Scrutiny of Finance and Budgets July 2007

Scrutiny of Finance and Budgets July 2007 Dr Peter Watt INLOGOV http://www.inlogov.bham.ac.uk/staff/wattp/ 2 Summary  The budget process and scrutinising the budget  The national picture of local government finance – Overview of local government spending, grants, accountability and local income tax, council tax, business rates, performance and efficiency – The Lyons Inquiry into Local Government – Final Report (March 2007) 3 Role of the Budget  planning  authorising expenditure  monitoring performance  allocating resources  ?motivating performance (may depend on target & incentive systems) 4 Timetable (Financial year April to March)  July – Sept. analyse overall position develop strategy  Sept – Nov. cost “commitment budget” cost options for policy changes  Dec. Govt. grant figures  Feb. Final budget approval  March tax bill sent 5 Traditional Budgeting: Incrementalism Build next year’s budget based on this year’s budget  determine “commitment budget” – this years budget » + inflation » + pay increments (net) » + full year effects of committed decisions » + ?demographic changes on entitlements  then consider resources  then make policy changes according to needs and resources 6 Budget scrutiny – some basic questions  How have budget targets been established – Drivers – Pressures – Assumptions  Consider and comment on allocations following RSG settlement 7 Budget scrutiny – key actions  Comment to the Cabinet on how far the following have been taken into account – Impact on services, clients, performance – Risks – Corporate priorities as in the corporate strategy – Consultation – Efficiency savings – Key issues – e.g. childrens/adults social care budgets 8 The Basic Budgeting Problem “On what basis shall it be decided to allocate x dollars to Activity A instead of Activity B” – Vernon Key (1940) in “The Lack of a Budget Theory” American Political Science Review 34 (6) didn’t have an answer then and we don’t have one now  But it depends on – Politics – institutions  We 9 Budgeting in a department Essentially based on cost–benefit analysis Benefit £ Benefit and cost £ Quantity Optimum budget Quantity 10 Budgeting in a department (Real) cost goes up? Benefit £ Benefit goes up? Benefit and cost £ Quantity Cut quantity – other things being equal Quantity Increase quantity – other things being equal Allocation between expenditure headings “As regards the distribution, as distinct from the aggregate cost, of optional government expenditure, it is clear that, just as an individual will get more satisfaction out of his income by maintaining a certain balance between different sorts of expenditure, so will also a community through its government. The principle of balance in both cases is provided by the postulate that resources should be so distributed among different uses that the marginal return on satisfaction is the same for all of them.. .Expenditure should be distributed between battleships and poor relief in such wise that the last shilling devoted to each of them yields the same real return.” Pigou, A.C. (1928) A Study in Public Finance, London: Macmillan 11 12 Budgeting across departments Department A Benefit per £ Benefit per £ Department B Quantity Quantity Equalise benefit from last pound spent in each department – otherwise switching budgets across departments can raise total benefits 13 Budgeting across departments Department A Benefit per £ Benefit per £ Department B Quantity Quantity In this case the last pound spent in department B provides much less benefit than the last pound spent in department A – hence budget should be shifted from B to A until benefits from the last pound are equal Rationales to Get a Bigger Budget I  14 Shroud waving/bleeding stumps  Investments  by spending now you will avoid larger costs in future – spend to save  Spin-offs  besides the expected gains there will be secondary benefits  Truly Needy  without spending people in extreme need would go wanting  Macroeconomic effects  this spending will improve inflation/unemployment/growth 15 Rationales to Get a Bigger Budget II  Leveraging  if the government spend more, then others will spend more too  Disastrous Consequences  if we don’t spend there will be a catastrophe  Level Playing Field  our competitors are subsidised, it’s only fair we should be too From Meyers, Roy. 1999. Strategies for Spending Advocates.In Handbook of Government Budgeting , edited by Roy T. Meyers , 548 – 67 . San Francisco Jossey-Bass . 16 Practical methods for budget scrutiny Adopt more the role of a “critical friend”  Convert budget scrutiny into a form of policy review on a some areas informed by budget pressures  Think long term – examine the medium term financial plan  Seek early guidance (November) from Director of Finance on possible topics for review  Examine relation between policy priorities and budget  17 Some possible questions for directors  Describe steps taken to maximise income where appropriate – sales, fees, charges etc.  Does the budget contain spend to save elements – costly short run but economical long run  Pay scales – are they in line with the market – how is this managed? 18 Expert advice  Useful for scrutiny to have its own independent expert advice – Consultants, academics etc – Officers 19 Problems with Conventional Budgets  incrementalism  limits innovation  difficult to deal with sudden changes  input orientation  focus on units, not services departmentalism  may assist existing managers to preserve their empires  annuality  encourages short-termism  gaming  real preferences are not revealed 20 Zero-Based Budgeting  approach task of resource allocation with a blank sheet of paper - a zero base  consider all alternatives rationally 21 Problems with ZBB  time-consuming technically  re-visits problems that have already been solved; ignores accumulated experience  may exceed capacity for politically coping with alternatives - incrementalism limits options to manageable amount - “muddling through”  “ZBB has always and everywhere failed” » Aaron Wildavsky 22 PPBS Planning Programming and Budgeting Systems  similar to ZBB - a rational approach  but has emphasis on planning by programme area rather than by input organisation 23 Budgets – pointers for practice  adopt essentially an incrementalist approach  add output/outcome measures explicitly to budget process  conduct periodic reviews of base by sector or sub sector  consider multi-year budgets  review inter-organisational working - “joined-up government” 24 Finance – the national scene Lyons Inquiry – short term  End capping (but Woolas affirms commitment to capping)  Independent scrutiny of central government's local government funding decisions (an Independent Commission) (Rejected by Woolas)  Extend business growth incentive schemes (proposals soon)  Council tax benefit rebate automatic (consider carefully)  Waste charging (will consider)  Reduce proportion of specific grants (yes - but) 25 Lyons Inquiry – for next Parliament     :Revalue council tax (for next Parliament - not before 2011) - and add extra bands at the top and bottom (Woolas unenthusiastic) Consider an element of "assigned revenue" for local government. I.e. reserve a fixed percentage of income tax to go for local government funding. As income tax is buoyant (rises as incomes rise so more revenue comes in automatically as the economy grows without a need for increasing the tax rate) this would have the effect of making local government funding buoyant. (Will consider) Tourist tax. (No) 26 Lyons Inquiry – Longer term If public support develops, – introduce local income tax, – and/or relocalise business rates. Govt: Think about later 27 Local Government spending  Overall local government gross expenditure and income in England was £141 billion in 2005-06  Overall cost to the central and local taxpayer of local authority services was about £115 billion, or £2,300 per head in 2005-06 (After deducting sales, fees, charges, receipts and other non-grant income)  25% of all UK government expenditure about 9% of national expenditure  90% revenue, 10% capital 10.0 12.0 14.0 0.0 2.0 4.0 6.0 8.0 % LG spending as % of all spending All Capital Current 19 59 19 61 19 63 19 65 19 67 19 69 19 71 19 73 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 28 29 30 Sources of current expenditure funding (excluding charges) 2006-07 26% Grants Business rates Local Taxes 20% 54% 100% 20% 40% 60% 80% 0% Percentage contributions of local taxes, grants and business rates to local current spending 1981/02 to 2006/07 Grants Business rates Local Taxes 19 81 /82 19 82 /83 19 83 /84 19 84 /85 19 85 /86 19 86 /87 19 87 /88 19 88 /89 19 89 /90 19 90 /91 19 91 /92 19 92 /93 19 93 /94 19 94 /95 19 95 /96 19 96 /97 19 97 /98 19 98 /99 19 99 /00 20 00 /01 20 01 /02 20 02 /03 20 03 /04 20 04 /05 20 05 /06 20 06 /07 31 32 Subnational revenues as a % of GDP Source: King, D. and Watt, P.A. (2005) Options for Local Government Finance – an Economic Approach, County Councils Network, October, pp. 36. http://www.lga.gov.uk/ccn/Backgrounds/backgd25OptionsForLocalGovernmentFinance.pdf IMF, Government Financial Statistics Yearbook 2004, data for latest available year, ranging from 1997-2001 Subnational revenues as % of GDP 33 35 30 25 20 15 10 5 0 Hu UK ng ar Fr y an ce Cz Lat ec via h Re Es p to Bu nia lga Lit ri hu a a Sl nia ov Ro eni a S l ma ov ni ak a Re p ar Sp k N' ain rla nd Po s lan d nm De Taxes Grants Other Source: http://www.im.dk/publikationer/decentralisation/kap01_4.htm#t1.9 and author’s calculations 34 Central Government Revenue Funding 35 The balance of funding – current expenditure  74% of funding from the centre  26% of funding from local taxpayers  “He who pays the piper calls the tune” Winston Churchill discussing local government finance in 1926 36 Disadvantages of high central funding  Gearing/Inflexibility with accountability  Problems with local democracy  Problems with grant allocation  Problems 37 Possible solutions  Introduce local income tax?  Give local authorities control over business rates  More charging?  Other new taxes? 38 Gearing/inflexibility CT Centrally financed 39 Gearing 100% increase? CT Centrally financed 40 Gearing CT CT CT CT CT Centrally financed To increase overall spending by 100%, council tax has to rise by 400%, to increase spending by 10% council tax has to rise by 40% - gearing is 4 to 1 41 Sources of local government revenue 2005-06 Council Tax Business Rates Revenue Support Grant (inc schools) Total £bn 21.0 18.0 26.7 65.7 2006-07 Council Tax Business Rates Revenue Support Grant Total RSG (excl schools) 8% £bn 22.0 17.5 3.5 43.0 RSG (inc schools) 41% Council Tax 32% Business Rates 41% Business Rates 27% Council Tax 51% 42 Gearing with specific education grant and no top up of education spending Dedicated schools grant introduced in financial year 2006/7. If school spending is not topped up, gearing reduces to about 2 times instead of 4 CT CT CT Dedicated schools grant 43 Funding and accountability The average taxpayer funds  76% of local government spending through central taxation via grant  24% of local government spending through local taxation (council tax) Taxpayer 44 Funding routes for local government Central Govt 75% 25% Central/local taxpayer LA1 LA1 LA2 (387 LAs) LA3 etc 45 Accountability routes Central/local taxpayer Central Govt LA1 LA1 LA2 (387 LAs) LA3 etc 46 Electoral decisions General Election Central/local taxpayer Central Govt Local Election LA1 LA1 LA2 (387 LAs) LA3 etc 47 Central accountability bundles too many issues together General Central Election Central/local taxpayer Govt LA1 LA1 LA2 (387 LAs) LA3 etc 48 Local Income Tax Central Govt LA1 LA1 Council tax continues LA2 (387 LAs) LA3 etc 49 Local Income Tax Local income tax – replaces CG grant to LG Central Govt LA1 LA1 Council tax continues LA2 (387 LAs) LA3 etc 50 Local Income Tax - equalisation Central Govt LA1 LA1 LA2 Independent (?) zero-sum equalisation LA3 etc 51 The current system puts high emphasis on grants  The main grant is the Revenue Support Grant  There are also specific grants  Uniform business rate is a form of grant 52 Formula grant  Compensates for a local authority’s “spending needs” and for “lack of resources”, damps year-on-year change 53 Formula Grant (four blocks)  Relative needs block (equalises for need)  Minus relative resource amount (equalises for taxbase)  Central allocation (a per head amount)  Floor damping Block (guaranteed minimum increase in grant) 54 RNF: Assessing “need to spend” Relative needs block Spending blocks: 1. Children’s Services; 2. Adults’ Personal Social Services; 3. Police; 4. Fire and Rescue; 5. Highways Maintenance; 6. Environmental, Protective and Cultural Services (EPCS); and 7. Capital Financing 55 Calculating RNF  The formula for each service area is built on a basic amount per client, plus additional top ups to reflect local circumstances.  The top ups take account of a number of local factors which affect service costs, but the biggest factors are deprivation and area costs. 56 Calculating the formula Spending X X X X X X X X X X £basic amount 1 client No of clients 57 Young adults in the RNF Basic Amount Younger Adults’ PSS Basic Amount 8.1050 Top-Up Younger Adults’ PSS Deprivation Top-Up 241.9375 multiplied by People Aged 18 to 64 Receiving Disability Living Allowance (0.0499); plus 65.4588 multiplied by People Aged 18 to 64 Who are Long Term Unemployed or Have Never Worked (0.0308); plus 22.1425 multiplied by People Aged 18 to 64 Who Work in Routine or Semi Routine Occupations (0.2683); plus 18.5033 multiplied by Households with No Family (0.3206); minus 12.5737 58 Grants - complexity Local Government – In Touch with the People announced a review to look for a “simpler, more stable, more robust and fairer than the present system for SSAs”  Simplicity and fairness generally work against each other  Modern 59 Uniform business rates   Also called National non-domestic rates NNDR Introduced in 1990 along with poll tax to replace commercial and industrial rates  Collected nationally pro rata to business property values and until 2006-07 distributed to local authorities on a per capita basis - an assigned revenue. Now used in equalisation  Set by central government - increased in line with inflation 60 Uniform business rates  Accountability issues  Future changes – government not keen on returning business rates to local control 61 Charges Charges (excluding rents) £10,19m in 2003/04 – equates to 54% of the amount raised by council tax (£18,945m)  Difficult to increase significantly without detriment to equity objectives  62 Council Tax Bands and Tax Ratios Value of house England up to up to up to up to up to up to up to above £40,000 £52,000 £68,000 £88,000 £120,000 £160,000 £320,000 £320,000 Scotland £27,000 £35,000 £45,000 £58,000 £80,000 £106,000 £212,000 £212,000 Wales £30,000 £39,000 £51,000 £66,000 £90,000 £120,000 £240,000 £240,000 Band A B C D E F G H Relative tax ratio 6/9 7/9 8/9 9/9 11/9 13/9 15/9 18/9 Council tax bands 2.5 63 2 1.5 1 0.5 0 0 100000 200000 300000 400000 500000 600000 700000 64 Council tax –the future  Council tax revaluation was to be commenced in 2005 to take effect in 2007  Still a major problem  Most countries delay property tax base revaluations (W. Germany 1956, E. Germany 1936)  Possible move to Northern Ireland system although recent Scottish experience suggests not  London and SE would pay a lot more – hence pressure for regional banding 65 Gainers and losers problem Gainers and losers: "It must be considered that there is nothing more difficult to carry out, nor more doubtful of success, nor more dangerous to handle, than to initiate a new order of things. For the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order..." Machiavelli The Prince [1513] (1950, p21) (see 238 Inquiry final report) 66 Dr Peter A. Watt Reader in Public Sector Economics, INLOGOV, School of Public Policy, University of Birmingham, B15 2TT, UK Tel + 44 (0)121 414 4983, mobile +44 7951089960 Email P.A.Watt@bham.ac.uk Web page: http://www.inlogov.bham.ac.uk/staff/wattp/