Following a period of financial difficulties, Birmingham City Council filed a ‘section 114 notice’ on 5 September 2023. This means the council cannot make new funding commitments and it must limit spending to its statutory duties. Some news reports described the council as having gone ‘bankrupt’. However, local authorities cannot actually go bankrupt. A section 114 notice relates to provisions of the Local Government Finance Act 1988. It allows a council’s chief finance officer to issue a report that the council’s expenditure for a future financial year is projected to exceed its income. Labour-controlled Birmingham City Council is reportedly facing liabilities for backdated equal pay claims totalling around £760mn, as well as an estimated £100mn cost related to problems with the rollout of a new financial ledger system.

In recent years, councils controlled by various political parties have issued section 114 notices. These include Conservative-controlled Northamptonshire (2018) and Thurrock (2022), Labour-controlled Croydon (2020) and Slough (2021), and Liberal Democrat-controlled Woking (2023, although it was Conservative-controlled for most of the period between 2007 and 2021).

1. Pressures on local authority finances

Like other councils, Birmingham has been affected by rising costs across local government. These include inflationary pressures, increased minimum and living wages, and increased demand for certain services, particularly children’s services and adult social care. Councils have also faced over a decade of real-terms funding reductions from central government. Figures from the National Audit Office (NAO) showed that between 2010 and 2021 councils’ average spending power in real terms had reduced by 26%. Spending power from central government funding over that period had declined by over 50%, while council taxes had increased.

In July 2023, the Local Government Association (LGA) said that councils in England would face a “funding gap” of almost £3bn over the next two years, due to high inflation and increased demand for services. The LGA said the funding gap represented the cost of maintaining services at their current levels. It did not include “addressing existing underfunding” in areas such as adult social care, children’s care and homelessness.

Other than central government grants, local authorities have two main sources of revenue—council tax and a retained share of business rates levied in their area. The rate at which local authorities can increase council tax is regulated by central government. Since 2012, any proposed council tax increase over a threshold set by Westminster must be put to a vote in a local referendum. The maximum annual increase is currently 5% for local authorities with social care responsibilities.

2. Exposure to commercial property investments

The NAO has raised concerns that some councils have sought to make up for funding shortfalls by investing in commercial property, financed by borrowing. In 2020, it said that councils in England had spent £6.6bn investing in commercial property, with most of that figure spent by just 49 councils (14%) concentrated in the southeast of England. In September 2023, a report by credit rating agency Moody’s found that several councils were exposed to commercial property investments that were at risk of failing, due to a downturn in property prices. Moody’s said it expected more councils to issue section 114 notices in future. Of three councils that had already issued section 114 notices—Thurrock, Croydon and Woking—Moody’s said they had based their property investments on “overly optimistic projections, with no or little provision for reserve buffers” and that there was a lack of internal and external scrutiny of the transactions. A list of the councils most exposed to property investment debt as a proportion of their income included several in the southeast of England, including Spelthorne, Runnymede, Eastleigh, Worthing and Surrey Heath.

3. Proposals for greater fiscal devolution

The sustainability of local authority finances has prompted a debate about the constitutional relationship between central and local government in terms of funding and tax-raising powers. A range of organisations and think tanks have made proposals for how local communities could benefit from greater devolution of tax-raising powers and control over how the revenue is spent.

In 2020, the LGA published an international comparison of fiscal devolution which compared the UK to Germany, Switzerland and the Netherlands. It said the UK was an “international outlier” as one of the most “fiscally centralised countries in the developed world”. The report recommended that the government should launch a consultation with councils to “identify the most popular options for local levies under fiscal freedom”. It also said the government should consider introducing a form of tourism tax nationally, which at the time of the report’s publication had been proposed in Birmingham for that city’s hosting of the 2022 Commonwealth Games (though it was never implemented).

The Northern Powerhouse Partnership, a think tank established by former Chancellor George Osborne and chaired by Lord O’Neill of Gatley (Crossbench), made similar arguments in a March 2023 report on fiscal devolution. It cited OECD data that in 2021 regional taxation amounted to 16% of GDP in Canada, 13% in Germany, 9% in the US, but “just 1.7% of GDP in the UK”. The report made the following recommendations:

  • Create three new council tax bands for the most valuable properties, following a revaluation of all homes (which has not been undertaken since 1991). The revenue raised should be “shared across the country”.
  • Devolve more business rates revenue or “replace it with a local land value tax”.
  • Devolve stamp duty to local authorities, before “replacing all residential property taxes with a land value-based tax”.
  • Devolve 1p of employers’ national insurance contributions to fund “local transport services and infrastructure”.
  • Introduce a locally retained “tourism tax on hotel stays” to fund cultural development and environmental protection. The think tank claimed this could “raise £5.5mn a year for the Lake District alone”.

However, a 2019 report on fiscal devolution from the Institute for Fiscal Studies (IFS) was more sceptical about how much revenue could be generated by devolving taxes and in particular about the effectiveness of a local tourism tax. The IFS said that income tax was the “most promising candidate for partial devolution”. It said that a “flat rate local income tax” of 3p on all income bands could raise £19bn a year, although the IFS acknowledged there could be some “tricky technical issues” to its implementation. On tourism taxes, the IFS said that although it could raise “useful amounts” in some well-visited areas, in many areas it would “raise little”. The IFS concluded that the economic case for a tourism tax was “far from clear cut”.

In March 2023, the Local Government Information Unit published the ‘State of local government finance’, which reported the results of a survey of local authority leaders. It concluded that council finances were in a “critical state”, with only 14% of senior leaders having confidence in their council’s financial resilience. The survey included questions on fiscal devolution, which asked respondents to choose their three most preferred options for raising revenue. The most popular option, chosen by over 70% of respondents, was for 100% retention of business rates revenue. The next most popular options (chosen by 25–30% of respondents) were scrapping the council tax referendum requirement and devolving a share of income tax.

Dr John Stanton, lecturer at City Law School, University of London, has written a recent book entitled ‘Law, Localism and the Constitution’ (2023). The book charts the historical development of local government in the UK, and it uses the examples of elected mayors and local government finance as case studies to propose some reforms. Summarising the book’s conclusions on the UK Constitutional Law Association blog, Dr Stanton said local government is “hampered by the constitutional system” of which it is a part. He said that the “predominance” of the Westminster Parliament and the lack of a codified constitution means that councils are “at the mercy of the centre”. He argued that the UK should protect the constitutional status of local government by passing legislation which is “undergirded” by the Council of Europe’s 1985 ‘European charter of local self-government’. The charter commits the parties to apply “basic rules guaranteeing the political, administrative and financial independence” of local government. The UK ratified the treaty in 1998, but it has never been put on a statutory footing in UK domestic law. Dr Stanton argued that constitutional protections could be achieved by creating “exceptions to the Parliament Acts” or by “giving the House of Lords a power of veto over any attempts to modify the constitutional position of local government”.

Cover image by Phil Wild on Pixabay.