Local news coverage could disappear unless the government provides direct financial support, according to an independent report on the future of the British media, which warns the industry’s collapse poses a threat to the “long-term sustainability of democracy”.

Dame Frances Cairncross was appointed by the government last year to investigate ways to secure the future of high-quality journalism in Britain.

Her report has concluded there should be a public investigation into the dominance of Facebook and Google in the advertising marketplace. She also recommends a new regulator to oversee the relationship between news outlets and technology giants, which have taken much of the advertising revenue that used to subsidise reporting.

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But the Cairncross review also concluded that many local newspapers which are vital to a functioning democracy are owned by debt-laden publishers which have cut investment and sacked hundreds of journalists in an effort to maintain profit margins.

She drew parallels with once-dominant businesses which have failed to make the digital leap, such as Kodak or Blockbuster, and said the priority should be ensuring high-quality journalism continues to be produced in Britain rather than attempting to save the newspaper industry in its current form.

Key recommendations in the report include:

Direct funding for public-interest news outlets, with public funds used to support the reporting of local democracy through a new institute of public interest news.

An investigation by the competition regulator into the online advertising marketplace, which would consider whether Facebook and Google’s position is too dominant.

A new code of conduct between publishers and large tech companies, overseen by a regulator which would ensure tech firms treat news publishers fairly.

Tax relief for publishers which invest in public interest journalism, potentially by giving charitable status to some publishers.

Removing the 20% VAT tax on digital news subscriptions, bringing online paywalls in line with printed newspapers.

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Cairncross said that job losses at local newspapers meant there was a crisis in the coverage of democracy. “The cost of investigative journalism is great and rarely seems to pay for itself … given the evidence of a market failure in the supply of public-interest news, public intervention may be the only remedy.”

She added that there was no clear way to provide profitable coverage of a local council meeting, since such stories tend to attract few clicks on the internet. “Ultimately, the biggest challenge facing the sustainability of high-quality journalism, and the press, may be the same as that which is affecting many areas of life: the digital revolution means that people have more claims on their attention than ever before.

“Moreover, the stories people want to read may not always be the ones that they ought to read in order to ensure that a democracy can hold its public servants properly to account.”

Sales of printed newspapers have collapsed during the last decade, with revenue from print advertising following the same downward trend. Although audiences have switched online, even national publishers have struggled to make similar sums of money from digital advertising given the scale and targeting offered by the likes of Facebook and Google.

Research commissioned for the Cairncross report found that the number of frontline journalists in the UK fell from an estimated 23,000 in 2007 to 17,000 today, with redundancies and closures of titles expected to continue.

Local newspapers have been particularly badly hit by the changes, especially in the classified market. Revenues from advertising placed by small businesses with the three biggest regional publishing companies fell from £2.8bn to £832m in the decade to 2016.

However, publishers did not escape criticism. Cairncross pointed out that many local newspaper groups have had to deal with large pension and debt liabilities, built up when they went on costly acquisition sprees before the market collapsed in the late 2000s.

Cairncross said this means the likes of Reach plc and JPI Media have had “less money available for investment in the substantial innovation that a successful digital future requires”, instead making cuts or restructuring their debt to the detriment of newsrooms.

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In an attempt to fix the problem she has proposed the establishment of an institute for public interest news, which could distribute funding from both the government and other sources, building on the success of the BBC local democracy reporter project and modest spending on journalism projects by Google and Facebook. She said an independent institution was necessary because if the state or large technology companies directly financed the production of news “the effect may be to undermine trust in the press still further”.

Cairncross concluded that the internet had been good for consumers, enabling them to read a wide variety of news sources for nothing. She also rejected proposals from publishers that Facebook and Google should be made to pay to include news content on their systems, warning that such a move could cause “significant harm to people who want to see news”. She suggested that the BBC needed to avoid stepping on the toes of for-profit local news sites.

The culture secretary, Jeremy Wright, said the government would consider the report in full and report back this year.

Cairncross, a former rector of Exeter College, Oxford, previously worked as a journalist for various publications, including a decade spent at the Guardian during the 1970s and 80s.