The Substitution — Where Your Recycling Money Actually Goes

Consider what happens when new money arrives at an institution that is already drowning.

Extended Producer Responsibility is meant to transform English recycling. Producers pay. Councils receive. Services improve. That is the promise, and it is not an unreasonable one. In late 2025 (Oct-Dec), the scheme entered its first producer-fee/payment phase; council payments begin in 2025/26. By the government's own announcement, GBP 1.1 billion will flow to councils in 2025/26, with the scheme expected to be worth GBP 1.2 billion by 2026/27.¹

But here is the question no one seems to want to answer precisely: what happens to that money once it arrives?

GBP 2.3 Billion

This is the funding gap facing English councils in 2025/26, according to Local Government Association analysis published in October 2024.² Not a projected shortfall. Not a warning. The arithmetic of what councils need minus what the government provides.

By 2026/27, LGA analysis shows this gap rises to GBP 3.9 billion.³ Over two years, English councils face a cumulative GBP 6.2 billion hole in their budgets.

Stay with me. This next part matters.

One in four councils say they are likely to need emergency government bailout in the next two years.⁴ The LGA's own language is unusually direct: "The risk of financial failure across local government is potentially becoming systemic."⁵

Into this context, EPR arrives with GBP 1.1 billion. You might think this helps. You might think councils will use this money to buy new recycling trucks, open sorting facilities, expand kerbside collections.

That is not what the structure produces.

65%

This is the proportion of a typical English council's budget consumed by adult social care and children's services, according to County Councils Network analysis from March 2024.⁶ For county councils specifically, the figure is 69%.⁷ For upper-tier authorities, CIPFA data from January 2025 shows the proportion has reached 78%.⁸

I'll say that again, because the number is easy to hear and difficult to absorb. In some councils, nearly four-fifths of the entire budget goes to social care.

These are statutory obligations. Councils cannot choose not to pay them. A child in care must be cared for. An elderly person requiring support must be supported. The law demands it.

What remains after social care is funded? Everything else a council does: libraries, parks, roads, planning, housing — and waste collection.

LGA analysis of MHCLG data shows that from 2022-23 to 2024-25, councils overspent their children's social care budgets by an average of 14.2% per year.⁹ Adult social care overspend averaged 5.2% over the same period.¹⁰ These are not one-off crises. These are structural features of the system.

And then there is homelessness. London Councils' analysis shows boroughs spent over GBP 900 million on homelessness in 2024-25 — an overspend of at least GBP 330 million, or 60% above their allocated budgets.¹¹

When you are overspending by 14% on children, 5% on adults, and 60% on homelessness — when two-thirds or more of your budget is already consumed by obligations you cannot escape — what do you do when new money arrives?

You use it for the emergencies you are already failing to fund.

Of course. Why wouldn't you?

Section 114

This is the mechanism of effective bankruptcy for English councils. When a council's chief financial officer determines that the authority cannot balance its budget, they issue a Section 114 notice. All new spending stops. Only statutory services continue.

Between 2018 and 2023, nine councils issued Section 114 notices — at least twelve in total, as some councils issued multiple.¹² The list reads like a roll call of financial failure: Northamptonshire in 2018 (twice). Croydon in 2020, 2021, and 2022 (three times). Slough in 2021. Thurrock in 2022, with debts of GBP 500 million. Woking in June 2023, carrying a GBP 1.2 billion deficit. Birmingham in September 2023 — an in-year shortfall of GBP 87 million, with an equal pay liability of GBP 760 million. Nottingham in November 2023.¹³

These are not abstract statistics. Birmingham is the largest local authority in England. Its effective bankruptcy was not a warning. It was an event.

And the projections suggest this is only the beginning.

London Councils' analysis indicates that half of London boroughs — seventeen — could require Exceptional Financial Support or face Section 114 risk by 2028.¹⁴ Seven already require emergency measures: Lambeth, Newham, Havering, Croydon, Enfield, Barnet, Haringey.¹⁵

Half of responding councils in a Local Government Information Unit survey warned they may issue Section 114 notices within the next five years.¹⁶

Half of English councils, facing effective bankruptcy within five years. Into this landscape, EPR arrives with GBP 1.1 billion for recycling.

GBP 0 (hard ring-fenced)

This is the amount of EPR funding that is hard ring-fenced as a separate grant line; EPR is paid as council income with use-conditions, but budgets remain fungible.

The government has stated that councils "must use this funding to deliver improved packaging waste collection services."¹⁷ But the enforcement mechanism — PackUK's power to reduce future allocations if funds are "used for other purposes" — has not yet been tested across a full financial cycle.¹⁸

The question is whether the government will actually investigate which councils are diverting EPR funds to social care, and then reduce those councils' recycling budgets. The political mathematics of this seem challenging.

But more fundamentally, there is a mechanism that makes ring-fencing irrelevant even if it existed.

The Substitution

At the EPR Conference in November 2025, representatives of LARAC — the Local Authority Recycling Advisory Committee — argued that ring-fencing was ineffective. Their assessment was blunt: the concept amounts to an "urban myth."¹⁹

Their explanation was precise. Dedicated EPR funds, they said, "simply replace existing council budgets rather than providing additional resources."²⁰

This is the mechanism that transforms the promise of EPR into something different from what producers were told they were paying for.

Here is how it works.

When EPR funding arrives, it is classified as council income. The government's provisional Local Government Finance Settlement for 2026-27 notes that councils will receive GBP 1.2 billion from EPR.²¹ In practice, councils can reallocate within their overall budgets, even where EPR comes with use-conditions and potential future-allocation penalties.

The provisional settlement notes the expected scale of EPR payments, but it does not state that general grants will be reduced pound-for-pound. Whether EPR is additional in net terms depends on future funding decisions and (more immediately) councils' internal budget reallocation.

THE RECEIPT: WHERE EPR GOES

The receipt cannot be completed because the endpoint is not fixed. The structure of council budgets — fungible income, statutory pressures consuming two-thirds or more of spending, no hard ring-fencing — suggests that EPR money substitutes for, rather than supplements, existing allocations. LARAC's assessment supports this reading. But no audited data currently confirms or disproves the net effect.

The councils' own trade body said it plainly: ring-fencing does not work as advertised. The money simply replaces existing budgets.

The Mirage

LARAC named the substitution. What they did not name is why it persists — why a mechanism visible to every actor in the system continues to operate as though no one had noticed.

The answer is in three documents.

The first is the Local Government Finance Policy Statement for 2025-26, published by MHCLG. It contains a sentence that, read carefully, is the architecture of the trap. EPR payments, the statement confirms, are "excluded from councils' Core Spending Power and will not be factored into any payments councils receive from the funding floor in 2025-26."²⁷ So far, so additional.

But the next sentence: "The government will assess the impact of additional pEPR income on the relative needs and resources of individual local authorities, and how we factor it into our measurement of local authority spending power, ahead of the 2026-27 Settlement."²⁸

I'll say that again more plainly. In year one, EPR is additional. From year two onwards, the government reserved the right to treat EPR income as part of councils' existing resources — which means it can be used to justify lower general grant allocations.

The LGA understood this immediately. Their briefing on the provisional 2026-27 settlement noted that if an adjustment were made to account for EPR income, "this will effectively represent a funding reduction for the sector."²⁹

This is the mechanism that no single public source assembles. The government announced GBP 1.1 billion for recycling. It simultaneously reserved the right to reduce general funding by an equivalent amount in subsequent years. The money arrives through one door. The baseline shifts to account for it through another. The net position remains approximately unchanged.

The second document is the OBR's Spring Statement 2025 accompanying forecast. In it, the Office for Budget Responsibility reclassified EPR payments. What had been described as fee receipts spent within departmental expenditure limits was relabelled as a tax — boosting the Treasury's tax revenue forecasts.³⁰ The Foodservice Packaging Association noted the shift and asked the question it implies: if EPR is classified as tax revenue rather than recycling investment, what guarantee exists that the money reaches recycling services?³¹

The OBR document provided part of the answer. The government's own assessment, reproduced within it, stated that "the policy is unlikely to have a material impact on rates of recycling or packaging waste volumes in the next five years."³²

The government's fiscal forecaster classified EPR as a tax. The government's own assessment predicted no recycling improvement. These are not contradictory findings. They are consistent ones — consistent with a system where the money is collected for one purpose and absorbed for another.

The third document is PackUK's own operational plan for 2026-27. It acknowledges that the Defra Secretary of State has "formally instructed PackUK to ensure that English local authorities spend the money on managing packaging waste."³³ It then describes the enforcement mechanism: PackUK's "stated intention" is to "work with local authorities" to emphasise appropriate use, "with recalculations anticipated as a last resort where a local authority is clear they do not intend to use their EPR for packaging income appropriately."³⁴

No specific monitoring mechanisms. No auditing procedures. No enforcement timelines. The last resort is a recalculation — a reduction in future payments to councils that are already facing Section 114 bankruptcy. The enforcement mechanism, in other words, is to give less money to the councils that are most financially desperate. The structure ensures it will never be used.

This is the geometry of the trap. The additionality is announced in year one. The baseline absorbs it from year two. The fiscal forecaster classifies it as tax revenue and predicts no recycling improvement. The enforcement body describes its powers as a last resort and provides no mechanism to exercise them.

Every document is public. Every actor is behaving rationally. And the net effect is that the substitution mechanism operates exactly as LARAC described — not because anyone is failing, but because the fiscal architecture was assembled from components that, taken together, ensure this outcome.

47%

This is the proportion of senior school leaders in England who reported using Pupil Premium funding — money allocated specifically to support disadvantaged pupils — to plug gaps elsewhere in their school's general budget, according to a 2024 Sutton Trust survey of 1,282 educators conducted by the National Foundation for Educational Research.³⁵ In primary schools, the figure reached 50%.³⁶ In 2019, the equivalent figure was 23%.⁴¹

The pattern is worth pausing on. Pupil Premium is ring-fenced. It comes with reporting requirements. Schools must publish strategies for how they plan to use it. And in 2024, nearly half of school leaders were using it to keep the lights on.

The Public Accounts Committee examined this in its March 2025 report. Their finding was direct: the Department for Education "cannot demonstrate it is achieving value for money" in the way it uses an estimated GBP 9.2 billion a year to narrow the disadvantage gap.³⁸ Not because schools are behaving dishonestly. Because schools under budget pressure do what councils under budget pressure do — they use whatever money arrives to address whatever crisis is most acute.

Now consider National Insurance. The fund has been notionally hypothecated to pensions, benefits and the NHS since 1911. In practice, as the Institute for Government concluded, hypothecation in the UK "is no more than a convenient mirage to help sell tax rises to a sceptical public."³⁹ When NI receipts exceed what is needed, the surplus is invested in the UK's national debt. When receipts fall short, the Treasury tops up from general taxation — the ring-fence flows both ways. The ring-fence is a presentational device, not a fiscal boundary.⁴⁰

The pattern is structural. Ring-fenced income arrives at an institution under statutory pressure. The institution absorbs the income into general spending because the statutory obligations take priority. The ring-fence provides political cover — the money was "allocated" for its stated purpose — while the fiscal architecture ensures it supplements the general budget.

EPR is the latest instance of this architecture. Not the first. Not the last. The same mechanism that absorbs Pupil Premium into school general budgets and National Insurance into the Consolidated Fund absorbs EPR payments into the council funding gap. The mechanism has a name in fiscal policy literature: it is the substitution effect, and it operates wherever earmarked funding meets institutions whose baseline obligations already exceed their resources.

The question is not whether EPR money will be substituted. The question is why anyone designed the system as though it would not be.

The Baseline That Does Not Exist

To understand why this happens, consider what councils have already cut.

Institute for Fiscal Studies analysis shows that between 2010-11 and 2019-20, central government funding for councils fell substantially in real terms.²² Spending per person on environment services — the category that includes waste collection — fell significantly during this period, alongside broader cuts to discretionary services.²³

Councils did not stop collecting bins. They found efficiencies, reduced frequencies, simplified sorting, merged services. But the money was already gone. The IFS analysis indicates that funding since 2020 has not restored cuts from the prior decade.²⁴

When EPR arrives, it lands on a baseline that has been eroded for fifteen years. It does not restore services to previous levels. It does not fund expansion. It arrives at a level roughly equivalent to what councils were spending on waste before the cuts — and the settlement structure ensures it substitutes for, rather than supplements, existing allocations.

The Opposition

The Local Government Association's position on ring-fencing is consistent and principled.

Daisy Robert, speaking for the LGA, stated: "We reject the call to ring-fencing that says funds can only go on collections. That is, in practice, a call for industry control of council waste services."²⁵

Cllr Arooj Shah, the LGA's environment spokesperson, added that "decisions about collections and services must remain in the hands of communities, not handed over to producers whose priority will inevitably be profit."²⁶

This is not an unreasonable position. Democratic accountability has value. Elected councils should, in principle, respond to local priorities. The idea that producers might dictate how local services operate is genuinely concerning.

But consider what this principle produces in practice.

When a council must choose between maintaining a children's home and improving recycling, it will maintain the children's home. When it must choose between temporary accommodation for homeless families and new collection trucks, it will house the families. These are not failures of values. These are rational responses to impossible constraints.

The principle of democratic discretion, in the context of a GBP 2.3 billion funding gap and a 65% budget lock in statutory services, becomes the freedom to choose which emergency receives inadequate funding.

The Ledger

If the brand pays the producer obligation, the money flows to councils. If the councils face a funding gap, the money addresses whatever emergency is most acute. If social care consumes two-thirds of the budget, the remaining third competes for everything else. If Section 114 looms, every discretionary pound is diverted to preventing bankruptcy. If the government factors EPR income into future needs assessments, the general grant adjusts downward. If the OBR classifies it as a tax, the Treasury counts it as revenue. If the enforcement body treats its powers as a last resort, no enforcement occurs.

Each actor in this chain is behaving rationally. The brand pays because the law requires it. The council diverts because the alternative is effective bankruptcy. The government permits substitution because ring-fencing would create political conflict with councils. The Treasury reclassifies because it needs the revenue line. PackUK defers enforcement because punishing financially desperate councils is politically untenable.

This is not failure. This is what the fiscal architecture produces. It is the same architecture that absorbs Pupil Premium into school budgets and National Insurance into the Consolidated Fund. The mechanism is not new. It is not specific to recycling. It is the standard operating system of UK fiscal policy when ring-fenced income meets institutions under statutory pressure.

Producers believe they are paying for recycling. Consumers believe their packaging is being collected more efficiently. The government announces GBP 1.1 billion for improved services.

But the ledger shows something different. The additionality is declared in year one and absorbed from year two. The fiscal forecaster predicts no recycling improvement over five years. The enforcement mechanism is designed not to be used. And the same substitution pattern has been documented, measured, and ignored in education and health for over a decade.

The packaging producers have paid. The consumers have paid through higher packaging prices. Whether the recycling improves is a question the structure is not designed to answer — because answering it would reveal that the money went somewhere else.

Now you have seen the architecture. Not just of this scheme, but of the fiscal mechanism that operates beneath it. You can read the next government announcement about ring-fenced investment and ask: is this additional, or substitutional? Is this money arriving, or is this money replacing money that is quietly leaving through another door?

The ledger is visible now.

The Levers

Three structural changes would close the gap identified in this report.

Hard ring-fencing with independent audit. If EPR funding were allocated as a separate, audited grant line — not absorbed into general council income — substitution becomes structurally difficult. The Scottish Government's approach to ring-fenced grants for specific services offers a model, though enforcement remains the critical variable.

Statutory baseline for waste services. Currently, councils must collect waste but have no mandated spending floor. A statutory minimum spend on waste and recycling services — comparable to the statutory obligations that protect social care — would prevent recycling budgets from being the pressure valve for every other shortfall.

Direct procurement by the scheme administrator. Rather than routing EPR funds through council budgets, PackUK could procure recycling infrastructure directly — purchasing collection vehicles, building sorting facilities, and contracting services. This bypasses the substitution mechanism entirely, though it raises the democratic accountability concerns the LGA has flagged.

None of these are simple. Each involves trade-offs between accountability, efficiency, and political feasibility. But the current structure, where the money arrives and the services do not change, is also a choice.

What Would Change This Analysis

If MHCLG published audited data showing that EPR payments resulted in net additional recycling spending — that is, spending above what councils would have allocated from general funds in the absence of EPR — the substitution mechanism mapped in this report would be weakened or disproved. Currently, no such audit exists.

If the final Local Government Finance Settlement for 2026-27 and subsequent years demonstrates that general grant allocations were not adjusted to account for EPR income — that baseline funding remained constant while EPR was genuinely additional — the additionality trap identified in The Mirage section would lose its structural basis. The government reserved the right to make this adjustment; whether it exercises that right remains to be seen.

If PackUK exercises its power to reduce future EPR allocations to councils that divert funds to non-recycling purposes, and this enforcement is sustained across multiple financial years, the practical fungibility of EPR income documented here would narrow significantly.

If the OBR revises its forecast and finds that EPR does produce a material impact on recycling rates within its first five years — contradicting its Spring Statement 2025 assessment — the inference that fiscal classification as a tax reflects the system's actual function would weaken.

If the local government funding gap closes substantially — through increased central government grants, council tax reform, or other fiscal restructuring — the pressure that drives substitution would diminish. Councils divert recycling money because they face impossible budget constraints. Remove the constraints, and the incentive to divert weakens.

Finally, if the Pupil Premium substitution effect reverses — if the proportion of schools using it for general budget gaps falls significantly from its 2024 peak of 47% — that would suggest the fiscal substitution architecture identified across multiple domains is not as structurally inevitable as the current evidence indicates. It would be one domain where ring-fencing, despite statutory pressure, proved effective.