Natural England

Review of Local Government Finance (AP02/16)

FOR DECISION

Background

The Local Government White Paper 

1. In December 2001 the Government published a White Paper for Local Government, Strong Local Leadership - Quality Public Services. It announced a wholesale review of the formula used in the allocation of finance to local government. The current system was seen to be too complicated and mistrusted by many in local government; there was a need to simplify the formula and make the allocation more transparent.

2. Other parts of the White Paper are also relevant to the allocation of local government finance. There is a strong emphasis on improving the efficiency and effectiveness of local government. It proposes that, by building on the successes and potential of best value, Comprehensive Performance Assesment and local Public Service Agreements, the Government will put in place a comprehensive framework for continuous improvement in the quality of local government services.

3. The Department of Transport, Local Government and the Regions (DTLR) will be publishing options for the funding formula in late Summer of this year and announcing the preferred option in November, with the aim of introducing the new formula to allocate funding in the financial year 2003/2004. This is a very tight timetable, especially as we know little about the options being studied.

The current allocation system 

4. At present each local authority is set a Standard Spending Assessment (SSA). This is a formula based figure which takes into account a number of variables that impact on the cost of providing each main block of services such as sparsity, density, need indicators, Area Cost Adjustment (which applies mainly to London and the South East and takes account of the higher cost of living and weights funding towards those areas) etc. This is then used to calculate the total amount a local authority should spend on its services in the following year. More detailed information on the SSA is in  Annex A.

5. For some services a variable is included to take account of the additional costs of rural service delivery. This is known as a "sparsity factor". This factor increases the amount allocated within the Standard Spending Assessment based on the number of people that live in each hectare of an authority. However, there are a number of problems with the sparsity factor itself and the extent to which it is used. These are:

• It does not accurately reflect the impact rurality has on service delivery. The sparsity indicator does not mirror the actual distribution of populations in rural areas, the high numbers of small dispersed settlements or the relative distance from principle service centres.   

• It can lead to false measurement, such as the inclusion of the City as London as a Super Sparse area, because it is a business district and very few people live there.   

• The sparsity factor is not used for all the service blocks. There are six service blocks within the SSA and each has its own formula. Of these, only three include a sparsity factor - Education; Environmental Protection and Cultural Services; and Personal Social Services. (However, in the latter sparsity is only included in the allocation for Older People's Domiciliary Care services of the Personal Social Services block and not for the other domains.)   

• The sparsity factor used differs in each spending block; for Older People's Domiciliary Care it is 0.5%, whereas for the entire Education block it adds 5% on to the amount received.   

6. Despite various discussions over the years with the DTLR and its predecessors, it is still not clear why rurality is not more consistently applied, despite evidence to suggest that the basic impact on the delivery of services is similar (although it is accepted that it would not always be exactly the same).

7. In addition, the current allocation does not take account of the fixed costs simply of a council being in business. These are the costs every authority, whatever its size, experiences just to exist and before they can begin delivering services.  These are far more onerous on smaller local authorities, as they do not benefit from the economies of scale of larger authorities.  There is a strong correlation between small local authorities and rural local authorities.

Countryside Agency response

8. For a number of years the Agency has been concerned that the SSA does not take sufficient account of the costs of delivering public services in rural areas and, in some cases, the formula used disadvantages rural authorities and residents. In the late 1990s, the Agency's predecessor, the Rural Development Commission, undertook research into the impacts of the local government funding allocations on rural local authorities and the services they delivered. They and the Agency have also worked with the County Councils Network and the Most Sparsely Populated Councils Group of local authorities on various research on this issue. This work has shown that costs arising from increased transportation, due to dispersed and remote communities, coupled with the lack of economies of scale found in larger urban centres, have not been taken into account to their full extent and that SSAs are based upon an assumption of lower spending levels per capita in rural areas than urban and metropolitan areas. (For example, in 1995/96 Inner London boroughs were expected to spend about £1.78 per head for every £1 spent by councils in shire areas to provide the same range of services. A note of the findings of research from a number of sources on these issues is at Annex B.) 

9. The Agency has welcomed the review of the finance system and the intention that the system should be more comprehensible and transparent. However, the White Paper did not outline the specific changes that would be made to the formula. Whilst the Government accepts that rurality is a cost driver, it seems likely to continue to address rurality in much the same way as at present.

10. We are also concerned that other elements of the current formula can have a negative impact on the allocation to rural authorities. Needs indices and the Area Cost Adjustment (which is used to offset the higher cost of employing staff in London and the South East) are both biased towards the capital and other urban areas. We are anxious to ensure that these concerns are addressed in the development of any new formula and that the obvious disadvantages to rural areas are overcome. But we believe we can make more impact if we focus on looking at the case for addressing rurality properly rather than on the relative distribution between urban and rural areas. 

11. We are also concerned that the fixed costs of being in business - the cost of democracy - has not been addressed. This would give a set amount of money to all authorities to take account of the fixed costs of being in business and has been pushed for by the Most Sparsely Populated Councils Group (MSPCG). This is something the Agency has recognised in its funding of Rural Community Councils and we believe there is a case for it being recognised for local authorities.

Action to date

12. Work carried out for us last year (summarised in Annex C) confirmed that there is a considerable body of research showing that rurality is a substantial cost driver in the delivery of public services. The two principal factors that increase the cost of service delivery are transportation and the lack of economies of scale. Despite this little work has been undertaken in England on more effective methods of addressing rural cost drivers in the formula based allocation method used to finance local authorities. New measures for rural cost drivers have however been examined in Wales and Scotland under their new parliamentary powers.

A new approach to addressing rurality

13. The evidence suggests that the sparsity factor, and the way it is used at present, does not provide adequate compensation for the true cost of delivering services to dispersed and remote rural communities. A better approach might be the one being explored in Scotland and Wales which has looked at the use of indicators of dispersion and of the settlement patterns within an area. By using these measurements, both economies of scale and the increased transportation costs can be addressed within a formula. 

• settlement pattern –  the percentage of an authority's population living outside settlements of 1,000+ population. (A settlement is a continuously built-up area that is at least 1 km from any other built-up area.) This would take account of facility-based services where there are losses of scale economies on account of the limited local population using the service.   

• population dispersion –  the aggregate of average distance between residents who live outside settlements of 7,000 or more, and their nearest settlement of over 7,000 population. The distance is weighted by population size and measured by straight line between the centre point of each output area and the nearest settlement of over 7,000. This would take account of services which have significant transport component (e.g. the service is "taken to" clients) where a more dispersed populations generate higher unit costs.   

Both indicators use information derived from the Census.

A round table discussion with central and local government representatives concluded that this different approach to assessing rurality had some merit, but that further work was needed to see if it was appropriate in England.

Next Steps

14. Given the short timescale for the Government's current review, we are not in a position to put the case for any wholesale change to the formula. However, we do consider we have sufficient evidence to make the case for rural costs to be more adequately reflected. To make the case for more radical change, we propose some short term and longer term actions for taking this work forward:

Short term:

15. For the current review, we propose to press DTLR to recognise rurality as a cost driver in all services delivered by local authorities and look for a more consistent approach to use of the sparsity factor within any new formula. There should be a presumption that a sparsity factor will be included in the formula for all service blocks, unless there were clear reasons why this would not be appropriate. The percentage factor used should be more consistent across all service blocks, again unless it could be demonstrated why particular services require different factors. 

16. In addition, in view of the continuing concerns over the suitability of the present way of compensating for the additional costs of rurality, ie through the sparsity factor, we would like the DTLR to agree to work with us and others on developing new indicators of rurality that can be used in local government allocation formulas. In particular, we might test whether the Scottish and Welsh model offers a potential way forward for England.

17. Finally, we would ask that the fixed costs of being in business are recognised and that a set amount be allocated for all local authorities to take account of these costs.

Longer term:

18. With a view to influencing future reviews, we propose to look further at the use of settlement pattern and dispersion indicators in England as an alternative to the sparsity factor. Initially, we propose to look at the effects of these indicators in a number of case study areas to determine the positive and negative impact on allocations and whether it accurately reflects rurality in the diverse rural areas of England. We also need to examine the impact of the current and any new approaches on market towns and less remote rural areas. 

19. In the light of the options which will be put forward by DTLR in the summer and their preferred option later in the year, we will need to consider whether further work is needed, eg in looking at the needs indicators used and/or the impact of the Area Cost Adjustment (if it remains). 

20. As part of our wider work on local governance we will also be examining the broader issues surrounding service delivery and the impact and opportunities that Best Value, Comprehensive Performance Assessments and of Local Public Service Agreements will create for rural service delivery. 

Risks and Mitigation

The risks associated with this work are:

• it is a large amount of work for a relatively small Branch.
• there is the possibility we will miss the boat (launching research that will only be relevant to the next review of local government finance)
• there is a need for very specific skills and knowledge to undertake much of this work.   

In order to mitigate these risks we will:

• work with a wide range of partners when undertaking this work.
• by having both long term aims as well as shorter term ones we will build a body of work with which to influence government in the future.
• we will buy in expertise as and when it is needed.   

Annex A  

Standard Spending Assessments (SSAs)

SSAs can be seen as central government's view of the relative spending needs of each local authority area, since the aim is to allow for standard levels of provision between areas on services such as education and social services. In broad terms each area's SSA is calculated on the basis of its population size, plus various other indicators reflecting need and cost. To calculate the amount of Revenue Support Grant an authority receives the amount they can raise in Council Tax and their Business Rate allocation is removed. In 2002/03 the total SSA is in the region of £50 billion with the Revenue Support Grant total around £20 billion.

Of the total SSA calculation Shire areas were estimated to spend £28 billion, 57% of entire SSA calculation. However, when this is calculated as a per head of population figure the distribution changes. Table 1 shows the distribution of SSA per head of population for London, Metropolitan areas and Shire Areas.

The SSA is made up of six service blocks. These blocks are:

• Education
• Personal Social Services
• Highways
• Environment, Protection and Cultural Services
• Police
• Fire   

Annex B

Examples of the impact of rurality on public service delivery and local authority funding

• research for the Rural Development Commission, published in 1996, found that SSAs for shire areas in 1995/96 were significantly lower than those for metropolitan areas and for London boroughs; for shire areas the allocations averaged £648 per head compared to £756 for metropolitan districts, £798 for outer London boroughs and £1,154 for inner London boroughs.   

• the same study revealed that the Area Cost Adjustment swung significant resources into the London area. In inner London it added about 23% to the SSAs   

• a County Councils Network (CCN) study in 1998 on Personal Social Services found transport costs were 10% dearer in very sparse areas and costs of providing a home care assistant to cook meals could be as much as five times the urban cost in extreme cases;   

• research for Norfolk County Council found much higher per pupil costs for small (village) schools;   

• work for the Scottish Executive (April 1998) found very strong evidence of higher costs where settlement sizes were under 1,000 residents for primary school provision and where settlement sizes were under 2,000 for secondary schools.   

• the 1996 RDC study found that, where there are less than 100 pupils in a school, the cost per pupil rises substantially, as economies of scale disappear. In a selection of shire counties 26% of primary schools had less than 100 pupils compared to 4% in metropolitan districts and 1% in London   

• an analysis of the 1997/98 SSAs showed that education SSAs for primary education implied that an average shire county should spend £1,800 per pupil whilst an average inner London borough should spend £2,546 per pupil.   

• 71% of the counties and unitary authorities in the sparsely populated fire authorities budgeted to overspend by more than 10%.   

• the SSA regression formula for fire underestimated the spending in 1990-91 of the 24 most sparse authorities by £5.836 million but overestimated the spending on the 22 least sparse areas by the same amount.   

• shire authorities overspend in relation to Children's Personal Social Services by up to 48.2%, compared to an England average of 28.7% and an inner London average of 10.7%   

• s study for the County Council's Network found that travel related costs were highest in more rural areas eg £94 per head in Birmingham compared to £210 per head in North Yorkshire.   

• for ambulance services a 1% increase in rurality leads to a 0.23% increase in travel costs and that a 1% increase in the total numbers of journeys leads to a 0.17% decrease in unit costs.   

• research in Scotland has indicated that around 45% of the total costs of General Medical Services might be influenced by remoteness.   

• research by National Economics Research Associates (NERA) in Scotland found that nursing care in remote areas may require higher grade nurses to carry out the full range of tasks in there area and that higher grade staff are carrying out both skilled and unskilled work.   

• there is an 87% correlation between population sparsity and per capita spending on transport.   

Annex C

Briefing note on Research on Local Government Finance.

A literature review of recent research into Local Government Finance and the cost of service provision to rural communities. (Including reviews of the research examined by the government's formula review groups for education and services other than education).

Background

The Countryside Agency has not been heavily involved in the Local Government Finance debate, although it has responded to the Green Paper we wished to get more involved in this important area. In order to participate in the important debate of financing local authorities the Agency needed a piece of research to update us on the research, policy and political background to the treatment of rurality and sparsity in the distribution of finance to Local Government. 

The research

The key aim of this piece of work was to:

• Provide the Countryside Agency with the background information necessary to influence the treatment of sparsity within the allocation of local government finance.   

With this aim in mind we commissioned a literature review of research and policy papers surrounding the treatment of sparsity not just in England but throughout the UK. The review examined research into how sparsity effects the cost of delivery in both local government and health services as well as highlighting how this has been addressed in the allocation of funding. Specific attention was paid to the research examined by the Education Funding Strategy Group and the Formula Review Group to assess how the government may treat sparsity in any new formula.

We also asked the researchers to examine the data from the Rural Services Survey to see if this could be used as a more relevant measurement of sparsity within a formula than the one currently used.

Overall Findings 

When the information is looked at as a whole the first area for concern is how little attention has been paid within government policy to the treatment of sparsity within local government allocation formula within England. Very little attention has been paid by central government to researching the effect of rurality on the cost of providing services in England. Much of the key work coming out of the Government on sparsity and cost is for Scotland, Wales and Northern Ireland. Work has been undertaken on sparsity costs in England, primarily by the County Council Network (CCN), and has been considered by various formula review groups, however, feedback on these reports has not been forthcoming.

There are also concerns that the government is moving towards a more decision based approach rather than a research/ regression based formula.

The formula Review Groups.

Education Funding Strategy Group Papers:

Papers presented to this group argued a variety of different points, some in favour of rural areas but the majority apparently having a negative impact on a rural allocation. Some of the key points from these papers are that:

• the sparsity factor weighting is too high.
• per capita transport costs were the only cost positively correlated with sparsity (discounting the argument that rural areas do not benefit from economies of scale).
• the area cost adjustment should not be based on pay in occupation closely allied to teaching
• a rejection of activity led funding that would take account of, for example the higher cost of providing small schools and that further work at this stage would not be productive.
• that big authorities spend more than small authorities.   

However, there were papers that argued for more rurally sensitive indicators. For example papers showed:

• The higher cost of providing small schools in rural areas and that any funding formula should reflect the number of schools in rural areas.
• the Area Cost Adjustment does not represent the actual cost faced by local authorities, particularly those employees subject to national pay scales such as teachers.   

The Funding Review Group Papers.

This group examined the funding formula for Local Authority services other than education. The key points from the literature reviewed in this group were:

• Questions were raised as to the link between deprivation and population change. Paper form Birmingham City Council felt that as those in higher status jobs moved form urban to rural areas the burden of income support etc. was left to urban areas and national core regions. No statistical evidence found but if further work done it would work against rural areas.
• local authorities in shire areas tend to overspend by as much as 48.2% on Children's Personal Social Services, a significantly greater extent than for other types of authority.
• The inclusion of an ethnicity indicator would operate to the disadvantage of rural areas and that current models working to show a higher cost in providing service to children from ethnic minorities is too blunt.
• Fostering cost adjustments are based on unit costs so risk reflecting historic levels of funding rather than actual need.
• travel related costs for social services provision are higher in rural areas.
• the need to include elderly people in residential care as the current system only includes those living in private households which skews resources away form areas with the highest need.
• significant travel costs and diseconomies of scale are apparent in the provision of Fire Services to rural areas and that the majority of Fire Authorities in sparsely populated areas overspend by up to 10%   

Examples of how rurality effects cost

The work shows that there are additional costs involved when delivering services to local authorities. A variety of research from throughout Britain shows that the principle areas where costs are greater are in transport and the lack of economies faced when delivering services to smaller dispersed communities. Examples include:

• a County Councils Network (CCN) study in 1998 on Personal Social Services, that found transport costs were 10% dearer in very sparse areas and costs of providing a home care assistant to cook meals could be as much as five times the urban cost in extreme cases;
• research for Norfolk County Council found much higher per pupil costs for small (village) schools;
• work for the Scotland Executive (April 1998) found very strong evidence of higher costs where settlement sizes were under 1,000 residents for primary school provision and where settlement sizes were under 2,000 for secondary schools.
• 71% of the counties and unitary authorities in the sparsely populated fire authorities budgeted to overspend in by more than 10%.
• Shire authorities overspend in relation to Children's Personal Social Services by up to 48.2%, compared to an England average of 28.7% and an inner London average of 10.7%
• A study for the County Council's Network found that travel related costs were highest in more rural areas. £94 per head in Birmingham and £210 per head in North Yorkshire.
• the SSA regression formula for fire underestimated the spending in 1990-91 of the 24 most spares authorities by £5.836 million but overestimated the spending on the 22 least sparse areas by the same amount.
• that for ambulance services a 1 percent increase in rurality leads to a 0.23% increase in travel costs and that a 1 percent increase in the total numbers of journeys leads to a 0.17% decrease in unit costs.
• Research in Scotland has indicated that around 45% of the total costs of General Medical Services might be influenced by remoteness.
• Research by NERA in Scotland found that nursing care in remote areas may require higher grade nurses to carry out the full range of tasks in there area and that higher grade staff are carrying out both skilled and unskilled work.
• there is an 87% correlation between population sparsity and per capita spending on transport.   

The treatment of sparsity in formulae.

Another key piece of information to come from the literature review is that there are other options to be explored when developing an indicator to reflect the true cost of service delivery to rural areas. Both Scotland and Wales have examined the use of dispersion and settlement indicators as an alternative to sparsity with positive recommendations from the researchers involved that this is a more accurate reflection than the current sparsity measures.

The Rural Services Survey.

The information from the Rural Services Survey could not be used in any allocation formula for a number of technical reasons. The consultants recommended that dispersion indicators and settlement patterns would be the best way of reflecting additional rural costs in any formulae.

Conclusion

The research basically shows that there is a considerable body of research showing that public service providers face extra costs when delivering their services in rural areas. They face increased travel costs and are effected by diseconomies of scale because of having to provide larger numbers of smaller services. 

The key points coming from the report are:

• There is a body of evidence showing the additional costs faced by rural areas.
• Research shows that the current method of allocating finance often leads to considerable overspend by public service providers in rural areas.
• The sparsity factor is not enough and that the Agency should push for these of settlement and dispersion indicators similar to those being proposed for Scotland and Wales.
• However, this must be tempered by the apparent urban bias within much of the material viewed by the Government and the lack of commitment to an exacting study of the costs of rural service provision and how to address this.