Levelling up – reducing economic imbalances between regions and social groups in the UK – was a key government manifesto pledge. And it will be one of the policies against which the government is judged at the next election.
The government’s stated aim is to “transform the UK by spreading opportunity and prosperity to all parts of it”. That will mean boosting regional productivity through localised investment – though not at the expense of London and the South-East.
This is easier said than done when the pot isn’t growing. New private-sector investment, above and beyond what firms already intend, will be required. Plus, the money must be targeted in the right areas for levelling up to work.
Funds can either come from foreign investors, who might otherwise have put their money elsewhere; or domestic businesses investing for growth. But as the Chancellor has admitted, “for decades, the UK has lagged behind international peers in investment in capital, people and ideas”.
He’s not wrong. In the ten years before the financial crisis, capital deepening only strengthened UK productivity by 0.4 percent per year – that’s less than half the OECD average. Then came a decade of flatlining productivity.
As a result, the IMF has halved its forecast for UK GDP growth in 2023, to just 1.2 percent. That’s the weakest outlook among the G7 economies.
Generating new investment against a languishing economic backdrop is challenging. But one lever the government can pull is the tax system. So what changes could we see in pursuit of levelling up?
Attracting overseas investment is proving increasingly difficult in a deglobalising world. Tax policy will be crucial to the UK’s international competitiveness.
The UK isn’t exactly rolling out the red carpet in this regards. There’s the rise in our corporation tax rate to 25 percent; the imminent end of the super-deduction; the increase in employers’ national insurance; and the threat of a windfall tax on sectors perceived as making too much money.
The UK relies largely on US capital for foreign investment. When America’s corporation tax rate was well above 30 percent, there was an obvious incentive to invest here. But with the US rate now 21 percent, that’s no longer true. We’re already seeing the ’reshoring’ of IP and management back across the Atlantic.
The UK government is therefore considering its options, including replacing the super-deduction and changing the capital-allowances regime. The R&D tax framework is also under review, but indications are that tweaks, not wholesale reform, are on the table.
Tweaks may not be enough. Currently, a business must spend €9.5 million on R&D in the UK to receive €1 million in tax benefit. But in France and Germany, they need invest only €3.3 million and €4 million respectively. Meanwhile, Belgium offers an additional tax deduction or credit of 13.5 percent of investment value, plus reductions of up to 80 percent of withholding taxes on salaries for researchers.
Whatever happens at a global level, the government will also need to trigger new investment from UK-based businesses.
Strategically, this may be better suited to levelling up. A lot of UK companies are privately owned and regionally located, so are less likely to exit overseas. And they typically take a longer-term approach to investment, wanting to create economic opportunities in the local community.
What’s more, many fall outside the 15 percent global minimum-tax regime – whose rules limit the scope to provide tax incentives to larger multinational businesses, without exporting tax revenues.
As such, private business may be fertile ground for encouraging new investment via targeted tax incentives.
But if we want growth from this sector, something needs to change. At a recent Institute for Government event, Kevin Hollinrake MP underlined that the UK is number one among OECD countries for start-up businesses – but only 13 out of 14 for scale-ups.
Options open to the government include cutting payroll taxes to boost local job creation; and increasing employee ownership, which we know improves productivity. The UK already has some tax-efficient employee-share schemes, but these could be expanded in scope, and targeted more at specific regions or sectors.
Many UK tax reliefs are focussed on exit or succession. The government could shift that emphasis, encouraging businesses to continue to grow and achieve their full potential, rather than cashing out when the going’s good. This could foster a longer-term investment horizon for private businesses committed to their local communities.
As noted, any new investment will need a regional focus to enable levelling up. At the moment, there’s little in the UK’s tax system to promote this.
Only Freeports come close: enterprise zones near airports or ports, offering relief from import tariffs and national insurance. Arguably, though, the impact of Freeports on regional investment has been diluted by the universally available super-deduction.
There’s also a broader structural barrier to regional incentives. Many countries with strong regional economies have highly devolved tax regimes, which bring about competition between different areas. That scarcely exists in the UK.
In it for the long haul
Levelling up is a long-term, highly expensive project, operating on a grand scale. An obvious parallel is the economic rebalancing that took place in Germany following reunification. The GDP gap between the old East and West Germany was narrowed from 40 percent to 15 percent.
According to the Centre for Cities, however, that programme cost some £71 billion per year, for more than three decades. The UK’s Levelling Up Fund, by contrast, is just £4.8 billion.
That leaves a large gap for the private sector to fill. This will take time, and tax alone can’t achieve it – but it could start to make a difference.
Heads of Tax should monitor the Autumn Budget carefully. There’s growing expectation of tax changes aimed at increasing investment in the UK – particularly in relation to capital investment and innovation. These may not be far-reaching reforms, but they could be the first steps on the long road to levelling up.