Paul Johnson, the director of the Institute for Fiscal Studies, talks to Mike Thatcher about the impact of local government funding cuts and how best to reform the finance system.
How to reform local government finance? It’s a question that has bedevilled politicians, civil servants and academics for decades.
There is certainly consensus on the fact that the system is not fit for purpose. Council tax is regressive, grant funding lacks fairness, business rates impose a crippling burden on many companies and the lack of a social insurance system means that many people have to sell their homes to fund long-term care.
We know what the problems are, but how best to deal with them? Agreement on the best way forward is rare, and when it does occur is often overtaken by political considerations.
So who best to offer some independent insight than Paul Johnson, director of the Institute for Fiscal Studies (IFS)? The IFS is the organisation that journalists and politicians turn to first for unbiased, forensic analyses of budgets, spending reviews and funding settlements, and Johnson, its main spokesman, is seen as one of the country’s leading economists.
He spoke to Room151 about the funding challenges facing local government and how the system could be remodelled to be fairer and more effective.
MT: How significant have the cuts been to local government spending in recent years?
PJ: The cuts to local government funding have been very substantial – councils’ spending per person on services has been cut by one quarter or thereabouts since 2010. This is huge. It is among the biggest areas of cuts that were imposed across different departments during austerity.
Local authorities responded in different ways in terms of the services that they cut. Children’s social care spending on the whole hasn’t gone down at all and, indeed, has gone up a little bit. Adult social care spending hasn’t come down by anything like 25%. The result is, of course, that many other services have been cut by a lot more than 25%. So there has been a dramatic reshaping of local government – to become much more a deliverer of social care with some other things added on.
The cuts have fallen in different ways on different authorities. Certainly, over the period 2010-2015, cuts were more significant in metropolitan and less well-off areas.
So the past decade has seen a really big change in the scale, shape and scope of local government in pretty much all respects.
The cuts to local government funding have been very substantial – councils’ spending per person on services has been cut by one quarter or thereabouts since 2010. This is huge.
MT: An IFS survey in January 2022 showed that council finances had not suffered as much as expected during the Covid-19 pandemic. So should we be less concerned about their overall financial situation?
PJ: It is important to understand that this is variable. There will be some councils that are underfunded but, on average, the sector received more than the additional spending that we can see. There are parallels with households. Lots of households built up reserves over the Covid period that they couldn’t spend, and some were over-compensated, as were some businesses. But some did very badly – so there is that average improvement in balance sheets with a tail who have suffered.
The government is unlikely to try to get this money back. This year’s local authority funding settlement was … generous isn’t quite the word to use, but it wasn’t too bad by recent historical standards. There wasn’t any evidence in that of any clawback. I think it would be quite difficult to do an out-of-settlement clawback.
22 March 2022
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MT Some councils have responded to the tough financial climate by becoming more commercial, including setting up energy companies or investing in commercial property. What is your view on this?
PJ: I am genuinely in two minds. It is odd that public sector bodies are risking money in the private sector like this often because they can borrow at very generous rates to do it. Central government doesn’t do that. When it comes to local government, one of the issues is that a lot of councils invest within their own area. That is not diversifying risk. But if you invest out of area then, arguably, the benefits of your money are going to other people.
I am torn on the question of whether it is appropriate because you can see why local authorities might be in a good position to invest in their area and get both public and private return from doing that. I am not going to come off the fence on this one.
MT Council tax is a regressive tax that benefits councils in more affluent areas. How could it be reformed to be fairer and more effective?
PJ: I kind of feel that we know the answer to how it should be reformed. It’s just I don’t have any confidence that it will be reformed given the politics. It seems to me obvious that we should be updating it to current house prices and we should be making payment proportionate to the value of the property without a cap.
That, of course, would result in much more money being raised in the south and much less being raised in the north, and would therefore require appropriate redistribution. We have a large amount of redistribution that goes on between councils anyway, so I don’t think that changes anything fundamentally.
The current system results in unfairly high council tax bills for a lot of people in the north because their property values haven’t gone up as fast as those in the south. You also get very large numbers in the lowest council tax bands, which, in my view, are overtaxed because they are taxed at a higher proportion of the property value than people in higher tax banks.
It seems astonishing to me that someone living in a £10m property can pay only three times as much as someone in a £40,000 property.
If you went down my ideal route, which is that everything is just done in proportion to value, then you would get a lot more winners than losers. The losers would be big losers though, so you would want to transfer to that gradually.
I kind of feel that we know the answer to how council tax should be reformed, It’s just I don’t have any confidence that it will be reformed given the politics.
MT How could the Fair Funding Review improve the current system?
PJ: I confess that I hadn’t realised until embarrassingly recently that current grants are still based on population levels and characteristics as of 2013. That is just extraordinary given the scale of population change. As an absolute minimum you could just update the basis on which these things are calculated.
The longer you leave it, of course, the bigger the difficulty in achieving change. Because even if you were just to update all the data, you’d have some big winners and losers as a result of that and you’d need to bring that in gradually. You may well find, though it depends how you do it, that adjustments to the formula exacerbate the winners and losers, which leaves you with a bigger headache.
This is something that will have to be sorted out in one direction or another. It seems to me quite urgent to sort this out.
MT What other aspects of local government finance do you think need reform, for example, business rates?
PJ: There are two high-level directions you could go in with business rates. One would be to change the formal incidence of them from the occupier to the owner. The argument that HMRC and others give is that we don’t know who all the owners are – though you might think we should.
The other big bang change, which is also administratively difficult, is to move to taxing the value of the land rather than the value of the buildings.
If you can’t get over those two administrative hurdles, then I think you are in a world where you’re fiddling around with the system that we have got. Frankly, business rates raise too much money to get rid of them.
MT Will the extra funding announced by the government for social care make a difference?
PJ: We know that there are three big problems with social care. The first is the sheer quantum of funding, which has gone down over time and results in a significantly smaller number of people getting free social care or publicly funded social care than used to be the case.
Second, there is a set of issues around the organisation of social care and the fact that it’s such a diverse set of small providers and the lack of public investment as a result of that.
And then, third, there is the whole issue of the fairness of the system in terms of people losing their life savings and houses.
In a welfare state, long-term care is the classic risk that you would insure socially, which is essentially what the structural reforms announced in September are designed to do. But the promises, which are also to improve a whole series of other things, don’t look adequately funded over the next three years and will require increased funding over time.
The subsequent announcement that means-tested payments won’t be counted towards the £86,000 cap means that this doesn’t even act as social insurance for people with modest levels of wealth. They gain very little from this reform, while people with much more significant levels of wealth gain an awful lot.
Whilst the changes were a step in the right direction, they were a much smaller step than they could have been.
In a welfare state, long-term care is the classic risk that you would insure socially, which is essentially what the structural reforms announced in September are designed to do. But the promises don’t look adequately funded over the next three years.
MT Could the social care reforms have an impact on the government’s levelling-up agenda?
PJ: Absolutely. Broadly speaking, people with around £100k to £120k of assets are going to gain remarkably little from this reform. That essentially describes owners of modest properties in the north and certainly doesn’t describe the owner of any property in the south.
There are two groups of people who are not going to benefit – those who are not home owners who have some financial assets and there are those who own properties that are of low value by national standards, which are almost all going to be in the north.
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