Today's manufacturing investment numbers are a positive sign amongst all the economic doom and gloom we've been hearing. Some of the 15.7% growth in manufacturing investment over the quarter may be a result of the 95% of manufacturers currently covered by the £100,000 Annual Investment Allowance bringing forward investment ahead of the 75% cut in this allowance next year. Nevertheless, investment growth is a key part of a better-balanced economy and investment by manufacturers is clearly a key part of this.
However, it's not what has happened that's focusing our attention at the moment, but what's about to happen.
The outlook for the economy is pretty murky. Anecdotally we have heard that ongoing problems in the Eurozone and fears this may spill into orders are starting to make manufacturers “sit on their hands” when it comes to investing.
So despite good numbers (at least for manufacturing) today, we are calling on government to take strong action to support positive investment decisions in the next couple of years.
We are calling for the introduction of 100% first year capital allowances for a time limited period of two years for all new investments currently covered by the main rate.
Why this policy in particular?
Government is counting on sustained strong investment growth supporting the recovery. 100% capital allowances would provide a boost to companies' cashflow, which is a key determinant of investment.
Cashflow is even more important for investment when firms are struggling to access finance. 100% capital allowances may therefore offset current struggles companies are having getting credit.
Why 100% Capital Allowances?
A study by the ICAEW found smaller capital allowances did not make any material difference to a firm's investment decision but “substantial capital allowances, however, do seem to generate increased investment. For example the 100% first year allowance for computers offered in the past and incentives for energy-saving investments”
What is the impact on the government's fiscal plan?
Economic growth is necessary for the government to achieve its fiscal targets. 100% capital allowances should support investment and therefore overall growth. Importantly strong investment in productive capital will also increase the country's potential growth in the long-run.
The introduction of 100% first year capital allowances for a time limited period of two years over time would pay for itself. For a given level of investment, 63% of the cost would be recovered in five years and 80% by 2020.
However, it would add to the deficit in the short term, and may therefore not comply with the Chancellor's immediate fiscal mandate.
But the point of the fiscal mandate is to illustrate the government's fiscal credibility. And fiscal credibility is more complex than a tick in a box against one self-imposed target.
The introduction of 100% capital allowances for a two-year period does bring forward a cost to the treasury. But this is all it does. Over the long term increasing capital allowances for a limited period does not add to the debt as depreciation is a legitimate expense that can already be claimed for now – albeit over a longer time period. Therefore, over the long term, increasing capital allowances for a limited period would not impact upon the government's fiscal position.
By introducing 100% capital allowances in the way we recommend, the government can demonstrate its commitment to genuine fiscal credibility and sustainable growth. Surely that's what Plan A is all about?