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Part 4:
Capital investment and borrowingWhy capital finance matters
4.1 Some local authority responsibilities demand substantial expenditure on investment and maintenance. Transport, schools and housing are obvious examples. Many local authority assets suffer from past under-investment and not enough has been spent on maintenance. At the same time as they tackle the legacy of the past, local authorities need to invest in the future. This means having assets which can support new and improved forms of service delivery. This might include, for example, taking advantage of the opportunities created by advances in information technology. We are starting to address these issues by:
- increasing revenue grant;
- backing additional local authority capital expenditure; and
- promoting private finance deals and other forms of partnership working.
The case for reform
4.2 The present capital control system was introduced in 1990. It is largely concerned with setting the scope and limits for financing capital expenditure by borrowing. At the heart of the system is the credit approval. Local authorities need a credit approval issued by Government before they can borrow (or enter into any other long term financing arrangement which spreads the cost of a project over a number of years).
4.3 The system’s main strength is that it protects those who use and pay for local services from local authorities running up unsustainable debt levels. However, it seriously erodes local freedom and responsibility. This is because it prevents local authorities from carrying out additional borrowing funded from their own resources, such as council tax or council house rents. It has encouraged an artificial distinction between capital and current resources, sometimes preventing good value ‘spend to save’ schemes from going ahead. Moreover, when schemes are funded by credit approvals, the revenue costs of repayment and interest are largely supported through increased government grants, so the investment is seen as a ‘free good’ without long term consequences for local taxpayers. The system has recently been extended to make partnerships with the private sector easier, but only at the cost of even greater complexity in the legislation.
A new approach
4.4 In the Government’s view, the present capital control system blurs accountability, limits local financial freedom and has become an obstacle to effective capital investment. We need a new regime where local authorities no longer have to get government approval before borrowing, but which protects taxpayers and promotes partnership working. It should enable local authorities to consider revenue and capital solutions on an equal footing, so that Best Value will be what counts. It should secure much greater local ownership of all spending proposals. A vital part of reform would be greater consultation with the community about the council’s investment plans and a clear understanding and debate locally of their long-term financial implications.
4.5 The system also needs to take account of the Government’s concerns. The Government does not have to exercise the direct and rigid controls implied by the current regime. To the extent that Government needs to intervene to ensure that national priorities are met, it can do so through the way it allocates support and through other mechanisms such as Best Value. However, the Government does need to consider the effect of local government activity on the economy – for example, to ensure that a rapid increase in local government borrowing does not disrupt it.
4.6 A new approach would have three central elements:
- the Government would set a limit on the rate of increase of individual authorities’ debt. This would avoid any initial surge in aggregate spending as local government adjusts to the new system. We do not see this as a permanent arrangement, but the precise length of the transitional period would depend on the Government being satisfied that authorities were demonstrating a prudent approach to investment. The Government would continue to monitor local government’s capital plans and might, exceptionally, reimpose limits on increases in debt if national economic circumstances demanded it. We would also have a reserve power to restrict the right to borrow freely for individual authorities which did not operate local prudential regimes effectively, were not delivering Best Value or failed to consult voters and local stakeholders;
- there would be a core set of prudential indicators for which local authorities would set their own ratios, e.g. of debt to revenue, working within a centrally agreed framework. These local prudential indicators would help make clear the impact of capital expenditure proposals on the revenue account over time and allow performance in managing investment to be monitored and assessed; and
- the regime would be backed up by the fundamental principle of the balanced budget requirement (enshrined in legislation) and accounting codes (which also have the force of law).
Further details of how this new prudential approach would work are in annex B.
Government support for capital investment
4.7 Under a prudential system a local authority would not need any form of Government approval to borrow for capital investment. However it would still come to Government when it wanted its support in meeting financing costs. Supported borrowing would probably still account for the majority of local authority investment. Central government would continue to decide in spending reviews how much investment in individual programmes it would support.
4.8 Ministers would need to be able to exert sufficient influence on supported investment to make sure that national as well as local priorities continued to be met. They would continue to have ways of assessing how local authorities were using investment to support delivery of key service objectives and outputs. Although the new ‘single capital pot[3]would end as a capital allocation mechanism, the underlying approach would continue. This way it would deliver the same key benefits, namely to:
- encourage a cross-cutting approach to use of capital assets, both across services and working with partners;
provide a means of consulting partners and the local community in developing a longer term approach to capital investment;
- provide a joined up approach by Government to decisions on allocations of capital resources;
- promote effective procurement and maintenance of capital assets, including partnerships and outsourcing where appropriate; and
- provide an element of performance incentive for local authorities, while ensuring that end users in poorly performing authorities are not penalised for their council’s shortcomings.
4.9 These objectives could be achieved under either a plan-based or a formula-based approach to revenue grant distribution. They are consistent with Best Value and a local PSA performance framework. The allocation of support for capital investment under a plan-based approach would be handled in the same way as support for other types of expenditure, on the basis discussed in part 3 (see paragraphs 3.20-22). Corporate capital strategies would be subsumed within the corporate plan, as might some existing capital bid documents or plans. Asset management planning for education and other local authority land and property would continue.
4.10 Under a formula-based revenue grant distribution system, the Government would continue with the new arrangements it is developing for the single capital pot. The difference would be that the allocation process would provide direct support rather than follow automatically from allocation of credit approvals. Capital strategies and asset management planning would continue and we would continue to allocate support through the pot on the basis of aÊcombination of service formulae plus an element of discretion. As with credit approvals, support could either be generalised or specific. We would of course maintain our commitment to move towards delivering the bulk of central government support for capital investment through the single pot mechanism.
4.11 Because revenue support may change over time, authorities do not know for certain what the total value of the Government’s contribution to a particular capital project or programme will be. Similarly, where the Government supports borrowing, it does so at a standard rate, taking no account of the nature of the investment. A further option, which might address these concerns would be to replace revenue grant funding with up-front capital grants. These could be allocated using either plans or the single pot process.
4.12 Again, recent experience with the private finance initiative has shown that the present arrangements do not work well with more flexible, modern approaches to procurement. This is because they fail to recognise the higher up-front procurement costs or the length of the contract. If an authority borrows to make improvements that will yield long term savings, it may need bridging financial support till the savings come on stream, but it would not need long term support. We will need to consider these as part of any reform of the system.
4.13 If credit approvals are abolished, the present receipts taken into account (RTIA) system will also go. However, new arrangements for allocating support could still take account of an authority’s ability to generate receipts. We will consult the local authority associations about this in due course.
4.14 Separate considerations apply to investment in council housing, which is financed through housing revenue account (HRA) subsidy. We will need to consider the implications for the distribution of this revenue support if we no longer issue credit approvals. We will also need to consider other housing issues that might arise from the reform of the capital finance system. These issues will be taken forward in discussions between the DTLR and the local authority associations. We will follow this with detailed consultation, as the future shape of the capital finance system becomes clearer. We will continue to support capital expenditure on housing other than that owned by the council (such as private sector renovation grants) through general revenue grant.
Partnership and private finance
4.15 Local authorities can secure investment directly in the traditional way, through a range of partnerships or via private finance. Some local authorities are keen to work in partnership with the private sector or with other public sector bodies to secure Best Value for those who use and pay for local services. They recognise that they would be acting contrary to the interests of the local community if they failed to take advantage of the fact that a partnership with another body could provide a better service at a lower cost. But this view is not universal. Other authorities retain a very proprietorial attitude to services, believing that they should be provided in-house whatever the benefits of partnership with others whether in the private sector or other public bodies. This is inconsistent with the Government’s view that authorities should plan positively for diversity – diversity of both provision and provider. Strategic partnerships with others are one of the ways by which the step-changes in performance that local people expect can be secured. But the Government recognises that it will not achieve this merely by restricting the funding available to authorities and thereby forcing them to seek partners. If we are to maximise investment in public services it will be important that all sources of potential funding are explored positively and imaginatively.
4.16 Best Value is designed to encourage such an approach, principally through the reviews that authorities are required to undertake. We will shortly be consulting on proposals to remove some of the remaining obstacles to partnership working, and are considering what other incentives might be needed to promote the new investment in services that modernisation requires. The new capital finance regime has a key part to play. Until private finance achieves more general acceptance, there is a case for continuing to provide ring-fenced grant to remunerate private finance deals. Existing private finance commitments will, of course, be fully taken into account when future levels of revenue support are determined but there may need to be a reserve power to restrict the right to borrow freely for authorities which are not serious about securing Best Value, have not developed proper local prudential regimes or are failing to consult voters and local stakeholders.
3 A cross service allocation mechanism for central government capital support to local authorities.
Published 19 September 2000
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