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Area Cost Adjustment

What is an Area Cost Adjustment?

The cost of delivering similar services varies across the country. In London, for example, services cost more to deliver because of London’s unique labour and property markets.

In order to allocate funding appropriately, the Area Cost Adjustment (ACA) intends to modify funding in order to account for the differences in service cost delivery across the country. In principle, the difference between funding for two otherwise identical authorities in different parts of the country would be the ACA.

The current ACA reflects differences in wages across the country (the ‘Labour Cost Adjustment’) and differences in rateable values (the ‘Rates Cost Adjustment’).

The Labour Cost Adjustment

In the current funding formulas, the Labour Cost Adjustment (LCA) uses wage rates data from the Annual Survey of Hours and Earnings (ASHE). The ASHE is a 1 per cent sample of all employees. Using this data, a Labour Cost Adjustment is calculated through regression analysis (controlling for factors such as age, gender, occupation and industry) for each local authority. The LCA is applied to each service block based on a weighting which estimates the level of spend on employees in each service block (this ranges from 40 per cent in highways to 85 per cent in education services).

The chart below - showing median earnings in 2017 - clearly shows the higher average wage rates in London compared to other regions.  

The Rates Cost Adjustment

The Rates Cost Adjustment (RCA) is of much smaller significance when compared with the LCA – as business rates costs are a much smaller proportion of spending than employee costs - but are nonetheless an important factor within the ACA reflecting the higher costs of land and buildings used by local authorities in different parts of the country.

The current RCA is based on a weighted average of the rateable value of office space per square metre (using Valuation Office Agency data) for defined areas of the country. These are defined as: the City of London; Inner London; Outer London; London’s fringe area; the rest of the south-east; the south east fringe; and the north. As with the LCA, the RCA uses the estimated proportion of total spend that goes on business rates in each service (typically 1-2% across all service types).

The chart below - showing the Rateable Value in 2017-18 - clearly shows that London has disproportionately high business rates costs compared to other regions.

Implications for the Fair Funding Review

It is vital that the needs assessment within any new funding formula continues to include an area cost adjustment. This is incredibly important for London boroughs and the surrounding South East of England, as the costs of delivering services in the capital and surrounding area are higher as a result its unique property and labour markets.

Any new ACA should be based on the most up to date data. The existing one uses data from different data sources dating from 1992/93 to 2007/08, which are now extremely out of date.

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