Charlotte Street Partners

BEYOND THE STREET

BEYOND THE STREET

Budget carrots

Written by Alex Massie
4 March 2021

Before Rishi Sunak delivered his budget on Wednesday – an event that has lost some of its salience in Scotland since the devolution of income tax responsibilities to Holyrood, but which still produces the climate within which the Scottish government is able to make its own weather – much of the pre-budget briefing and counter-briefing focused on the chancellor’s plans for corporation tax. 

As is so often the way, the Treasury prevailed. Corporation tax for the largest, most profitable, firms will increase from 19% to 25%. George Osborne’s ghost has been exorcised and Britain will not – surprise! – be the Singapore of the east. Well, fancy that.

Granted, smaller businesses are protected from this otherwise swingeing increase and a taper will be introduced to soften the blow to medium-sized enterprises. Even so, it is impossible to avoid the conclusion this represents a singular change. But just as not every tax cut is virtuous, so not every tax increase is malign. It is in any case difficult, I think, to complain about increases to corporation tax that still leave the top rate of such levies lower than it was when the Conservatives returned to power in 2010.

More importantly, just as previous cuts to corporation tax were offset by reductions in tax-deductible expenses, so this increase is accompanied by – at long last – major changes to the incentives for business investment. For two years, businesses will be able to take advantage of “super-expensing”, writing off 130% of capital investments against their tax bill. This is, as I say, long overdue, not least since changes introduced by Osborne effectively reduced the tax relief on new industrial or corporate buildings to zero.

Between 2015 and 2018, business investment in the UK was effectively all but flat. Solving Britain’s productivity problem has tested governments of every stripe for decades. None have found a solution. Considered as a collective enterprise, British business – and thus the economy more generally – has typically preferred jam today over the prospect of greater quantities of jam tomorrow. Short-termism can always be justified in individual cases; collectively it stores up trouble. Those troubles are measured out in terms of lower productivity and, in the end, lower wages and lower economic growth.

So, allowing “full-expensing” – and then some, in fact – for businesses is one way to cushion the blow of tax increases. Indeed, without the stick of tax hikes, the carrot of greater investment incentives would be less appealing. Here again and as so often, it is a question of balance.

There is evidence that full-expensing has its desired effect. Estonia’s tax system, which is much simpler overall than the UK’s, has profited from precisely this approach. When full-expensing was introduced there 20 years ago, business investment increased in Estonia by almost 40% more than it did in broadly-comparable Latvia and Lithuania. But there are also grounds for thinking that such measures can produce helpful outcomes in larger economies too.

One study comparing American states that adopted full-expensing during two windows when such measures were available (in 2002 and 2008 respectively) concluded that five years later states which had taken full advantage of the opportunities afforded by full-expensing had employment levels almost eight per cent higher than comparable states which had not pursued this course. Wages and production output also grew much more quickly in full-expense states than in their peers. That finding is broadly consistent with analysis of the impact of more generous historic capital allowances on smaller and medium sized enterprises in the UK too.

This being so, increasing rates of corporation taxation becomes positively virtuous if these measures are matched by greatly increasing the incentives for business investment, the lack of which – by international standards – has plagued the UK economy for years. It rewards companies which invest in their own future at the expense of those content, relatively-speaking, to coast on Easy Street. A regime offering 130% deductibility of investment in plant and machinery may not be sustainable forever, but full-expensing of business investments is both sensible and a disconcertingly rare example of allowing the long-term view to prevail over short-term expediency.

This would have been useful even before Covid rewrote the Treasury’s fiscal assumptions. If the pandemic is not quite a once-in-a-century event, it remains the kind of trauma which will impose costs to be paid for at least a generation. As a minimum, this is so in terms of the immediate crisis and the shorter-term economic outlook. It scarcely needs arguing that this is an inconvenient moment at which to be erecting trade barriers with your largest trading partner (and if this is a truth that must go unmentioned in Downing Street, it is also one that Bute House goes to great lengths to avoid confronting).

Since the Institute of Fiscal Studies calculates that average earnings will be no higher, in real terms, in 2026 than they were in 2008, it is disagreeable to contemplate the fundamental weakness of the longer-term position in which the United Kingdom finds itself. There are other ways in which that weakness may be measured. It seems worth noting that Baillie Gifford’s Scottish Mortgage Investment Trust, Britain’s largest such enterprise, has scarcely been able to find British companies that meet its investment criteria. Changes to the rules governing business investment do not seem likely to alter that in the short to medium term, but they remain a useful starting point if the question to be asked is ‘How might we build the kind of economy that will be attractive to long-term investors?”

As such, and despite not being the subject of many headlines this week, the move to super-expensing may yet be the most significant aspect of the chancellor’s budget. No budget can confront, let alone solve, every weakness or problem and Sunak’s second such presentation was no exception to that eternal rule. That does not mean it was bereft of useful measures. Full-expensing is not sexy, but it can make a difference. For, yet again, the economy, like everything else, is primarily a question of culture and in this instance it is a question of ‘go long, or go nowhere at all’. 

About Beyond the Street and Alex Massie

We are all guilty of being too inwardly focused sometimes, especially as we navigate these changed times. It is all too easy to be caught up in the problems close to home, and for overarching trends to pass us by.

To remedy that short-sightedness, Charlotte Street Partners has enlisted the ingenuity and talent of the writer and commentator Alex Massie. As our new correspondent at large, Alex will look at the bigger picture for us each week. We have challenged him to come up with something a bit different: broad, lateral thinking, thematic insights and a more global perspective.

Alex is a freelance journalist and commentator based in Edinburgh. Not only is he Scotland editor of
The Spectator, but he also writes a political column for The Times and The Sunday Times. He features regularly on the BBC as a political commentator and has written in the past for The Telegraph, Politico, The Washington Post, the Los Angeles Times, The New York Times, the New Statesman, The Observer, and TIME magazine, among others. He was also the Washington correspondent for The Scotsman and assistant editor of Scotland on Sunday

We hope you enjoy his work – and do feel free to forward this email on to colleagues and friends you think might be interested. They can subscribe to Beyond the Street and our other regular briefings here

Share this post

Share on facebook
Share on twitter
Share on linkedin
Share on email