EEF blog

George Osborne has made a major improvement to the UK’s tax environment for R&D today by announcing in his Autumn Statement that the R&D tax credit will become payable ‘above the line’ from 2013/14.

This reform will increase investment from companies already the UK as well as bring additional investment in R&D to the UK.

The change means that rather than large firms accounting for the R&D tax credit in their tax return ‘below the line’, the benefit will be accounted for upfront in R&D budgeting ‘above the line’.

The key benefits of moving to an above the line credit are:

• Creating a simpler system;
• Strengthening the link between the R&D tax credit incentive and the parts of companies where investment decisions on R&D are made;
• Increasing certainty around the timing of the benefit of the R&D credit by decoupling it from a company’s tax profile.

Innovation is crucial for keeping ahead of the competition, generating better balanced growth, and creating high-value jobs.

When the R&D tax credit system was introduced it was a positive development for the UK. But our competitors do not stand still. Many countries have sought to incentivise greater expenditure on innovation and attract mobile R&D investments by introducing reforms to their own schemes to increase the incentive effect.

Today Mr Osborne has responded. He has made clear that the ambition he stated in March, to make the UK ‘the most competitive tax environment in the G20’ means the whole tax system, not just the headline rate. This is welcome news because it corresponds to how companies see the impact of taxes.

PwC has conservatively estimated this reform would deliver £665 million per annum of additional value to the economy at a net cost to the Exchequer of £205 million per annum. These are meaningful numbers at a time when the UK must be doing all it can to support growth.

On Monday EEF released its submission to the government in advance of November’s Autumn Statement from the Chancellor. Below is a short summary of what we said, which we’ll go into more detail on over the next week.

Manufacturing has performed strongly since the recession

Latest revisions to ONS data suggest that manufacturing has grown by 7.5% since 2009q4. This compares with an expansion of only 2.8% in the wider economy since 2009q3.

The sector is at the heart of the rebalanced economy we need

The economy needs more investment, innovation, and exporting. Manufacturing accounts for over half of UK total exports. In 2008 manufacturing accounted for 71% of UK business R&D investment.

We support the government getting a grip on the public finances…

We agree that a credible fiscal plan was the number one priority following the election. Maintaining fiscal credibility continues to be an important part of providing economic stability to the UK and helping keep interest rates lower for longer.

…even as the external economic environment has deteriorated

Necessary fiscal consolidation has meant manufacturers have been looking to external demand to support their growth. But macroeconomic turbulence has increased over 2011 in key external markets leading to weaker growth prospects from these markets, notably Europe but also the U.S.

Manufacturers are still busy but bad press from key markets is denting recruitment and investment

EEF’s own survey data and discussions with companies suggest output and orders are holding up. But the bad news and mounting uncertainty from key markets is making companies nervous – and future-looking business decisions are now being impacted with firms pulling back on investment and recruitment.

Systemic policy reform no longer seems enough given the uncertainty

Since Budget 2010 we’ve been urging the government to take a more urgent and focused approach on policy reform to support growth. We continue to call for a focus on tackling the most important barriers to growth in tax, regulation, skills, and access to finance. However this is no longer enough to support growth in the short-term.

Government should support investment now via enhanced capital allowances

The weak outlook for demand means we now call for the government to take short term action to boost investment. We propose a temporary two-year regime of 100% capital allowances, providing a major cashflow incentive for firms to action investment and offsetting the weak demand environment.

These recommendations reflect our urgency on boosting growth…

Our recommendations are consistent with our views that a more competitive business environment is a priority for growth in the medium term but that short term concerns on external demand require more urgent action.

…while retaining a commitment to fiscal credibility.

Fiscal credibility will only be maintained if the private sector can deliver sustainable growth. Our proposals focus on improving growth. Further, our major temporary recommendation on capital allowances is a measure, which – though it has a short-term fiscal cost – will over time pay for itself to the Exchequer.

Stephanie Flanders breaks down the IMF statement, noting that some of the risks and caveats to the IMF's support for the Chancellor's deficit reduction plan:

"...the IMF's own research, for last year's autumn World Economic Outlook...suggested that Mr Osborne's plans were likely to have a significant effect on growth in the short-term.

The risk - spelled out in today's report - has always been that this short term cost will turn out to be permanent, because capacity gets lost forever.

To repeat, the IMF does not think that this has happened yet.

Today's report says that the government's policies are broadly right. It explicitly rejects the advice offered by some economists in Sunday's Observer [calling for a Plan B].

But the Fund does clearly believe that the chancellor should have a wider range of back-up plans than he has so far been willing to own up to."

Alongside the Budget last week, the government published the Plan for Growth.

The Plan prioritises four key ambitions for the UK:  

• To create the most competitive tax system in the G20;
• To make the UK one of the best places to start, finance, and grow a business;
• Encourage investments and exports;
• Create a more educated, flexible workforce.

Furthermore, each of these ambitions is backed by ‘measurable benchmarks’. For example under tax a benchmark is to have the lowest corporate tax rate in the G7.

The coalition makes clear that the focus on growth begun with the Growth Review will continue over the whole parliament.

Now compare this with the recommendation in our Budget Submission where we called for a Growth Mandate, featuring:

• Prioritisation of four key areas;
• Measurable indicators of success;
• A parliament-long focus on growth.

That’s a pretty good correlation. But before we award the Chancellor and Business Secretary an A+ there are a couple of reasons to pause for thought.

We called for a Growth Mandate and we chose that name deliberately. We wanted the Growth Mandate to match the Fiscal Mandate with its clarity, predominance in the setting of the budget, and currency in the media.

It might seem a subtle point but by publishing the Plan for Growth as a separate 126 page document, co-authored by HMT and BIS, the government has risked the Plan succumbing to the fate of so many other such documents in the past.

In the past, such documents seemed to be de rigueur for a budget. Endless publishing of strategies seemed to overtake and blur each other, making the direction of travel less clear, not more.

Now, that’s not happened yet. But the challenge for the government is to give the Plan for Growth the necessary backing to give it ongoing relevance.

Secondly, we need to see real prioritisation. We suggested focusing on tax, finance, skills, and regulation – the top four concerns our members have with the UK business environment.

The Plan for Growth is a little patchy here. The tax and skills ambitions are good. But making the UK a great place to start, finance, and grow a business is a bit loose. It could potentially cover all manner of government actions to support growth.

And while there are multiple worthy areas where the government could make progress, the point of prioritising, particularly in an era of such limited resources, is to focus on the most important issues.

The final area to watch is the measurable benchmarks. It is good that the government has shown willingness to be held to account.

However the choice of some indicators is not exactly stretching (home to most top universities outside U.S. - already the case) and some are not within the government's ability to directly influence (increase in exports to key target markets). The number of them looks on the high side too – giving it a ‘scorecard’ feel rather than creating an expectation for concrete progress on each indicator.

Despite these cautions the Plan for Growth has the potential to be very positive. The real test will not be in its writing but in its delivery. We’ll be doing our part by watching carefully on how the government follows through.

Regular readers of this blog should take a look at the Infor Manufacturing Blog.*

My first post for the blog looks at why investment in innovation and IT have helped manufacturers drive the broader economic recovery. However, I also flag up some of the key challenges firms face when innovating in the UK:

"Tackling technical troubles [while innovating] can cost firms time and money as they strive to get to market quickly.

Yet in competitive global markets, time and money are luxuries that most manufacturers do not have."

UK manufacturers don’t compete on price or labour, they compete on innovation and technology. The longer it takes, the more cash is spent in developing and commercialising innovation, the less likely the company will generate a return on its investments in innovation.

What does this mean for the Chancellor's Budget in under two weeks time? Well, R&D tax credits could play a part here.

Right now, the UK only provides tax credits for research and tax breaks for patents. Yet it’s the time-consuming and costly development phase of R&D where the value of innovation – the profits, the jobs & the growth – is generated. And because we don’t support development and commercialisation, other countries reap the economic benefit of our innovative ideas.

The bottom line is that we can't take growth for granted: firms will invest, innovate and grow; they have to if they want to stay in business. The question is whether the Chancellor give them a reason to invest, innovate and grow in the UK?

* Full disclosure: Infor and EEF have a long-standing relationship. This includes partnering with our economists on two reports: the 2008 IT & Productivity survey and our 2010 Innovation Monitor. Infor are also the lead partner for EEF's Future Manufacturing Awards.

Over the weekend, the Prime Minister committed the government to "taking on the enemies of enterprise":

"...for over a decade in this country the enemies of enterprise have had their way.
 
Taxing.  Regulating.  Smothering. Crushing.  Getting in the way.

...

So I can announce today that we are taking on the enemies of enterprise.
 
The bureaucrats in government departments who concoct those ridiculous rules and regulations...The town hall officials who take forever with those planning decisions...The public sector procurement managers who think that the answer to everything is a big contract....
 
There's only one strategy for growth we can have now...

...and that is rolling up our sleeves and doing everything possible to make it easier for people to start a business and to grow a businesses.

While the wags may have focused on the alliterative powers of the PM's speech writer, we support the PM's focus on doing everything to make it easier for people to start and to grow a business in the UK.

That's why we've put together a Manufacturers' Most Wanted - the top ten 'Enemies of Enterprise' for manufacturers planning to grow over the next 5-10 years.

As we said yesterday, the government can't take growth for granted - not all growth is equal and it doesn't have to happen in the UK.

If the PM lives up to his words and tackles these 'Enemies of Enterprise', he can ensure the UK captures all the benefits - the jobs, the investment and the exports - that the right type of long-term, balanced growth in manufactring can generate.

1.        Lower Capital Allowances: Inefficiently taxing investment in the UK.
The UK’s capital allowance regime is inefficient, outdated and uncompetitive, and the government’s plans to lower the level of allowances from 20% will add to the cost of investing in technology and growth in the UK.

2.        Tax Complexity & Uncertainty: Raising risks to long-term investments in the UK.
The government’s departures from its ‘New Approach to Tax Policy Making’, such as the decision to retain revenues from the Carbon Reduction Commitment, have unnecessarily increased uncertainty for firms making long-term investment decisions.

3.        The Carbon Reduction Commitment: Unnecessarily & inefficiently taxing production in the UK.
Combined with the carbon floor price and the CCL, the CRC provides triple taxation of carbon, inefficiently raising the cost of producing in the UK.

4.        The Climate Change Levy: Taxing electricity consumption at 10x EU minimum.
The EU requires the UK to have the CCL, but the UK has unilaterally chosen to impose a levy 10 times the EU minimum.

5.        The Lack of Competition in Lending: Entrenching a risk-averse approach to lending to UK manufacturers.
Not enough competition means it’s harder for growing firms to secure the loans they need on reasonable terms and tougher to switch providers when service standards aren’t up to scratch.

6.        The T&C’s Attached to Bank Lending: Capping the flow of finance to growing UK manufacturers.
From personal guarantees to impossible covenants, the range of T&Cs attached to lending places a cap on manufacturers’ ability – and willingness – to invest in the UK.  

7.        Inadequate Impact Assessments: Consistently underestimating the burden of red tape on UK manufacturing.
Poor Impact Assessments – such as for the Default Retirement Age and the Carbon Floor Price – fail to accurately assess the additional and cumulative impact to business of UK and EU regulations. These assessments need to improve if the government is the scale of the barriers to private sector growth.

8.        The Default Retirement Age: Reducing labour market flexibility.
Rapid introduction leaves firms scrambling to comply with red tape and complicates plans to manage workforce skills.

9.        10 Years of Tinkering with Apprenticeships: Making apprenticeships and funding unstable.
The lack of stable funding and overuse of centrally-planned targets have made good-quality apprenticeships harder to come by for both students and manufacturers.

10.    Failure to Deliver STEM Skills in Schools: Shrinking the future workforce of manufacturing.
Without a solid foundation in STEM skills, students are less likely to have the skills needed to begin an apprenticeship, pursue an engineering degree or even seek a career in manufacturing.

 

In some ways the coalition government’s economic policies were always going to be dictated by the prevailing economic and fiscal situation. At a time when the UK’s public sector net debt stands at nearly 64% of GDP, tax rises and cuts to public sector spending were more or less inevitable. But the choices the government takes in how to raise taxes and cut spending says as much about the state of the economy as it does about the government’s economic world view.

The coalition’s approach – somewhere between the Third Way and Thatcherism – is based around a faith in markets and business. This 'Two Thirds Way' is based on the belief that our economic competitiveness requires a smaller government and smaller government debt, which should then reduce long-term interest rates and encourage private sector investment and growth. In the Emergency Budget, however, it appears a traditional free market purist approach was tempered by a concern for low-income earners, as business taxes were cut alongside a higher personal allowance threshold for income taxes.

The government also departed from the traditional free market approach with some more interventionist tax measures, including the banking levy and creating tax incentives for start-ups to locate outside of the greater South East. The 'Two-Thirds Way' ultimately favours markets over government, but sees a distinct, but targeted role for government in encouraging investment and regulating business.

This week the Prime Minister – with several cabinet ministers and business representatives – went on a trade mission to India, with the hope of developing a new ‘special relationship’. This is part of a drive to promote exports following on from the Emergency Budget. It is clear that the UK will no longer be able to rely on government spending for growth: the OBR’s growth forecasts are dependent on business investment and exports picking up.

In light of the impending austerity measures hitting most of the UK’s main export market in Europe, and the likelihood of continuing suppressed demand in the US, it is only natural that the government has looked to India – with its economy forecast to grow by 8.2% this year – as somewhere to grow the UK’s exports.

In fact, India’s trade relationship with the UK is already worth £11.5bn per year, and announcements made during the trade mission have highlighted a £700m agreement between BAE Systems, Rolls Royce and Hindustan Aeronautics Limited to supply 57 Hawk Trainer Jets to India.

Despite all this, these figures must be put into context. This year to May, India has only accounted for 1.6% of the UK’s export market. As George Osborne has noted, the UK currently sells more to Ireland than it does to Brazil, Russia, India and China combined. As the Chancellor is aware, these markets are those with some of the greatest growth potential in the coming years.

Figure 1: Percentage of exports (by volume) to the UK's main trading partners

Source: HMRC 2010

Positively, in the five years between 2004 and 2009 the proportion of UK exports going to India more than doubled (it was only 0.7% in 2004). In addition there are several factors which count in favour of a strong trading relationship between the two countries.

India is already the biggest investor in Britain after the US, and Tata – an Indian company – is Britain’s largest manufacturer. Additionally, the two countries have a shared language which makes trading relationships simpler.

But increasing India’s demand for UK exports will not be an easy ride. Those markets where the UK has most to offer India – such as retail and banking – are burdened with significant barriers to entry for foreign companies. In addition, the UK will not be the only country looking to export to the high-growth nation. However, the UK’s Engineering and infrastructure development skills could become highly exportable to a growing, developing country.

Whatever the case, it is unlikely that exports to India alone will be enough to drive the UK’s growth. But it could be a move in the right direction. 

EEF's take on the Emergency Budget was simple: job well done on deficit reduction, but there needed to be more about longer-term growth and rebalancing.

Echoing EEF's comment piece in the Telegraph before the Budget, a piece in the FT by Mohamed El-Erian, the Chief Executive of PIMCO, one of the leading global investment management firms, writes about the false debate between growth versus austerity:

"The majority of industrial countries need to adopt both fiscal adjustment and higher growth as twin policy objectives....Squaring the circle of growth and fiscl stability needs policies that focus on long-term productivity gains...[with a] new emphasis on infrastructure and technology investment."

Given the need to complement austerity with growth, EEF's key concerns about the Budget hinged on a few key announcements: the government maintaining savage cuts to capital spending (around 1.5% of GDP) and cutting the level of capital allowances to 18% and lowering the Annual Investment Allowance to £25,000.

Deep cuts to capital spending limit long-term productivity and economic growth - it places a cap on future growth. The cut to capital allowances makes the investment needed to rebalane the economy more expensive.  

On Wednesday, the Institute of Fiscal Studies detailed analysis of the Emergency Budget echoed our view on capital allowances:

"Cutting capital allowances is not a good way to raise money [because] capital allowances are an efficient way to promote investment. The reform is not a simplification."

And a leader on the Budget in today's Economist notes that:

"...Mr Osborne should not have accepted inherited plans to trim capital spending by as much as 1.5% of GDP; a growing economy needs modern roads, railways and the like."

With the experts worried that the Budget didn't quite deliver the investment needed for growth and rebalancing, Martin Wolf writes about the implications for the government and the economy:

"The biggest economic point in the Budget is the need to rebalance the economy away from debt and government consumption. Moreover, the Office of Budget Responsibility believes this is likely to happen....A surge in fixed investment and net exports is forecast....the average contribution to growth of gross fixed capital formation and net exports was 0.5 percentage points and minus 0.3 percentage points, respetively between 2000 and 2008; these figures are expected to jump to 1.2 and 0.7 percentage points between 2011 and 2015."

Given the deep cuts to capital spending and the higher cost of investments, rebalancing is less likely. Wolf continues:

"The depressed level of investment, the low interest rates and the big fall in the real exchange rate make these shifts conceivable. But they are far from assured....[The Chancellor] assumes what is still to be proved: a rebalancing of the UK economy....Mr Osborne may believe this Budget was unavoidable. So, too are the risks the government now runs."

UPDATE: Krugman queries El-Erian's piece, asking what the policy recommendations are and invoking Keynes about all being dead in the long run.

El-Erian's point was not so much about specific policies (though his view does have specific policy implications, very much in line with our views on capital spending and investment allowances.) What El-Erian is trying to say is that growth and deficit reduction can and should be complementary aims, and that the current simplistic debate pits them as contrasting visions.

Combining El-Erian's subtle point with Wolf's critique is extremely relevant to the UK: once the public sector has been pared back and reformed, we cannot simply assume that the private sector will fill the void. We need to lay the foundation for future growth - through investment in infrastructure and new technologies - now.

There were no easy choices on deficit reduction and the Budget was never going to tick all our boxes - that's why we were supportive of the decisions the Chancellor made on deficit reduction, such as the VAT rise.

And rebalancing our economy will be an easier job with the deficit firmly under control. But now that we've had a Budget that made investment in growth more difficult, it's up to the other parts of government to support rebalancing. Whether that's a Green Investment Bank, support for bank lending or a carbon tax we can still move towards a better balanced economy through some strategic policy choices.

But it is important to remember that rebalacing isn't simply matter of preventing the public sector from crowding out the private sector - the public sector filled a void over the past decade because there was minimal private sector growth.

Sure the private sector will eventually drive growth and jobs outside of London and the South East, but only in the long run. But in the long run...well, lets just say its what comes before that matters.