Since taking over control of East Lothian Council five months ago, the new Labour/Tory administration has not exactly hit the ground running. But what they have been busy doing is sowing alarm and despondency about the “parlous state” of council finances and using every opportunity to declaim “last year’s record 26% increase in capital spend to a total of £71m“.

To a large extent, this is predictable politics. They made a number of election promises like restoring free heavy kerb-side uplifts and building house extensions. These need to be funded at a time when incomes are dropping, so something will need to be cut to allow for them; finding fault with the previous budget is good cover to blame someone else.

Except that both Labour and Tory budgets last February committed even more capital spend and Labour, in particular, had been vocal in criticising the scale of reserves, claiming that the council could therefore afford to give everyone a pay rise. However, at the Audit Committee meeting of September 18th, an audit report from KPMG sided with the new administration, criticising both over-commitment of reserves and a debt-to- revenue ratio at 1.62 that they presented as the worst in Scotland.

Auditors—especially ones of the stature and charging the fees of KPMG—are expected to get things like this right by listening to the details. This lot may have looked for the beef in the figures but they wound up corned beef. Here’s why.

Firstly, not only was the present recession was anticipated and built into ELC budgets as early as 2010/11 but ELC was praised for its handing of it. The Report on the 2010/11 Audit by Audit Scotland of October 2011: “The General Fund recorded a net surplus of £5.9 million, attributable mainly to savings across service budgets” and “an additional £7.4 million statutory surplus was added to reserves” and most importantly “most of the council’s recent borrowing is to finance the building of social housing and debt charges can be met from housing revenues.” All this was achieved while securing local jobs by sticking to plan giving people affordable homes and key facilities like schools.

Secondly, until this spring, the UK Governments was driving Scotland towards a reduction in finance of 4% over each of three years to 2013/14, followed by a slow recovery to original levels by 2020. Faced with an option between shedding 12% of staff or building a “bridge” across the dip, ELC chose temporary use reserves to keep services stable and staff secure. The dip in revenue and ‘bridge’ across its low point is illustrated in Chart 1.

Thirdly, the new KPMG report to ELC’s Audit Committee last month appeared to be written wearing a set of blinkers. By claiming “all reserves committed” and a “record rise in capital spend by £71m” and “largest debt by revenue of all 32 councils” they interpreted numbers narrowly. The use of reserves had been planned that way (see 2 above). The key figure for debt was £24m, rather than £71m (see table below) and; c) non-housing debt by revenue—the one that matters because it’s repaid from revenue was 0.95, not KPMG’s 1.62.

Table 1—Breakdown of ELC Capital Investment for 2011/12

The reason net non-housing debt should be used is twofold: several councils (e.g. Glasgow & Borders) have no housing debt at all and; housing debt is no real burden as rents not only cover borrowing costs but can even supply financial support elsewhere. Therefore only the non-housing part need be funded from general revenue budget. Redrawing KPMG’s chart gives Chart 2.

This shows three councils deeper in debt than East Lothian, none of whose housing, education or general infrastructure (i.e. buildings) are in as excellent a shape as East Lothian. Indeed, one reason for East Lothian’s debt has been making its estate sound in anticipation of money being tight in the near future. This secured many jobs in the county while allowing the council to shed 400 jobs naturally, thus far avoiding any mass compulsory redundancies.

Fourthly, putting that another way, some £106m (over £1,000 per resident) has been pumped into local jobs in providing 1,000 affordable homes over the last five years. Crucially, all resulting debt can be carried within the self-sustaining Housing Revenue account (HRA). Over the same time, the General Services account borrowed an additional £43m that will cost just over £1m in additional interest. An equivalent sum was taken every year from the HRA by the earlier Labour administration—clearly such numbers can be sustained.

All that said, no-one questions difficult times ahead. A double-recession has delayed when the corner in Chart 1 will be turned. Any 3-year budget set last February does now need revision to allow for new circumstances. But whether ELC’s new administration can absorb the rigorous budgeting necessary—or KPMG twigs how local government capital finance works—is entirely another matter.