Influences on investment by UK businesses: evidence from the Decision Maker Panel

Quarterly Bulletin 2021 Q2
Published on 25 June 2021

By Philip Bunn (Bank of England), Myrto Oikonomou (Bank of England), Lena Anayi (Bank of England), Paul Mizen (University of Nottingham), Gregory Thwaites (University of Nottingham) and Nicholas Bloom (Stanford University).

  • This article uses data from the Decision Maker Panel (DMP) – a large and representative survey of UK businesses – to examine recent trends in UK business investment and prospects for the future.
  • We show how both the UK’s decision to leave the EU and Covid-19 (Covid) have weighed heavily on investment in recent years, and how that weakness can be accounted for by the businesses most exposed to those events.
  • Businesses expect investment to recover over the next year as the factors that have held investment back wane, supported by recent corporate tax changes that increase the incentives for businesses to invest.

Overview

Over recent years, business investment in the UK has been weak. This article uses data from the DMP to better understand how the UK’s decision to leave the EU and the Covid pandemic have affected investment. It also describes how businesses see the prospects for investment over the next year, following the UK’s formal departure from the EU and the end of the transition period, and as Covid-related restrictions on the economy ease. We also examine how businesses expect to react to the corporate tax changes announced in the March 2021 Budget.

Introduction

Business investment accounts for around 10% of GDP in the UK. But it also tends to be one of the most cyclical components of GDP, and consequently accounts for a greater share of the volatility of GDP. It is important for monetary policymakers to understand the factors driving investment to help them form a view about the prospects for the economy and decide on the appropriate stance of monetary policy. And investment does not only affect the demand side of the economy, it matters for the supply side of the economy too, because there also is a link between investment and productivity growth. Hence, it matters for the balance between demand and supply, which has an impact on inflation.

Two of the main factors affecting business investment over recent years are likely to have been the UK’s decision to leave the EU and the Covid pandemic. Both events have increased uncertainty and lowered current and either near-term demand or expected medium to longer-term future demand, each of which would be likely to lead to lower investment.

The impact of both the UK leaving the EU and of Covid is evident in the aggregate business investment data. Following the EU referendum in June 2016, there was little growth in investment, on average, over the following four years, compared with an average growth rate of around 6% over the previous five years (Chart 1). And in 2020, investment fell by more than 20% as the Covid pandemic hit. But to properly understand this weakness in investment, we need to know which types of businesses have invested less. And to be more confident in asserting the link to the UK’s decision to leave the EU and Covid, we need to show that the businesses that invested less were indeed those most affected by those events. In the first part of this article, we use firm-level data from the DMP to demonstrate this and to estimate the relative contributions of these two shocks.

Chart 1: Business investment has been weak over recent years

Level of aggregate business investment (a)

Line depicts aggregate business investment from 2004 to 2020

Footnotes

  • Sources: ONS and authors’ calculations.
  • (a) Chained-volume measure.

Business investment is likely to recover in 2021 as demand improves and uncertainty falls. In its May Monetary Policy Report, the Bank of England’s Monetary Policy Committee expected business investment to grow by 7% in 2021 and 13.5% in 2022. That recovery in investment is also supported by corporate tax changes announced in the March 2021 Budget. The DMP also asks businesses about their views on the prospects for investment. Panel members expect a strong recovery in investment as both the effects of the UK’s withdrawal from the EU on uncertainty and Covid are expected to wane, and as the Budget measures provide a boost to investment. The second part of this article examines those expectations.

The DMP was launched in August 2016 by the Bank of England, in collaboration with Stanford University and the University of Nottingham.footnote [1] The DMP is a large and representative survey of British businesses and is well-placed to analyse the uncertainty facing businesses and how they expect to respond to that uncertainty. It is a flexible tool for assessing business conditions and, in particular, it has been adapted to collect detailed information on how businesses are affected by important economic events.

The DMP is a monthly online survey of Chief Financial Officers of UK businesses. The panel grew quickly after its launch and has averaged around 3,000 responses a month since 2019. Businesses across the UK with at least 10 employees are randomly selected and invited to participate in the survey. This ensures it provides a representative view across the economy. It covers small, medium and large private sector businesses across all industries. Results are weighted using employment data. The survey methodology is described in more detail in Box A.

This Quarterly Bulletin article builds on previous Bulletin articles using the DMP: Bloom et al (2017) introduced the survey soon after its launch, and Bloom et al (2020) used it to examine the effects of Covid on the distribution of businesses’ expectations. The main advantages of the DMP relative to other business surveys are the quantitative data that it provides and the fact that it is flexible and able to respond quickly to economic events and collect data in close to real time.

Recent developments in investment

Businesses typically decide whether to make an investment based on their expectation of that investment’s ability to yield a sufficiently high profit in return. When demand in the economy is lower, that may make some investments less profitable and therefore less likely to go ahead. Lower investment can also be associated with higher uncertainty. When uncertainty is high, there is an incentive to delay investment until things become clearer. Investments are often hard to reverse and involve upfront costs that cannot easily be recovered if a business were to change its mind. So when uncertainty is high it often makes sense for businesses to wait until future prospects are clearer before deciding whether it is worth incurring those fixed costs. Uncertainty creates a so-called ‘option value of waiting’, which means businesses can often be better off waiting for uncertainty to be resolved before investing. Other factors, such as the cost and availability of finance, will also be relevant to investment decisions.

The UK’s decision to leave the EU created substantial uncertainty for businesses. On average since the 2016 referendum, around 45% of businesses in the DMP have reported that Brexit was in the top three sources of uncertainty for their business, peaking at just under 60% (Chart 2). This uncertainty has persisted for almost five years, which has been an unusually long period for uncertainty to last. The majority of uncertainty shocks in recent experience have generated a surge in uncertainty that subsides reasonably quickly as initial concerns are allayed by further information becoming available.

The Covid pandemic has also created a large amount of uncertainty for businesses. At the peak of uncertainty related to the Covid pandemic in April 2020, 97% of businesses reported that Covid was in the top three sources of uncertainty for their business, and it was the top source for 86% of businesses (Chart 2). Covid-related uncertainty has gradually fallen over the past year, but remains high. In the most recent May 2021 DMP data, 74% of respondents reported that Covid was still in their top three sources of uncertainty.

Chart 2: Brexit and Covid have both been important sources of uncertainty for businesses

Brexit and Covid as sources of uncertainty (a)

Percentage of businesses reporting Brexit and Covid as sources of uncertainty from 2017 to 2021

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) The results are based on the questions: ‘How much has the result of the EU referendum affected the level of uncertainty affecting your business?’; and ‘How important is the spread of coronavirus (Covid-19) as a source of uncertainty for your business?’. For each question, respondents could provide one of the following answers: (i) Not important, (ii) One of many (iii) Top two or three, and (iv) Largest source of uncertainty.

As well as creating substantial uncertainty, businesses report that the UK’s decision to leave the EU and the spread of Covid have also both impacted demand. However, the nature of those changes in demand are different for each shock. For the UK’s withdrawal from the EU, the effects are likely to be longer term. Respondents to the DMP estimate that their sales will be about 3% lower in the long term, on average, than if the UK had remained a member of the EU. The effects of Covid are estimated to be primarily in the shorter term. On average, over the year to 2021 Q1, sales were estimated to be around 19% lower than they would have been. In 2022 and beyond the effect of Covid on sales is estimated to be close to zero, on average, although responses were varied; some businesses and sectors expect to do better and some expect to do worse. In part this may be due to structural changes in the economy arising from Covid, such as an increase in the share of employees working from home in certain sectors.

Higher uncertainty and lower demand associated with the UK’s decision to leave the EU and Covid are likely to have both led to lower investment. Below we investigate this in more detail using firm-level data from the DMP. However, we should mention that it can still be difficult to separate out the effects of higher uncertainty and lower demand because it is often the same businesses that are affected by both channels.

UK’s decision to leave the EU

Chart 3 shows that since the EU referendum, businesses with a higher level of Brexit uncertainty have had lower investment growth than those with lower Brexit uncertainty. That is in contrast to the five years before the referendum where those businesses subsequently more affected by Brexit uncertainty had reported higher investment growth.

Businesses with a higher level of Brexit uncertainty are typically more exposed to the EU, for example because they export to the EU, import from the EU or rely on EU migrant workers.

Chart 3: Businesses more affected by Brexit uncertainty have had lower investment growth since 2016

Investment growth by Brexit as a source of uncertainty (a)

Bars show investment growth from 2011 to 2015, and 2016 to 2020, split by Brexit uncertainty

Footnotes

  • Sources: DMP, Bureau van Dijk (based on Companies House data) and authors’ calculations.
  • (a) Businesses are split into high and low Brexit uncertainty based on whether, on average, they have reported Brexit to be in their top three sources of uncertainty since the EU referendum when responding to the question reported in the footnote to Chart 2. Data are for financial years. Uses investment growth from the DMP where available and estimates from company accounts in all other periods. Investment growth is calculated using Davis, Haltiwanger and Schuh (DHS) growth rates. This is the change between two periods, divided by the average of those two periods.

To assess the impact of the UK’s decision to leave the EU on investment, we update the regression analysis of Bloom et al (2019) to cover the period up to March 2021, which adds an extra two years of data to those earlier estimates. This approach compares how trends in investment growth have changed for businesses more affected by Brexit relative to those less affected. It combines investment estimated from company accounts with data reported in the DMP to allow us to assess trends prior to the EU referendum (before the DMP was launched). It also controls for the effects of Covid (discussed in more detail in the next section).

Our estimates imply that the UK’s decision to leave the EU has lowered the level of investment by almost 25% in 2020-21 (Chart 4). This effect has built gradually over the past five years, and at least up until the start of the Covid pandemic it can largely explain why there was no growth in investment since the EU referendum. We estimate that more than 90% of this investment impact is associated with higher uncertainty, with only a small effect coming from lower expected future demand, although the caveat about the strong correlation between the two channels remains.

Also, note that the firm-level investment data we use to produce these estimates imply lower investment growth than the official ONS data, and therefore the contribution of the UK’s decision to leave the EU may need to be scaled down slightly from our estimate of 23% when considered in the context of the official data. However, the overall trends in the two sets of investment data are similar and the differences are modest in the context of the volatility of investment data.

Chart 4: Both the UK’s decision to leave the EU and Covid have had a large impact on business investment

Estimated impact of Brexit and Covid on investment (a)

Estimated impact of Brexit and Covid on investment from 2015 to 2021

Footnotes

  • Sources: DMP, ONS and authors’ calculations.
  • (a) Estimates are derived from an updated version of the difference-in-difference type regressions reported in Bloom et al (2019) which also include additional controls for Covid in the latest year. Data are for financial years. These regressions use investment growth from the DMP where available and estimates from company accounts in all other periods.

Covid

The spread of Covid and the actions taken to contain it have had a dramatic impact on the UK economy and on many other countries around the world. Respondents to the DMP estimated that in 2020 Q2 their sales were, on average, around 30% lower than they otherwise would have been and were still almost 20% lower in 2021 Q1 (Chart 5). DMP members have also estimated that Covid has had a large impact on investment, lowering investment by up to 35% in 2020 Q2 and by an average of 25% over the year to 2021 Q1 (Chart 5). The effect of Covid on investment is expected to ease in the near term to -5% and -3% in 2021 Q3 and 2021 Q4 respectively, and a marginal increase in investment is expected in 2022 and beyond.

Chart 5: Covid was estimated to have reduced investment by up to 35% in 2020 Q2, although the effects have been smaller in more recent quarters

Impact of Covid on sales and investment (a)

Two lines showing percentage impact of Covid on sales and investment from Q2 2020 to 2022 and beyond

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) The results are based on the questions: ‘Relative to what would otherwise have happened, what is your best estimate for the impact of the spread of Covid-19 on the sales/capital expenditure of your business in each of the following periods?’. Data for 2020 Q2 are from the July 2020 DMP survey, data for 2020 Q3 are from the October 2020 DMP survey, data for 2020 Q4 are from the January 2021 DMP survey and data for 2021 Q1 are from the April 2021 DMP survey. Data for 2021 Q2, 2021 Q3, 2021 Q4 and 2022+ are from the May 2021 DMP survey.

As well as using DMP members’ estimates of the impact of Covid on investment, an alternative approach is to include proxies for Covid-related uncertainty and sales impacts in the regressions described above that are used to estimate the impact of the UK’s decision to leave the EU on investment. This gives a very similar estimate for the impact of Covid on investment in 2020-21 to DMP members: 27% (Chart 4) versus the 25% average self-reported impact (Chart 5). The effect of Covid on investment came through much more quickly than the estimated effect of the UK’s decision to leave the EU. The effect of Covid is slightly bigger than the estimated impact of UK’s decision to leave the EU on the level of investment, although these results suggest that both events have had a large effect on investment.

This approach also allows us to estimate the relative importance of uncertainty versus lower demand. It suggests that around two-thirds of the investment effects of Covid are linked to uncertainty and one-third to lower demand, although again the two measures are closely correlated, making it difficult to separate the effects precisely.

Beneath these overall effects, the marginal impact of Covid on investment has been very different for different businesses. Chart 6 shows the distribution of these effects. For some, there has been no impact from Covid on investment (around a third of businesses in 2020 Q2 and half in 2021 Q1). For a small proportion (5-10%), there has been an increase in investment. For the remaining businesses, the effects have been negative. For some, those negative effects have been relatively modest, but for others they have been very large. In 2020 Q2, around 20% of businesses reported that investment had fallen by more than 80% due to Covid, and in some cases they stopped investment altogether. By 2021 Q1, there were fewer businesses reporting very large negative impacts, but still around 10%.

Chart 6: Some businesses report that Covid has had little effect on their investment, but for others the impact has been very large

Distribution of the impact on Covid on investment (a)

Bar chart showing distribution of percentage impact of Covid on business investment in Q2 2020 and Q1 2021

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) See footnote to Chart 5 for question wording. Data for 2020 Q2 are from the July 2020 DMP survey and data for 2021 Q1 are from the April 2021 DMP survey.

The large negative effects on investment have typically been largest in consumer-facing businesses, where a large proportion of spending involves face-to-face contact and/or social activity. Investment has fallen since the start of the pandemic across a range of industries. But businesses report that the effects have been larger in consumer-facing industries, such as accommodation and food (Chart 7). The least-affected industries were reported to be other production (which includes agriculture, mining and utilities) and health.

Chart 7: Covid’s impact on businesses’ investment has been largest in industries most affected by Covid-related restrictions

Impact of Covid investment by industry over the year to 2021 Q1 (a)

Percentage impact of Covid on investment, split by industry, and showing that accommodation and food sector was worst hit

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) See footnote to Chart 5 for question wording. Data are averages of the four quarters from 2020 Q2 to 2021 Q2.

The outlook for investment

In the previous section we discussed the weakness of investment over recent years and showed how both the UK’s decision to leave the EU and the Covid pandemic have had large effects on investment. Over the next year, a recovery in investment is expected. Now that the UK has left the EU and a trade deal has been agreed, Brexit-related uncertainty is likely to fall. And Covid-related restrictions have eased as the vaccination programme progresses, which should support demand and reduce uncertainty. In addition, the March 2021 Budget announced a set of corporate tax changes that create an incentive for businesses to invest. All three of these factors should help to support a recovery in investment.

Businesses in the DMP expect a relatively strong recovery in investment over the next year. Each quarter the DMP asks businesses about their investment over the past year and about their expectations for the next year. The solid blue line on Chart 8 shows how overall investment has fallen sharply in 2020, consistent with the large impact from Covid. The dashed blue line shows expectations for the year ahead. The final data point of the dashed blue line refers to expected average investment growth between 2020 Q4 and 2021 Q4, as collected in the DMP between February and April 2021. Earlier data on expectations are from previous surveys. In the recent surveys, businesses expected investment to grow by 13% between 2020 Q4 and 2021 Q4, broadly consistent with the latest projections from the Bank of England’s Monetary Policy Committee. There is evidence in the DMP that the waning effects of the UK’s decision to leave the EU and Covid, and tax changes announced in the March 2021 Budget will all support the recovery in investment. The remainder of this article discusses those three effects in turn.

Chart 8: Businesses expect a strong recovery in investment over the next year

Realised and expected investment growth (a)

Lines show realised and expected investment growth since 2017, and includes expectations for the year ahead

Footnotes

  • Sources: DMP, ONS and authors’ calculations.
  • (a) The results are based on the questions: ‘In the first/second/third/fourth quarter of this year, what was the approximate sterling value of your capital expenditure (in £ thousands)?’; ‘Looking back over the year from first/second/third/fourth quarter of this year, what was the approximate sterling value of your capital expenditure in the same quarter a year earlier (in £ thousands)?’; and ‘Looking a year ahead from the first/second/third/fourth quarter of this year to the first/second/third/fourth quarter of next year, by what percentage do you expect your sales revenue to have changed in each of the following scenarios: lowest, low, middle, high and highest?’. For the last question, respondents were then asked to assign a probability to each scenario. A point estimate is constructed by combining the five scenarios with the probabilities attached to them. DHS growth rates are used.

The UK’s decision to leave the EU

The UK left the EU single market and customs union at the end of January 2020, with the transition period extending to the end of 2020 and a trade deal in place following the end of the transition period. That is likely to have reduced the uncertainty associated with Brexit that businesses face by providing some certainty about what trading arrangements will look like, and it removed the possibility of the UK leaving the EU without a trade deal in place. Following the UK’s departure from the EU, uncertainty associated with Brexit has indeed fallen. The percentage of panel members reporting that Brexit was in the top three sources of uncertainty facing their business has fallen from 55% in September 2020 to 34% in May 2021 (Chart 2), the lowest level of Brexit uncertainty recorded since the DMP was launched in August 2016. But some uncertainty still remains. Text comments reported in the DMP and feedback from businesses to the Bank of England’s Agency network suggest that there is still some uncertainty about the implementation of new trading arrangements and about some of the details of those future arrangements that have not yet been fully agreed.

The fall in Brexit-related uncertainty in 2021 should help to support investment. A new question added to the DMP in May 2021 asked panel members how they thought the UK’s decision to leave the EU had affected their investment in 2020, and how they expected those effects to evolve in 2021 and 2022. Businesses reported that in 2020 investment was 5.5% lower than it would have otherwise been, with this effect expected to ease to -3.2% and -2.3% in 2021 and 2022 respectively. The effects of Brexit on own business investment are lower than our regression based estimates (Chart 4). It is worth noting, however, that estimating the counterfactual outcome of investment under a scenario in which the UK had not decided to leave the EU, which is an unobservable outcome, may have been difficult for survey respondents.

Chart 9: The impact of UK’s decision to leave the EU on investment is expected to wane in 2021 and 2022

Impact of UK’s decision to leave the EU on businesses’ average capital expenditure for the years 2020 to 2022 (a)

Bars show impact of Brexit on businesses' average capital expenditure from 2020 to 2022

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) The results are based on the question: ‘Relative to what would otherwise have happened if the UK had remained a member of the EU, what is your best estimate for the impact of UK’s decision to leave the EU on the capital expenditure of your business in each of the following periods?’. Data are from May 2021 DMP survey.

Covid

Since March 2021, Covid-related restrictions have eased as cases have fallen and the vaccination programme has progressed. The first step was the return of children to school followed by retail and outdoor hospitality reopening in April, and indoor hospitality, and entertainment facilities reopening in May. The final step to remove all legal limits on social contact had yet to be confirmed at the time of writing but was not expected to take place before 19 July in England, while social distancing rules are scheduled to be further reviewed in Scotland and Northern Ireland and Wales later in June.

This easing in restrictions is likely to support investment. In the May DMP, businesses expected the impact of Covid on investment to fall from -18% in 2021 Q1 to -11% in 2021 Q2 and further ease to -5% in 2021 Q3 and -3% in 2021 Q4 (Chart 5). That improvement coincides with a declining impact from Covid on sales (Chart 5) and the impact of the economy reopening. In 2022 and beyond, businesses reported that they expect investment to be marginally higher than it would have otherwise been without Covid. That could reflect catch up in some paused investment and/or the Covid pandemic leading businesses to want to make new investments, for example in digital technology. More generally, structural changes in the economy arising from Covid, such as an increase in online sales and a higher proportion of employees working from home, might also affect the types of investments businesses make over the longer term.

Tax changes in the March 2021 Budget

In addition to the UK’s withdrawal from the EU and the Covid pandemic, the corporate tax measures announced in the March 2021 Budget are also expected to influence business investment. The measures introduced include:

  • tax-based investment incentives aimed at stimulating investment in plant and machinery, including the introduction of a ‘super deduction’; and
  • future corporation tax rises.

These changes are described in more detail in Box B. In this section, we examine the expected response of investment to the Budget measures using survey-based evidence from the DMP.

Survey responses point to a strong investment response to the Budget tax changes, with businesses reporting that they expect the changes to raise investment by around 6% between April 2021 and March 2023. The DMP allows us to identify how much of this increase reflects changes in the timing of investment (previously planned investment being brought forward), as opposed to an increase in long-run (previously unplanned) investment. Businesses reported that just over a third of the expected investment increase corresponds to investment brought forward from future years after March 2023, with the remaining two-thirds of the expected investment increase accounted for by higher overall investment.

The DMP evidence is broadly consistent with analysis by the Office for Budget Responsibility (OBR), who estimated that business investment would increase by up to 10% during 2022-23. It should be noted that the OBR estimates are specific to the effects of the super-deduction on investment. In contrast, the DMP asks about the combined impact of Budget measures on investment, including the future corporation tax increase. The DMP evidence is also consistent with findings from previous research using other tax changes to estimate how the impact of capital depreciation changes investment, as outlined in Box B. A key finding of our analysis is that there is considerable variation across businesses in the reported investment effects. The majority of businesses (79%) reported that they expect the Budget measures to have no impact on investment for the period between April 2021 and March 2023. That is consistent with theoretical models where fixed investment adjustment costs and financial constraints are important (Bloom et al 2007, Winberry, 2021), which predict lumpy investment dynamics with a large mass of businesses undertaking zero investments. Meanwhile, 20% of businesses reported that they expected a positive impact and 2% expected negative impacts.

Chart 10: The majority of businesses expect Budget measures to have no impact on investment

Distribution of marginal impacts of Budget tax changes over next two years (a)

Distribution of Budget impact on investment between April 2021 and March 2023

Footnotes

  • Sources: DMP and authors’ calculations.
  • (a) The results are based on the questions: ‘Do you expect the corporate tax changes announced in the March 2021 Budget to affect your capital expenditure for the period between April 2021 and March 2023?’; and ‘Please provide an estimate in percentage terms of how much higher/lower you expect the level of your total capital expenditure (including plant, machinery, structures, software etc) to be between April 2021 and March 2023’.

Businesses’ responses differed substantially depending on their industry. The largest average impact on investment was expected by businesses in the accommodation and food and manufacturing industries (both were above 10%). Conversely, businesses in other services (including activities of membership organisations and repair of computers, personal and household goods) and health reported more minor impacts. To uncover the reasons behind these differences we examine different splits of the data, finding that different levels of exposure to the Budget measures are a key factor. Businesses with a higher share of plant and vehicles in their total assets, who are most likely to benefit from the super-deduction, reported higher marginal impacts.

Chart 11: Businesses in industries with a higher share of plant and vehicles in total assets reported higher marginal impacts to the Budget measures

Investment response to Budget changes, split by industry (a)

Scatter plot showing investment response to Budget changes, split by industry

Footnotes

  • Sources: DMP, Bureau van Dijk (based on Companies House data) and authors’ calculations.
  • (a) See footnote to Chart 10 for question wording.
  • (b) Plant and vehicle assets as a percentage of total assets in latest set of available company accounts.

It is also possible to use company accounts data to estimate the impact of the Budget measures on the cost of capital of each business ie their cost of investment after taking tax deductions into account.footnote [2] On average, the Budget tax changes are estimated to lower the cost of capital between April 2021 and March 2023 by around 2.5%.footnote [3] Businesses that saw a greater reduction in their estimated cost of capital as a result of the Budget measures reported higher investment impacts (Chart 12). This preliminary evidence from the DMP is consistent with previous empirical findings that highlight the importance of the cost of capital channel for investment.

Chart 12: The impact of Budget measures on businesses’ cost of capital is an important driver of investment responses

Correlation between changes in businesses’ post-tax cost of capital and investment impacts (a)

Scatter plot showing correlation between changes in businesses' post-tax cost of capital and investment impact

Footnotes

  • Sources: DMP, Bureau van Dijk (based on Companies House data) and authors’ calculations.
  • (a) See footnote to Chart 10 for question wording. Each dot represents 5% of observations grouped by the impact of the Budget tax changes on cost of capital (only 10 dots are shown because the impact is zero for more than 50% of businesses). Impact on cost of capital is estimated using data from company accounts on businesses’ asset composition, size of investments and level of taxable profits. In the counterfactual scenario we assume that the AIA threshold is set at £1,000,000 for 2021 and is reduced to £200,000 from 2022 onwards in line with the November 2020 Spending Review. The baseline scenario follows the same assumption regarding the AIA but also accounts for the super-deduction and first-year allowance Budget measures.

Conclusion

This article has used firm-level data from the DMP to analyse recent trends in investment by UK businesses. It has shown how both the UK’s decision to leave the EU and the Covid pandemic have weighed heavily on investment in recent years. Uncertainty associated with these events has played an important role, but there have been negative effects from lower demand too. The effects of the UK’s decision to leave the EU have built gradually over a number of years since the EU referendum, whereas the effects of Covid have come through more quickly.

Investment is expected to recover over the next year. DMP members expect the effects of both the UK’s decision to leave the EU and Covid on investment to wane, and they expect the tax changes announced in the March 2021 Budget to provide a further boost to investment. Better understanding which businesses are more likely to respond to the Budget measures is important for evaluating the different channels that drive investment behaviour, and for assessing how differences in businesses’ responses can affect the macroeconomy. We plan to further explore this topic in future research using data from the DMP.

Box A: Survey methodology

The Decision Maker Panel was launched in August 2016 by the Bank of England, Stanford University and University of Nottingham, supported by funding from the Economic and Social Research Council. The sampling frame for the DMP is the population of all 48,000 active UK businesses with at least 10 employees in the Bureau van Dijk FAME database.footnote [4] Businesses are selected randomly from this sampling frame and are invited by telephone to join the panel by a team of trained analysts based at the University of Nottingham. The invitation to join the survey is typically made to the Chief Financial Officer (CFO) of the business, or the Chief Executive Officer (CEO). Approximately 85% of respondents are in these two positions (70% are CFOs and 15% are CEOs). Once they have agreed to participate, panel members receive a monthly email with a link to the latest survey, which is carried out online. Each survey takes five to 10 minutes to complete.

The DMP grew quickly after its launch. It has received, on average, around 3,000 responses per month since late 2018 (Chart A). That makes it one of the largest regular UK business surveys. The DMP covers small, medium and large private sector businesses across all industries. Results are weighted using employment data to ensure that it is representative. The survey has a rotating three-panel structure. This means that each business only receives one third of the survey questions in any given month, so that within each quarter all businesses rotate through all of the questions.footnote [5] So, with a sample of 3,000 businesses, around 1,000 would respond to questions in each of the panels in any given month. This approach allows a wider range of questions to be asked, but keeps the survey relatively short in order to encourage panel members to complete it.

Chart A: The DMP receives around 3,000 responses a month

Bar chart showing number of responses per month to DMP survey from September 2016 to March 2021

Footnotes

  • Source: DMP.

Since its launch, the DMP has included questions asking about recent and expected year-ahead growth in sales, prices, employment and investment. These expectations questions ask about the distribution of expectations rather than asking for a point forecast. In addition to the regular questions described above, the DMP also contains questions relating to special topics, such as Brexit and Covid. Some of these questions are frequently included in the survey, while other special questions may only be asked once. Bloom et al (2017) contains some further detail on the survey methodology.

Box B: Changes to corporate tax policy and business investment

What changes were announced in the 2021 Budget?

The 2021 Budget, announced on 3 March, featured a number of corporate tax changes. The main ones included (i) changes in the main corporation tax rate and (ii) changes in capital allowances.

More specifically, the main corporation tax rate is set to increase from 19% to 25% in the financial year starting on 1 April 2023. This increase will apply to businesses with annual profits over £250,000. Businesses with profits equal to or below £50,000 will continue to pay the current rate of 19% (ie will be eligible for the small profits rate, SPR), while businesses with profits between £50,000 and £250,000 will face a gradually increasing corporation tax rate, whereby their main rate will change to 25% but they will be eligible for marginal relief.

The Budget also announced significant changes to capital allowances, which allow businesses to write off expenses on eligible capital assets from their taxable income. For qualifying new plant and machinery investments incurred from 1 April 2021 to 31 March 2023, businesses will benefit from an enhanced first-year allowance (FYA) of 130%, also referred to as a super-deduction. Additionally, for investment in special rate assets (such as long-life assets, related to mechanical or electrical systems of a building, thermal insulation etc) the Budget announced an enhanced FYA of 50%. It should be noted that spending on certain assets, such as used and second-hand assets, cars and plant and machinery for leasing, is excluded from these enhanced capital allowances. However, these are eligible for the Annual Investment Allowance (AIA), whose limit was extended in the November 2020 Spending Review to £1,000,000 for expenditures incurred in 2021.

What drives investment responses to corporate tax changes?

There are different underlying mechanisms by which changes to corporate taxes, such as those announced in the 2021 Budget, can affect business investment. An increase in corporation tax rates can lead to lower investment by reducing businesses’ expected return on their capital. It will also reduce expected cash flows, hindering businesses’ ability to fund future investment projects. And when the corporation tax changes are announced in advance, for businesses affected by the announced tax rises it may also generate an incentive to postpone planned investments in order to write off spending in periods when the higher tax rate takes effect.

Turning to changes in capital allowances, the super-deduction may impact businesses’ investment decisions via two main channels: changes to businesses’ effective cost of capital and changes to their cash flow. Firstly, the super-deduction changes the tax-adjusted cost of capital, as businesses can write off 24.7p for every £1 of qualifying spending. By drastically decreasing the after-tax cost of plant and machinery purchases, it can generate a strong incentive to increase investment in these assets (Chart 11). Given the temporary nature of the super-deduction, it may also influence the time profile of investment: businesses with planned investments may shift their investments forward from the years after 2023 (when the after-tax price is expected to be higher). Therefore, the super-deduction can act as a counterweight to the announced increase in corporate taxes, which contrary to the super-deduction generates an incentive for businesses to postpone their investments. Additionally, the super-deduction creates positive cash-flow effects as businesses can decrease the outflow of cash in tax liabilities in the current period. This channel is expected to be particularly beneficial for businesses that are liquidity-constrained.

Previous empirical studies looking at different episodes of temporary tax incentives have found strong effects of capital allowances on investment and evidence in favour of the two channels analysed before. Among others, Zwick and Mahon (2017) and House and Shapiro (2008) studied the effects of the temporary 2003 Bonus Depreciation, reporting high US investment responses, while Maffini et al (2019) found strong impacts on UK investment data due to a permanent increase in the mass of businesses that are eligible for enhanced capital allowances.

References

Bank of England (2021), ‘May Monetary Policy Report’.

Bloom et al (2007), ‘Uncertainty and Investment Dynamics’.

Bloom et al (2017), ‘Tracking the views of British businesses: evidence from the Decision Maker Panel’.

Bloom et al (2019), ‘The Impact of Brexit on UK Firms’.

Bloom et al (2020), ‘The impact of Covid-19 on businesses’ expectations: evidence from the Decision Maker Panel’.

House and Shapiro (2008), ‘Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation’.

Maffini et al (2019), ‘The Impact of Investment Incentives: Evidence from UK Corporation Tax Returns’.

Winberry (2021), ‘Lumpy Investment, Business Cycles, and Stimulus Policy’.

Zwick and Mahon (2017), ‘Tax Policy and Heterogeneous Investment Behavior’.

  1. The DMP also receives financial support from the Economic and Social Research Council.

  2. By taking into account businesses’ asset composition, size of investments and level of taxable profits, we estimate both how much of their past investments would be eligible for the super-deduction, the enhanced first-year allowance (FYA) for special rate assets and the Annual Investment Allowance (AIA) extension, as well as what their corporation tax rate will be in April 2023. Accounts data are based on Companies House data, mainly from 2020 and 2019.

  3. The cost of capital is affected not only by changes in the tax-adjusted price of capital goods but also by changes in the financial cost of capital (ie, changes in cost at which firms borrow in order to finance investment). In our calculations, we focus on the former and abstract from changes in the financial cost of capital which is assumed to be unaffected by the super-deduction and FYA measures and to remain constant between the baseline and counterfactual scenarios.

  4. This database is based on information from Companies House and includes information on the characteristics of businesses and information from their accounts.

  5. New panel members are randomly assigned to one of the three panels when they join the survey.

Share your thoughts with us at QuarterlyBulletin@bankofengland.co.uk.

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