Britain’s economy needs an investment shot in the arm
Industry leaders are calling for incentive schemes as cliff-edge looms, write Eir Nolsøe and Szu Ping Chan
The Chancellor will take with both hands from businesses when the corporation tax rate shoots up and the generous superdeduction ends next month.
Without intervention from Jeremy Hunt in this week’s Budget, experts warn the cliff-edge will force companies to slam the breaks on already weak investment.
Sir Philip Hampton, a former chairman of pharmaceutical giant GSK and RBS, says he fears policymakers have not “woken up” to the fact that America and the EU are issuing massive subsidies that will suck investment from places like Britain.
“The level of research and development investment in this country is the lowest amongst any of our peers,” he said. “And it’s been very low for a very, very long time.”
The stagnating British economy desperately needs investment as living standards sink and businesses continue to reel from the energy crisis.
There is a strong link between investment and growth, with one study suggesting a 10pc rise in capital stock raises GDP by 2-3pc.
Both business investment and economic expansion have largely flatlined over the last five years and pressure to solve the problem is mounting. Encouraging companies to invest through measures in this week’s Budget will be key to ensuring that Britain can remain competitive, economists say.
The Government should be “as aggressive and bold” as it can “within the fiscal constraints that exist,” says Tom Clougherty, head of tax at the Centre for Policy Studies.
As it stands, companies face a “double whammy” in April when the corporation tax rate rises by six points to 25pc and the generous superdeduction ends, the Confederation of British Industry (CBI) has warned.
The super deduction allows businesses to offset 130pc of what they spend on investment against their tax bill, meaning they deduct more than what they spend.
The CBI is calling for it to be replaced with a permanent investment deduction of 100pc. Louise Hellem, director of economic policy at the CBI, said it would “pay for itself over time”.
Businesses and economists have warned that failing to provide an incentive to invest while ramping up the tax burden would suppress growth substantially.
Hunt is considering the CBI proposals. It is less generous than the expensive super-deduction, although it will be costly in the first few years. The Treasury has estimated it would cost £11bn a year.
“There’s a big upfront cost, which looks a little bit scary,” says Clougherty. However, the “cost drops away quite significantly”.
Such a policy “would certainly be better than not doing anything,” says Michael Devereux, the director of Oxford’s Centre for Business Taxation.
“If the investors in a business need a 10pc [profit] to be persuaded to go ahead with an investment, then a good system would be when we only tax profit over and above that 10pc,” he says. “Full expensing gets you to that sort of position.”
However, dour economic forecasts from the Office for Budget Responsibility (OBR) could make it difficult for the Hunt to get away with expensive policies like this.
Cara Pacitti, an economist at the Resolution Foundation and former OBR economist, says the high upfront cost of such tax breaks makes them “trickier for the Chancellor”.
“While he might be optimistic that they’ll pay for themselves through higher growth, the OBR is historically much more cautious in factoring those effects into the forecasts,” she says.
If Hunt does not act, tax breaks for investment will revert to the previous regime: businesses would only be allowed to offset £18 for every £100 spent on plants and machinery each year. The full amount of investment can still be deducted from tax bills, but only gradually over several years.
Observers expect Hunt to introduce some changes to offset the tax break cliff-edge, but opt for something less than full expensing.
Crucially, however, economists say he should put an end to the flipflopping on tax systems and commit to a new regime for the long term, whatever that may look like.
Clougherty says: “My hope is that what they do is permanent. Temporary schemes just shift investment around, but they don’t change the long-term picture – and we do need to change the long-term picture.”
The Chancellor has already signalled that he is preparing to make the system more stable. In the Autumn Statement he confirmed that an increase in the annual investment allowance to £1m would be made permanent, rather than reverting to £200,000 in March as it was scheduled to.
This effectively provides most smaller and medium-sized businesses with full expensing, as they rarely invest more than that in a year. But it
‘Temporary schemes don’t change the longterm picture – and we do need to change it’
will have little impact on large businesses that invest far more.
Another issue, according to Stuart Adam of the Institute for Fiscal Studies, is that only allowing companies to offset investment in plants and machinery is becoming rather outdated.
Putting money towards intangible assets – such as software, patents and training for staff – is just as important in improving productivity.
“I would like to see them at least thinking about assets beyond plants and machinery,” he says, but warns that tax breaks for intangible assets are “horribly complicated”.
Hunt will spend the coming days putting the finishing touches on his plans to address all these issues and more. Without bold action now, we could all be paying the price for years to come.