It’s thought to be unlikely that chancellor Rachel Reeves will axe the programme altogether
Crackdown on R&D cash
Will Labour revise state help designed to foster research and development?
Could research and development (R&D) tax credits be a target for Rachel Reeves in her first Budget? The annual cost of the credits, paid to businesses investing in innovation, has increased to around £7.5bn a year. And amid warnings that not all claims are bona fide, that pot of cash could make a tempting target.
More than 55,000 small businesses received R&Dtax credits last year, thelatest figures from HM Revenue & Customs show, underlining the value of this scheme to large numbers of companies. However, the scheme has already undergone substantial changes, with reforms introduced in April aimed at simplifying the system and cracking down on ineligible claims.
Recent reform
The new arrangements have merged the two separate schemes that discriminated between claims made by small and larger businesses. However, the principle remains the same: if your business invests in innovation, it should be able to offset some the cost of that investment against its corporation tax. And if you’re not paying corporation tax because your business is not currently profitable, you should still be eligible for support.
The rules get quite technical, but the relief is a valuable one, enabling you to claim back up to 27% of your innovation costs (depending on your circumstances) under the new merged scheme. Claims can be made in relation to innovation costs incurred in your past two accounting years.
Importantly, innovation has a broad meaning under the scheme. It might be that your business is investing in trying to make some sort of advance in science or technology. Or you may be seeking to overcome some sort of scientific or technological uncertainty. That brings a broad range of work into play. It’s not only major technology breakthroughs that count, but also investments in process or development – a company that finds a new way to run an operation or execute its production, say, may be eligible to claim. While HMRC’s figures show that companies in the information and communications sector account for more R&D tax credits than any other, it also receives plenty of claims from manufacturers, professional services companies and the construction industry.
The bottom line is that if your firm is pursuing innovation of any kind, it is worth looking in to whether you are eligible for support. And while it seems unlikely that the chancellor would axe the scheme altogether, she may seek to make further changes to the rules. It therefore makes sense to assess your position now, if only to understand how the budget affects you.
That said, tread carefully with claims. In recent years, the government has become increasingly concerned about the quality of claims – and fraud – and HMRC has been scrutinising filings more closely. The tax authority even has powers to claw back credits it decides should not have been paid, with a growing number of small businesses handed bills for thousands of pounds. Some of those demands relate to claims made several years ago.
It’s therefore imperative not to leave yourself vulnerable to a difficult inquiry from HMRC. It may be a good idea to take professional advice from an accountant or a tax-credits specialist before proceeding with a claim. But work with an adviser you trust. A small cottage industry has grown up around the tax-credits sector, with firms making bold claims about how much support they can secure for businesses. They will typically take a sizeable chunk of this cash – and if HMRC does subsequently investigate your case, it may be difficult to pursue the adviser.
Part way through Joe Root’s record-breaking innings against Pakistan this week, one of the commentators on Test Match Special talked about the regular power cuts in the city of Multan, where the Test was played. The former England player Alex Hartley, said she had become wary of running on the treadmill in the hotel gym in case the power suddenly went off and she ended up flat on her face.
Why does Pakistan have such frequent power cuts? The state of its grid is partly to blame. Another problem is an intermittent and expensive supply of gas for its power stations. Pakistan has learnt the hard way that relying on imports of liquefied natural gas (LNG) can be a perilous game.
Things got really bad two years ago when the price of gas spiked thanks to Russia’s invasion of Ukraine. The commodities trader Gunvor decided that it would not deliver four promised tankers and the Italian oil and gas company Eni another seven. Pakistan was forced to go to the spot market at short notice to fill the gap, at huge cost. Eni and Gunvor said they had done nothing wrong under the terms of their contracts: Eni claimed to have been let down by its supplier and, although Gunvor never confirmed it, it was widely reported at the time that it had decided to pay the penalty for non-delivery and sell the gas elsewhere at a much higher price.
One would hope that Ed Miliband was listening to the cricket as well. Labour’s new energy policy is all about eliminating fossil fuels from our energy mix. If this can be achieved Britain will no longer be exposed to the vicissitudes of the international gas market. We will produce most of our own electricity, so there will be no need to worry if there is yet another price shock.
Unfortunately, as this column has pointed out before, it will take much longer than Labour claims for energy independence to arrive. Miliband, the energy secretary, wants a net-zero grid by 2030. The future planning by Neso (National Energy System Operator, the organisation that runs the UK grid) does not envisage an end to gas-fired electricity generation before 2036, and even that date is tied to optimistic assumptions about how quickly new wind, solar and nuclear stations can be built. Miliband admits that gas will still be required but says that net zero can still be achieved because the carbon dioxide produced will be captured and stored underground.
But where will the gas come from? The second prong to Miliband’s energy policy is the penalisation of domestic oil and gas production through windfall taxes. North Sea companies have complained long and loud about Labour’s plan to raise those tax rates, and increase their life, saying that it will deter investment in new fields. In a report out this week, the highly regarded oil and gas analyst Chris Wheaton at the investment bank Stifel, tried to work out the combined effects of the two policies: the dash for renewable power and the curtailment of domestic production.
CHRIS DUGGAN
His verdict? “Higher windfall taxes will force UK gas production into decline faster than the UK can decarbonise through investment in renewable energy.” He says that the higher windfall taxes will mean that domestic gas production will fall by 70 per cent by 2030. Demand for gas will not fall at anything like the same rate, however, because households will still want it for cooking and heating and there will still be a need for gas-fired power stations to meet peak electricity demand, and to fill in at periods when wind and solar are not producing at full capacity.
The result is that the UK will have to import more gas. A lot more. Wheaton calculates that by 2030 Britain will need to import 80 per cent of the gas it will need. Another way to look at it is that the UK will need to secure about 5 per cent of global LNG production, and make sure it comes here rather than sailing off to China, Japan or even Pakistan.
It is possible that this might not be a problem over the next couple of years because Qatar is planning a big expansion of its export capacity and most analysts think this will keep prices down. Possible, but you wouldn’t want to bet on it. We know that any kind of geopolitical tension can lead to an increase in gas prices and you can hardly say that the Middle East, the source of much of this LNG, is looking set for a long period of tranquillity.
In the long term, Miliband’s vision may well come to pass. For the next decade and a half, however, the loss of domestic gas production could end up being an extremely expensive policy. We might all end up being a bit cautious around the treadmills in gyms.
French PM Michel Barnier unveils shock therapy in 2025 budget
Minority government bets on mix of spending cuts alongside tax rises on companies and the wealthy
Prime Minister Michel Barnier said: ‘We cannot sacrifice the future of our children or continue to write bad cheques that will fall on them’ Leila Abboud in Paris
The French government has proposed a budget for next year with some €60bn worth of spending cuts and tax increases on companies and the wealthy, as it seeks to narrow its widening deficit.
Prime Minister Michel Barnier has cast tackling France’s “colossal” public debt as his biggest priority, despite the political risk such measures entail for his fragile minority government.
“We cannot sacrifice the future of our children or continue to write bad cheques that will fall on them,” Barnier said on Thursday. “The attractiveness [of France] and credibility of the French signature must be preserved.”
In the proposed budget, some 440 large corporations with revenues above €1bn would be hit by an “exceptional” tax lasting two years with the aim of raising a total of €12bn. Share buybacks would also be taxed.
The state-owned electricity utility EDF will pay a special dividend to government coffers — together these changes, and others affecting business, would raise €13.6bn.
If passed, the moves would break with the economic policies espoused by Macron since 2017 that include lowering taxes and curbing strict labour protections in an effort to boost growth and competitiveness.
Few lawmakers believe the budget can be adopted without Barnier using a constitutional clause that allows him to override parliament, but doing so could open him up to the risk of a no-confidence vote.
At stake is Barnier’s ability to both calm investors’ jitters about lending to France and withstand pressure from Brussels, which has admonished Paris for its excessive deficit. French borrowing costs now exceed not only those of Germany, but also Spain’s.
The government claims two-thirds of the €60bn effort in 2025 will come from spending cuts, such as on medical costs, unemployment, and reducing the number of public servants. The rest will come from tax increases.
But an independent government advisory body, using a different calculation method, recently estimated taxes will account for 70 per cent of the effort.
The divergence matters because Macron’s centrists staunchly opposes tax increases, while Barnier’s own party also wants more spending cuts.
Barnier has said the budget draft is a starting point for lawmakers, but warned them not to derail the goal to reach a deficit to 3 per cent of national output by 2029.
Another hit to companies will come from delaying a planned cut in production taxes, which groups pay on their activities regardless of whether they are profitable. Cutting these was a hallmark of Macron’s supply-side strategy.
Airlines and private jets face a new levy on flights to generate €1bn next year, while container shipping companies, including Marseille-based CMA-CGM, will be slapped with a separate levy that would raise 800mn in the next two years.
Businesses will also be affected by higher labour costs caused by scrapping tax breaks on low-income workers and phasing out apprenticeship subsidies.
Although Barnier has argued working people will be insulated, households will be affected by higher taxes on electricity bills.
Individuals are also likely to face higher healthcare costs if the government scales back reimbursements of doctors’ visits and medicines as planned.
In another shift from Macron’s approach, France’s wealthiest are being asked to contribute €2bn in a new tax on those who earn about €500,000 annually, who are estimated to represent 65,000 households.
The deficit will stand over 6 per cent of GDP by year end. The government aims to trim it to 5 per cent by the end of 2025, although public spending will still increase next year because all the spending cuts and taxation will only slow the pace of increase.
France has repeatedly overshot its deficit targets since last year, prompting concern that the government has lost control over spending and also cannot accurately predict tax inflows. Its debt pile represented 110 per cent of GDP as of July, the third-worst in the EU behind Greece and Italy.
Successive French governments have not presented balanced budgets for decades.
The public has a renowned appetite for costly welfare programmes and supports a high level of income redistribution.
One of Barnier’s particularly controversial proposals asks retirees — long protected by politicians as a key voting bloc — to delay the annual inflation-adjusted increase to their state pensions by six months.
The move would save about €3.6bn. Several parties have already railed against it, including the far-right Rassemblement National.
Pushing the issue is risky for Barnier because Marine Le Pen’s RN is the key swing voting bloc needed for a no-confidence vote to pass.
Governments are bigger than ever. They are also more useless
Why voters across the rich world are miserable
Illustration: Lehel Kovács
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You may sense that governments are not as competent as they once were. Upon entering the White House in 2021, President Joe Biden promised to revitalise American infrastructure. In fact, spending on things like roads and rail has fallen. A flagship plan to expand access to fast broadband for rural Americans has so far helped precisely no one. Britain’s National Health Service soaks up ever more money, and provides ever worse care. Germany mothballed its last three nuclear plants last year, despite uncertain energy supplies. The country’s trains, once a source of national pride, are now often late.
You may also have noticed that governments are bigger than they once were. Whereas in 1960 state spending across the rich world was equal to 30% of GDP, now it is above 40%. In some countries growth in the state’s economic power has been still more dramatic. Since the mid-1990s Britain’s government spending has risen by six percentage points of gdp, while South Korea’s has risen by ten points. All of which raises a paradox: if governments are so big, why are they so ineffective?
The answer is that they have turned into what can be called “Lumbering Leviathans”. In recent decades governments have overseen an enormous expansion in spending on entitlements. Because there has not been a commensurate increase in taxes, redistribution is crowding out spending on other functions of government. This, in turn, is damaging the quality of public services and bureaucracies. The phenomenon may help explain why people across the rich world have such little faith in politicians. It may also help explain why economic growth across the rich world is weak by historical standards.
Chart: The Economist
America, which has some of the best fiscal data, shows how one government became a Lumbering Leviathan. In the early 1950s we estimate that state spending on public services, including everything from paying teachers’ salaries to building hospitals, equalled 25% of the country’s gdp (see chart 1). At the same time, entitlements spending, broadly defined, was a small line item, with outlays on both pensions and other sorts of welfare equivalent to about 3% of GDP. Today the situation is very different. The American government’s outlays on entitlements have swelled and spending on public services has crashed. Both now equal around 15% of gdp.
Other countries have followed a similar path. We have examined long-run GDP data, looking at how much governments spend each year on social benefits and transfers. This includes standard entitlements, such as pensions and tax credits, but also the provision of transfers “in kind”, such as discounts on health insurance and help with housing. Both types have become a lot bigger. On average across the OECD, social expenditure in countries with available data rose from 14% of GDP in 1980 to 21% in 2022 (see chart 2).
Chart: The Economist
Moreover, conventional statistics understate the scale of the change. Governments have accumulated mind-boggling off-balance-sheet obligations to dole out money in the future. Adapting work by James Hamilton of the University of California, San Diego, we estimate that America’s federal government has made pledges of compensation to different groups worth, in aggregate, six times America’s GDP (see chart 3). In addition to reported public debt, Uncle Sam guarantees people’s bank deposits, health-care payouts and mortgages. He will also need to make good on promises to future retirees. In the history of the modern state, this represents a uniquely large financial commitment.
Some of the growth in entitlement spending has been unavoidable. In 2022 there were 33m people over the age of 85 in the rich world, representing 2.4% of the total population—a huge rise on the 5m, representing 0.5% of the total population, around in 1970. Governments have not helped themselves by failing to raise the retirement age: the average person in the rich world currently retires at age 64, no older than in the late 1970s. But it would have been hard (and unwise) to have stopped pension spending from growing.
Chart: The Economist
Because entitlements for the old tend to be universal—European countries, for example, have little private pension provision—more cheques are going to the well-heeled. We estimate that in the oecd between a fifth and a third of entitlements spending, broadly defined, goes to the richest 20% of households. The American government spends about $400bn, or roughly half the budget of the Department of Defence, on transfers for the top income quintile. In 2019 an average household in the top 1% received $16,000 in transfers from Uncle Sam, including from things such as Social Security and Medicare.
Transfers to the working-age population have increased even faster, making the system more redistributive. In 1980 the bottom fifth of American earners received means-tested transfers equal to a third of their gross earnings. By the late 2010s the figure had doubled, before the covid-19 pandemic sent it higher still (see chart 4). A similar pattern is evident in Canada and Finland, two other countries with good data. Spending often follows a ratchet effect. For instance, since the 1970s the share of Americans on food stamps has doubled, to one in eight people. In recessions the number of recipients rises like a rocket; thereafter it falls like a feather.
Across the board, governments have become more generous in times of trouble. During the pandemic they shovelled money to affected workers and companies, as well as to many that were carrying on largely as normal. Throughout the energy crisis of 2022, lots of governments threw caution to the wind. Even the German government, historically among the more tight-fisted, allocated 4.4% of GDP to measures shielding households and firms from its effects. More recently, some have lost the plot. In Italy a project to encourage homeowners to make their homes greener has spiralled out of control, with the government so far disbursing support worth more than €200bn (or 10% of GDP).
Nordic nirvana
A rise in entitlement spending is not necessarily a problem if governments are able to adequately and efficiently fund themselves. Textbook economics says that the societal cost of redistribution comes from the distorted incentives tax and welfare spending can create. These cannot be judged merely by the size of redistribution—the design of the system is what matters most. Indeed, Scandinavian countries have long sustained big states alongside thriving market economies, in part by funding redistribution with high rates of VAT, one of the least-distorting taxes, and by keeping down taxes on capital, which are particularly harmful to growth.
But in recent years politicians have preferred to act as if extra spending can happen with little more taxation of any kind. From the 1960s to the 1990s the tax take, as a share of rich-world GDP, rose steadily. Since the 2000s it has hardly grown. A database of tax reforms maintained by the IMF, and last updated in 2018, suggests that whereas in the 1970s and 1980s reforms were evenly split between revenue-raisers and revenue-cutters, more recent ones have focused on cutting taxes.
Illustration: Lehel Kovács
By 2022 some 85% of reforms to rich countries’ personal-income-tax bases caused them to narrow, while just 15% broadened them. The biggest reform of the past decade was President Donald Trump’s enormous tax cut in 2017. Neither Mr Trump nor Kamala Harris, the Democratic nominee, promise sober fiscal stewardship in the years to come. To the extent that today’s governments implement measures to raise revenue, they tend to take the form of crafty workarounds. According to our calculations, in 2022 American federal, state and local governments raised $80bn from fines, fees, penalty taxes and settlements—nearly three times as much, relative to GDP, as in the 1960s and 1970s.
Politicians who fail to raise revenues face two choices. One is to run large fiscal deficits: this year rich-world governments will run an aggregate deficit of 4.4% of GDP, even with the global economy in decent shape. Another is to fund more generous entitlements by making cuts elsewhere. Demand for public services has grown hugely. Yet in 2022 the median rich country spent 24% of GDP on them, the same as in 1992. Public-sector employment, as a share of the total, has drifted down since the late 1990s. Everything from state-provided health care to education and public safety has suffered.
Another historical role of government—now waning—was to provide an efficient bureaucracy. It is tough to measure this quantitatively, but researchers have had a go. Data produced by the Berggruen Institute, a think-tank, and the University of California, Los Angeles, combine objective measures, such as tax revenue, and subjective measures, such as perceptions of corruption, to devise a cross-country measure of “state capacity”. In the G7 group of advanced economies this measure is falling. The same is true of the “rigorous and impartial public-administration index”, produced by V-Dem, another think-tank, which illustrates the extent to which public officials respect the law.
The effects of declining state capacity show up everywhere. Some are small-bore. In America the time lag between a residential project being granted permission to build and construction beginning has doubled since the 1990s. Builders face long waiting times as they form-fill and box-tick. In Britain employment tribunals are facing huge delays owing to a shortage of judges, with hearings on everything from unfair dismissal to racial discrimination now scheduled as far ahead as 2026. Five years ago the website of Australia’s passport office said that the processing time for an application was “three weeks”; two years ago it said “up to six weeks”; by last year it said “minimum of six weeks”.
Chart: The Economist
Governments also seem less willing and able to pull off big projects. It is just about impossible to imagine that the Empire State Building could be built in a year—and yet, in the 1930s, it was. Moreover, throughout the 20th century governments invested both money and intellect in science and R&D, seeking to shift economic growth into a higher gear. Initiatives like DARPA, undertaken in America to devise and spread groundbreaking technologies, hinted at the scale of governments’ ambitions. In the 1950s and 1960s governments, including Germany’s and Japan’s, built millions of units of public housing and millions of miles of road and rail.
Now politicians just want to get from one day to the next. Spending on short-term fixes takes precedence over difficult, long-term projects. Mr Biden talks up his industrial policy, which is supposed to revive manufacturing jobs and reduce America’s dependence on China. In practice, the fiscal outlays associated with the policy are trivial. Elsewhere in the rich world public investment is well down, while governments have slashed r&d departments. Across the OECD the state now accounts for less than 10% of total R&D spending, a sharp change from the post-war norm (see chart 5). Governments are no longer hotbeds of innovation. Almost all of the recent artificial-intelligence developments have emerged from the private sector.
When it comes to growth-boosting reform, such as tweaks to labour laws, governments have almost entirely lost interest. A paper published in 2020 by Alberto Alesina of Harvard University, and colleagues at the IMF and Georgetown University, measured structural reforms, such as changes to regulations, over time. In the 1980s and 1990s politicians in advanced economies implemented lots of reforms. By the 2010s, however, they had ground to a halt. According to our analysis of data from the Manifesto Project, political-party manifestos in the OECD are about half as focused on growth as in the early 1980s.
Leviathans may not remain lumbering for ever. Running large deficits in order to fund transfer payments will, eventually, become too expensive—as countries such as Greece and Italy discovered in the 2010s. At some point populations, fed up with weak economic growth and poor services, may demand that politicians make some difficult choices. Then again, Lumbering Leviathans are formidable. Interest groups are entrenched, familiar incentives apply and it is easier to live for the short term. The system has a life of its own. ■
Correction (September 25th 2024): This article previously said that the Golden Gate Bridge was built in a year, rather than the Empire State Building. Sorry.
