EEF blog

Last Friday I commented on the FT article noting Oxford University research on how the UK’s corporate tax environment is not as competitive as it might seem following cuts to the headline rate of tax.

This research provides yet more evidence that the government needs to look beyond the headline rate to achieve its aim of creating ‘the most competitive corporate tax regime in the G20’.

In particular the UK’s poor capital allowances regime is uncompetitive.

Capital allowances are the tax system’s way of handling depreciation – a major issue in capital-intensive sectors like manufacturing.

For small companies, capital allowances are essential. Capital allowances support cash flow – which empirical evidence suggests strongly correlates with investment particularly for liquidity-constrained firms, including SMEs with fewer finance options than larger firms.

For large companies, FDs or tax directors often have their personal performance partly assessed on the effective average tax rate (EATR) they achieve for their company. EATRs will of course be the result of multiple taxes companies face.

The Oxford research shows that the corporate EATR in the UK overall in January 2012 placed the UK 22 out of 33 OECD countries.

With the government's programme of further cuts to the headline rate, we are on course to 'rocket' up to 16th by 2015 - but that assumes no other country in the OECD changes their policies beyond what has already been announced.

While 16th would be an improvement it’s not quite fitting with the spirit of the government’s ambition. It seems to me the government needs to go a bit further.

We believe the obvious target is the capital allowances regime.

Look at what’s happening elsewhere in the world.

On 1 June, the U.S.-based National Association of Manufacturers, along with a long list of major manufacturing companies, wrote to both houses of Congress saying they should:

‘…provide an immediate and temporary incentive for businesses to make new capital investments in the United States by extending 100 percent expensing…through 2012.
Enacting this legislation will enable businesses to access capital for immediate investment and create jobs in the United States now…

…Currently, however, businesses can only elect to deduct 50 percent of the cost of these investments.’

This is a scheme that was in place in the U.S. until the end of 2011. There are strong suggestions the boost in orders for manufacturing technology seen last year were the result of this intervention.

Canadian Manufacturers and Exporters continue to say:

‘Companies that can write-off older, inefficient equipment faster, have greater incentive and opportunity to invest in newer, more efficient technology. CME is advocating for making the two year write off on manufacturing and processing equipment permanent.’

The Canadians are saying the current two-year write down on manufacturing and processing equipment should be permanent. NAM goes further in the U.S. given the economic situation and talks about 50 percent deductions (two-year write downs on a straight-line basis) as not being enough.

Under these regimes write-downs take TWO years. And just to be clear, American and Canadian manufacturers are saying this is not fast enough.

Under the UK’s current system, investments in plant and machinery take more than THIRTY years to write down.

Spot the competitiveness problem.

FTAlphaville had a post yesterday about ‘missing GDP' in the US. A couple of key points to note were:

• the main reason for a slower-than-average recovery is weak consumer spending
• exports have outperformed so far, but this may not continue as they are vulnerable to global growth

This is not so far from the UK’s position, either. The graph below shows total GDP growth, which has lagged behind previous recessions...

...But, as the next graph shows, if we exclude household spending, a different pattern emerges, with growth at a roughly similar pace to that following previous recessions.

Given the weakness in the labour market, and households’ desire to pay down debts, this will not come as a surprise. It is also unlikely that household spending will improve much this year.

Although GfK NOP’s consumer confidence indicator moved up to a six-month high today, it remains subdued by long-term standards, and there is little indication so far that this has translated into increased spending. However, whilst subdued consumption clearly reflects a degree of economic stress, ‘rebalancing’ the economy does require less growth coming from household spending, and more growth from exports and investment.

In the UK exports have continued to grow but, as FTAlphaville point out, they are particularly vulnerable to global growth. The UK’s exposure to the Eurozone is therefore a key issue for the year ahead.

However, UK manufacturers – who account for around half of total exports – are relatively positive about their export potential in the year ahead. As our Executive Survey showed, over four fifths of manufacturers expect export sales to be the same or greater in the year ahead. Key to this, UK manufacturers are targeting non-traditional markets, seeking out the new growth opportunities that exist there.

That's the view of Brad de Long, who says that the weekly US unemployment insurance claims (similar to the Claimant Count in the UK) are flashing a big 'Stalled Recovery' sign.

Or as Paul Krugman shows it: