Communities and Local Government Committee. Reforming Local Authority Needs Assessment

Transcription

1 LG FUTURES Communities and Local Government Committee Reforming Local Authority Needs Assessment Paper 2 Simplifying the Funding Model October 2017 FINANCE WITH VISION LG Futures Ltd., Marlowe House, Watling Street, Hockliffe, Leighton Buzzard LU7 9LS T Incorporated in England and Wales under registration number: VAT registration number:

2 Contents Contents 2 1. Key Points Overview of the Formula Funding Model Implications for Funding Critiques of the Current Funding Model A Simplified Funding Model Potential Disadvantages of the Simplified Model Conclusions... 23

3 1. Key Points The Department for Communities and Local Government (DCLG) is currently undertaking a Fair Funding Review of local authority funding allocations. This review was originally initiated alongside plans for the introduction of 100% business rate retention, which was planned for 2019/20. Whilst indications from the government are that there will be movement towards 100% nationally, it is likely that this will not take place in the timeframe originally intended and that there will be no stepped change to the scheme as soon as 2019/20 (i.e. from 50% to 100% retention). The Fair Funding Review will determine the future funding allocations, whether these are delivered in the form of retained business rates, central government grants, or a combination of the two. One determinant of a local authority s funding level is its level of assessed needs. The first paper in this series demonstrated a method for reducing the complexity of the needs assessment formula, using the current Relative Needs Formula (RNF) as an example. This paper focuses on the broader funding model. This is the mechanism that converts each local authorities assessed needs into funding. Simplifying the needs assessment formula, without also simplifying this wider funding model, would not necessarily improve the transparency of the overall system and its accessibility to relevant stakeholders. A major source of complexity is the Formula Funding model, which was used to allocate 17.9 billion in funding in 2013/14. 1 In general terms, this model distributes a notional amount of funding between local authorities on the basis of their assessed needs (as measured by the RNF). The model also deducts funding based on authorities ability to fund services through council tax, as measured by their council tax base (Band D-equivalent properties). Complexity arises because these allocations and deductions are not made in proportion to each authority s assessed needs or council tax base. In other words, there is not a simple -terms allocation for each unit of need, or a simple -terms deduction for each council tax property. Instead, a highly complex system of thresholds is used. For groups of authorities providing similar services, the threshold authority is defined as the council with the smallest needs per head, and with the smallest council tax base per head. Each authority s units of need (or properties) above this threshold are effectively converted 1 The figures referred to in this report exclude police authorities, the Greater London Authority and the Isles of Scilly. FINANCE WITH VISION 3

4 into funding (or deductions) at one rate, while those below threshold are converted into funding (or deductions) at another rate. The use of thresholds greatly increases the complexity of the funding allocation formula. It also causes major changes to the way in which funding is allocated. In some years, the effect is to skew funding towards authorities with high needs and small council tax bases per resident; in other years, it has the opposite effect, favouring authorities with low needs per head and large council tax bases. These effects are unpredictable, opaque, and are unlikely to be understood by most local government practitioners. Since its introduction in 2006/07, the current version of the Formula Funding model has been criticised for its perceived complexity, lack of transparency, and potentially unfair funding allocations. Critics have included local councils, the Local Government Association and academic researchers. For example, researchers at the University of Plymouth have concluded that the model is deeply flawed and generates an inequitable allocation of this major source of local authority revenue. 2 Simplicity and transparency could be greatly improved by reverting to a system in which funding is allocated in direct proportion to assessed need, and in which resource deductions are applied in direct proportion to each authority s council tax base. This would eliminate the use of thresholds, and would be similar to the system that existed prior to 2006/07. One reason thresholds were introduced in 2006/07 was to break the link between each authority s assessed needs and its level of funding. This was to avoid what the government perceived as a widespread misinterpretation of the previous system, where notional funding and council tax figures were confused with actual spending targets or forecast changes in council tax. 3 The paper acknowledges that increasing the transparency of the funding formula will restore a direct link between an authority s assessed need and its notional funding, and therefore the potential for this misunderstanding. However, this risk is mitigated by other features of the funding system which break the link between an authority s assessed funding allocation and the actual revenue it receives, such as changes in locally retained business rates revenue. The current use thresholds may serve as a discretionary policy lever, providing DCLG with additional criteria that can be used to distribute funding amount local authorities in 2 Gibson, A. and Asthana, S., Resource allocation for English local government: a critique of the four-block model, Journal of the Royal Statistical Society, 2011, p Lyons Inquiry into Local Government Final Report, Annex A: Understanding the Current Grant Distribution System, 2007, p.5, p.8. FINANCE WITH VISION 4

5 L England. However, similar outcomes could be achieved through more direct and transparent discretionary tools, as outlined in this paper. FINANCE WITH VISION 5

6 2. Overview of the Formula Funding Model 2.1. DCLG is currently undertaking a Fair Funding Review of local authority funding. This review was originally initiated alongside plans for the introduction of 100% business rates retention, which was planned for 2019/20. Whilst indications from the government are that there will be movement towards 100% nationally, it is likely that this will not take place in the timeframe originally intended and that there will be no stepped change to the scheme as soon as 2019/20 (i.e. from 50% to 100% retention) The Fair Funding Review will determine the future funding allocations, which could be delivered in the form of retained business rates, central government grants, or a combination of the two The first paper in this series considered simplifications to the needs assessment formula. This paper considers simplifications to the broader funding model, which is used to convert each authority assessed needs (and its council tax base) into funding A major source of complexity in local government funding is the Formula Funding model. The model was used to distribute 17.9 billion 4 in funding in 2013/14, and was part of each authority s Start-up Funding Assessment (SFA). The SFA was delivered to each local authority in the form of (a) Revenue Support Grant from central government, and (b) as baseline funding under the current business rate retention scheme. 2013/14 was the final year in which local authorities funding shares were calculated; in subsequent years, funding shares were effectively frozen. 5 The relationship between the various components of the funding system are illustrated below. 4 All figures in this section exclude police authorities, the Greater London Authority (GLA) and Isles of Scilly. 5 From 2014/15 funding was cut at a uniform rate for all authorities with similar functions and responsibilities. From 2016/17, local authorities council tax revenue was also taken into account when in determining cuts. FINANCE WITH VISION 6

7 Chart 1: Relative Needs Formula, Formula Funding and the wider funding system, 2013/14 Formula Fundi111g Start-Up Fund-111g metrics Assessment 24.9blll,.;-~ [ ~~::~ ~ AIKwe ', 1 Relative Needs fhreshold Needs Block ~ Fcmm.da F111lding Formula 15. lllm (Units of Needl) l , 17.9tm I I I Below' l Oeillral Block 1 1 Other Grams fhreshold J 8. 1b ~ 7.Albn Council 1ax base,(number of propeirties) l Resource Bloclk I ' Aoove.. 6.2bn -:--.J '... _fi]m,s,!iq!g.../ """ ': ~ ' Tailored Grartts 1 2.0bn ~ I The focus of fhis paper J Damping Block ~... 0,0bn Figures shown in this diagram exclude po1fce euthorilies, the GlA 8nd the Jsfes of Sci1Jy. Trarnsfers.. 1.0lm Delivery meclhanism ~ Revenue St.1pport 60% Gram 15.otm Retained business rales baseline 10.0bn 40% FINANCE WITH VISION 7

8 2.5. This paper focuses on the Formula Funding model. Specifically, we focus on a key source of complexity in the model - the use of blocks and thresholds The 2013/14 Formula Funding model comprised the following five blocks: 6 A Needs Block of 15.0 billion, allocated using the Relative Needs Formula (RNF). Specifically, this funding was allocated in proportion to each authority s needs above a threshold. The threshold is defined as the minimum needs per head from among all local authorities that deliver a common set of services. A Resource Block, a negative figure of 6.2 billion, which reflects each local authority s capacity to fund services through council tax. This is measured using the number of Band D-equivalent properties. Deductions are allocated to authorities based on the number of properties above a threshold, where the threshold is the minimum number of properties per head from among all comparable local authorities. A Central Block, of 8.1 billion, is sometimes described as being allocated on a percapita basis. It is actually based on each authority s needs per head below the threshold and properties per head below the threshold, described in more detail below. Tailored Grants of 2.0 billion are allocated within the Formula Funding model using bespoke allocation criteria (rather than the Relative Needs Formula). The Damping Block ensures that the year-on-year change in local authorities funding (from the four blocks above) will not fall below a given floor. The level of the floor depends the type of authority and its reliance on central government funding (versus council tax revenue). 7 The floors are financed by scaling back the amount of funding received by authorities above the floor. In this way, the block is entirely selffinancing The calculations underlying these allocations are publicly available, but are highly complex and unlikely to be well understood by a non-specialist audience. 8 To illustrate this complexity, Annex 3 provides a step-by-step description of how each local authority s assessed needs and properties are converted into monetary values in the form of its Needs, Central and Resource block allocations. 6 In addition to these blocks, there was a also transfer of funding of 1.0 billion away from local government to reflect a share of central education functions being assumed by academies. 7 In 2013/14, the value of the floors ranged from -2.7% to -11.7%, excluding police authority floors. 8 The Formula Funding model for 2013/14 can be accessed here: FFmodels.xls FINANCE WITH VISION 8

9 2.9. DCLG s model can be simplified, mathematically, to show that each authority s allocations can be expressed as follows: Each unit of need 9 above the threshold is allocated funding worth x, delivered through the Needs Block. Each property above the threshold receives a deduction in funding of - y, delivered through the Resource Block. Each unit of need below the threshold is allocated funding worth x, multiplied by a scaling factor, delivered through the Central Block. Each property below the threshold receives a deduction in funding of - y, multiplied by a scaling factor, also delivered through the Central Amount A worked example of this simplified calculation is provided in the table below. This shows the calculations used to determine Formula Funding for the shire district of Adur, which was 2.997m. 10 In this year, the scaling factor was equivalent to 70.1%. Table 1: Illustration of Adur s Formula Funding in 2013/14 Number of units of need for Adur Above the threshold A Below the threshold B Number of properties for Adur Above the threshold 1, C Below the threshold 2, D Funding and deductions (for all authorities) Funding per unit of need 71,885 x 1 million E Deduction per property - 1, F Scaling factor % G Final funding calculation for Adur Funding for needs above the threshold 1.512m H = A * E Deduction for properties above the threshold m I = C * F Funding for needs below the threshold 4.484m J = B * E * G Deduction for properties below the threshold m K = D * F * G Total funding* 2.997m * From the Needs Block (H), Resource Block (I) and Central Block (J+K) It is important to note that the scaling factor is not made explicit in the Formula Funding model, but has been derived mathematically by LG Futures. 9 RNF measures need in purely relative terms, using an arbitrary scale, as opposed to a common unit of measurement such as pounds ( ). In this report, the measurements are referred to in terms of units of need. In DCLG s original formula, the number of units of need for all authorities in England sums to This is the sum of the Needs, Central and Resource allocations, but excludes tailored grants and damping. In the actual Formula Funding model, this is presented as a Needs amount of 1.512m (line H in the table above), a Resource deduction of 1.268m (line I), and a Central amount of 2.753m (the sum of lines J and K). FINANCE WITH VISION 9

10 3. Implications for Funding 3.1. The implications of the scaling factor and thresholds are two-fold. First, they make the funding formula much more complex. Rather than simply allocating notional funding in proportion to each authority s relative need, and allocating deductions based on the size of each authority s council tax base, a complex system of thresholds must be used. Different thresholds are calculated for different tiers or groupings of local services, as illustrated in Annex Second, thresholds arguably distort the distribution of funding between local authorities. Thresholds and the scaling factor mean that needs (properties) above the threshold are converted into funding (deductions) at one rate, while needs (properties) below the threshold are converted into funding (deductions) at another rate. Because some authorities have a larger share of their total needs and properties above the threshold than others, this has consequences for the distribution of funding All else being equal: A scaling factor of less than 100% will (i) increase the share of funding for local authorities with high needs per head, and (ii) increase the share of deductions faced by local authorities with a larger number of properties per head. A scaling factor of more than 100% will (i) increase the share of funding for local authorities with lower needs per head, and (ii) increase the share of deductions faced by local authorities with a smaller number of council tax properties per head The effect of scaling on shire districts needs-based funding is illustrated below. 11 This shows the relationship between each authority s assessed needs per head (horizontal axis) and funding per unit of need (vertical axis). 12 The chart shows that authorities with higher needs per head also receive a higher average level of funding for each unit of need. For example, in 2013/14, the shire district with the highest level of needs per head received 14.6% more funding per unit of need than the district with the lowest needs per head. In other words, shire districts with higher levels of need received more funding per resident both because (i) they have more units of need per resident, and (ii) they received higher average funding per unit of need. 11 We focus on a single type of authority, in this case shire districts, to enable a like-for-like comparison between councils providing the same range of services. However, the effects described are the same for all groups of local authorities. 12 Funding refers to each authority s notional allocation, based on units of need, delivered through both the Needs and Central Blocks. This was calculated by LG Futures, derived mathematically from DCLG s original Formula Funding model. FINANCE WITH VISION 10

11 Chart 2: Average funding per unit of need versus needs per head (shire districts) Highest-need district " II & ,('0,,(!J) ~ -'O,(!J) ~ 100 Q, :=:,c ;:::,,._,Cil),,(l_ i? 9'5 ;a,c ::J u Lowest-nee district ' Needs per head (average = 100) Year The scaling factor is determined indirectly by DCLG, based on its choice as to what the size the Needs, Central and Resource Blocks should be. 13 This has varied significantly between years. For the years 2008/09 to 2010/11, the scaling factor was greater than 100%, meaning it had the opposite effect on resource allocation to that in the latest settlement. In these years, revenue was reallocated away from authorities with high needs and small tax bases per head, and towards those with low needs and high tax bases per head. The chart below illustrates how the impact of the scaling factor on shire districts funding has changed over time. 13 As described above, the scaling factor is determined by an interaction between (a) the relative size of the Needs, Central and Resource blocks, at the England level, and (b) the thresholds for needs per head and the thresholds for properties per head. Holding all else constant, a change to either the relative block sizes, or the levels of the thresholds, is sufficient to change the scaling factor. FINANCE WITH VISION 11

12 Chart 3: Average funding per unit of need versus needs per head (shire districts) ~ 0 0 II 105 8, a, a5 ~ -'O Q) Q) C C :J._ <I> a. 0, C u C :J LI Year 2008/ / / / / /14 Needs per head (average = 100) 3.6. The change in scaling factors over time represent a fundamental shift to the basis on which funding is allocated. The implications of the changing scaling factor can be illustrated by considering the case of two shire districts, Pendle and Test Valley: In 2008/09, Pendle and Test Valley had virtually identical levels of total assessed needs (a difference of less than 0.03%). Despite this, Pendle was allocated 4.7% less notional funding than Test Valley. 14 This is because Pendle s total needs were the product of a smaller population and higher needs per resident than Test Valley. The effect of the scaling factor in this year was to skew funding to the authority with lower needs per resident, even though they had the same assessed needs overall. By 2011/12, Pendle s assessed needs were 2.0% lower than Test Valley. However in this year, Pendle received 7.6% more notional funding than Test Valley. This is because the effect of the scaling factor was reversed in 2011/12, at which point funding was reallocated towards authorities with higher needs per resident, all else being equal. 14 This only considers needs-based funding, i.e. notional funding based on units of relative need. It does not include the offsetting resource-based deduction in funding, based on the number of properties. FINANCE WITH VISION 12

13 L 3.7. Despite its fundamental impact on the allocation of funding, the rationale for changing the scaling factor each year does not appear to be explicitly stated by government. It is unclear as to whether this is conscious policy decision to alter the basis on which funding is allocated, or an incidental result of other adjustments to the model. The level of the scaling factor appears to have rarely been addressed in consultations prior to funding settlements, with the exception of 2011/12, when it was proposed that the effects of the scaling factor should be greatly reduced (discussed below). The size and effect of the scaling factor is not made explicit in the Formula Funding model, and so it is unlikely that the implications are understood by the majority of local government practitioners. FINANCE WITH VISION 13

14 4. Critiques of the Current Funding Model 4.1. Since its introduction in 2006/07, the current version of the Formula Funding model has been criticised as complex, lacking in transparency, and potentially unfair, as referenced further below When DCLG consulted publicly on the introduction of the model it was supported by only 4% of respondents. The majority of those rejecting the proposal considered it too complex, less transparent than the existing system and subject to more Ministerial judgement, 15 though the government disagreed that this was the case The changes were also opposed by the Local Government Association (LGA), who believed that the model obscures rather than clarifies key decisions about grant changes. 17 The LGA later argued that, while local treasurers could understand and explain the previous system, the new model never secured that degree or acceptance or understanding within local government. 18 The House of Commons Committee of Public Accounts described the current system as highly complex and not sufficiently transparent, making it virtually impossible to follow the link between calculated service needs and funding allocations. 19 DCLG has acknowledged that the grant system is extremely complex Academics at the University of Plymouth argued that behind this complexity the model is, in fact, deeply flawed. 21 They pointed to the effect of thresholds which altered the average rate at which authorities needs and properties were converted into funding. They concluded that this resulted in a funding allocations that cannot be fair in that it leads to inconsistent funding relative to the measured level of need and estimated capacity to raise council tax The same researchers described the instability of the model due to thresholds. They illustrated how small changes in the assessed needs of a threshold authority (such as Wokingham) would be sufficient to cause major reallocations in funding across England. This point was also raised by the National Audit Office, who noted that a hypothetical 5% 15 Office of the Deputy Prime Minister, Consultation on Formula Grant Distribution: Summary of Representations, 2005, p House of Commons debate 5 th December 2005, column Cited in Gibson, A. and Asthana, S., Resource allocation for English local government: a critique of the fourblock model, Journal of the Royal Statistical Society, 2011, p Local Government Association, Formula Grant Distribution consultation LGA Response, 2010, p House of Commons Committee of Public Accounts, Formula Funding of Local Public Services: Fifty-fifth Report of Session , 2011, p Cited in National Audit Office, Cross-government landscape review: Formula funding of local public services, 2011, p Gibson, A. and Asthana, S., Resource allocation for English local government: a critique of the four-block model, Journal of the Royal Statistical Society, 2011, p.530. FINANCE WITH VISION 14

15 reduction in Wokingham s relative needs for upper tier services in 2011/12 would have led to 235 million being redistributed between local authorities across England (including a shift of 111 million out of London). This is despite there being no change in these other authorities assessed levels of need, and the fact that Wokingham s original funding was only 10.4 million National Audit Office, Cross-government landscape review: Formula funding of local public services, 2011, p.26. FINANCE WITH VISION 15

16 L 5. A Simplified Funding Model 5.1. This section considers a simple alternative to the current Formula Funding model which would potentially improve its transparency and stability. Under a simplified funding model, total funding would be allocated in proportion to each authority s share of assessed needs, and total deductions would be applied in proportion to each authority s share of the total council tax base. The outcome would be similar to the funding system that was in place prior to the introduction of the current model in 2006/ The simplified model could be presented as each authority receiving x per unit of assessed need (via a Simplified Needs Block ) and have y deducted per property (via a Simplified Resource Block ). Such a model is illustrated below Under this approach, the Central Block could be eliminated. Thresholds would be redundant (with the scaling factor effectively fixed at 100%) and so could also be eliminated. Because thresholds would no longer be used, it would not be necessary to first split each authority s assessed need between service tiers, as is currently the case (illustrated in Annex 3); notional funding would simply be allocated in proportion to each authority s overall assessed need. It is assumed that DCLG would continue to specify the share of the council tax base that is apportioned between each tier of government, i.e. between the Upper, Lower, Fire and Police tiers This simplified approach would allow local authorities to identify a direct link between their assessed need for each service and notional funding. For example, it would allow an upper-tier authority to identify how much of its notional funding was attributable to Children s Social Care versus Highway Maintenance. This is not the case in the current model. It would also allow authorities to identify how much notional council tax revenue they were assumed generate for the purpose of the funding allocation formula. It is noted, however, that the current system avoids such direct links, given the potential misinterpretation of notional funding and council tax amounts as determining local authorities actual budgeting and tax rate decisions. This is discussed in more detail below. FINANCE WITH VISION 16

17 Chart 4: A simplified Formula Funding model ] asses:sed 111eec:ls (uni1ts o1f RiNF) Oou 111cil tax base tpmpemties) SpM between tiers based on assumed sh8res k("' Upperliier tax base w ILO'lver Trer t.aoc base Fire liier tax oose wm applicbblf! tiers. s_h_ar_,e_u_f_lo_ ~~a_l p_ro_p_e._r1_ie_s,~ I ~by x per u nit of need y per property Fumlirng foc ooeds ( ) S1im pi ified Needs AmrOl!1 nl Deduction for properties ( ) SimpUied Res,ou1rce Almount 5.5. To assess the potential impact of moving to a simplified formula, we examined what the impact on local authorities funding would have been in 2013/14. We considered how much authorities actually received from the Needs, Central and Resource Blocks, compared to what they would have received using a (hypothetical) Simplified Needs Block and Simplified Resource Block. FINANCE WITH VISION 17

18 5.7. It was first necessary to make assumptions about the size of these blocks under the hypothetical scenario. Under the simplified model, at the national level, the size of Simplified Needs Block (in billion) and Simplified Resource Block (- billion) would presumably continue to be set by judgement. For exemplification purposes, the approach used in this paper was to select the combination of block sizes that would have minimised the median (absolute) percentage change in local authorities funding, relative to what they actually received in 2013/14. The full process used to arrive at these figures is presented in Annex Based on this criteria, we found that introducing the simplified funding model would have had the following impacts: Half of all local authorities would have experienced an absolute change in funding of ±1.5% or less, relative to what they actually received in 2013/14; 90% of local authorities would have experienced an absolute change in funding of ±4.7% or less; and. The largest change was ±91.6% (though this was something of an outlier), with the second largest change being ±21.9% To put this impact in context, we also looked at the actual change in local authorities funding between 2012/13 and 2013/14. To enable a like-for-like comparison between years, we scaled each authority s funding as though a consistent quantum of funding had been available at the England level in both years. Moving from 2012/13 to 2013/14, the impact on local authorities funding levels were as follows: Half of local authorities experienced an absolute change of ±5.3% or less; 90% of local authorities experienced an absolute change of ±16.6% or less; and The largest change was ±82.1% (with the second largest change being ±70.9%) In other words, for the majority of authorities, introducing the simplified model would have had a much smaller impact on their share of funding than the change they actually experienced between 2012/13 and 2013/14, controlling for funding at the England level. 23 Furthermore, all of the changes referred to above relate to notional funding, before the use of floors or damping. The effect of the Damping block would be to further reduce the change in each authority s actual or cash-based funding, relative to the figures listed above There is evidence that such changes would be welcomed by local government. In its consultation on the 2011/12 formula grant distribution, DCLG proposed changes which would have largely eliminated the effect of thresholds. They reported that the vast majority of authorities that responded believe the scaling factor should be set close to one [i.e. 100%] as this would increase the clarity, stability and fairness of the formula giving equal 23 The impacts would have been larger had we not controlled for changes in the total amount of available funding, given large cuts between 2012/13 and 2013/14. FINANCE WITH VISION 18

19 importance to both relative needs and resources above and below the minima [i.e. thresholds]. 24 This indicates that there could be wider support for a change which removed the effect of thresholds, which would be a key feature of the simplified formula described here Department of Communities and Local Government, Consultation on Formula Grant Distribution: Summary of Representations, 2011, p There is an important difference between setting the scaling factor close to 100% and setting it exactly equal to 100%. Both options would eliminate some or all of the funding reallocations caused by thresholds. However, setting the scaling factor close to 100% would still require the use of thresholds (however trivial their impact on funding might be), and so would not improve the simplicity of the formula. Only by setting the scaling factor to exactly 100% would DCLG be able to dispense with thresholds and the Central Block, greatly reducing the model s complexity. FINANCE WITH VISION 19

20 6. Potential Disadvantages of the Simplified Model 6.1. There are at least two potential disadvantages to the simplified funding model: First, given the model s transparency, relevant stakeholders could potentially misinterpret notional funding for each service as prescribed spending shares, or misinterpret notional council tax revenue as a determinant of what their actual council tax levels should be. Secondly, the use of thresholds and scaling factors provides DCLG with an additional policy lever with which to reallocate funding among authorities across England. (i) Model Transparency 6.2. The current funding model was introduced in response to the first of these problems. The Lyons Inquiry into Local Government reported that the new model was introduced to get away from what the Government regarded as the widespread misinterpretation of some components of the previous system, particularly the tendency for notional spending and council tax figures to be confused with actual spending targets or forecast changes in council tax. 26 In a 2011 review of national funding formulae, the National Audit Office confirmed with DCLG that one of the main objectives of the model was to avoid what the previous Government identified as a misunderstanding associated with the previous system; that there were direct links between calculated levels of need and funding allocations, which local authorities used to set local budgets and council tax The simplified model described here would allow direct links to be drawn between assessed need, properties and funding, and so could be subject to this criticism Were a simplified funding system to be introduced, any misinterpretation of the funding calculations could be mitigated through direct communication with local government. The LGA has previously stated that if a simplified approach were used then it would be understood that the needs total and the assumed council tax used within this model were government assumptions for the purpose of deriving grant totals and not figures against which actual spending or council taxes could be compared Nevertheless, it is recognised that a fully transparent system could result in pressure on local authorities to account for differences between notional funding for each service and 26 Lyons Inquiry into Local Government Final Report, Annex A: Understanding the Current Grant Distribution System, 2007, p.4,8. 27 National Audit Office, Cross-government landscape review: Formula funding of local public services, 2011, p Local Government Association, Formula Grant Distribution consultation LGA Response, 2010, p.2. FINANCE WITH VISION 20

21 actual expenditure shares, or between notional tax revenue and the council tax rates paid by local residents There are, however, other features of the current funding system which obscure the link between a local authority s assessed need for each service (and its council taxbase) and the amount of revenue it receives First, assuming that damping continues to be used to minimise year-on-year changes in funding, then the actual funding received by authorities (net of damping) differs from the assessed funding levels determined by the underlying formula. Second, if funding continues to be delivered in the form of retained business rates, then the actual revenue received by local authorities would diverge from their assessed funding levels, due to growth (or reductions) in their business tax base. These factors serve to break the link between an authority s assessed needs, its council taxbase, and the actual revenue it receives. (ii) Policy Levers 6.8. The use of blocks and thresholds in the current funding formula could also serve as policy levers with which to reallocate funding between local authorities. One effect of varying the size of the Needs, Central and Resource Blocks is (via the scaling factor) to change the average rate at which each authority s needs are converted into funding, and the average rate at which each property is converted into assumed amounts of council tax revenue. For each authority, these rates depend on the proportion of their needs and properties that are above and below the thresholds By eliminating thresholds, the simplified approach would eliminate one of the policy levers at the government s disposal. The government would still have discretion over the relative size of the Simplified Needs Block and the Simplified Resource Blocks. However, unlike the current system, these would be allocated among local authorities in direct proportion to their assessed level need and number of properties, respectively To compensate for the loss of the scaling factor, additional policy levers could be introduced. One option would be to transform each authority s assessed level of need at the outset of a retention period. For example, if A represents local authorities assessed need per head for a particular service (for example, Children s Social Care) then this could be transformed using the function A x, where the value of x was set by judgement The function described here, A X, is just an example and potentially any transformation could be used. The transformed needs for every authority could be scaled so that they summed to the original control total. FINANCE WITH VISION 21

22 L This relationship could then be used to reallocate funding as follows: Setting x to exactly one would mean funding was allocated in proportion to assessed needs; Setting x to a value greater than one would increase the share of funding received by authorities with high needs per head; and Setting x to less than one would increase the share of funding received by authorities with lower needs per head Similar transformations could also be applied to local authorities tax base per head. This could increase or decrease the deduction in funding assigned to each local authority, depending on whether it had a larger or smaller number of properties per resident. These discretionary changes could be applied as a one-off change to each authority s baseline funding position at the outset of the funding scheme to be introduced. The approach described above would be more complex than if funding were allocated in direct proportion to each authority s relative needs and tax base. However, it would make policy judgements more explicit and transparent than is currently the case. FINANCE WITH VISION 22

23 L 7. Conclusions 7.1. The first paper in this series considered ways in which DCLG s needs assessment formula could be simplified. This paper considers the broader funding model, and the way in which assessed needs is converted into funding. It is argued that simplifying the needs assessment formula is necessary, but not sufficient, for improving the transparency of the overall funding system. Even a simplified needs assessment formula, if introduced, would remain subject to the wider funding system which has been described by critics as complex, lacking transparency, unstable, and potentially unfair A simple solution, suggested in this paper, is that funding be allocated in direct proportion to authorities assessed needs, and resource deductions be applied in direct proportion to authorities council tax bases. The resulting allocations could then be subject to damping to minimise year-on-year fluctuations in funding, as is currently the case. This is not a novel approach, and would be similar in practice to the funding model that was in place prior to 2006/ Such a simplified approach would not rule out the use of ministerial judgement. Nearly all the discretionary aspects of the current funding system could be retained (for example, the relative quantum of needs-based funding and resource-based deductions at the England level). One discretionary policy lever the poorly understood needs and resource thresholds would be eliminated, but could be replaced with better targeted and more transparent adjustments to the funding formula The risk is that such a simplified funding formula could become too transparent, in the sense that directly-observable links between assessed needs and funding (and between council tax bases and funding deductions) could be misinterpreted as targets guiding local authorities spending and council tax decisions. This risk is mitigated by features of the system which break the link between an authority s assessed funding and the actual revenue it receives However, it is acknowledged that under a simplified system local authorities may come under increased pressure to justify perceived differences between funding allocations and their spending patterns. Ultimately, it must be left to policy makers to weigh these relative costs and benefits and to decide on the optimal level of transparency for the local government funding system. FINANCE WITH VISION 23