Why do councils go bust and what happens when they do?

Nottingham, Birmingham and Woking councils all went bust in 2023. They followed and Thurrock and Croydon (for the third time) in 2022 - with half of councils warning of effective bankruptcy within five years without reform.

Councils technically can't go bankrupt - but they can issue what's called a section 114 notice, where they can't commit to any new spending, and must come back with a new budget within 21 days that falls in their spending envelope.

And when they do, it often means an impact on residents with severe cuts to frontline services.

Councils are required by law to have a balanced budget each financial year and provide "Best Value" to residents.

But more and more councils are finding it harder to do so.

Thirteen section 114 notices have been issued since 2018 - compared to just one before, in the year 2000. Two of those notices were due to misallocation of funds, however, rather than financial challenges.

"With every council that issues a section 114 there are specific circumstances, there are decisions that have been made that have lead them to that point," says Jonathan Carr-West, chief executive of think-tank the Local Government Information Unit.

"And it's appropriate in those cases to ask questions about decision making, governance, and accounting."

In Birmingham, those circumstances are a bill for equal pay claims going back over a decade and a botched new IT system.

Nottingham lost millions of pounds when council-owned energy firm Robin Hood Energy collapsed in 2020.

Thurrock invested hundreds of millions in commercial investments including a renewable energy scheme that had been overvalued.

Woking also invested in commercial schemes like development projects, while a report found that Croydon has poor governance and invested in a delayed housebuilding scheme.

"But there's also been a systemic problem with local government financing. Over the last 13 years, we've seen the amount of money that central government gives to local government reduced by more than 40%," says Mr Carr-West.

A reduction in money given to councils by central government doesn't necessarily mean that a council's spending power drops by the same level, as councils have built up other local income.

But their spending power has also dipped significantly.

The Institute for Government think tank estimates that between 2009/10 and 2021/22 the average fall in spending power for local authorities was 31% when not including Covid grants. The Local Government Association says that councils' spending power has dropped 27% since 2010.

Demand for adult social care is now at a record high, with requests almost reaching two million people last year, according to health think-tank The King's Fund.

"We spend 70% of our budget on adult's and children's social care," says Peter Oakford, deputy leader and cabinet member for finance on Kent County Council.

Councils must provide social care by law, so meeting the increased demand means cuts elsewhere.

"All of our money is spent on social care, meaning areas such as education, highways, youth services, the voluntary sector all suffers," says Mr Oakford.

The government says they've provided around £2bn in additional grant funding for social care in 2023/24 - while they say spending power will rise by an additional £4.5bn in 2024/25.

"You've got this incredible pressure on councils who are effectively trying to deliver £110 worth of services for £80," says Prof Tony Travers, an expert in local government at the London School of Economics. "They're spending less than they were 13/14 years ago, whereas the NHS - itself in trouble - spending is up 20% in real terms."

At the same time as spending power has been reduced, demand on council services has been growing.

"Partly because of demographic pressures, partly because of the pandemic, partly because of the cost of living crisis. And of course, like all of us, councils are subject to inflation, subject to higher energy costs," says Mr Carr-West.

"So you've got a perfect storm, where a council's costs are rising, the demand on their services is rising, just as their resource, their income is getting both smaller and harder to predict over multiple years."

The way in which local government is funded has also changed over the last 13 years. Councils used to get around most of their money from central government, but now they get most from local sources.

That includes council tax, retained business rates, and charges for services like parking, swimming pools, and planning applications. It also includes making commercial investments, which is where some councils have got into difficulty.

Additional funding from central government can also come through competitive funding bids, but all this means that funding is now largely based on local economic factors, rather than an area's need.

Mr Carr-West says that means a council could have a larger than average number of people who require around the clock care but funding doesn't take into account of that.

"We've lost that link between demand on your services and the way you're funded."

The government says that the majority of funding councils receive from them is not ringfenced, to allow local authorities to allocate it depending on local needs.

A spokesperson for the Department for Levelling Up, Housing and Communities, which looks after local government, said: "Councils are responsible for the management of their own finances.

"The Local Government Finance Settlement for 2023/24 makes available up to £59.7bn for local government in England, an increase in Core Spending Power of up to £5.1bn or 9.4% in cash terms on 2022/23.

"Through the 2023/24 Local Government Finance Settlement, the most relatively deprived areas of England will receive 17% more per household in available resource than the least deprived areas."

The government allocated an additional £600m for councils in January in recognition of the pressures they face. They say this means all authorities will see a minimum increase in core spending power of 4%, with total funding available in the 2024/25 settlement being £64.7 billion.

They also gave nineteen councils permission to sell or borrow against assets to plug gaps in day-to-day spending, something they're not usually allowed to do.

Funding settlements to local government are now on a yearly basis, rather than the previous three-yearly basis.

"One-year settlements do not help anybody...I used to manage a big business, and at the very minimum we had a three-year plan and a three-year budget," says Mr Oakford of Kent County Council.

When a council goes bust and makes cuts, it means prioritising services they're required to provide by law, while other 'discretionary' services like arts and voluntary funding face the brunt.

But those services required by law can still be cut. For example, while councils are legally required to provide library services, there's no legally defined level. "One library in the town centre - is that a library service? You've got quite a lot of freedom to decide what level of service," says Prof Travers.

"We saw judicial reviews in several councils around school transport for children with special educational needs [that they're required to provide by law], but the council decides who qualifies for it, which children get how much of it," says Mr Carr-West.

It can also mean a big hike in council tax - in 2023 Croydon raised theirs by 15%, while Thurrock and Slough, which has also issued a section 114 notice, both raised theirs by 10%. Birmingham is to raise theirs by 21% between 2024 and 2026 - at the same time as making £300m worth of service cuts.

Analysts at financial rating firm Moody's said they expect more local authorities to "fail over the near term" due to lost value of commercial property, high inflation, interest rates and service demand.

They named 20 councils with high debt levels including Spelthorne, Warrington, Guildford, and Surrey Heath. They also said that more councils may fail as they complete their delayed financial audits.

Failing councils can have a knock on effect on other services like the NHS and the police as well, as they have to pick up some of the slack.

Although Mr Oakford says Kent is not in the position of issuing a section 114 notice, he can't be sure that won't change in 18 months' time - "if we have another couple of years like last year, then we won't be in a strong position," he says.

As budgets are crunched, services are being stripped right back, says Mr Oakford. "Local government will become a provider of statutory services […] everything else will disappear. Local government will become meaningless."

"The question is, how much further can you go?" asks Mr Carr-West. "And I think what many people in local government would say is look, you know, people keep saying you need to trim the fat.

"Well, we trimmed the fat a decade ago. And then we trimmed the flesh. And now we are just right down to the bone."