements of local authority expenditure relate to policy areas that are the responsibility of other Ministers, e.g. education, community care, environmental services, leisure and recreation, etc. As part of the spending review process the Cabinet Secretary for Finance, Employment and Sustainable Growth holds bilateral discussions with other Ministers as well as COSLA about the allocation of resources for local authority revenue expenditure and capital investment.

15. Responsibility for the administration of the local government finance system rests with the Local Government Unit within the SG's Local Government and the Third Sector Directorate covering local authority revenue expenditure, revenue grant distribution, the prudential regime for capital and policy on council tax and non-domestic rates. However, as noted above, responsibility for specific policy areas remains with the relevant portfolio lead.

16. The SG consults with councils collectively about the financing, structure and operation of the local government finance system, through COSLA. This role has been developed and expanded under the terms of the Concordat including a number of set piece meetings throughout the year between both politicians and officials from both the SG and local government.

17. It is for local authorities to determine their expenditure priorities from the resources available to them (excluding ring-fenced resources) and their council tax income, on the basis of local needs and priorities having first fulfilled their statutory obligations and the jointly agreed set of national and local priorities, including the SG's key strategic objectives.


Best Value

18. In taking decisions about their revenue or capital expenditure, local authorities are expected to demonstrate their commitment to pursue Best Value across the full range of their activities. Best Value is an approach to effective performance management that encourages the pursuit of continuous improvement through the collection and appraisal of information about current performance, alternative options for service delivery, and the assumptions and objectives which underpin such services. An important means of collecting this information is consultation with stakeholders, and the maintenance of a positive attitude to transparency and accountability.


Local Government Finance Settlement

19. The details of each settlement are set out in full in the relevant Local Government Finance Circulars following each Spending Review and following the signing of the Concordat these include details of the agreed a package of measures to underpin the 3 year revenue and capital grant settlements for each council (or in the case of Spending Review 2010 a one year settlement).


Total Revenue Support

20. The total level of revenue support is determined by Scottish Ministers in discussion with COSLA as part of the spending review process which should normally take place every 2 years but the timing of spending reviews is linked to the similar process carried out by the UK Government. Total revenue support is made up of 3 components: Specific ring-fenced Grants, Non-Domestic Rate Income (NDRI) and General Revenue Grant (GRG):

  • "Specific ring-fenced Grants" form a very small part of the overall grant support to local government through the annual local government finance settlements. Their allocation and distribution are set centrally and linked to specific ongoing policy initiatives and expectations. Specific grants count for just over 8% of total revenue funding. Following the signing of the Concordat the number of specific grants has been reduced considerably and the general presumption is against the establishment of additional hypothecated allocations within the local government settlement.
  • "Non-Domestic Rates" are collected by all 32 authorities on the basis of a national poundage set by the Scottish Government, paid into a central pool and with effect from 1 April 2012, redistributed to councils based on how much each local authority is expected to collect. The amounts estimated to be available for distribution from the pool each year depends on forecasts of gross rate yield, losses from appeals and adjustments from previous years. Adjustments are made, either up or down, to the level of General Revenue Grant (GRG) to reflect variations between the estimated Non Domestic Rates Income (NDRI) and the actual amount collected, so the amount collected by an individual authority has no direct impact on its revenue funding allocations.
  • "General Revenue Grant" makes up the balance of total revenue funding each year after estimates of specific grants and NDRI have been subtracted from the national revenue funding total. All Scotland's local authorities are responsible for the full range of local services, including education, social work, maintaining the local roads network etc. Certain services, including policing and the fire service are provided jointly by a number of authorities. General Revenue Grant supports councils' recurring expenditure on these services, for example on staff costs, etc. It also supports the debt servicing costs of some local authority borrowing to fund capital investment, leasing payments and approved Public Private Partnership projects.

Local Authority Self-Financed Expenditure

21. In reaching their decision about total revenue grant, Ministers must have regard to the impact on council tax levels. Total revenue grants fund around 85% of Scottish local authority net revenue expenditure with the remaining 15% funded largely from the council tax. The proportion of local authority expenditure funded from the council tax is known as Local Authority Self-Financed Expenditure (LASFE) and counts towards total public expenditure at a GB level, but is not part of the Assigned Budget. It is for each local authority to set its council tax level, based on its own spending decisions and following consultation with its local electors but following the signing of the Concordat the Scottish Government has provided additional funding to allow local authorities to freeze their council tax levels at 2007-08 levels.


New Burdens

22. In setting the total level of local government support Scottish Ministers must also consider local authorities' on-going responsibilities and any new burdens or transfers of responsibility. These issues are discussed at the time of the individual spending reviews but following the signing of the Concordat they are also discussed on a regular on-going basis between the Scottish Government and COSLA. New burdens arise where central government policies give rise to an additional financial pressure for councils. Although the local government finance settlement is set for 3 years, adjustments can be made for new burdens or transfers of responsibility during this period. Where policy divisions within the Scottish Government consider that a policy initiative or legislative change might place a new burden on local authorities they should contact Local Government Unit and discussions must take place with COSLA before any public announcement is made.


Distribution of Local Government Finance Settlement

23. The total revenue funding is distributed between Scotland's 32 local authorities using a "needs-based" grant distribution system developed over many years through consultation between central and local government. The system recognises key factors which impact on councils' relative revenue expenditure needs. Grant distribution is calculated on the basis of councils' Total Estimated Expenditure (TEE) funded from both grant and local taxation. Councils' expenditure needs are split between expenditure on services and debt servicing (loan & leasing charges).


Loan & Leasing Charges & Support for Early PPP Projects

24. The Scottish Government supports the debt servicing costs of some local authority borrowing to fund capital investment, leasing payments and a few approved early Public Private Partnership projects. Support for loan charges, including for joint police and fire boards, is calculated based on a combination of councils' actual historic debt levels and notional debt based on their capital allocations. Redemption and interest rates are determined by the Scottish Government's Local Government Finance Statisticians. As loan charges support is calculated, in part, on a notional basis, local authorities can seek best value in their capital investment without losing the associated revenue grant support.

25. In addition to loan & leasing charges, local authorities also receive support through the settlement for some approved early Public Private Partnership (PPP) projects. The level of support is based on an agreed final development plan. As the allocations for PPP projects must be included within the settlement totals fixed each year, Local Government Unit must be advised no later than October of any changes to the now historic funding allocations in the following financial year.


Grant Aided Expenditure - Pre Spending Review 2007

26. Before Spending Review 2007 and the signing of the Concordat, once loan & leasing charges and PPP support had been top sliced from TEE, the remaining provision, known as Grant Aided Expenditure (GAE), was sub-divided between specific service and sub-service headings, known as GAE allocations. If it made sense to distribute total GAE amongst authorities pro rata to population, it would not be necessary to produce service or subservice GAEs. However, it is recognised that there are other factors, in addition to population, that impact on councils' relative expenditure needs for different services.

27. The first stage in the Scottish distribution system was to allocate the aggregate level of GAE amongst services. This was known as the "GAE service split". The service split was a top-down process determined by the Scottish Ministers in consultation with COSLA, taking account of a range of factors, including: new burdens on authorities; actual levels of expenditure on particular services; and any political priority Ministers wished to give to particular services.

28. Once the GAE service split had been made, the next stage was to allocate the service GAE amongst sub-services. For example, there are around 20 Education sub-service GAEs - primary school teaching staff, secondary school teaching staff, etc. The aim of sub-dividing a service GAE was to introduce further refinement into the arrangements for distributing GAE amongst authorities. Each GAE allowance has, therefore, its own distribution formula.


Client Group Approach

29. The next stage was to give each authority a share of each sub-service GAE. This was done by means of what is known as the client group approach, which was first introduced in the 1980s and has been continually refined since then. The client group approach is an objective method of estimating the relative need of local authorities to incur expenditure on a particular service or sub-service. The approach takes into account variations in the demands for services and the costs of providing them to a similar standard and with a similar degree of efficiency. Fundamental to the approach is that the demand and cost factors must:

  • be outwith the control of local authorities· (i.e. so that the distribution of GAE cannot be manipulated by authorities' own policy decisions);
  • offer plausible explanations; and
  • be shown to be associated with inter-authority expenditure variation.

30. The approach involves determining a primary indicator (PI) for each service or sub-service and, where found to be justified, one or more secondary indicators (Sls). The PI is what is regarded as the most significant single determinant of expenditure on a service or sub-service. For example, the PI for the Primary School Teaching Staff GAE is the number of primary school pupils at the most recent date available. However, it is recognised that authorities need to maintain schools with relatively small rolls in rural areas and that those schools have a higher ratio of staff to pupils and as a result are relatively more costly per pupil to run. Therefore, for this GAE there is a SI which takes account of this and has the effect of skewing part of the GAE towards authorities which have to maintain small schools. A number of GAEs are distributed on the basis of councils' actual or budget expenditure in previous years, where no suitable alternative methodology has been determined.

31. A local authority's GAE is the sum of its share of each service or sub-service GAE. The detail of the make-up of each authority's GAE is contained in the so-called "Green Book" which is produced for each year after each spending review. There had been a tendency to view councils' service and sub-service GAE allowances as spending targets or limits - which they are not. The GAE allocations merely contribute to the calculation of councils' total un-hypothecated grant allocation. As a result it was agreed as part of Spending Review 2007 that the additional funding resulting from that spending review would not be allocated to individual services or sub-service GAEs thus breaking the link between GAEs and funding.


Revenue Funding Distribution - Post-Spending Review 2007

32. As a result of the changes in the local government finance system resulting from the Concordat the distribution of the 2008-12 local government finance settlements were treated somewhat differently from the process described above in paragraphs 26-28. For these 3 years figures the 2007-08 GAE figures were not increased (with the exception of Police) but the indicators were updated to reflect local authorities' relative need over the period 2008-11. These revised proportions were used to distribute both the existing 2007-08 GAE provision as well as the additional funding resulting from Spending Reviews 2007 and 2010. All the former specific ring-fenced grants rolled up into the general revenue grant were distributed on the basis of the 2007-08 distribution to ensure stability in local authorities' funding. For 2011-12 the needs-based indicators for all the former ring-fenced grants were updated. The additional funding to allow local authorities to freeze their council tax levels was distributed on the basis of each local authority's share of the 2007-08 council tax income.


Review of Distribution

33. As part of the outcome of Spending Review 2007, the Cabinet Secretary for Finance, Employment and Sustainable Growth in agreement with COSLA set up a joint Officer Group to undertake a review of the distribution methodology to ensure that it is as fair and equitable as it can be. The joint review group has been asked to make recommendations for changes by October 2009 with any agreed changes to be implemented in 2011-12 the first year of the next 3 year local government finance settlement. The joint review concluded that the distribution formula was generally fair and should be retained for 2011-12.


Council Tax Equalisation

34. The grant distribution formula is calculated on the basis of councils' total estimated expenditure. As noted above, the gap between this level of expenditure and total revenue support is funded from the council tax. The distribution formula takes account of the resources that each council can raise from the council tax, by distributing the gap between TEE and total revenue support between local authorities on the basis of each council's council tax base (Band D equivalent properties). A council's total revenue support is calculated by deducting its estimated council tax income from its TEE. This "equalisation" adjustment is calculated on the basis that councils could set a standard Band D council tax level. In practice, each council sets its own council tax rate to match its actual expenditure decisions.


3 Year Settlements & Minimum Grant Floor

35. Firm 3 year revenue grant allocations are provided to each local authority by the Scottish Government following each spending review which should normally take place every 2 years but are dependent on the UK Government's budgetary timetable. The allocations for each of the 3 years are calculated using the methodology described above. However, for years 2 and 3, certain PIs are updated to use population projections. In addition, to ensure a stable and fair distribution of grant, the distribution calculations include a minimum grant "floor" to ensure that all councils receive at least a minimum guaranteed increase in total revenue support for each year when there is an overall increase in revenue funding or a maximum guaranteed decrease in those years where overall revenue funding decreases. The level of the floor for each year is set with reference to the aggregate increase in total revenue support. Where an individual council's total revenue support allocation from the distribution formula is below the "floor" in any one year, its allocation is increased up to the "floor", by redistributing grant from other councils based on their share of total revenue support.


Revenue Capping Powers

36. Total revenue support supports around 85% of local authority net revenue expenditure, with the remainder met largely from the council tax. It is the responsibility of each local authority to allocate the total financial resources available to it (excluding ring-fenced resources) on the basis of local needs and priorities having first fulfilled its statutory obligations and the jointly agreed set of national and local priorities including the Scottish Government's key strategic objectives. Scottish Ministers have reserve powers to cap local authority expenditure, by imposing a reduced council tax level, where they consider an authority's expenditure or expenditure increase to be excessive. These powers are unnecessary when the council tax levels have been frozen and as a consequence have not been used in recent years.


Council Tax Benefit Subsidy Limitation

37. The devolution settlement provides that the Assigned Budget may bear any extra Council Tax Benefit (CTB) costs if average council tax rises faster in Scotland than the rest of the UK. The CTB limitation arrangements require individual councils to contribute towards these costs, where their council tax increases exceed a threshold set by Ministers. However, the CTB subsidy limitation thresholds are not alternative guidelines, but encourage councils to consider the benefit implications of their expenditure decisions. This subsidy limitation scheme was suspended even before the council tax freeze was introduced in Scotland from 2008-09.


Capital Expenditure

38. Capital investment by local authorities is largely funded through borrowing. The Scottish Government supports local authority capital investment in a number of ways: a) by funding the debt servicing costs (i.e. loan charges and redemption fees) of some of this borrowing, known as "supported borrowing", via general revenue grant, b) by the payment of specific ring-fenced capital grants and c) by payment of a general capital grant. Any unsupported borrowing is financed through local authorities' own general resources.

39. The Local Government in Scotland Act 2003 abolished the previous limits on local authority capital expenditure known as section 94 consents. Instead the 2003 Act places a duty on local authorities to determine and keep under review the maximum amount they can afford to allocate to capital expenditure. This allows local authorities the freedom to make their own decisions about capital investment. In doing so regulations require authorities to have regard to a Code of Practice developed under the auspices of CIPFA, called the Prudential Code for Capital Finance in Local Authorities. This requires local authorities to ensure that their plans are prudent, affordable and sustainable. Together the different elements of this framework are known as the Prudential Regime. Local authorities also have a duty to adhere to statutory guidance on Best Value, which stresses the importance of good financial management and project management control and of linking expenditure plans to effective asset management.

40. Although no national or local limits have been set for borrowing, HM Treasury reserves the right to do so. In the meantime, the Scottish Government monitors capital plans, outturn expenditure and borrowing levels, and passes information to HM Treasury for monitoring on a UK-wide basis.

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Last updated June 2011