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Ambition for tax reform must look at the whole picture

Andrew Johnson October 25, 2011 15:17

The government’s Plan for Growth in March set out an ambition of making the UK the most competitive tax regime in the G20.This is a really positive ambition. But the ambition jars a little with the reality of some of the policy changes and some of the rhetoric.

The government used a cut in capital allowances to help pay for its headline corporate tax cut. And in the measures included under its Plan for Growth ambition, the ‘lowest corporate tax rate in the G7’ appears as a measure.

It all seemed to suggest the focus is very much on corporate tax alone.

For manufacturers, indeed for businesses in general, tax is tax no matter what its label might be. Mobile investors will take into account the complete picture including incentives for R&D, capital allowance regimes, and environmental taxes – as well as main rate corporate taxes.

However, recently there does seem to have been a greater acknowledgement by the government of the breadth its ambition for the most competitive tax regime must have to be credible.

For example in recent consultations on modifying the R&D tax credit, HM Treasury explicitly mentions its ambition for creating the most competitive tax regime.

We now want to see the ambition broadened out further to include the full picture on tax faced by businesses. An important part of this would be creating a measure to demonstrate how the overall burden of taxes faced by businesses is changing – and how that compares with our competitors.

This measure is necessary to not only show progress year-on-year as the government rolls forward its tax reforms but also to help define the success we are aiming for.

By creating this framework we then have something we can hang policy proposals off. And this is what leads me to EEF’s recommendations in our submission to the government in advance of the Autumn Statement.

We are looking for reforms that cover a wide span of the tax landscape manufacturers face:

1. We want to see the UK create the most competitive tax regime for innovation

Reforming the R&D tax credit by shifting it ‘above the line’ in corporate accounts thus lowering the pre-tax cost of R&D in the UK and increasing the incentive to invest in innovation

 2. A shift in our capital allowances regime to accounts depreciation

Matching tax treatment of capital depreciation to accounts depreciation will free up cash flow and help drive faster reinvestment

3. Rationalising the carbon tax landscape

There are too many different carbon taxes and we are pushing too far ahead of our competitors, particularly in energy-intensive sectors. We need to recalibrate how far the UK is pushing on carbon reduction and introduce measures for the industries most severely impacted by policies that reduce their competitiveness

Currency wars debate: some conclusions

Felicity Burch November 16, 2010 10:23

A currency war is on hold – though it depends on the performance of the US Economy

 “The prospect of a full blown trade war is unlikely; it benefits nobody” … “it is not in China's interest to provoke the US”
World_First

Additionally, currency intervention… “May go off US agenda if QE2 works/economy grows” … “I suspect that a war will be averted”
JeffreyPeel

“The G20 is split - Washington consensus is dead. But sanity may prevail. No-one really wants no-win #cwars or #fx wars”
JeffreyPeel


Chinese currency depreciation is not win-win

JohnPullin asked “What will be effects on scarcity of raw materials including strategic metals?”

“that is defintely one of the aces up China's sleeve and should we see supply concerns come to the fore then the pressure will rise”
World_First

“If the West achieves its objectives re. Chinese revaluation may mean more expensive input costs”… “may be good for US steel and other traded goods though - China hasn't all aces”
JeffreyPeel

For UK manufacturers the largest impact of currency wars is likely to be price volatility

We asked whether the UK would “be collateral damage from fx volatility?”

“you have a point. To an extent it depends how much the Chinese are prepared to pump-prime and how much US resists”
JeffreyPeel

“we are advising manufacturing clients to hedge at these GBP levels to negate volatility and lock in profit”
World_First

 

Or, as we put it on twitter: "currency war is on hold as QE2 gets going & eurozone distracts markets. But..." "QE2 could go down like the Titanic if it hits China's raw materials iceberg." "So for now, UK manufacturers have little to worry about, except maybe protecting themselves from #fx volatility."

Currency wars: what does it mean for manufacturers? #fx #cwars

Jeegar Kakkad November 15, 2010 11:30

Although we've blogged on how global demand - especially from emerging economies - is helping drive the recovery in manufacturing, today's news out of Ireland is a pretty stark reminder of the risks posed by the global economy.

The G-20 meeting in Seoul managed only loose commitments to resolve the economic imbalances behind the currency war.

China is signalling it’s concern about inflation (which is code for their going to let the reminbi appreciate), which has knocked 5% off the Shanghai markets. This could have been typical pre-G-20 posturing, or it could reflect significant concern about rampant credit.

And now rumours are swirling of Ireland requiring, but shunning a bailout.

Where does this leave UK manufacturers? Many UK businesses I’ve talked to are concerned about the impact on three key points: demand, costs and profits, with further Sterling volatility being the worrying wildcard.

The concern about demand

If goods exports to China have risen by 44% since the start of the year, a trade war involving China and other developing economies, such as Brazil, could undermine the demand that is helping to drive growth in the UK. Most manufacturers worry that, if the currency battles slip into protectionism, then developing economy demand may dry up, profits could get hit or materials costs could rise (e.g. China produces 97% of global rare earth mineral supply).  

So far, so good. But what will happen to UK exports if the UK doesn't try to competitively devalue its currency? Would that help mitigate the damage from a trade war? Would the UK be viewed by China, Brazil and others as a benign trading partner, and so avoid the worst of the restrictions? Or would UK exports become collateral damage, caught in the crossfire between the US, China and others?

With the bulk of exports still headed for the EU, UK firms will have a decent buffer against such global headwinds. But the longer a trade war between the US and China persisted, the more likely the global economy - and UK exports with it - will suffer.

Profitibility could be hit 

Over the past decade, many firms protected themselves against a strong pound by buying and selling in dollars and eruos rather than pounds. This is standard practice for firms operating out of small, open economies and with exports making a big contribution to turnover. This way, if sterling moves, then firms take the hit on profits rather than on orders. This is why, as sterling fell during the recession, EEF's Business Trends survey showed improving profit margins on exports, even as world trade fell.

What's this mean for a currency war?

If the UK doesn't try to devaule it's currency, sterling will probably rise, for example, relative to the dollar. As discussed above, this will hit profitability, while potentially protecting orders. The knock to profits could eventually feed through to greater caution on investment and employment intentions.

If the UK tries to devalue the pounds, for example, through further QE, then profitibility could be temporarily protected, but at the cost of demand if protectionist measures begin to bite.

Cost of commodities

Over the past couple of years, a weaker dollar has meant rising commodity prices. Allowing sterling to appreciate could insulate UK firms from rising costs, while also helping to dampen down inflationary pressures in the UK (as import costs reduce).

But as we said before, getting caught up in competitive devaluations could mean getting caught out on access to China's supply of rare earth minerals.

A spanner in the works

The one issue that could through all this analysis - and firms' best laid plans - out the window is further exchange rate volatility.

Stirling volatility over the past year or so made planning for the recovery difficult, and another bout of it could keep cash-rich companies' on the sidelines of the economy until the G-20 manages to either resolve the currency crisis or settle the Doha trade round.

TWITTER DEBATE: Do UK companies have anything to fear from currency wars? #fx #cwars

Felicity Burch November 15, 2010 11:02

Do UK companies have anything to fear from currency wars?

Join the debate!
(Monday, 15 November 2010, 15.00 - 15.45)

On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars.

 Time:  3.00pm - 3.45pm 
 Hashtags:          #fx #cwars
 Participants:

@EEF_Economists (Moderator)
@World_First (panellist)
@JeffreyPeel (panellist)

 Key questions:      1. What is a currency war and should we be worried?
2. How would a currency war impact Sterling?
3. What, if anything, should UK manufacturers be worried about?
4. How should the government and the Bank of England respond?

Pre-debate, we've put together some background information: 

Currency wars: the story so far

Currency wars: the best of the press

Currency wars: the view from manufacturing

--

16/11/2010 Update

Here is a summary of the discussion -

Currency wars debate: some conclusions

 

Currency wars: the best of the press

Felicity Burch November 11, 2010 15:43

In the G20 meeting in Seoul last week one of the key issues was how to avoid the currency wars which threatening global economic recovery. Although some agreement was made over continuing discussions, tensions have not dissapated. On Monday 15th November at 3pm EEF is hosting a twitter debate on the impact of currency wars on the UK, and UK companies. 

 

As a background to this, here are some key articles and blogs that have been written on currency wars in the last couple of months:

 

What is a currency war?

The BBC’s animated guide: http://ow.ly/388kiOr, if you’d prefer something to read, Stephanie Flanders’ summary is here: http://ow.ly/38bb7

When did this one start?

The first rumblings of currency hostility started in March 2010 when 130 bipartisan US Congressmen sent a letter last week to US Secretary of Commerce Gary Locke, calling for the government to identify China as a currency manipulator. However, it was Guido Mantega, Brazil’s finance minister, whose announcement on September the 28th branded competitive depreciations as “currency wars”. Reported by the FT: http://ow.ly/38bp8

Who is fighting whom?

The BBC’s Andrew Walker sets out the key players and the main battlegrounds: http://ow.ly/388oq What impact could currency wars have on the global economy?Competitive depreciation could represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth could be hindered by surplus countries accumulating excess reserves to boost their own exports. The FT reported here: http://ow.ly/38bOK

What has happened with currency wars in the past?

Douglas Irwin at the Wall Street Journal summarises how high tariffs and currency wars caused problems in the 1930s: http://ow.ly/38bxy

What happened at the G20?

According to the Guardian "the summit set vague "indicative guidelines" to measure imbalances" however "the leaders were unable to agree on how to identify when global imbalances pose a threat to economic stability, merely committing themselves to a discussion of a range of indicators in first half of 2011": http://ow.ly/39MMK  

 

Therefore, questions remain: What would trade wars mean for the UK? Crucially, how will UK companies be affected if exchange rates become increasingly volatile, or if currency tensions lead to increased protectionism?

 

Join the debate! On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars. The debate will start at 3pm and last for 45 minutes. 

Disclaimer
This is an informal blog about manufacturing and the economy written by EEF's policy and representation staff. While it is written from an EEF perspective, contributions should not be taken as formal statements of EEF policy, unless stated otherwise. Nor does it cover all the issues on which we campaign - you can check these out in more detail at our main site.

We welcome and encourage comments, but we reserve the right to remove any that are offensive or irrelevant. We are not responsible for the content of external internet sites.

About EEF

EEF helps manufacturing businesses evolve and compete.  We provide business services that make them more efficient and management intelligence that helps them plan.  Our work with government encourages policies that make it easy for them to operate, innovate and grow.

Find out more at www.eef.org.uk