Research tax relief plan could be a big let-down

The UK government’s proposed tax credits for research and development may not be large enough to boost the struggling manufacturing industry.

The government’s proposed tax credits for research and development may not be large enough to boost the struggling manufacturing industry, some industry experts are warning.

They believe that the downturn in the UK economy may force the chancellor to cut the amount of relief on offer.

Gordon Brown has committed the government to offering R&D tax credits for larger firms in the 2002 Budget, but the level of relief has yet to be decided.

Dr Nick Bloom, senior research economist at the Institute for Fiscal Studies, said the credits may not be as generous as many firms hope, as the government’s finances have been hit by the downturn in the economy.

‘The one major concern for large companies looking for generous R&D tax credits is that the government’s finances appear to be deteriorating. The economy is less healthy than it was a year ago, and that will affect the government’s spending plans.’ The Treasury’s consultation period on the tax credits has now ended, following submissions from industry groups including the Engineering Employers’ Federation and the Confederation of British Industry.

Split over tactics

During this consultation a split emerged over the type of scheme the government should introduce. The CBI wants a volume-based approach, to reward firms for all their R&D spending, while the EEF favours an incremental scheme to offer tax relief on any increase in spending over a threshold based on the last two or three years.An announcement is expected in the pre-Budget statement this autumn, but there are already suggestions that the government prefers the CBI approach.

Tim Bradshaw, senior policy advisor for technology and innovation at the CBI, said the organisation recently held a meeting with Chris Wales, Gordon Brown’s chief advisor on tax issues, who said an incremental scheme would present problems. ‘At our meeting, Chris Wales said an incremental system would be extraordinarily difficult to operate, and that, on balance, he favoured a volume-based scheme,’ Bradshaw said.

But with the slowdown likely to cut the funds available for tax credits, a volume-based scheme could mean the available money being spread too thinly to encourage more R&D spending and promote the growth in the sectors that need it most.

Stephen Radley, chief economist at the EEF, warned that such money as there is could be swallowed up by existing large spenders, such as the aerospace and pharmaceuticals giants, and would have little impact on the medium-sized firms that the government wants to see investing more in R&D.

‘If it was a straightforward volume-based scheme with a relatively limited amount of money, we would be concerned about the incentive it would provide for encouraging extra investment in R&D,’ Radley said.

The proposed credits will form part of the chancellor’s efforts to boost UK productivity, which is trailing drastically behind that in the US. Figures published this week by the Institute of Management Services (IMS) show that UK productivity growth was flat in July – its lowest rate since February 1999.

Productivity was continuing to grow at a slightly faster rate in manufacturing than the service sector, but this was largely a result of job cuts, the report said.

Chris Williamson, chief economist at NTC Research, which carried out the report on behalf of IMS and Lloyds TSB, said that if the global slowdown continues, the only way firms would be able to maintain productivity is through further job cuts.

‘If manufacturers think things are going to pick up, they may want to hold on to their staff and allow productivity to fall for a while, but I suspect most companies think the outlook in the short to medium-term is fairly bleak,’ Williamson said.

Hope for exporters

But there were some signs that life may be starting to improve for exporters, he said. This week the value of the pound fell to a five-month low against the euro, following a decline in the strength of the dollar.

On Tuesday the pound closed at £0.632 (DM3.09) against the euro, after falling around 6% since the beginning of July.

‘A re-adjustment of the euro to a more appropriate level – which is already starting to happen – is going to help enormously, especially if that is on the back of a global economic recovery,’ Williamson said.

Hopes of a further cut in interest rates were also raised this week when new figures from the Office for National Statistics showed that factory gate prices rose by just 0.1% in the year to July, easing fears of inflationary pressures.