Contact: Paul Carey-Kent, Deputy Treasurer, 01962 847525

1 Three-year revenue and capital settlements

1.1 Most of the Government's financial support for local government services, and almost all of that for Fire and Rescue, is currently allocated on an annual basis. It includes £46bn of formula grant, £28bn of specific grants and £12bn support for capital investment. Since the Government introduced three-year Spending Reviews for its public spending plans in 1998, it has cascaded three-year financial planning from central Government departments to executive agencies and other budget holders including the National Health Service, the Learning and Skills Council and the Regional Development Agencies.

1.2 The Government now wishes to extend three-year plans to local government, including police and fire authorities, starting in 2006/07.

1.3 The Government believes that this "would offer greater certainty and stability in funding. It would increase the planning horizon, strengthen financial management and support efficient use of resources at the local level. Better management of risks should enable local authorities to publish at least indicative budgets for the same period and associated local tax rates increasing transparency and accountability at the local level. It also provides an opportunity for three-year settlements to be cascaded to other bodies, building on the [Government's] commitment already made to introduce three-year settlements for schools."

1.4 In part, the proposals are a response to criticisms from local authorities about the tardiness of Government notifications about revenue and capital allocations prior to the start of each financial year.

1.5 The concept of three-year Government financial settlements should be supported, in principle. However, there are a number of other changes over the next two years affecting local government finance that cast doubts on whether it sensible to press ahead with the introduction of multi-year settlements as early as 2006/07. These changes include:

· the council tax revaluation to be implemented from 2007/08 - valuations will not be published by the Valuation Office until September 2006 which will be after the Government plans to set the first multi-year settlement in November 2005

· revisions to the formulae used for Formula Spending Shares (FSS) in 2006/07 following the expiry of the existing freeze on methodology at the end of 2005/06

· the possible expansion of the current pilots for the Government's Local Area Agreements which bring together Government funding streams

· the results of the Lyons enquiry into local government funding which is due to report at the end of 2005

· the Gershon efficiency review

· the Government's Spending Review for 2006 which is likely to be published in July 2006

· the uncertain timing of the repayment of transitional funding

· the regionalisation agenda.

1.6 According to the consultation paper, the Government has decided that the council tax revaluation does not justify postponing the introduction of three-year settlements until 2007/08. It has concluded that there will still be benefits from the early announcement of its support for 2007/08 in November 2005, alongside the 2006/07 settlement, even if the 2007/08 figures have to be qualified as provisional and subject to alteration as a result of the council tax revaluation. Given the Government's recent track record of making last minute changes to its grant settlements to moderate their effects, it would seem to be proposing to take a big risk at local authorities' expense. There seems little point issuing "firm and fixed" figures which are also "provisional and subject to alteration".

1.7 In addition, the Government's consultation paper raises the possibility of radical changes to the FSS system which would be very difficult to design, exemplify, consult on and implement between the end of this consultation period in mid March 2005 and the target for announcing the first multi-year allocations in November 2005. The Government's last attempt, in 2003/04, to reform the grant distribution system led to significant turbulence in grant allocations. As well as the large losses for Hampshire and other South East authorities, the unforeseen consequences (unforeseen by the Government) included the disruption of schools budgets that has eventually led to the Government proposing to transfer schools' funding to a ring-fenced specific grant in 2006/07.

1.8 If the Government maintains its intention of not revisiting the settlement during the multi-year period, there will be no opportunity to unscramble the impact of any of these changes until 2008/09.

1.9 The Authority may take the view that it would be better to postpone the introduction of three-year settlements by twelve months until 2007/08 when the position on these changes should be clearer.

1.10 The Government suggests in the consultation that it may legislate to require local authorities to publish three-year budgets and council taxes that could only be amended in "unforeseen circumstances". This could have the perverse effect of encouraging local authorities to set higher budgets on a precautionary basis, including higher reserves and balances, and should be resisted.

1.11 The Government's track record over the grant settlements from 2003/04 to 2005/06 illustrates the impossibility of fixing council taxes for two years ahead. It will be compounded by the one-off nature of funding in the 2005/06 settlement, formula changes in 2006/07, the unwinding of the grant floor for schools and the proposed ring-fenced specific grant for schools which has yet to be exemplified. Specific information on Gershon efficiency savings and the requirement for an efficiency plan in June each year are also not available.

2 The Government's proposals

2.1 The proposed three-year allocations for local authorities will mirror the Government's biennial Spending Review which is normally announced in the July prior to the first year of the three-year period. The Government envisages confirming the allocations to local authorities set in the previous Spending Review for year one, which would not normally be changed, and announcing for the first time firm and fixed allocations for years two and three. The last two years would reflect any new revisions to the distribution formulae as well as being based on new data. The proposals would give local authorities at least 18 months' notice of their grant allocations.

2.2 As the Government will be halfway through the current Spending Review period, the first multi-year announcement in November 2005 will be transitional. The full process is summarised in the following diagram for the Spending Reviews in 2006 and 2008.

2.3 The allocations will cover the revenue support grant settlement, most specific grants and most capital allocations.

2.4 The main points of the consultation paper are summarised in the following paragraphs, followed by a commentary.

3 Function changes and unforeseen circumstances

3.1 Main points:

· function changes will normally only occur as a part of Spending Reviews

· any unavoidable new burdens between Spending Reviews will be matched by additional specific grants

· adjustments for unavoidable transfers of function away from local authorities will be subject to consultation with local government

· authorities should have regard to existing legislation on appropriate reserves when deciding on the level of reserves to cope with unforeseen circumstances under three-year settlements.

Commentary:

3.2 Function and funding changes are currently amongst the more significant sources of uncertainty about grant levels. It remains to be seen whether all Government departments can be restrained from making mid-term changes. The promise of consultation about transfers out of local government gives little comfort. Specific grants for added functions should be allocated on a non-ring-fenced basis and absorbed within the general formula grant as soon as possible.

3.3 The requirement to publish three-year budgets may result in higher levels of reserves and balances for the later years of the three-year period, particularly if the proposed budgets and council taxes for those years are perceived as being set in stone. Higher reserves and balances would not represent an efficient use of resources.

4 Formula grant

4.1 Main points:

· the Government is considering a replacement of the existing Formula Spending Share (FSS) system overlaid with grant floors by a simpler system that recognises the overriding influence on grant allocations of the floor mechanism

· this could include a basic floor increase in grant for all authorities plus a variable top-ups to reflect each authority's relative service costs as calculated by formulae and, secondly, resource equalisation

· or a formula-based system with flat rate percentage increases in grant over the three years

· or an underlying formula-based allocation with percentage increases in grant for different groups of local authorities according to how close those groups are to the underlying grant distribution

· or a much simpler formula using just three or four indicators to cover all services including, presumably, Fire and Rescue.

Commentary:

4.2 Having introduced a new system of revenue grant distribution as recently as 2003/04 after a lengthy review, the Government now appears to be considering radical changes.

4.3 The consultation paper provides no further explanation of how these options might work in practice. It is difficult to interpret them from the very brief description in the consultation paper. The Government will have very little time to develop them into workable proposals prior to the first multi-year announcement next November. The results of a rushed job would be in place for 2006/07 and 2007/08 if the Government goes ahead with its proposals. There is a strong case for a deferment until 2007/08, so that these ideas can be properly developed and exemplified.

4.4 The Government's justification for possibly abandoning the existing Formula Spending Shares (FSS) system under three-year settlements appears to focus on the impact that relatively crude grant floors currently have in overriding the detailed FSS calculations. The Government envisages that floors will continue but a preferable solution would be to revert to a grant distribution that did not require such severe floors to protect authorities that lost grant so heavily in the 2003/04 review.

4.5 If a simplified system allocated a greater proportion of grant as `basic' amounts per client group and less as top-ups for deprivation, it could also work to the Authority's benefit. But it seems unlikely that the Government would devise a system that disadvantaged the authorities that gained in the 2003/04 review.

5 Changes in data used in FSS formulae

5.1 Main points:

· The Government suggests using forward projections of some data for the three-year period, including population and council tax base, whilst using frozen data for other indicators averaged over a number of years to smooth out volatility

· retrospective amendments to grant allocations will be avoided unless a major systematic error is found

· higher grant floors could be used in years where data changes in order to reduce volatility.

Commentary:

5.2 As a principle it is better to use up-to-date information for indicator data in FSSs, in line with the Authority's view of the Government's delay in using socio-economic data from Census 2001.

5.3 There will be a trade-off between the possible accuracy of data used in the formulae and the benefits gained from the certainty provided by three-year settlements.

5.4 A much simplified FSS system using fewer indicators would reduce the difficulties of keeping data up-to-date.

6 Specific grants

6.1 Main points:

· most specific grants will be allocated on a three-year basis

· exceptions could include grants that are paid in response to claims for actual expenditure, bid-based grants, grants based on performance or to support pilot projects.

Commentary:

6.2 The Government should reduce the exceptions as far as possible, eliminating the bid-based and performance-related grants. Even better would be to transfer specific grants into the general formula grant.

7 Capital allocations

7.1 Main points:

· firm three-year capital allocations are proposed

· bid-based allocations would be aligned to provide three-year allocations

· capital funding for emergencies could continue to be allocated as and when required - with the funding provided as capital grant rather than borrowing approvals that generate revenue support grant


·

Commentary:

7.2 In principle, local authorities need as much certainty as possible about future Government allocations for capital schemes for planning purposes.

7.3 It is not essential that capital funding for emergencies takes the form of capital grants, provided that borrowing approvals are fully matched by revenue grant towards the loan charges.

8 Three-year budget and council tax information

8.1 Main points:

· local authorities to publish three-year budgets and council tax figures

· initially publication would be on a voluntary basis as primary legislation would be required, but this is likely to become a statutory requirement once legislation is enacted

· publication could be on websites or by inclusion in the budget leaflets sent to council tax payers with their bills

· parishes and other levying bodies may also be required by statute to provide three-year figures to local authorities

· local authorities' ability to alter their three-year projections of budgets and council tax could be limited to "unforeseen circumstance", either on a voluntary or statutory basis

· capping powers will be retained by the Government, covering the three-year period.

Commentary:

8.2 Unlike other organisations to which the Government has cascaded its three-year financial plans, local authorities are tax-setting bodies. They are also elected and the Government should not force local authorities to publish budget plans including the resultant council taxes for future years, particularly for periods that overlap local elections. It would be wrong for an outgoing administration to commit its successor for two or three years. Given the electoral patterns of the Cities and the County Council, political power on this Authority could change on an annual basis and the new administration should not have to wait for two or three years to set its own budget or council taxes, either above or below previously published levels.

8.3 Whilst the Government publishes three-year spending plans, it does not commit itself to the rates of income tax, VAT or national insurance for those three years. Nor have its spending plans remained unchanged over the Spending Review period as, in both 2004/05 and 2005/06 local authority grant settlements, the Government has increased its planned support for local authority spending at short notice.

8.4 The recent move to three-year national pay settlements would also have to be maintained if local authorities are to have the necessary certainty about a major part of their cost base for the three-year period.

8.5 The Authority publishes each year a forecast of its budget for years two and three based on current policies. This is not intended to be a fully costed three-year financial plan including new developments and initiatives. The projected percentage increase in the council tax for years two and three are also published, based on assumptions about Government funding. None of this information is included in the budget leaflet sent to each council tax payer. Further statutory requirements to publish information is not necessary.

8.6 There can be no objection to publishing indicative figures for budgets and council taxes for a three-year period. Medium term planning is an important financial management tool which can help to promote longer term stability and certainty. But local authorities should retain full flexibility to change their published budgets and council taxes for years two and three as they see fit, irrespective of the electoral cycle. They can be encouraged, or even required, to explain any such changes but it is important that local authorities, like central Government, retain the freedom to amend their tax raising policy on an annual basis and not just in "unforeseen circumstances".

8.7 No commercial organisation would commit itself to such rigidity in a constantly changing environment. A three-year plan is a plan - and plans, by definition, should be capable of being amended to adapt to new circumstances such as political changes at the national or local level, economic cycles, etc. It should not be a straitjacket forced on local authorities that would undermine the credibility of the underlying three-year planning process.

9 Recommendations

9.1 That the Treasurer in consultation with the Chairman, be authorised to submit a written response to the Office of the Deputy Prime Minister on behalf of the Authority to the proposals for three-year settlements.

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:

1. Published works.

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

TITLE FILE

ODPM consultation paper on Three-year Revenue and Capital Settlements issued 15 December 2004