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Adam Smith Institute - Abolish the Factory Tax to level up Britain

A new paper from the neoliberal think tank the Adam Smith Institute says that if the Prime Minister is serious about boosting wages and levelling up; then he needs to Abolish the Factory Tax. 

  • The UK has had the lowest level of private investment in fixed capital as a share of GDP in the G7 for over two decades 

  • Abolishing the Factory Tax by allowing businesses to immediately write-off capital expenditures, would boost investment by 8.1%

  • Annual rate of growth in output per hour since the financial crisis has been 0.3%. Abolishing the factory tax would boost labour productivity by 3.54%, the equivalent of £2,214 per worker, in the long run

  • UK is currently ranked 33rd (out of 36) in the OECD on the Tax Foundation’s Capital Cost Recovery index

  • The Factory tax accelerates deindustrialisation and holds back growth in parts of the country that are relatively more dependent on manufacturing, including the North and Midlands 

In the Prime Minister’s first speech to Parliament after winning the leadership of the parliamentary Conservative Party, Boris Johnson made boosting the productivity right across the country a central pillar of agenda. In the upcoming Budget, the Adam Smith Institute argues that new Chancellor Rishi Sunak should commit to Abolish the Factory Tax.

The Factory Tax is the inability to fully expense investments in machinery and buildings — that encourages low-capital intensive knowledge economy businesses in the South East and London over high-capital intensive businesses in the Midlands and North that need to invest in long-run assets.

At the heart of the UK’s recent productivity issues, the authors argue, is a lack of investment. Every year since 1998, the UK has had the lowest level of private investment in fixed capital as a share of GDP in the G7. This low level of investment has contributed to the rapid downfall of the UK’s manufacturing sector, which has declined by more than any other G7 nation. 

The UK’s tax treatment of capital investment is in effect a Factory Tax, the free market think tank argues. According to the Tax Foundation’s Cost of Capital Recovery index, the discounted value of the deduction for plants and machinery in the UK is just 75.6% of its total cost. As the costs of capital investment, unlike other costs, cannot be fully recovered capital-intensive businesses are penalised. 

The think tank says the tax system should not discriminate between day-to-day spending and long-term investment, that it should not favour one form of financing over another (such as debt rather than equity), and that it should be sector-neutral. Investing in capital means not spending today in order to get more in return tomorrow. High taxes on capital discourage saving, and mean taxing consumption at a later date higher than just spending the money now. In the long run this means the lower wages and lower growth the UK has experienced in the past few decades. 

The amount of revenue raised from corporate tax has remained relatively stable despite substantial reductions in the rate over recent decades. This is largely because of decisions to make the system less friendly to investment. 

The UK’s headline corporate tax rate was reduced from 30% to 19% from 2018 to 2017. But the headline rate cut was financed by reductions in the value of capital allowances. The rate at which investments in plants and machinery can written-off has fallen from 25% to 18%. These changes have led to a dramatic fall in the value of investment deduction.

On top of this the fall in the value of the UK’s capital came at a time when “all other G7 countries have seen their present value of capital allowances increase.” In the United States at both a state and federal level the Factory Tax has been reduced in recent years, leading to the conclusion by economist Eric Ohm that full expensing increased investment by 18%. 

The authors set out three recommendations to Abolish the Factory Tax:

  1. Allow businesses to immediately deduct capital expenditures on plants and machinery from their taxable income by making the Annual Investment Allowance (AIA) unlimited.

  2. Allow businesses to immediately deduct expenditures on non-residential structures and buildings as well.

  3. Allow trading losses to be carried forward to compensate for inflation.

Allowing firms to write-off the costs of new investments immediately would unlock 8.1% in additional investment and boost labour productivity by 3.54%, with most of the benefits going to places outside London and the South-East. Abolishing the Factory Tax, the Adam Smith Institute argues ahead of the Budget on March 11th, would help the Prime Minister ensure that the campaign promise to “level up” the economy becomes more than just a slogan.

Sam Dumitriu, Fellow of the Adam Smith Institute and co-author of the report, said:

“Beneath Britain's internationally-competitive Corporation Tax rate lurks one of the most restrictive treatments of investment in productivity-boosting equipment in the OECD. We should follow the lead of Canada and the US and move to a system where businesses can write-off new capital expenses immediately. Ending the Factory Tax would unlock investment and raise productivity in the long-run.”

Notes to editors:  

For further comments or to arrange an interview, contact Matt Kilcoyne, Head of Communications, | 07904 099599.

The Adam Smith Institute is a free market, neoliberal think tank based in London. It advocates classically liberal public policies to create a richer, freer world.

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