The impact of investment incentives: evidence from UK corporation tax returns

Many studies have attempted to analyse how taxation affects firms’ capital expenditure. However, few studies have focused explicitly on the role of capital allowances. Given the reduction in capital allowances over time in the UK, and the abolition of capital allowances for investment in buildings, this is potentially an important issue for policy. In this research, we analyse the impact of a 2004 exogenous change in the qualifying thresholds for the first-year depreciation allowances (FYAs), which provides us with a treatment group of firms affected by the change, and a control group of firms that were not affected. We use data from confidential UK corporation tax returns, available from the HRMC Datalab. Results suggest that the investment rate increased by between 2.1 and 2.6 percentage points when firms became qualified for FYAs, relative to firms that did not qualify. This implies a very large average increase in investment rate of 11%. We exploit exogenous variation in the timing of tax payments to show that this large effect is not due to an increase in available cash and hence, is primarily a cost of capital effect.

Giorgia Maffini, Jing Xing and Michael P Devereux. CBT Working Paper 16/01