Council ‘bankruptcies’: Why is one in 10 councils blowing its budget?

Local councils in England are only about 50% funded by council rates. The balance of their budget comes from government grants and retained business rates.

With these funds, local authorities must provide numerous vital public services. From neighbourhood services such as waste collection, libraries and certain aspects of transport, education and housing, to vital social care programs, the roles a council plays are essential.

So, what happens when a council can no longer afford to carry out its duties?

In September 2023, Birmingham City councillors voted to issue a Section 114 notice, often considered a notice of bankruptcy. But in fact, as a report by the Institute for Government’s Stuart Hoddinott explains, local authorities can’t actually go bankrupt.

Instead, the Section 114 notice “is a report from the council’s finance officer that they believe that the authority is about to incur expenditure that is unlawful according to the Local Government Finance Act 1988”.

Typically, this means the council’s expenditure will exceed its income during a financial year, which is not permitted under the Act.

And according to a recent study by SIGOMA, the Special Interest Group of Municipal Authorities, one in 10 SIGOMA councils is currently considering making a Section 114 notice. In poor areas, almost a third of councils are considering issuing such notices in the next 24 months.

Why are councils struggling?

The pressure of inflation is not, surprisingly, the main cause of this situation.

“Even when inflation improves, local authorities’ cost bases will likely not return to pre-pandemic levels – the effects of the bout of inflation are effectively baked in, going forward,” Stuart Hoddinott, senior researcher at the Institute for Government, says.

The SIGOMA study identified the main driver of financial stress: increasing pressure around children’s and adults’ social care. Inflation is of course a contributing issue, alongside energy costs and wage rises.

“At the same time as inflationary pressure, councils are facing increasing demand for services, particularly in the care sector,” says Councillor Sir Stephen Houghton, Chair of SIGOMA.

“Pay increases are putting substantial pressure on budgets, and so the government must ensure that local authorities have the additional funding they need to fully fund these pay increases or risk impacting future service delivery.

“The funding system is completely broken. Councils have worked miracles for the past 13 years, but there is nothing left.”

Do council services stop after a Section 114?

When a council issues a Section 114, it is unlikely that residents will notice any change, at least in the immediate future.

The notice means the council cannot incur any new spending that is not specifically permitted by the Finance Officer. All usual services, such as waste collection, continue.

Behind the scenes, councillors and central government members begin a process of examining options to enable services to continue through cuts in spending in particular areas, reallocating budgets elsewhere and increasing council taxes.

Councils are limited to a council tax increase of either three or five per cent in the 2023/24 financial year.

“The five per cent cap on council tax increases is for local authorities with responsibility for social care,” Hoddinott says. “That’s made up of a three per cent allowance that all local authorities can use, including authorities that don’t provide social care, and a two per cent social care precept which only social care authorities can take advantage of.”

However, after a council has issued a Section 114 notice, it may be given permission to make a larger increase.

“The government has allowed three local authorities – Croydon, Thurrock and Slough – to increase their council taxes by 15 per cent, 10 per cent, and 10 per cent for this financial year in response to Section 114 notices that those authorities issued last financial year,” Hoddinott says.

“Local authorities can, in theory, raise council tax by more than the annual limit, which the government changes year to year, but they have to undertake a referendum to do so, which no authority has ever won.”

What are the solutions?

The potential solution to the problem of councils’ financial challenges is complex, Hoddinott says.

Areas that benefit most from council tax increases are in less-deprived parts of the country. And so, council tax increases offer the greatest benefit to the areas with the least need.

In cases where authorities have large outstanding liabilities, council tax increases also don’t achieve a great deal. Even large council tax increases raise relatively little compared to what is needed, Hoddinott says.

“For example, Thurrock raised £73 million from council tax in 2022/23,” he says. “Increasing that by 10 per cent means that it will raise a further £7 million. But it has outstanding debts of £1.5 billion. Even increasing council tax by 100 per cent in Thurrock would barely scratch the surface of its outstanding liability.”

Other options include an increase in grant funding from central government, allowing local authorities more freedom to raise money locally through increased council taxes plus other taxes, fees and charges, allowing local authorities more choice in the extent and level of services they provide.

“The downside to this is that you could end up with wildly varying levels of service provision across the country, and likely better service provision in better-off parts of the country if there is no redistribution,” Hoddinott says.

The government could implement the Fair Funding review to change the formula used to allocate funding – last set in 2013. It could also change the timing of grant allocation to allow more time for planning, and reduce the use of competitive funding pots, allowing local authorities more say over how that funding is spent.

Whatever happens, Hoddinott is not optimistic about the financial health of local councils.

“I think there will likely be more section 114 notices. Currently central government has refused to countenance the possibility of bailing out local authorities, as they say financial matters are for local authorities to manage themselves. That seems unlikely to change,” he says.

“The people most likely to be affected by this are sadly those who are the most vulnerable or most deprived. That’s most obvious in social care, both for children and adults.”