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 Ministry of Housing, Communities and Local Government (MHCLG) 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 ‘local authority self-financed expenditure’ or ‘LASFE’. As with other spending, it is split into current and capital components.

In our latest forecast, we expect LASFE in 2018-19 to total £63.3 billion (with £52.5 billion of current LASFE and £10.8 billion of capital LASFE). That would represent a little over a third of total local authority spending (i.e. including that financed by central government grants) and around 7.8 per cent of total public spending. It is equivalent to £2,200 per household and 3.0 per cent of national income.

  • Latest forecast

    Our latest fiscal forecast was published in March 2018. Current LASFE is forecast to remain relatively stable as a share of GDP between 2016-17 and 2022-23 2022-23, but capital LASFE falls from 0.5 per cent of GDP in 2015-16 to 0.4 per cent of GDP by 2022-23. This fall in capital LASFE towards the end of the forecast reflects two main factors. First, we expect capital spending by Transport for London subsidiaries to decline as construction of Crossrail is expected to have been completed by the end of the forecast. Second, reflecting recent outturn data, information from sector experts and changes in local authority behaviour, we expect near-term capital spending financed by prudential borrowing to persist at higher levels in the early years of the forecast, before tapering off. This tapering off reflects our assumption that spending at these higher levels will not persist in the medium term, in part due recent updates to the Prudential Code and to MHCLG guidance on local authority investments, both of which are expected to reduce commercial activity by authorities.

    Note: Current LASFE outturn data have been adjusted for the effect of localising English and Welsh business rates (a DEL to AME switch), so as to ensure they are consistent and comparable over time. Forecast data have also been adjusted to remove the effect of business rates 100 per cent retention pilots, which reduce DEL and increase LASFE by equal and offsetting amounts. Details of these adjustments are available in a supplementary spending table that is published alongside each EFO.

    More detail on our latest forecast and how it was revised relative to our previous forecast in November was provided in paragraphs 4.121 to 4.133 of our March 2018 EFO.

    Expand to read the extract from our March 2018 EFO

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  • Forecast methodology

    Forecast process

    The Treasury and MHCLG produce the majority of the 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 under way, 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 MHCLG, 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 BRC – 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 353 principal local authorities in England alone, so forecasting LASFE bottom-up by aggregating forecasts for each authority is not feasible. Our forecast requires significant amounts of judgement to be applied 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 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, both about 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.
    • 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. This was important when the Government’s fiscal targets were set in terms of the current budget balance (i.e. under the Coalition from 2010 to 2015).

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  • Previous forecasts

    Given the way that we forecast it, there are two broad potential sources of error for self-financed local authority spending: errors in forecasting the income streams that finance this spending, such as council tax and retained business rates, 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 the income and spending are offsetting, but 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 running down) their stock of reserves. More recently, they have 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 £1.3 billion in 2016-17. Our latest forecast assumes local authorities will draw down from their stocks of reserves in each year up to and including 2020-21.

    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. Our March 2018 forecast also incorporated changes to council tax referenda limits (the maximum amount authorities can increase council tax on the previous year with triggering a local referendum), as per the levels announced in the 2018-19 local government finance settlement.

    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. The significantly higher forecast for capital LASFE in November 2017 reflects recent outturn data, which showed markedly higher capital spending financed by borrowing in 2016-17 than we had forecast in March 2017. While we assume that the most recent high levels of spending will not be sustained across the full forecast period, spending is assumed to remain higher across the forecast period than we assumed in March 2017. Our forecast for English local authorities’ use of prudential borrowing was further increased in March 2018.

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  • Policy measures

    Since our first forecast in June 2010, governments have announced 37 policy measures affecting our forecast for current LASFE and nine 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 was 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 last 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.

    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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