Contact: Jon Pittam, ext 7400

1 Summary

1.1 The Cabinet is asked to endorse the response made to the Government's consultation on its support for local authority capital investment.

2 Reason

2.1 The Government's deadline for responses of 19 September 2003 precedes this meeting and a response was necessary so that the Council is able to influence the Government's approach to supporting local authority capital investment.

3 Other options considered and rejected:

3.1 Not applicable.

4 Conflicts of interest declared by the decision maker or a member or officer consulted

4.1 Not applicable.

5 Dispensation granted by the Standards Committee

5.1 Not applicable.

6 Reason(s) for the matter being dealt with if urgent

6.1 Not applicable.

Approved by: (signature) Date: (date of decision)

Councillor T.K Thornber, C.B.E.

Contact: Jon Pittam, ext 7400

1 Introduction

1.1 The Government issued a consultation paper on 8 August 2003 seeking views on whether it should support local authorities' capital investment in future with capital grants or with revenue grants towards the cost of borrowing. As the deadline set by the Office of the Deputy Prime Minister (ODPM) for comments on the paper was 19 September, the response attached as Appendix 1 has been agreed with the Leader and forwarded to the ODPM. Any further comments by Cabinet will be passed onto the ODPM following the meeting.

1.2 This report sets out the background to the response.

1.3 The ODPM also issued another consultation paper, on 29 July 2003, on the detailed regulations underpinning its proposed new `prudential' capital control system. As the deadline for comments on this paper is 29 October, a full report including a draft response will be made to the next meeting of the Cabinet on 27 October.

2 Background

2.1 The Local Government Bill due to receive Royal Assent during September 2003 includes proposals to replace the existing rigid central controls over local authorities' ability to borrow for capital purposes with a more flexible `prudential' regime. The Government hopes to implement the new system from 1 April 2004. It will allow local authorities to raise loans for capital purposes whether or not the Government provides any support in the form of grant or borrowing approvals, provided they remain within certain prudential limits set out in a Code of Practice prepared by the Chartered Institute of Public Finance and Accountancy. These limits are based on `proper accounting practices' instead of detailed statutory regulations. In addition, local authorities will be able to undertake `unsupported' borrowing provided they remain within prudential limits. No grants will be available from the Government for such loans and local authorities will have to finance the repayment and interest costs from their own resources.

2.2 As part of these developments, the Government is looking ahead in the longer term to applying depreciation to local authority accounts. It is seeking views from local authorities now on this vision.

2.3 The second part of the consultation paper deals with the choice between capital grants or revenue support for borrowing, partly in the context of adopting depreciation charges in the long run.

3 Depreciation

3.1 At present, local authorities' revenue accounts include charges for depreciation but they are reversed out before the amount to be funded from the council tax and Government grant is calculated. Instead, the charge that affects the council tax depends on the way in which the asset was originally financed. No charge is included if the asset was financed from revenue contributions, capital receipts or capital grant. If borrowing was the source of finance, an annual `minimum revenue provision' (MRP) of 4% of the amount borrowed is charged to the revenue account, together with interest. The Government provides revenue grant to support the MRP amounts including interest.

3.2 The Government wants to move to a system of charging depreciation to the revenue account for all assets. Government support would be provided for the depreciation charges for existing assets as a revenue grant. New assets would be supported by capital grants. The Government believes that this would deliver:

· more consistency with generally accepted accounting practice

· improved transparency and accountability for the costs imposed by capital assets as they would impact directly on council tax levels

· more effective and efficient capital spending because of this impact

· better procurement as a result

· improved management and maintenance of assets to avoid increases in depreciation charges

· greater focus on outcomes for services

· an incentive to dispose of surplus assets.

3.3 This change will need to be affordable, as depreciation charges may be higher than the present MRP charges and revenue contributions to capital, which would have implications for the level of Government support and the council tax. It will also need to be based on a consistent accounting treatment and robust information on assets. Neither are currently in place and so the Government envisages this taking some time to implement, possibly on a phased basis as robust information on particular classes of assets becomes available.

3.4 The Government has asked for views on this longer term vision, including the move to depreciation, and on whether there are implications for the form that Government support for local authorities' capital investment should take in the future.

Commentary

3.5 The present system of charging the revenue account with MRP amounts for assets financed by borrowing and nothing for assets financed from other capital funding sources is difficult to justify. Its replacement by depreciation would be a step forward but the Government is wrong to imply that inadequate provision for the maintenance of assets is a result of not applying depreciation. The lack of funding for local government and the resultant pressure to cut costs, together with poor asset management practices, have led to maintenance being neglected by some local authorities. The County Council's record, however, demonstrates that effective and efficient asset management is possible under the present arrangements.

3.6 The Government has assumed that the present practice of capitalising maintenance costs would continue under a deprecation regime. Charging `capital' repairs of buildings and structural maintenance of highways to capital has been encouraged by the Government's funding arrangements which provides support for these costs through capital grants and borrowing approvals. However, capitalising maintenance costs is not consistent with a more accounting-based approach to depreciation. The Government's proposals imply that the depreciation charge for an asset matches the annual cost of maintenance to keep it in a steady state of condition, which is clearly unrealistic. It would be more consistent with proper accounting practice to charge all maintenance costs directly to the revenue account. They should be supported by the Government, where appropriate, through the revenue grant system.

3.7 The enhancement of assets, as opposed to their maintenance, would be charged to capital. If assets are depreciated over prudent periods, depreciation charges are likely to run ahead of the need to finance the replacement assets. This surplus would have been financed by higher Government grants and/or increases in the council tax. That may not be acceptable politically or to the public, who may require some convincing why a technical accounting change should lead to higher taxation to pay for extra depreciation costs to be accrued and set aside in a reserve, with no immediate improvement in services as a result.

3.8 Implementing depreciation on a phased basis could lead to increased confusion and less transparency and accountability. It would be better to wait until robust information is available on asset values and lives for all classes of asset.

4 Government support for capital in the shorter term

4.1 The Government currently supports local authorities' capital investment with capital grants and borrowing approvals backed up by revenue grants towards the resultant loan charges. When the prudential regime is in place, the Government will continue to provide a similar level of support allocated, as now, via the so-called single capital pot.

4.2 The Government is seeking views on whether the present mixture of capital grants and revenue support for borrowing should continue or whether the balance to swing more towards, or away from, capital grants.

Commentary

4.3 Up-front capital grants have the advantage of certainty. Revenue support towards borrowing costs could be vulnerable to changes by the Government to its methodology for distributing revenue grants over the life of the loan. On the other hand, the Government is more likely to want to ring-fence up-front capital grants to specific capital schemes or programmes which would reduce local authorities' flexibility.

4.4 Revenue grants would give local authorities more scope to choose the best way of acquiring an asset, such as purchase, construction, leasing or a partnership approach. It is particularly important that Government funding for the Private Finance Initiative (PFI) is delivered on a level playing field so that decisions on the method of procurement are not distorted by the availability of particular sources of Government finance. The existing separate funding pots for the PFI should be absorbed within the Government's general support for local authorities' capital investment. Revenue grants provide a better match for the stream of contractual payments over the long-term life of PFI contracts than capital grants.

4.5 If all Government support was provided as capital grants, local authorities' borrowing would be limited to loans financed from their own resources. The borrowing limits under prudential regime would then be much more transparent.

4.6 Even if all the Government's support for new assets is provided as capital grants, revenue support will continue for existing assets. As depreciation charges will reflect the condition and life of each authority's assets, they are likely to vary much more significantly between local authorities than the charges to the revenue account under the present MRP system. It is likely that there would be a much greater mismatch between revenue grants and revenue charges for some authorities.

4.7 On balance, there are more advantages for local authorities in receiving support as 100% capital grants, provided the Government maintains its commitment to reduce the level of ring-fencing. But as that cannot be guaranteed and as revenue grants are more appropriate for support for PFI projects, it may be more sensible to maintain the existing mixture of capital and revenue grants.

Recommendation

That the Cabinet endorse the response sent to the Office of the Deputy Prime Minister, attached as Appendix1, subject to any further comments at the meeting.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

None.

i:\ . . . . \ian\docs\cap support Cabinet 220903.doc 27 April 2004

Appendix 1

Ross Buchanan

Office of the Deputy Prime Minister

5/E1 Eland House

Bressenden Place

LONDON

SW1E 5DU

Dear Mr Buchanan

7

Support for Local Authority Capital Investment

The following response to the consultation paper issued on 8 August 2003 has been agreed by the Leader of the County Council and will be reported to the Cabinet on 22 September. I will let you know if the Cabinet wish to add any further comments.

Depreciation

The present system of charging the revenue account with minimum revenue provision amounts for assets financed by borrowing and nothing for assets financed from other capital funding sources is difficult to justify. Its replacement by depreciation would be a step forward but the Government is wrong to imply that inadequate provision for the maintenance of assets is a result of not applying depreciation. The lack of funding for local government and the resultant pressure to cut costs, together with poor asset management practices, have led to maintenance being neglected by some local authorities. The County Council's record, however, demonstrates that effective and efficient asset management is possible under the present arrangements.

The consultation paper appears to assume that the present practice of capitalising maintenance costs would continue under a deprecation regime. Charging `capital' repairs of buildings and structural maintenance of highways to capital has been encouraged by the Government's funding arrangements which provides support for these costs as capital grants and borrowing approvals. However, capitalising maintenance costs is not consistent with a more accounting-based approach to depreciation. The consultation proposals imply that the depreciation charge for an asset equally matches the annual cost of maintenance to keep it in a steady state of condition. This is unlikely to be the case given the uneven incidence of maintenance costs from year to year. It would be more consistent with proper accounting practice to charge all maintenance costs directly to the revenue account and to support them with Government grants, where appropriate, through the revenue grant system.

If assets are depreciated over prudent periods, depreciation charges are likely to run ahead of the need to finance the replacement of assets. This surplus would have been financed by higher Government grants and/or increases in the council tax. That may not be acceptable politically or to the public, who may require some convincing why a technical accounting change should lead to higher taxation to pay for extra depreciation costs to be accrued and set aside in a reserve, with no immediate improvement in services as a result.

Implementing depreciation on a phased basis could lead to increased confusion and less transparency and accountability. It would be better to wait until robust information is available on asset values and lives for all classes of asset.

Government support in the shorter term

Capital grants may be preferable in principle but the Council is concerned that the present commitment to reducing the level of ring-fencing may not be maintained by central government in the longer term. Revenue grants are also a more appropriate form of support for Private Finance Initiative (PFI) projects as they provide a better match for the stream of contractual payments over the long-term life of PFI contracts than capital grants.

Revenue grants would also give local authorities more scope to choose the best way of acquiring an asset, such as purchase, construction, leasing or a partnership approach. It is particularly important that Government funding for PFI projects is delivered on a level playing field so that decisions on the method of procurement are not distorted by the availability of particular sources of Government finance. The existing separate funding pots for the PFI should be absorbed within the Government's general support for local authorities' capital investment.

On balance, the County Council considers that the existing mixture of support in the form of capital and revenue grants should be retained.

There is a further point on the impact of adopting depreciation. Even if all the Government's support for new assets is provided as 100% capital grants, revenue support will continue for existing assets. As depreciation charges will reflect the condition and life of each authority's assets, they are likely to vary much more significantly between local authorities than the charges to the revenue account under the present minimum repayment provision (MRP) system. It is likely that there would be a much greater mismatch between revenue grants and revenue charges for some authorities.

Yours sincerely

County Treasurer