Local authorities are drawing up their revenue budgets and setting their Council Tax for the 2021/22 financial year in turbulent economic times. The balanced budget requirement means that the difference between “robust” estimates of revenue income and expenditure must be made up with either higher Council Tax or withdrawals from revenue reserves, providing always that reserves remain “adequate” to cover unexpected additional expenditure or lower than expected income.
In the current economic climate, there is much more uncertainty about the future, and the adequacy of reserves to cover unexpected items will need to be reviewed. If reserves need to be increased then either expenditure must be cut or Council Tax increased, neither of which are particularly welcome in a recession.
Income and expenditure are mainly determined by International Financial Reporting Standards (IFRS), but local government benefits from several statutory overrides that reduce the uncertainty in the revenue budget that might arise from financial markets. For example, the cost of restructuring loans following a change in interest rates can be spread over the term of those loans.
Also, impairments and revaluation losses on property and shareholdings don’t count as revenue expenditure, irrespective of whether they are held to provide local public services or as investments. The quid pro quo is that revaluation gains don’t count as revenue income either. The same applies to gains and losses incurred on all types of pension fund investments, including pooled funds.
There is also a statutory override for gains and losses on pooled investment funds held outside of a pension fund. This was introduced in 2018 following a change to IFRS. At the time, government said it felt it was inappropriate for revaluations to “impact on the balanced budget requirement or on the quantum of funds available to support delivery of services.” But this particular override is time-limited and is due to expire in April 2023.
Of course, come 2023, it is highly likely that it will remain inappropriate for public service expenditure budgets and Council Tax to be set according to the vagaries of the financial markets. Government may have been hoping that authorities would use the five-year override period to slowly sell out of their pooled investment funds, but their own statistics show the opposite. With cash interest rates now very close to zero, and government, CIPFA and the press shouting loudly against direct investment in property, it’s hardly surprising that local authorities are looking to well managed and highly diversified pooled investment funds that pay between 3% and 7% income each year.
On the other hand, Government may have been hoping that local authorities would cut service expenditure or raise Council Tax to increase their reserves to a level adequate to manage the risk of valuation losses. We have certainly supported authorities placing some of the additional income earned from pooled investment funds into a treasury risk management reserve. But the coronavirus pandemic has put so much pressure on local government finances that building up reserves is no longer feasible for most. You don’t put money aside for a rainy day when you’re being soaked by a thunderstorm.
Government has a long history of extending time-limited statutory overrides, but only late in the day. The 2018 regulations introducing the pooled funds override also extended the equal pay override for the fourth time. We think Government will have little practical option except to extend or make permanent the pooled fund override too. Local authorities would prefer to hear that decision sooner rather than later. The alternatives of selling their highest yielding investments, raising Council Tax or cutting local public services will be no good for local or central government, nor their taxpayers. The sooner government acts to sort this out, the better.