This is a big measure, and a change to a very big measure indeed, introduced four years ago. It follows consultation that was promised when the legislation was first introduced. The total value of the relief that was originally introduced is £600 million. The total value of the relief that we are discussing today is £35 million. The Financial Secretary will correct me if I have got those numbers wrong. The clause extends the relief to include computer software and so-called consumables such as water, fuel and power, and it simplifies the definition of materials, which has been a bugbear for a good number of people trying to claim R and D tax credits.
We are talking about large sums of money, and I shall return to that general point in a minute. First, I want to ask a few specific questions, some of which have been put in the public domain in various representations. One comes from Intellect, the computing services association. It is worried that tax inspectors are applying their interpretation of claims against definitions inconsistently, and it has written to express that concern. I would be grateful if the Economic Secretary would take a look at that. He may have discussed it with it or with the Inland Revenue. I do not need an answer now, but it is something that he ought to consider.
Secondly, will the Economic Secretary explain why sole traders and unincorporated businesses are still to be excluded from that area? It is often where most of
the innovation is to be found. Thirdly, does he have any evidence—I am sure that there must be some—to suggest that the relief is becoming part of the avoidance industry. It is complicated. Anecdotal evidence from the accounting firms is substantial—they are taking on staff and moving them into the area specifically to use R and D as a means of tax avoidance. Will it be long before a substantial cluster of people try to get hold of that relief?
I have many much more general points, which relate to the overall effectiveness of the scheme and whether the £35 million, or for that matter the £600 million, is being well spent. A recent survey of middle-market companies—carried out by KPMG, in conjunction with the Economist Intelligence Unit—reported that only 5 per cent. of executives felt that the R and D scheme had encouraged them to spend more on R and D. A quarter of executives had not even heard of the scheme and 80 per cent. said that it had no impact on their business. Is the extra £35 million—or whatever the final figure turns out to be—provided by the clause throwing good money after bad? I do not know whether the money will be, or is being, well used. I do not think that the Government know either, and I will return to that point.
In a nutshell, the Government have introduced and extended the relief, because they believe that the social rate of return is greater than the private rate of return—what firms earn. The Government say—and have said repeatedly in statements, including the Chancellor's Budget statement—that the good take-up of £600 million means that we are closing the gap between the social and the private return. However, the increase in the relief tells us nothing about whether the money is being well spent and whether the £35 million will be well spent.
The conclusion of a thorough short survey of the area—produced by the Institute for Fiscal Studies—came to a worrying conclusion. It said:
''Unfortunately, many unanswered questions remain about the extent to which and how we can subsidise R and D. This means that the Government should tread carefully in trying to design and implement any particular policy. While there is a strong rationale for subsidising R and D, there are many potential pitfalls and we could end up causing more problems than we solve.''
I agree that there is a rationale for the sort of subsidy seen in the clause, and I acknowledge that there are potential benefits in several sectors, particularly pharmaceuticals. However, I am not sure whether that rationale is as strong as some of the theoretical research suggests.
My main point is that the pitfalls to obtaining those benefits are large. I illustrate that by posing some questions to the Economic Secretary. First, there is the issue of deadweight costs, which was discussed when the measure was introduced. For example, how much of the money is going in extra pay? Since it is a handout to companies, they naturally enough increase the pay of their staff once they have got it. How much of the extra £35 million will find its way there?
In order to work that out, perhaps we should consider the £600 million, as that would give us some guidance. Judging by what has already happened to the relief, how much will go in deadweight as extra
pay? I do not believe that the Government will know the answer, but I can tell the Committee that best research suggests that around half goes in pay—in other words, it has a limited effect.
The hon. Gentleman talks about the deadweight of pay, but surely increased pay rates sometimes encourage people to stay in the United Kingdom or with a particular company and not go off to where they could earn more by managing a restaurant or similar, and society as a whole benefits. Pay increases are not all deadweight and are often desirable per se.
As it happens, before I came to the Committee I scribbled on a piece of paper three possible reasons for the money going to pay not being completely disastrous. They were: it may encourage more people to go into such jobs, which the hon. Gentleman did not mention; it might make them work harder, although I am slightly more sceptical about that; and it might keep them in the United Kingdom, which is certainly possible, and he mentioned that. I think that he would also agree that if those are the objectives, they could all be accomplished much more cheaply and efficiently through a direct spending scheme or subsidy. All the theoretical and practical evidence suggests that a light rather than a blunderbuss tax break is preferable. The R and D tax relief is an inefficient way of achieving all the objectives on pay to which I alluded.
When the hon. Gentleman refers to an alternative model—you will direct me if I stray too far on this, Mr. McWilliam—is he suggesting a more direct state-sponsored model rather than one that comes through tax relief primarily to private companies? If he is, that surprises me, given the Benches on which he sits.
Mr. Tyrie rose—
Why do not I have a go at answering the question, and if you do not like it, Mr. McWilliam, you can shut me up.
One way of implementing the clause would be to create a spending line to have the same effect and to vote some money in a departmental budget and give a group of people the power to allocate it, as opposed to doing that through a tax subsidy. I am not going to try here to suggest an alternative model. I would be ruled out of order, and that is not a legitimate subject for discussion today. I want to make a general point that, inasmuch as those are the objectives, the clause and what it builds on are not the best way to go about attaining them.
My first question was about deadweight costs. Many other aspects of such costs might be triggered by the clause and the four-year-old legislation that it builds on, but I shall let that pass. I hope that I have made the point by illustration.
My second question concerns the administrative cost of running the scheme, to which we are adding with the clause. Do the Government know what the
full administrative cost and the full compliance burden of running the relief will be for both firms and the Government? The terms of the relief are extremely complex, which has been a bugbear and a moan of the industry. Although it will be billed as simplification when the Minister responds, on balance we will find that the clause introduces simplification on one hand and complication on the other. It also plays into the hands of big firms that can obtain the best advice on how to collect the R and D relief, and that worries me very much indeed. That is almost always the way with tax reliefs—they go to those who can obtain good advice, which is reflected in the KPMG survey to which I have just alluded.
Thirdly, there is the tax avoidance industry issue. A little while ago, I asked the Minister how much that had grown and whether he had any estimates. I doubt whether he has, but I shall be interested to hear anything that he has to say about that. There is quite a lot of anecdotal evidence to suggest that it is already quite a lively industry.
The fourth issue is the general pitfall of thinking that we need to engage in a tax competition with other countries. The argument goes like this: other countries may have a clause like clause 131, and they may already be giving subsidies for computer software, so we had better do the same. It is true that the UK is, in general, following a path that other G7 countries have already gone down in terms of increasing the scope for tax reliefs on R and D. In a debate in 2000, my hon. Friend the Member for Arundel and South Downs referred to Canada and the extremely generous scheme that is available there. Incidentally, I think that that scheme includes a relief on, among other things, computer software.
I realise that mentioning Canada in the same Room as the hon. Gentleman is extremely dangerous. I will move on very quickly.
Getting involved in an auction of R and D subsidies with other countries is a crazy idea. Just because some other countries already have subsidies, that should not be an argument for the implementation of the clause.
It is worth noting in passing that a good number of UK firms do much of their research abroad. Indeed, the UK virtually heads the global overseas research list. We need to think carefully about why that is so.
A fifth reason for being concerned about a further extension of the relief is that it will only add to an existing problem, which is that whenever relief is introduced on this scale, there will inevitably be a heavy distortion at the margin of what constitutes R and D. Indeed, in 2000, the Committee dealing with the Finance Bill dwelt heavily on the definition of R and D, and we will have exactly the same problems with the definition of R and D for software. When is software new? Is it new after six months? The tax advice industry will be having that debate.
That is very good of you, Mr. McWilliam. Perhaps you will be able to get some financial advice from the Economic Secretary. I have no interest to declare. I am doing my best to offer my views, without any axe to grind except trying to increase overall economic performance in the country.
I have a sixth concern. Given that we are going to spend £35 million on the clause, what will be the overall yield? What will be our long-term benefit as a country from spending this money in the R and D field? Of course, the Government will not be able to answer that question because, by definition, R and D takes many years to show a benefit in most cases. Even when it does show a benefit, it is difficult to spot, because of spillover effects, as the economists call them, and therefore we have the constant problem of trying to create a shadow rate of return in order to justify any subsidies. That is a dangerous game to get involved in. I am not against the idea in principle, as a theoretical rationale, but it is dangerous and we must think where it leads. I worry that we may just be throwing some more money at another area of the R and D industry in this country, without any clarity about what we will get back.
Although I do not necessarily think that there is any connection between these facts, in the 1960s and 1970s Britain was a leading R and D performer—we were jolly nearly top of the league in spending money on R and D—but our economic performance was lousy. In the past 20 years we have slipped down the R and D league, but our economic performance is very near the top of the EU and much better in global terms.
Rob Marris rose—
I am grateful for that protection from putative interventions. Incidentally, although I shall not labour the point, Japan is a mirror of the position that I have described for the UK. It was bottom of the R and D league and top of the growth league, and now it is top of the R and D league and bottom of the growth league. We are not talking about the odd year, but decade by decade. We need to be careful about thinking there is some inevitable logical connection, and that this £600 million—soon to be £1 billion, I should think, at the rate we are going—is going to have a dramatic impact.
The hon. Gentleman is briefly questioning the 20 years that we have just had versus
the previous 20. Would he concede that in the 1960s in this country a higher proportion of R and D money was spent on defence research, which is arguably not very productive, and that that changed in the previous 20 years, which might explain the apparent contradiction in his figures?
That was an interesting intervention, with which I have a lot of sympathy. It would be interesting to know how much of the £600 million is already going on defence. My guess is that it will probably be about a third—I have seen independent research suggesting that it is 37 per cent. We may have had our feet in the treacle, but we have not yet got them out.
Alongside aerospace, another major area is pharmaceuticals, where there is a stronger case. The lead time in pharmaceuticals is very long, and I have no doubt that the industry will benefit from the clause, among other parts of this relief. Even there, of course, it is worth bearing in mind the fact that the lion's share of R and D comes through the charitable sector, through Wellcome or, again, through direct spending subsidies through the NHS and off the NHS budget, rather than indirectly through the tax system. Again, we have to ask ourselves who is better at allocating this, and who is better at deciding whether software and consumable items are best handled through a tax system, or whether we should find some other way, if we want to at all, of giving a special subsidy.
What do I conclude from all this? Apart from the fact that the very reason that we have this relief is that the Chancellor, although he never talks about it any more, believes in neo-classical endogenous growth theory—or perhaps I should say, if it is not Brown, it is Balls. Certainly, Ed Balls wrote about this subject extensively in the mid-1990s. He did many excellent things, such as the Bank of England's independence, which I shall not mention any more because I can see that the Chairman is leaning forward. If—
Order. I am just pointing out to the hon. Gentleman that I was talking not about neo-classical endogenous growth theory but about non-endogenous economic growth theory.
I think you need to have a conversation with Ed about that, Mr. McWilliam. Ed will be absolutely clear in his mind that he thinks endogenous growth theory is the key driver for this £600 million worth of relief.
Before we go any further down the road of spending money on such clauses, we need a serious, full and independent study of whether it is being well spent. The Inland Revenue is, for the first time, committed to producing core statistical information about the relief, which will presumably include the clause. That is important but, far more important, we need to take that and say, ''Now we're going to spend £0.66 billion or £1 billion.'' There will no doubt be further clauses to extend the provision, because people will be like bees around a honeypot, trying to increase the relief. We must decide whether the relief will be properly used.
The questions we need to ask are basic, but not necessarily easy to answer. Who is getting the money?
What is happening to it? Is it going in pay? Is it going towards the creation of genuinely new products? Is a large proportion of the money being absorbed in administration? What is the long-run return on such money and what alternatives are there to further extensions of the tax credit?
I am encouraged by that speech and am stimulated to make a short speech in a similar vein. The hon. Gentleman pointed out that the Government are inviting us to approve additional expenditure of public funds on the R and D tax credit, and the extension of its reach. He said that those additional funds might total £35 million. The Red Book appears to indicate that the figure will total some £65 million over three years.
The hon. Gentleman raised exactly the right issue by asking whether the proposals amounted to throwing money at a problem without providing clarity about what the Government were seeking to get back. I shall not rewind to our earlier debate about the film industry tax relief, but the clause seems to deal with a similar example of the Government seeking to subsidise an activity—R and D expenditure. However, they are not always clear about the economic return through enhanced revenues to the industries concerned, or to the taxpayer.
In justifying the Government's film industry tax relief, the Paymaster General said that she was relying on a report prepared by the Select Committee on Culture, Media and Sport. I imagine that, if that Committee had condemned the Government's measure and said that the economics did not stack up, the Treasury would have relied on its own figures. It is odd that, when we table parliamentary questions on the cost-benefit analysis of such subsidies, it turns out that the Treasury has undertaken no such analysis, and has not assessed the economic benefits, or how much tax will come back through enhanced activity. That is surprising in light of the fact that the Treasury is the one Department that we would look to for rigour on and concern about the expenditure of public funds.
We cannot, therefore, escape the suspicion that the Chancellor, or some other member of the Government may have decided that it would be fantastic to be seen to be subsidising an activity such as R and D or the film industry, and to be urging officials and other Ministers to bring forward proposals in that area, without being aware of the costs and benefits.
The hon. Member for Chichester referred to a recommendation that the Treasury Committee made. That Committee should not judge whether the R and D tax credit is value for money. Rather, the Treasury should do so. It should produce estimates of the boost to R and D expenditure as a consequence of such tax reliefs and demonstrate how the enhanced revenues resulting from economic growth would benefit the taxpayer.
The hon. Gentleman mentioned that expenditure on the R and D tax credits is something of the order of £600 million and is growing considerably. I would have thought that, before we approved an additional £65 million of expenditure on them, we would want a Treasury assessment of how effective the relief has been to date, what the returns from it will be, and what the effect on taxpayer revenues will be through enhanced yields as a consequence of additional growth.
We would certainly want some estimate of how much additional R and D spend the Economic Secretary anticipates there will be as a consequence of clause 131. How much extra R and D expenditure are the Government anticipating we will get for the expenditure of £65 million of taxpayers' money? If we do not know those figures, how can we judge whether the tax relief has been a success and whether it offers value for money?
When we had the debate about film industry tax relief, the evidence that the Treasury cited came not only from a departmental Select Committee, whose degree of rigour on economic questions cannot be expected to be as great as that of the Treasury, but from industry bodies, which are not objective or independent in such matters. It also cited anecdotal evidence that there was additional expenditure as a consequence of those subsidies. However, the question is not whether there is some additional expenditure. After all, if we are spending £1 billion on film industry tax relief or close to £1 billion on R and D tax credits, we would expect there to be some economic consequence. The question is how much economic consequence flows from that. How much impact is there?
I hoped that we would be looking at the possibility not of amending or extending the R and D tax credit, but of abolishing it. If we were talking not about abolishing it but about extending it, I hoped that the Economic Secretary could have come forward with a serious study showing how the R and D tax credit has worked to date in economic terms. He should certainly be giving us today an indication of how much more R and D expenditure will result from the additional £65 million of taxpayers' money that will go into this Government policy.
I was interested in the general critique of the R and D tax system offered by the hon. Member for Chichester. He described it at one point as rather inefficient, and many of his comments were echoed by the hon. Member for Yeovil. I am not sure whether that means that either of their parties would axe that tax credit, if they were ever in a position to make such a decision.
Mr. Laws indicated assent.
The hon. Gentleman is nodding. I am sure that that will be of interest to business organisations that have urged us to introduce and to develop that tax credit.
In contrast to those general comments, clause 131 is relatively narrow in scope. Last year, we said that we would introduce a change to include the expenditure
on software used in R and D as a cost that qualifies for R and D tax credit. We also invited views on whether the definition of materials used in R and D could be improved. Clause 131 implements those changes, and includes a further change to widen the range of qualifying costs, so that expenditure on power, water and fuel is included, as the hon. Member for Chichester pointed out.
Both hon. Members cast doubts on the nature and purpose of the tax credits. We believe that we need those tax credits. It is a belief that is shared by business organisations and many of the businesses that are now benefiting from them. We need them to encourage new products, services and technologies. The economy needs such innovation to grow in the long term.
It is vital that companies invest in R and D, and to be able to do so it is vital that finance is available to support what are sometimes long-term and risky investments. The UK has trailed competitor countries in investment for some time. Giving an incentive to invest in R and D is one way to help to reverse that trend. More investment in R and D should lead to greater innovation and, ultimately, to higher productivity.
The credits work by giving companies extra tax relief for their spending on R and D. Before the credits, companies could set 100 per cent. of their R and D spending against profits. For small and medium-sized companies, the credits raise that to 150 per cent., and for a larger company to 125 per cent.
Since the inception of our schemes in 2000, more than 9,000 claims from SMEs have been received, providing support to innovative companies of around £530 million. As the hon. Member for Chichester said, this is a big measure. It is also, although he did not concede this, welcomed by businesses and has been of benefit to them. I am not sure whether those 9,000-plus companies would agree with him that it is not making a difference.
We have had no reports at the Inland Revenue of large-scale avoidance as part of this relief. I am also happy to say that we have had no reports of deaths as a direct result of the tax credit.
I turn to the serious issue of evaluation. At present, with tax credits relatively recently introduced and still bedding down, and because they are designed to stimulate long-term investment with long-term impact,
it is too soon to say precisely what effect they are having. The Inland Revenue is starting a full evaluation, which, as hon. Members would expect, will include an analysis of value for money. It will cover precisely the issues that the hon. Members for Yeovil and for Chichester have raised. It will provide information and analysis on the effects of the policy over a number of years.
All the academic evidence suggests that tax credits are a measure for the longer term. The impact of R and D on the prospects and productivity of individual companies, and on the economy more generally, will become clearer only in the longer term. Without doubt, the Government are making an investment in the long-term prospects, the long-term growth and the long-term stability and prosperity of the British economy.
I do not think that the hon. Gentleman listened carefully enough. The evaluation is being undertaken by the Inland Revenue, which is appropriate as it is responsible for this area of taxation. The work is starting now, and at the moment I do not know when the results will be published. As soon as Ministers can confirm such detail, no doubt we will.
The hon. Member for Chichester referred to the Institute for Fiscal Studies. It has raised some important questions, which he and the hon. Member for Yeovil have echoed. We will bear them in mind as we carefully design and carry out the evaluation. However, I remind the hon. Gentlemen that the IFS also argued for a system of tax benefits to boost investment.
I turn to one or two other specific points that I took from the hon. Member for Chichester. He cited intellect and claimed that there had been an inconsistent application of the definition for the purposes of the relief. He has heard that message from professionals and some representative bodies; we heard the same message. He may remember that, during the 2004 Budget, we announced that the Inland Revenue would be looking hard at the practical delivery of tax credits. I can confirm that, as part of that, the Revenue will be considering, both internally and by holding discussions with outside interests, whether the schemes can be improved. That will include careful consideration and examination of whether there are grounds for the claims that he has heard.
The hon. Gentleman asked why unincorporated bodies and sole traders should be excluded from the R and D tax credit. The short answer is that all the evidence, including our discussions with business, suggests that almost all the R and D over £10,000 is conducted by limited companies. Where a company sub-contracts R and D to an individual, which is perhaps the most likely scenario that he is considering, it can claim the R and D tax credit. He might accept that, in the long term, that may mean a benefit to the
individual, as the company may be able to conduct more R and D than individual concerns.
''Tax incentives seem a natural policy tool for a market-oriented government wanting to increased R and D expenditures.''
It goes on to say:
''Economists, however, been traditionally been sceptical over the efficacy of fiscal provisions.''
The last line of the report concludes:
''While there is a strong rationale for subsidising R and D''—
we agree that that is a reference to the theoretical rationale, which nobody is disputing—
''there are many potential pitfalls and we could end up causing more problems than we solve.''
I think that the hon. Gentleman simply amplifies the point that he made earlier, which I dealt with.
The hon. Gentleman also said that R and D tax credits are becoming a part of the avoidance industry. The Revenue does not yet have evidence of any large-scale avoidance emerging in the R and D tax credit regime. I say to him, quite directly, that if, as he was suggesting, accounting firms know of tax avoidance of that nature, I hope that they will help us to stamp it out, rather than taking on extra staff and turning it into a business activity for their own ends.
Finally, the hon. Gentleman said that the definitions are complicated, and suggested that they may somehow play into the hands of big companies. The Committee will recognise, and I accept, that the definition of research and development is not straightforward. It simply reflects in legislation the fact that the definition and practice of R and D are constantly changing and quite difficult to pin down. It is an area of innovation, new activity and new techniques, and it is never going to be straightforward to reflect such activity in tax legislation. Nevertheless, I was not sure that I heard him do so, but I hope that he will welcome our attempt to improve the definition.
The feedback that we have received from business and the industry has been very welcoming. For example, Deloitte said:
''The new guidelines are generally acknowledged as a significant improvement on the original'',
and PricewaterhouseCoopers said that the new definition that we proposed in the Budget is ''clearer and simpler''. In passing, I make it clear to the Committee that it also welcomed the extension of tax credits to apply not just to software but to power, fuel and water.
The changes in the clause will widen the range of costs that qualify for the relief, representing, as the hon. Gentleman said, a further Government investment in R and D of £35 million per year. We have listened, in addition, to calls to simplify the definition of materials used in R and D, which this clause implements, in the terms recommended by many companies and professionals. To be clear, the same changes are being made to all the R and D tax
credit schemes: first, the small and medium-sized company scheme; secondly, the large company scheme; and thirdly, the vaccines research scheme.
I do not know what the hon. Gentleman will choose to do, but I hope to see very strong support on the Labour Benches for an innovation that the Government introduced in 2002 and for clause 131.
Question put and agreed to.
Clause 131 ordered to stand part of the Bill.