David Green calls on the government to listen to feedback on the Minimum Revenue Provision consultation and avoid unintended consequences.
Local authorities can fund capital expenditure, but not revenue expenditure, from borrowing. However, the loans borrowed must be repaid, so it is only ever a temporary source of funds. In the absence of anything else, the permanent financing comes from Minimum Revenue Provision (MRP). The total capital expenditure yet to be permanently financed is known as the Capital Financing Requirement (CFR). Different arrangements apply in Scotland.
Before 2008, the detailed calculation of MRP was specified in law, based on 4% of the CFR. But for the past 14 years, local authorities have had the flexibility to adopt their own approach to charging MRP, with the law merely requiring this to be a prudent amount. There is no longer a minimum, but the name MRP has stuck.
Getting more capital projects off the ground
This change has allowed long-life assets such as land and buildings to be charged over 50 years at 2% per annum, or less if the annuity method is used, aiming to match the pattern of benefits received to the MRP charge. Capital investment in local services has therefore been cheaper in the early years than the old 4% charge, allowing more projects to get off the ground.
The 2008 flexibility has also allowed local authorities to make capital loans to charities, housing associations and other service providers. These loans count as the local authority’s capital expenditure when made, but then the loan repayments count as capital receipts when they eventually come in.
These receipts can’t be spent on revenue activities, but they can finance capital expenditure, and under the current regulations it is generally considered prudent to use these receipts to pay back the expenditure incurred on making the loan in the first place. Such loans are therefore self-financing without the need for an MRP charge to revenue. This has been a great benefit to helping others deliver local public services.
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Now some councils have taken this a step further, and started making no MRP on any assets from which they expect a capital receipt in the future, for example when they eventually sell an investment property. This approach, together with the PWLB’s previous “no questions asked” policy on borrowing, meant there was no upper limit to the sum of investments a local authority could make. A few have borrowed and invested more than £1bn each.
As currently drafted, the proposals will stop local authorities making capital loans to local charities and other organisations, which is surely an unintended consequence.
Borrowing to invest curtailed
The government is now consulting on changing the law in England to stop capital receipts being used in this way and ensuring an MRP charge to revenue is made for every piece of capital expenditure in the CFR. The hope is that this will severely curtail borrowing to invest, although I rather suspect the recent changes to the PWLB lending arrangements, the new Prudential Code and the pandemic have done that already.
But, as currently drafted, the proposals will also stop local authorities making capital loans to local charities and other organisations, which is surely an unintended consequence. These loans provide the lending authority with contractual capital receipts of known amounts on known dates that will exactly write down the CFR over time in line with the current government guidance.
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In its recent consultation on the Prudential Code, CIPFA showed itself very willing to listen to local authorities and made many changes to its original proposals. Let’s hope the government is also in listening mode and isn’t just pretending to consult.
That seems a far more prudent reason to charge no MRP than hoping to one day sell a property to persons unknown at whatever price the market allows in order to make a return on borrowing to invest.
In its recent consultation on the Prudential Code, CIPFA showed itself very willing to listen to local authorities and made many changes to its original proposals. Let’s hope the government is also in listening mode and isn’t just pretending to consult. No-one wants to throw the baby of service loans out with the bathwater of investment property.
David Green is strategic director at Arlingclose Limited, treasury advisers to UK local authorities.
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