Targeted capital allowances are a smart stimulus to investment in troubled times

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EEF's submission to HM Treasury in advance of the Autumn Statement reflects the economic reality we find ourselves in.

Our members are telling us they're still busy and their order books still relatively healthy. But at the same time they're becoming very cautious.

Cautious because the economic drums around the world are not beating a hopeful tune:

• Europe is struggling with its state and bank debts, twisted in a morass of cumbersome, and so far ineffective, economic governance.• U.S. unemployment remains stubbornly high and the President's jobs bill looks set to be the latest victim in the vitriolic bear pit that is the current Congress.• Demand in emerging markets isn't falling off any cliffs – but latest trade data suggests exports to these markets in the second half of the year has started weaker than those in the first did.

All this suggests to manufacturers reading the papers is that the external demand we need to power the UK recovery (and rebalancing) may be about to falter.

The most important way these clouds of doubt are manifesting in economic behaviour at the moment is to cause firms to hold off investing and hiring permanent employees.

In and of itself this behaviour is worrying in the short term as it detracts from growth. But it's also concerning for the medium term that investment is being held back as it will put UK companies at a competitive disadvantage in future years.

This is why we are calling for government action to offset these doubts caused by the external environment by introducing 100% first year capital allowances for a time limited period of two years.

While we can't improve weaker external demand, we can make compensating improvements to the business environment faced by firms considering investing.

Capital allowances are an important part of the financing picture for SMEs given their fewer options for external finance compared with larger firms.

We know that the government's fiscal plans require private sector investment to deliver growth for the economy and SMEs in particular are most prone to holding off investment.

Importantly to have an impact in the short term reform options need to impact on cash flow in the short term. The short-life asset extension announced in Budget 2011 is a stepping stone towards removing disincentives to invest from the UK's tax system.

But that's all it is – a stepping stone, not a destination. It will have no impact on cash-flow until the final four years of the depreciable life of short-life assets.

By contrast a 100% year allowance will provide a cash-flow boost in the short term.

It's also a reform that is cognisant of the globally competitive market we are now in for attracting investment into the UK. Our U.S. friends have introduced a similar time-limited policy. And many other countries offer a permanent capital allowance regime that is more generous than the UK's.

We recognize the cost such a reform has. But the cost of not acting has become too great.

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