MPs have warned the near collapse of a rural Westcountry council is an "early warning sign" about the health of other hard-pressed financial authorities.
A report by the Public Accounts Committee warned ministers do not fully understand the impact of significant cuts to council budgets and need to prepare for the financial meltdown of multiple local authorities.
It cited West Somerset Council, which serves 34,000 people, which was labelled financially "unviable" by officials after losing £100,000 a year. It is merging with neighbouring Taunton Deane.
The cross-party committee of MPs said the Government should draw up contingency plans to intervene in the event of "multiple financial failures".
They added funding continued to be cut while demand for some services was increasing, meaning "serious questions will arise about the viability of some councils".
The committee's Labour chairman Margaret Hodge said: "Central government is cutting funding to local authorities by more than a quarter over four years but does not properly understand what the overall impact will be on local services."
The central government grant to councils is being cut by £7.6 billion in real terms between 2011 and 2015, and major changes to the way authorities are funded are also being implemented, with reforms to business rates and council tax benefits.
Local Government Secretary Eric Pickles has said this year's average 1.7% cut to council "spending power" represented a "bargain", despite unions warning of libraries and day care centres closing.
Plymouth City Council has been among the biggest critics of the cuts, with one councillor claiming Mr Pickles "seems determined to bring a return to Dickensian Britain".
Councils have indicated that the £80 million of savings that Devon and Cornwall's four upper-tier councils will have to find over two years is an underestimate. Small district councils, arguably under greater pressure, are being encouraged by ministers to share "back office" services, which West Devon and South Hams have pioneered.
The committee's report said the Department for Communities and Local Government's procedures for managing problems with town hall finances or service provision were designed for dealing with one-off failures rather than a wider collapse.
"In the current funding environment, however, there is an increased risk that a number of councils become financially unsustainable, with the example of West Somerset Council, deemed 'not viable' by an LGA report, serving as an early warning sign," the report said. "The department must clarify its role and responsibilities in the event of multiple financial failures of local authorities, and draw up contingency plans for intervention."
In response to the report, local government minister Brandon Lewis said: "Every bit of the public sector needs to do its bit to tackle the deficit left by the last administration, including local government which accounts for a quarter of all public spending.
"However, there is more councils can do, such as recover the £2 billion a year of uncollected council tax, reduce the £2 billion lost to fraud and error and utilise the £16 billion sitting in reserves."