The UK's decision to raise corporation tax from 19% to 25% in April 2023, while offset by certain investment incentives, is likely to result in a long-term reduction in business investment, according to a recent analysis by the Institute for Fiscal Studies (IFS). The think tank's research suggests that, despite the introduction of 'full expensing' – a measure allowing companies to deduct the full cost of qualifying plant and machinery investments from their taxable profits – the overall impact on investment will be negative.
The IFS estimates that, in the long run, the higher corporation tax rate could lead to a 3% reduction in business investment. While full expensing and other capital allowances are designed to encourage businesses to invest, the report indicates that these measures will only mitigate approximately a third of the negative effect stemming from the increased headline tax rate. This means that for every £100 of potential investment lost due to the tax hike, only about £33 is recovered through the incentives.
This shift places the UK's corporation tax rate among the highest in the G7 for profitable companies, a notable change from its previous position as one of the lowest. For companies making significant profits, the marginal effective tax rate on new investments has increased, potentially making the UK a less attractive location for capital allocation compared to nations with more favourable tax regimes. This could have broader implications for the UK's competitiveness on the global stage.
The report highlights that the primary objective of the corporation tax increase was to boost government revenue, with forecasts suggesting an additional £15 billion annually. However, the trade-off appears to be a dampening effect on the very investment that underpins long-term economic growth. Lower business investment typically correlates with reduced productivity gains, which can ultimately impact wage growth and living standards for UK households.
The implications for UK businesses are varied. Companies with substantial investment plans, particularly in plant and machinery, may find some relief from full expensing. However, those with less capital-intensive operations or those focused on intangible assets, which are not covered by full expensing, will primarily feel the burden of the higher headline rate. This could influence strategic decisions regarding expansion, research and development, and job creation across different sectors of the economy.
The Bank of England closely monitors business investment as a key indicator of economic health and future productive capacity. A sustained decline in investment could influence the Bank's outlook on inflation and growth, potentially impacting future monetary policy decisions, including interest rates. For UK savers, mortgage holders, and investors, this could translate into a more subdued economic environment, potentially affecting returns on investments and the affordability of borrowing.
Source: Institute for Fiscal Studies