25 February Rt. Hon George Osborne MP Chancellor of the Exchequer HM Treasury 1 Horse Guards Road London SW1A 2HQ

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1 25 February 2015 Rt. Hon George Osborne MP Chancellor of the Exchequer HM Treasury 1 Horse Guards Road London SW1A 2HQ I am writing to outline the CBI s priorities for Budget As we reach the end of this Parliament, the UK economy is now enjoying solid growth, with the recovery more firmly entrenched. We expect the expansion to remain strong in the medium-term, with the CBI forecasting GDP growth of 2.7% in 2015 and 2.6% in The last few years have seen record rises in employment, with 1.4 million more people in private sector employment in the UK compared to just before the onset of the recession, and the employment rate at a record high of 73.2%. Finally, there have been welcome steps taken in this Parliament to improve the competitiveness of the UK s business environment, chiefly the reductions in the Corporation Tax rate to the lowest in the G20 by April Our submission focuses on four areas which can support business investment and productivity growth, taking account of the fiscal challenges that remain and the progress made on improving the competitiveness of the tax system over the course of the Parliament. It also focuses on measures which promote stability, certainty and simplicity. First, the Government must take steps to support the expansion of medium sized businesses, encourage innovation and boost exports. Promoting the availability of alternative sources of growth capital, such as private placements and equity finance, is essential to equip growing firms with the finance they need to expand and invest. The R&D Tax Credit is a key feature of the UK s attractive business environment and of importance to investment in innovation across a whole range of sectors. Broadening the definition of the R&D Tax Credit to cover high-value development would also help to make the UK an attractive location for development in addition to research. Tackling the burden of Air Passenger Duty will encourage the development of business links from all regions and nations which are essential for improving the UK s export performance. John Cridland CBE Director-General DL: +44 (0) DF: +44 (0) E: john.cridland@cbi.org.uk CBI, Cannon Place, 78 Cannon Street, London EC4N 6HN T: +44 (0) F: +44 (0) W: Director-General: John Cridland CBE President: Sir Michael Rake Registered No: RC (England and Wales) Registered Office: CBI, Cannon Place, 78 Cannon Street, London, EC4N 6HN

2 Second, the Government should provide stability and certainty to boost investment. The CBI believes that making the Annual Investment Allowance permanent at 250,000 would do much to encourage investment amongst small and medium sized firms. In addition, urgent reforms are required to improve the competitiveness of the UK s tax system in order to support high-value jobs and investment in the UK Continental Shelf, including reducing the Supplementary Charge back to 20%. Third, the Government should take concrete steps to reduce complexity in the tax system, to support business investment by smaller and medium-sized firms. Immediate measures include: helping medium-sized businesses to invest through lifting the threshold for Quarterly Instalment Payments of Corporation Tax; increasing the threshold for transfer pricing rules; and giving parent companies the option to submit a single consolidated tax return. Fourth, at this point in the economic cycle, the Government should do what it can to address skills shortages in order to underpin the UK s future economic success. This must involve action to boost further education and higher learning in areas of particular economic need. With the Government still borrowing over 90 billion per year, it is essential that this Budget is delivered in a fiscally neutral setting so as not to jeopardise the fiscal consolidation plan. The CBI s package of proposals for the Budget involves a modest cost of 0.6 billion in 2015/16 which could be realistically delivered from further efficiency savings, before rising to 1.6 billion in 2019/20 when the fiscal consolidation plan is forecast to be complete. Taking into account the impact of our proposals on economic activity, the net cost of our package of measures in this Budget falls from 1.6 billion to 960 million in 2019/20, or less than 0.2% of public spending in that year. To fund these costs and maintain fiscal discipline further steps should be taken to reform public services in the next Parliament, as outlined in the CBI s 21 st Century Public Services report. Finally, looking beyond Budget 2015, in the annex to this submission we outline the five key priorities for the business community where the next Government must direct its focus in the next Parliament. These were set out in the CBI s People and Prosperity submission to party manifestos. Support the expansion of medium-sized businesses, encourage innovation, and boost exports Much has been done in this Parliament to encourage more of a contribution to GDP growth from other domestic sources apart from private consumption, but there are further steps required if we are to rebalance the economy more generally and address the productivity challenge. More work is needed to ensure long-term sources of growth capital are available to high-growth medium-sized firms. Moreover, further supporting innovation can be a triple win: driving higher productivity, stimulating investment in intangible assets, and boosting exports through helping to give UK firms a competitive edge. Finally, improving the UK s export performance will be critical if we are to address the UK s sizeable current account deficit. Promote more sources of long-term growth capital to support the expansion of medium-sized businesses Over this Parliament, the CBI has consistently emphasised how sustaining economic growth in the UK depends on unlocking the potential of our high growth medium-sized firms. These firms make up less than 1% of all businesses, but represent 16% of UK-wide employment and 22% of total business sales. They are resolutely focused on expanding their business the CBI s Financing our 2

3 Future Economy report found that 64% of medium-sized firms view growth as a high priority in the next year but they need the financing tools to succeed. In particular, as the outlook for business investment is forecast to improve in the future, this means ensuring that these firms have access to long-term growth capital in order to fund capital intensive activities. The Government has taken some welcome steps here, most recently with the pledge to inject a minimum of 100 million of new lending into the Business Bank as part of the Help to Grow pilot. As the demand for long-term growth capital from medium-sized firms intensifies, we need to take further steps to promote alternative sources of finance, alongside continued efforts to boost choice and competition in the banking sector. To maintain this momentum, the CBI would like to see a focus on two areas at Budget: Kick-starting a private placement market in the UK: this should build on the good intention of the withholding tax exemption that was announced in Autumn Statement 2014 by lowering the minimum eligible issuance size to 5 million and clarifying that it will apply to loans as well as bonds. Promoting equity finance should be at the heart of the Government s plan for increasing access to growth capital: the CBI s Slice of the Pie report showed that 81% of small and medium-sized businesses that have used equity finance would recommend it to another business. But the use of external equity finance by businesses in the UK lags behind other large economies. The CBI wants to see a cross-departmental review (involving HM Treasury, HMRC, and the Department for Business, Innovation & Skills) to look at ways of boosting the use of equity finance by growing businesses and whether there is a role that the tax system can play in achieving this. Enhance incentives for businesses to invest in development as well as research to encourage innovation in the UK. Innovation is essential to raising the UK s long-term growth rate and creating high-skilled jobs. Past and current Governments have taken significant steps to help create a welcoming business environment for innovation in the UK, including the introduction of the Patent Box and the abovethe-line R&D Tax Credit. It is vital that these incentives are maintained in the next Parliament, since they help to explain much of the UK s existing strength in investing in intangibles. But the CBI believes that more must be done to ensure that the full benefits of R&D can flow into the UK economy. This means making sure that the production and development of high-value innovations takes place in the UK, not just the research. A key means to ensure that these spill-over benefits of R&D do not move overseas would be the introduction of an incentive to encourage post R&D activity to take place in the United Kingdom. For example, introducing a supercharged R&D tax credit which would apply to the manufacturing of innovations would cost 310 million in 2015/16 before rising to 372 million in 2019/20. An alternative would be to widen the scope of the R&D tax credit to cover the development of prototypes and other steps towards commercialisation. Reform Air Passenger Duty to support export routes from all regions and nations While the CBI s Industrial Trends Survey in January showed that manufacturing export orders rose for the first time in three quarters, growth was only very slight and was not expected to continue in the coming quarter indeed, expectations for exports growth were at their lowest in one-and-a-half years. More generally, the survey shows that growth in export demand has been particularly paltry 3

4 over the last few years, while the average contribution of net trade to the growth of the economy has been weak over the same time period. Part of this picture must involve letting worthwhile investments in UK Export Finance bed-in. But, there are some specific areas where the CBI would like to see action now. The first is around further reform of Air Passenger Duty (APD), which still acts as a disincentive to the development of new business routes with emerging markets from airports across the UK. Left unreformed, APD risks becoming an important cost factor holding back UK exports. Analysis from PwC suggests that a reduction of APD would lead to a significant increase in investment and exports, with the total abolition of this duty having even greater economic benefits. In addition, the CBI s Trading Places report found that there is the potential for an annual boost to trade to the tune of 1 billion if the UK can produce just eight new daily direct routes to emerging market economies alone over the long term. Such rewards will be much harder to attain while the UK s air passenger tax regime is the least competitive in the EU, particularly for long-haul routes affected by Band B of APD that connect us to emerging markets. Here, UK competitiveness is worsening, with significantly above inflation increases for UK flights since 2010 contrasting with the abolition of air passenger tax in a number of EU states, including the Netherlands and Ireland. The pledge of the Smith Commission to devolve APD to Scotland brings the question of UK-wide competitiveness further into focus. At a minimum, the CBI believes that the UK Government should freeze Band B (the remaining long-haul band) which would have a static cost of 54 million in 2015/16 before increasing to 370 million by the end of the Parliament. The Government should also signal its clear intent to take steps to ensure that no region of the UK will be disadvantaged as a result of devolution particularly in their ability to maintain and develop new long-haul routes. Provide stability and certainty to promote investment Business investment has been a key support to GDP growth over the past years, contributing around 30% to growth since But while we expect a strong outlook in the years ahead, total investment as a share of GDP in nominal terms in the UK currently at 16% has been below the G7 average for the last 20 years. In the next Parliament, Government investment in areas like infrastructure and innovation can best unlock economic potential and help our businesses grow. That is why the CBI is calling on the next Government to set out plans to increase capital spending once the deficit is eliminated as a percentage of UK GDP in the next Parliament and beyond. But more immediately, more must be done by the Government in the Budget to provide stability and certainty in policy making to encourage investment by businesses. The CBI wants to see clarity on the following three specific areas of uncertainty. The first relates to the future of the Annual Investment Allowance a worthwhile incentive that encourages investment in plant and machinery among smaller and medium-sized firms. The second relates to the urgent need to make the UK s offshore tax system more competitive, given the pressure on jobs and investment in the North Sea. The third relates to actions which can help to lock in valuable support for the UK s energy-intensive firms. 4

5 Make the Annual Investment Allowance permanent at 250,000 to provide a structural incentive for business investment. The increase in the Annual Investment Allowance (AIA) in Budget 2014 played an important role in bringing forward investment spending, but the AIA drops from 500,000 to just 25,000 in early Since investment plans are sometimes several years in the making, having a clear path for the level of the AIA going forward is critical. Enhancing the role of the AIA as a structural incentive to promote investment would also provide a lasting benefit to smaller and medium-sized firms in particular, where underinvestment is more concentrated relative to other major economies. SMEs in the UK account for only 35% of all business investment in contrast to France, Italy, Spain and Germany where SMEs account for over half. Therefore, we call on the Government to provide the certainty that businesses require by making the Annual Investment Allowance permanent from 2016 at the level of 250,000, in order to support investment in plant and machinery. This would cost 670 million in 2016/17 before rising to 754 million at the end of the Parliament in 2019/20. Reduce the burden on North Sea oil producers to promote investment and job creation The sharp fall in global oil prices since mid-2014 will have positive implications for consumers and businesses in the economy, particularly as the UK is a net importer of oil. However, the fall in oil prices has also compounded existing pressures on investment in the UK Continental Shelf (UKCS). Production in the North Sea has been declining, as shown by a 38 per cent fall in production in the UKCS between 2010 and Moreover, operating costs have been climbing since 2005 during which the headline tax rate has increased. In particular, the UKCS was subject to a windfall tax increase in the form of a 12% hike in the Supplementary Charge in 2011, despite the need to support a basin with high and rising costs. These factors have led to a situation where the industry has had to cut a significant number of jobs many of them high-skilled and scale back investment plans, making urgent action necessary. Therefore, as an immediate step, the CBI calls on the Government to fully reverse the 2011 increase in the Supplementary Charge, to 20%. This move would provide an effective signal to investors since it would take headline tax rates on oil and gas in the UK to the same level as the Netherlands, meaning the joint lowest in the North Sea. It would carry a relatively modest cost of around 100 million per annum, based on an oil price assumption of around $60 per barrel. Going forward, the Government must also introduce a simplified investment allowance to help reduce the effective tax rates which operators face and provide stability and certainty for firms operating in the North Sea. Encourage investment by ensuring the competitiveness of energy-intensive industries The UK energy market requires significant levels of investment to keep the lights on and diversify and decarbonise our energy mix. The need for long-term investment must be balanced against the costs borne by both households and businesses. While the fall in the oil price has proved welcome for businesses as a whole, many of the UK s energy-intensive industries still face significant competitiveness challenges, with heavy users facing electricity prices over 30% higher than the EU15 median. We welcomed the support package for energy-intensive industries in Budget 2014, providing much needed relief. But, to ensure that this relief is felt as soon as possible, the Government must do everything it can to secure state aid approval for the budget package, and commit to bringing forward payment of compensation for the Renewables Obligation and small scale Feed-in-Tariffs as soon as state aid approval is secured. 5

6 Reduce complexity in the tax system to support business investment by smaller and medium-sized firms The progress made through the Corporation Tax Roadmap on reducing the headline rate of Corporation Tax to 20% by April 2015 has sent a positive signal about the UK as a good place to grow and invest. This rate stands as the lowest in the G20 and must be maintained in the next Parliament if we are to further build on the UK s existing strength as the number one location for Foreign Direct Investment in the EU. The Government can further enhance the competitiveness of the UK business tax system in two main ways: reducing business tax rates to increase investment and through tax simplification to reduce the compliance burdens the Government places upon business. As the recent Oxford University Centre for Business Taxation study states, whilst gains have been made to the competitiveness of the tax system over the course of this Parliament, the Government has been much less successful in trying to simplify it. Wholesale tax simplification must be a key focus for the next Government but, more immediately, a reduction in tax complexity should be a Budget priority since it will result in tangible benefits for a range of businesses without long term fiscal costs. A simpler tax system frees up more business time and resources to invest and grow, while it provides lower administrative costs and increased compliance rates for Government. The CBI s Stuck in the Middle report found that 45% of mediumsized businesses asked said that tax was a factor in slowing down commercial decisions. For this Budget, the Government should focus on policy reforms that can make the UK tax system more efficient for smaller and medium-sized firms who are currently subject to disproportionate compliance burdens. The CBI identifies three immediate reforms here: Increase the threshold at which businesses pay Quarterly Instalment Payments of Corporation Tax from 1.5 million to 5 million. The current threshold unduly captures a range of growing firms. Raising it would take 37,000 companies out of the regime at no permanent cost to the exchequer, allowing them the space to invest by ensuring that tax administration does not unduly jeopardise the cash-flow of growing firms. Reduce the number of companies caught within transfer pricing rules by increasing the threshold from 250 employees to 500 employees to be in line with R&D SME definition (with the added bonus of harmonising different and confusing SME definitions). The effectiveness of the transfer pricing rules, and other parts of tax legislation like the worldwide debt cap, needs to be reviewed, as the associated compliance burden for this size of business is seen as real barrier to growth. Investigate giving parent companies the option to submit a single consolidated tax return instead of one for each company within the group to reduce unnecessary compliance and put the UK on a similar footing to international counter-parts who already operate on a consolidated basis. Looking to the next Parliament, the CBI believes that there are further steps the next Government needs to take in order to boost the competitiveness of the tax system, whilst locking in gains made over this Parliament. This includes going further on tackling the burden of Business Rates. The Government must take ambitious steps through the review announced in Autumn Statement 2014 to modernise our Business Rates system and alleviate the burden on growing firms. Removing the smallest firms from paying rates, changing the indexation of rates from RPI to CPI and introducing 6

7 more frequent valuations via an online one-stop shop for rate payers would go a long way to achieving a more competitive Business Rates regime that incentivises business investment and growth. Address skills shortages to underpin the UK s future economic success While headline GDP growth is solid as we approach the end of this Parliament, some pressures on living standards remain which must be addressed if we are to make growth worth for everyone. In particular, as the CBI s Better off Britain report outlined, the UK s future economic success relies on us building an innovative, knowledge-intensive economy, underpinned by a skilled workforce. Both initial and later training has to be aligned to delivering high quality pathways to higher skills especially as technician roles tend to require a higher level of qualification than they did in the past. Take action to address skills shortages through support for business-relevant learning in universities and apprenticeships, including part-time courses The Government has taken welcome steps in this Parliament by, for instance, pledging capital funding to science, technology, engineering and maths (STEM) subjects. But there is scope to go further. For instance, this Budget should take forward work on developing partnership funding models between business and government for business-relevant degree courses. These types of more innovative partnerships were first considered by the CBI in our 2013 report Tomorrow s Growth, but the case for them is now pressing especially in light of the huge collapse of part-time higher learning that is now a serious brake on the retraining of the older workforce. This has created a disincentive to learn at a time when we must address our national productivity performance. Such a policy would also help create a pool of cheaper-to-access STEM courses for students. Survey evidence from the Institution of Mechanical Engineers shows that 48% of the public say that Government subsidies for STEM degrees would persuade them to encourage their children to consider a career in engineering, for example. In addition to higher learning, the Government should press ahead with plans to reform apprentice training funding to put businesses more in control, thereby creating a true market in provision. This will ensure the current public spend on apprenticeships is used more effectively, boosting productivity and growth. In short, this Parliament has seen welcome progress to enhance the UK s attractiveness as a place to do business. Moreover, the UK has benefited from high employment growth and an improving outlook for the economy. But, as this submission has emphasised, there is more to do both in this Budget and in the next Parliament to support growth and investment by all sizes of business and make economic growth sustainable in the longer term. John Cridland Director-General 7

8 Annex: CBI priorities for the next Government as contained in People and Prosperity: the Business Vision for a Better Britain 1. Shaping the state to deliver growth now and in the future Unlock the potential of our medium-sized businesses with targeted ideas to improve productivity and increase access to finance, helping them grow. Direct public spending towards capital spending and innovation: the things that will best unlock economic potential and help our businesses grow. Set out a roadmap for increasing capital spending once the deficit is eliminated as a percentage of UK GDP in the next Parliament and beyond. Lock in recent improvements to our tax system, then focus on reforming the distortive business rates system and exploring the increasing National Insurance burden facing business and employees. Get the most out of our public finances and improve people s experiences by reforming our public services to deliver better value and higher quality services. 2. Forging our economy to unleash business potential Unlock the potential of our medium-sized businesses with targeted ideas to improve productivity and increase access to finance, helping them grow. Get UK businesses seizing opportunities and selling more overseas with an ambitious export strategy targeting key markets and exploiting UK successes. Focus on strengthening key sector supply chains by deepening industrial strategy, recognising and promoting interdependencies rather than arbitrarily dividing the business community into big versus small. Boost business investment and UK competitiveness by extending the UK s capital allowance regime. Take a pro-competition and pro-consumer approach to markets, and allow regulatory bodies to do their jobs free from unnecessary political interference. Support diverse sources of business finance and ensure financial regulation has, as part of its core purpose, the objective of sustainable financing for the economy. 3. Getting Britain building to meet our infrastructure needs Establish an independent body to determine future infrastructure needs and how they should be met, without delaying projects already underway. Get 10 new garden cities completed or underway by 2025 to tackle the chronic housing shortage. Implement all elements of Electricity Market Reform to secure the necessary levels of investment in our power sector, and put energy efficiency at the centre of a future energy and climate change strategy. Commit to implementing the recommendations of the Airports Commission to bring an end to the hiatus over UK aviation capacity with spades in the ground by Securing our global future to capitalise on the changing world Make the case for the UK staying in a reformed EU so we maintain our access to the world s largest single market, developing alliances with other member states to achieve reforms that encourage enterprise and identify where the EU should do less. Get the EU to work for all member states by not regulating on things better done at national level and safeguarding the interests of non-eurozone members in the Single Market. 8

9 Prioritise progressing the EU single market in digital and services as part of the UK s efforts to make Europe more outward looking and competitive. Renew our role as a trading nation by helping get the Transatlantic Trade and Investment Partnership over the line, while ensuring EU trade talks with Japan and key emerging markets also deliver results. Equip our businesses for global success by playing to our strengths here at home, boosting competitiveness in all UK nations while maintaining the integrity of the UK s internal market. 5. Making growth work for everyone to raise living standards Announce the extension of free childcare to all 1 and 2 year olds to help families with childcare costs and support parents getting back to work. Re-shape our education system so it encourages development of the behaviours and attitudes that prepare rounded and grounded young people for success beyond the school gates, not just a focus on exam results. End the presumption that the same education will suit all young people by treating academic and vocational routes equally, starting with the creation of a vocational A-level and a shift away from GCSEs. Scrap the unhelpful net migration target, be prepared to raise the tier 2 skilled visa cap and deliver high service levels on visas and work permits so that skilled immigration can continue to add value to our economy. Set a target for reducing the gender pay gap by 2020 to show we re serious about tackling years of inequality in the workplace. Put improving productivity the real route to boosting pay and opportunity at the centre of a long-term labour market strategy. Don t meddle with labour market flexibility, which would risk pricing young people and the low-skilled out of opportunities. 9