Local Government Finance

2. It is for local authorities to determine their expenditure priorities from the resources available to them (excluding ring-fenced resources) and their council tax levels, following consultation with their local electors.

3. Support for the 3 year revenue grant settlements is known as Aggregate External Finance (AEF). The total level of AEF for the 3 forward years is determined by Scottish Ministers as part of the Spending Review process which takes place every 2 years. AEF is made up of 3 components: specific grants, non-domestic rate income and revenue support grant.

4. Where policy divisions within the Scottish Executive consider that a policy initiative or legislative change might place a new burden on local authorities they should contact Local Government Finance and Local Funding Division at an early stage.

5. Total AEF is distributed between Scotland's local authorities using a "needs-based" grant distribution system. In addition, to ensure a stable and fair distribution of grant, Ministers have introduced a minimum grant "floor" within the settlement calculation, to ensure that all councils receive at least a minimum guaranteed increase in AEF for each year.

6. AEF supports around 80% of local authority expenditure, with the remainder met largely from the council tax. It is for each local authority to set its council tax level in consultation with local electors. Ministers have reserve powers to cap local authority expenditure, by imposing a reduced council tax level, where they consider an authority's expenditure or expenditure increase to be excessive.

7. Capital investment by local authorities is largely funded through borrowing. The Scottish Executive funds the debt servicing costs (i.e. loan charges and redemption fees) of some of this borrowing, known as "supported borrowing", via revenue support grant whilst the unsupported borrowing, arranged under the prudential regime, is financed through local authorities own general resources. Local authorities are now free to make their own decisions about capital investments as long as their capital spending plans are prudent, affordable and sustainable.

Background

8. The local government finance system supports revenue expenditure on services and capital investment in infrastructure by Scotland's local authorities across the full range of their non-housing responsibilities - including education, social work, environmental services, roads and transport, etc.

9. Scottish Executive revenue grant is paid to local authorities on a weekly basis under an Order made by Ministers under Schedule 12 of the Local Government Finance Act 1992. Although councils are advised of their grant allocations for a 3 year period following each biennial Spending Review, approval is required from the Scottish Parliament each year for the annual Local Government Finance (Scotland) Order. Schedule 12 also requires that Ministers consult "such associations of local authorities as they consider appropriate" before laying the annual Order. Capital investment by local authorities is largely funded through borrowing financed either by revenue grant "supported borrowing" or through local authorities own general resources. Entirely separate finance arrangements operate for local authority housing. These are described in the Annex to this section on the operation of the Housing Revenue Account.

10. The detail of the local government finance system can appear complex. In part, this reflects the variety of functions that it must fulfil; it must:

provide a stable and equitable allocation of revenue and capital grant between Scotland's local authorities,
reflect councils' diverse characteristics and expenditure needs, including any changes in circumstances over time, such as population movement;
provide councils with the certainty to plan their future spending and investment;
reflect new financial burdens on councils as they arise, including new policy initiatives or transfers of responsibility between central and local government; and
acknowledge the wider impact of local authority expenditure and investment on public finances.

11. Not all of these aims are necessarily compatible, for example, pressure to reflect changes in councils' circumstances must be balanced against the need for stability, to allow councils to plan for changes in their expenditure and service provision. Ultimately, the system allocates resources from a fixed pot and any adjustments impact on all councils. It is important, therefore, that the system is transparent and, as far as possible, commands broad agreement amongst local authorities.

Responsibilities

12. Within the Scottish Executive, responsibility for local government finance matters rests with the Minister for Finance and Public Service Reform. However, many of the elements of local authority expenditure relate to policy areas that are the responsibility of other Ministers, e.g. education, community care, environmental services, leisure and recreation, etc. As part of the Spending Review process the Minister for Finance and Public Service Reform holds bilateral discussions with other Ministers about the allocation of resources for local authority revenue expenditure and capital investment.

13. Responsibility for the administration of the local government finance system rests with the Local Government Finance and Local Funding Division within Finance and Central Services Department, covering local authority revenue expenditure, revenue grant distribution, the prudential regime for capital and policy on council tax and non-domestic rates.

14. The Scottish Executive consults with councils collectively about the structure and operation of the local government finance system, through the Convention of Scottish Local Authorities (COSLA), although councils can make individual representations about issues that impact on them.

15. It is for local authorities to determine their expenditure priorities from the resources available to them (excluding ring-fenced resources) and their council tax levels, following consultation with their local electors.

Best Value

16. In taking decisions about their revenue or capital expenditure, local authorities are expected to demonstrate their commitment to pursue Best Value across the full range of their activities. Best Value is an approach to effective performance management that encourages the pursuit of continuous improvement through collection and appraisal of information about current performance, alternative options for service delivery, and the assumptions and objectives which underpin such services. An important means of collecting this information is consultation with stakeholders, and the maintenance of a positive attitude to transparency and accountability.

Local Government Finance Settlement

17. Scottish Ministers have agreed:

firm 3 year revenue grant settlements for each council;
firm 3 year supported capital borrowing allocations for each council; and
abolition of expenditure guidelines, subject to councils' agreement to publish indicative 3 year council tax levels.

Aggregate External Finance

18. Support for the 3 year revenue grant settlements is known as Aggregate External Finance (AEF). The total level of AEF for the 3 forward years is determined by Scottish Ministers as part of the Spending Review process which takes place every 2 years. AEF is made up of 3 components: Specific Grants, Non-Domestic Rate Income (NDRI) and Revenue Support Grant (RSG):

'Specific Grants' form a small part of the total grant support to local government through AEF. Their allocation and distribution are set centrally, linked to specific ongoing policy initiatives and expectations. Specific grants account for around 9% of total AEF and are used to fund expenditure on policing and certain education initiatives. The general presumption is against the establishment of additional hypothecated allocations within the local government settlement. (Specific grants for time-limited policy initiatives are normally classified as outwith AEF. The decision on whether a specific grant should be within or outwith AEF is the responsibility of the business area concerned.)
'Non-Domestic Rates' are collected by local authorities on the basis of a national poundage set by the Executive, paid into a central pool and redistributed to councils in proportion to their populations. The amount estimated to be available for distribution from the pool each year depends on forecasts of gross rate yield, losses from appeals and adjustments from previous years. Adjustments are made, either up or down, to the level of Revenue Support Grant (RSG) to reflect variations between the estimated Non Domestic Rates Income (NDRI) and the actual amount collected, so the amount collected by an individual authority has no direct impact on its AEF allocations.
'Revenue Support Grant' makes up the balance of AEF each year after estimates of specific grants and NDRI have been subtracted from the national AEF total. All Scotland's local authorities are responsible for the full range of local services, including education, social work, maintaining the local roads network etc. Certain services, including policing and the fire service are provided jointly by a number of authorities. Revenue grant supports councils' recurring expenditure on these services, for example on staff costs, etc. It also supports the debt servicing costs of some local authority borrowing to fund capital investment, leasing payments and approved Public Private Partnership projects.

Local Authority Self-Financed Expenditure

19. In reaching their decision about total revenue grant, Ministers must have regard to the impact on council tax levels. AEF funds around 80% of Scottish local authority expenditure with the remaining 20% funded largely from the council tax. The proportion of local authority expenditure funded from the council tax is known as Local Authority Self-Financed Expenditure (LASFE) and counts towards total public expenditure at a GB level, but is not part of the Assigned Budget. It is for each local authority to set its council tax level, following consultation with its local electors.

New Burdens

20. In setting the total level of AEF, Ministers must also consider local authorities' on-going responsibilities and any new burdens or transfers of responsibility. New burdens arise where Scottish Executive or UK policies give rise to an additional financial cost for councils. Although the AEF total is set for 3 years, adjustments can be made for new burdens or transfers of responsibility during this period. Where policy divisions within the Scottish Executive consider that a policy initiative or legislative change might place a new burden on local authorities they should contact Local Government Finance and Local Funding Division at an early stage.

AEF Distribution

21. Total AEF is distributed between Scotland's local authorities using a "needs-based" grant distribution system developed over many years through consultation between central and local government. The system recognises key factors which impact on councils' relative revenue expenditure needs. Grant distribution is calculated on the basis of councils' Total Estimated Expenditure (TEE) funded from both grant and local taxation. Councils' expenditure needs are split between expenditure on services and debt servicing (loan & leasing charges).

Loan & Leasing Charges & Support for PPP Projects

22. The Scottish Executive supports the debt servicing costs of some local authority borrowing to fund capital investment, leasing payments and approved Public Private Partnership projects. Support for loan charges, including for joint police and fire boards, is calculated based on a combinations of councils' actual historic debt levels and notional debt based on their capital allocations. Redemption and interest rates are determined by the Scottish Executive's Local Government Finance Statisticians. As loan charges support is calculated, in part, on a notional basis, local authorities can seek best value in their capital investment without losing the associated revenue grant support.

23. In addition to loan & leasing charges, local authorities also receive support through the settlement for approved Public Private Partnership (PPP) projects. The level of support is set based on an agreed final development plan. As the allocations must be included within the settlement totals fixed each year, Local Government Finance and Local Funding Division must be advised no later than October if a project is due to commence or if there is any planned change to its agreed full business case (fbc) in the following financial year. If projects do not proceed in accordance with the agreed fbc then funding can be stopped or even reclaimed.

Grant Aided Expenditure

24. Once loan & leasing charges and PPP support is top sliced from TEE, the remaining provision, known as Grant Aided Expenditure (GAE), is sub-divided between specific service and sub-service headings, known as GAE allowances. If it made sense to distribute total GAE amongst authorities pro rata to population, it would not be necessary to produce service or sub-service GAEs. However, it is recognised that there are other factors, in addition to population, that impact on councils' relative expenditure needs for different services.

25. The first stage in the Scottish distribution system is to allocate the aggregate level of GAE amongst services. This is known as the "GAE service split". The service split is a top-down process determined by the Scottish Ministers in consultation with COSLA, taking account of a range of factors, including: new burdens on authorities; actual levels of expenditure on particular services; and any political priority Ministers wish to give to particular services.

26. Once the GAE service split has been made, the next stage is to allocate the service GAE amongst sub-services. For example, there are around 20 Education sub-service GAEs - primary school teaching staff, secondary school teaching staff, etc. The aim of sub-dividing a service GAE is to introduce further refinement into the arrangements for distributing GAE amongst authorities. Each GAE allowance has, therefore, its own distribution formula.

Client Group Approach

27. The next stage is to give each authority a share of each sub-service GAE. This is done by means of what is known as the client group approach, which was first introduced in the 1980s and has been continually refined since then. The client group approach is an objective method of estimating the relative need of local authorities to incur expenditure on a particular service or sub-service. The approach takes into account variations in the demands for services and the costs of providing them to a similar standard and with a similar degree of efficiency. Fundamental to the approach is that the demand and cost factors must:

be outwith the control of local authorities (i.e. so that the distribution of GAE cannot be manipulated by authorities' own policy decisions);
offer plausible explanations; and
be shown to be associated with inter-authority expenditure variation.

28. The approach involves determining a primary indicator (PI) for each service or sub-service and, where found to be justified, one or more secondary indicators (SIs). The PI is what is regarded as the most significant single determinant of expenditure on a service or sub-service. For example, the PI for the Primary School Teaching Staff GAE is the number of primary school pupils at the most recent date available. However, it is recognised that authorities need to maintain schools with relatively small rolls in rural areas and that those schools have a higher ratio of staff to pupils and as a result are relatively more costly per pupil to run. Therefore, for this GAE there is a SI which takes account of this and has the effect of skewing part of the GAE towards authorities which have to maintain small schools. A number of GAEs are distributed on the basis of councils' actual or budget expenditure in previous years, where no suitable alternative methodology has been determined.

29. A local authority's GAE is the sum of its share of each service or sub-service GAE. The detail of the make-up of each authority's GAE is contained in the so-called "Green Book" which is produced each year. In recent years there has been a tendency to view councils' service and sub-service GAE allowances as spending targets or limits - which they are not. The GAE allocations merely contribute to the calculation of councils' total un-hypothecated grant allocation.

Council Tax Equalisation

30. The grant distribution formula is calculated on the basis of councils' total estimated expenditure. As noted above, the gap between this level of expenditure and total AEF is funded from the council tax. The distribution formula takes account of the resources that each council can raise from the council tax, by distributing the gap between TEE and AEF between local authorities on the basis of each council's council tax base (Band D equivalent properties). A council's AEF allocation is calculated by deducting its estimated council tax income from its total estimated expenditure. This "equalisation" adjustment is calculated on the basis that councils set a standard Band D council tax level. In practice, each council sets its own council tax rate to match its actual expenditure decisions.

3 Year Settlements & Minimum Grant Floor

31. Firm 3 year revenue grant allocations are provided to each local authority by the Scottish Executive following the Spending Reviews which take place every 2 years. The allocations for each of the 3 years are calculated using the methodology described above. However, for years 2 and 3, certain PIs are updated to use population projections. In addition, to ensure a stable and fair distribution of grant, Ministers have introduced a minimum grant "floor" within the settlement calculation, to ensure that all councils receive at least a minimum guaranteed increase in AEF for each year. The level of the floor for each year is set with reference to the aggregate increase in AEF. Where an individual council's AEF allocation from the distribution formula is below the "floor" in any year, its allocation is increased up to the "floor", by redistributing grant from other councils based on their share of total AEF.

Revenue Capping Powers

32. AEF supports around 80% of local authority expenditure, with the remainder met largely from the council tax. It is for each local authority to set its council tax level in consultation with local electors. Ministers have reserve powers to cap local authority expenditure, by imposing a reduced council tax level, where they consider an authority's expenditure or expenditure increase to be excessive. Ministers have not been required to use these powers to date and expect authorities to continue to show restraint in setting their council tax and expenditure levels.

Council Tax Benefit Subsidy Limitation

33. The devolution settlement provides for the Assigned Budget to bear any extra Council Tax Benefit (CTB) costs if average council tax rises faster in Scotland than the rest of the UK. The CTB limitation arrangements require individual councils to contribute towards these costs, where there council tax increases exceed a threshold set by Ministers. However, the CTB subsidy limitation thresholds are not alternative guidelines, but encourage councils to consider the benefit implications of their expenditure decisions.

Capital Expenditure

34. Capital investment by local authorities is largely funded through borrowing. The Scottish Executive funds the debt servicing costs (i.e. loan charges and redemption fees) of some of this borrowing, known as "supported borrowing", via revenue support grant whilst the unsupported borrowing, arranged under the prudential regime, is financed through local authorities own general resources. The Scottish Executive also administers a number of capital grants relating to specific areas of spend, such as Police and Fire.

35. For borrowing financed through general resources, the new prudential regime was introduced from 1 April 2004 by the Local Government in Scotland Act 2003 which abolished the previous limits on local authority capital expenditure, known as section 94 consents. Local authorities are now free to make their own decisions about capital investments as long as their capital spending plans are prudent, affordable and sustainable. Councils have a duty to keep this under review and, in doing so, must have regard to a Code of Practice developed under the auspices of CIPFA, called the Prudential Code for Capital Finance in Local Authorities. They also have a duty to adhere to statutory guidance on Best value, which stresses the importance of good financial management and project management control and of linking expenditure plans to effective asset management.

36. Although no national or local limits have been set for borrowing, HM Treasury has indicated that the option to do so will be kept under review. In the meantime, the Scottish Executive will monitor capital plans, outturn expenditure and borrowing levels, and will pass information to HM Treasury for monitoring on a UK-wide basis.

Last updated June 2005

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