Tax by tax, spend by spend

Locally financed expenditure

This Forecast in-depth page has been updated with information available at the time of the March 2023 Economic and fiscal outlook. We are aware of a technical issue with our tableau charts across the site. Access the data from our March 2023 forecast and our November 2023 forecast supplementary tables directly.

The Treasury manages public spending within two ‘control totals’ of about equal size:

  • departmental expenditure limits (DELs) – mostly covering spending on public services, grants and administration (collectively termed ‘resource’ spending) and investment (‘capital’ spending). These are items that can be planned over extended periods.
  • annually managed expenditure (AME) – categories of spending less amenable to multi-year planning, such as social security spending and debt interest.

Within resource DELs (RDEL) are grants that finance local authority spending, in particular the Revenue Support Grant from the Department for Levelling Up, Housing and Communities (DLUHC) and the Dedicated Schools Grant from the Department for Education. This spending is factored into our DELs forecasts. Local authorities are also able to finance spending through local sources – notably council tax and business rates. This spending needs to be accounted for in our AME forecast. We call it ‘locally financed expenditure’. As with other spending, it is split into current and capital components.

In our March 2023 forecast, we expect locally financed expenditure in 2023-24 to total £69.9 billion (with £60.3 billion of current expenditure and £9.6 billion of capital expenditure). That would represent approximately 31.9 per cent of total local authority spending (i.e. including that financed by central government grants) and around 5.9 per cent of total public spending. It is equivalent to £2,455 per household and 2.7 per cent of national income.

  Forecast methodology

Forecast process

The Treasury and DLUHC produce the majority of the locally financed expenditure (LASFE) forecasts using assumptions and judgements that we supply. These forecasts are then scrutinised by OBR staff and the Budget Responsibility Committee. We make judgements about the spending choices of local authorities (LAs) using the latest information from LAs’ annual budgets and other in-year spending returns, which we adjust in light of how outturns have compared with previous in-year returns. We also incorporate updated projections from Scotland and Wales on local taxes (e.g. non-domestic rates), which are used to finance spending that is covered in our LASFE forecast.

Some of the main components of current LASFE are also included in our receipts forecast, most notably council tax and business rates. (Current LASFE includes the 50 per cent of business rates that have been retained by English local authorities since 2013-14, all Scottish business rates and all Welsh business rates from 2015-16 onwards. The Government has announced that local authorities in England will be able to retain all business rates in the future, but that this will be accompanied by further changes to ensure that the policy does not add to borrowing. These have not yet been specified, so we have not included the effects of the full policy in our forecast yet. Some pilot schemes are underway, the effects of which have been factored into our forecast.)

Forecasting models

We forecast LASFE by generating a forecast for total local authority income – from grants, council tax, business rates and so on – and then making a judgement about whether LAs in aggregate will spend more or less than that amount. A number of different forecasting models are used in producing each element of our current and capital LASFE forecasts. These are typically owned by the Treasury or DLUHC, with the models and outputs quality assured by the OBR. Two of the main sources of financing for LASFE are council tax and business rates. As with all forecast models, it is important to remember that the forecast itself reflects the assumptions and judgements fed into the model – the responsibility of the Budget Responsibility Committee – rather than model itself.

Main forecast determinants

The main economic determinants driving the forecast are:

  • Residential property forecast (including house prices and property transactions): used to forecast growth rates for local authority housing sales.
  • Commercial property forecast: used as a proxy to inform our forecast for non-housing asset sales.
  • CPI inflation, affecting business rates uprating and council tax uprating for the period beyond which uprating policy is currently set.

The latest local government settlement (within DELs) is also a key driver, determining how much LAs need to self-finance their spending.

Main forecast judgements

There are 333 principal local authorities in England alone, so forecasting LASFE bottom-up by aggregating forecasts for each authority is not feasible. Our forecast involved a range of judgements in light of the information available in annual LA budgets, in-year quarterly outturns and historical trends. These information sources can be revised substantially over time.

Our main judgements include:

Current LASFE

  • Council tax: this involves judgements about growth in the council tax base (i.e. the number of taxable properties) and the rate at which council tax will rise over time. That in turn is based on judgements about the effects of government policy – e.g. the centrally-imposed referendum cap or social care precept in England in recent years, and the parameters of localised reduction schemes (which are determined locally and vary in scope and generosity across authorities) – and historical trends. Since we assume that virtually all LA income is spent, these judgements are important for the level of receipts and spending, but are neutral for borrowing.
  • Local authority reserves: the financial position of each LA is different, and while some LAs will regularly run a large surplus and add to reserves each year, others will draw down some reserves to finance spending. Our LASFE forecast uses an aggregated estimate for the change in the level of LA reserves, based on the latest in-year data for the current year and our judgement about spending pressures for future years.
  • Interest receipts: while some information is available about the stock of LA investments, there is little detail on LAs’ rates of return or the maturity of investments. We therefore have to apply judgement to generate a forecast, drawing on recent interest rates available to LAs, our own interest rate assumptions and outturn trends.
  • Capital expenditure financed from the revenue account (CERA): while the impact of CERA on the overall LASFE forecast is neutral (higher capital expenditure offset by lower revenue expenditure), it does impact on the split between current and capital and there is significant year on year variation.

Capital LASFE

  • Borrowing: some indication of the level of LA borrowing, and plans to spend it, is available in annual budgets for the year ahead; however, this can prove inaccurate in relation to both the size and the timing of the borrowing and spending. Again, some judgement is required to mitigate the risk of over or under-estimating the level of spending financed by prudential borrowing in each year. A further complicating factor is the fact that spending financed by borrowing is only recorded when the spending actually takes place, so spending in a particular year may be financed by prior borrowing activity. There is no straightforward relationship between the amounts LAs have borrowed and their use of prudential borrowing to finance capital spending in a particular year. (The main source of borrowing is the Public Works Loan Board – PWLB – a statutory body that issues loans at favourable interest rates from the National Loans Fund (a central government entity) to local authorities in England, Scotland and Wales.)
  • Capital expenditure financed from the revenue account (CERA): as above.

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  Previous forecasts

Given the way that we forecast it, there are two broad potential sources of error for LASFE: errors in forecasting the income streams that finance this spending, such as council tax and retained business rates, which has been a particular issue during the coronavirus pandemic, and errors in our assumptions about how much authorities will spend relative to their current income by adjusting their current reserves or the amounts they set aside to repay debt. The first source of error does not directly affect net borrowing, since the errors on income and spending are offsetting. However, any errors in our assumptions about movements in current reserves or monies set aside to repay debt will have a direct effect on net borrowing, as they reflect local authorities spending a higher or lower proportion of their income.

Our earlier forecasts assumed that local authorities would ease the downward pressure on their spending from tighter financial settlements by drawing down reserves. This was consistent with plans shown in local authorities’ own budgets. But they repeatedly surprised us by underspending against their budgets and adding to reserves, meaning from our March 2013 forecast, we began to include an assumption for how much local authorities would add to (rather than run down) their stock of reserves. Local authorities then stopped adding to reserves, leading to higher spending than expected: English local authorities drew down from their stocks of reserves by £0.4 billion in 2015-16 and £1.5 billion in 2016-17. More recently, local authorities returned to adding to their reserves, by £7.6 billion in 2020-21 and an additional £3.5 billion in 2021-22. In our latest forecast we assume that there will be zero use of reserves.

Current LASFE has also been subject to significant classification changes – notably the introduction of 50 per cent business rates retention in England in 2013-14 – which also explain why our forecasts since December 2012 have been higher than our earlier forecasts. Forecasts from March 2017 onwards also include the pilots for full business rates retention, which boost current LASFE spending for the two-year period from 2017-18 to 2018-19.

There have also been a number of upward revisions to our recent council tax forecasts as a result of government policy changes. These changes relate to the Government permitting larger council tax increases for upper-tier authorities (those that are required to fund social care services via the adult social care precept). This policy was originally announced in the 2015 Spending Review, but there have been further changes at subsequent fiscal events, including a further increase to the adult social care precept in our October 2021 forecast.

On the capital side, errors in forecasts tend to arise as a result of the nature of capital projects, where spending is often uneven across years, with history suggesting that the level and timing of expenditure is subject to considerable uncertainty. There is also considerable uncertainty over the source of finance for local authority capital spending, with spending possibly being financed by central government grants, local authority income or borrowing. Again, forecasts of capital LASFE spending from March 2017 onwards include the effect of business rates retention pilots in 2017-18 and 2018-19. Since March 2020 our forecast for capital LASFE in 2020-21 has experienced large revisions between fiscal events, largely due to changes in assumed spending on Transport for London, reduced usable capital receipts, and increased prudential borrowing financed spending that has evolved throughout the pandemic response.

 

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  Policy measures

Since our first forecast in June 2010, governments have announced 90 policy measures affecting our forecast for current LASFE (39 of which were announced following the onset of the coronavirus pandemic) and 19 for capital LASFE. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking is set out in Annex A of the relevant Economic and fiscal outlook.

Key themes on the current spending side include freezes to council tax in the previous Parliament and, in this Parliament, changes to allow local authorities to increase council tax more rapidly in order to fund adult social care spending. There have also been changes to business rates uprating, transitional relief and exemptions. Since March 2020 the majority of current LASFE spending policy measures have been in relation to various business rates reliefs.

Such policy changes are not always included on the Treasury’s scorecard because they can be neutral for borrowing. We show their effects in each forecast, as the measures are not neutral for spending and receipts.

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Other expediture

Boxes

Within each of our key publications we include topical ‘boxes’. These self-contained analyses are unique to this publication and tend to cover recent developments in the economy or public finances that complement the main discussion of our analyses.

General government employment

General government employment
Our general government employment (GGE) forecast is based on projections of the growth of the total government paybill and paybill per head, which is in turn based on the Government's latest spending plans. Ahead of our March 2011 forecast, ONS estimates of general government employment were revised up, largely reflecting the reclassification of employees in further education colleges. In this box we set out the extent to which changes to our general government employment forecast were a result of our revised projections for paybill growth as opposed to data revisions.

Economy categories: Labour market, Employment and unemployment, General government employment

Fiscal categories: Public spending, Departmental spending, Locally financed expenditure

Switches between DEL and AME affecting local authorities

Switches between DEL and AME affecting local authorities
In this forecast there were two policy switches that shifted spending between RDEL and AME, which applied from 2013-14 onwards. These policies were for the 50 per cent retention of business rates for local authorities in England, and for localised council tax reduction schemes. This box outlined these changes and examined the subsequent impact these would have on our forecasts.

Fiscal categories: Public spending, Locally financed expenditure, DEL and AME switches

Cross-cutting categories: Classification changes, Data revisions

Local authority budget pressures and reserves

Local authority budget pressures and reserves
Local authorities’ net use of reserves (the amount they add to or drawdown from their stock of reserves) is a key judgement in our fiscal forecasts. This box from our March 2018 EFO examined two indicators of the general financial health of English local authorities over the period 2010-11 to 2016-17, assessing how these metrics might be used to inform our forecast judgements.

Fiscal categories: Locally financed expenditure, Public spending

The rise in ‘prudential’ borrowing – the Spelthorne example

In recent years, local authorities have increased their 'prudential' borrowing to take advantage of the low interest rates offered by the Public Loans Work Board. In this box we discussed the example of Spelthorne Borough Council, looking at some of its riskier investments in commercial property and how those may pose a risk to the public finances in the event of an economic downturn.

Fiscal categories: Public spending, Locally financed expenditure

Local authorities’ retention of business rates

Business rates are a major source of locally-raised finance used to fund locally-administered spending. The Government announced in Autumn Statement 2015 that it would let English local authorities retain 100 per cent of business rates by the end of the Parliament. This box outlined the change in local government financing arrangements and the responsibilities that might be devolved, as well as how these changes would affect our forecast.

Fiscal categories: Public spending, Receipts, Business rates, Locally financed expenditure

Business rates retention pilots

Business rates retention pilots
The Government has been piloting full business rates retention since 2017-18. These pilots featured in our forecasts from March 2017. This box reconsidered and re-estimated the fiscal effects of the 100 per cent local retention pilots scheme.

Fiscal categories: Receipts, Public spending, Locally financed expenditure, Business rates

Local authorities’ use of reserves

Local authorities’ net use of reserves (the amount they add to or drawdown from their stock) is a key judgement in our local authority current spending forecasts as it directly affects borrowing. This box outlined recent trends in use of current reserves, split by English authorities with and without upper-tier responsibilities (such as education and social care), which underpinned our November 2017 forecast judgements.

Fiscal categories: Public spending, Locally financed expenditure