The UK’s failed Annual Investment Allowance

The law of unintended consequences is an immutable constant of life. But British politicians seem to be particularly inept in designing policies that have the intended benefits. Having lived in Germany, Switzerland and now for a decade in the UK, I have to say that British politicians are far less competent than their Germanic counterparts. Case in point: the Annual Investment Allowance for businesses.

Back in the long-forgotten days of the financial crisis, the Labour government introduced the Annual Investment Allowance (AIA) for businesses. The idea was that starting in April 2008, businesses would get an extra incentive to invest in machinery and equipment by being able to deduct up to £50,000 per year from their taxes. Excluded from the AIA were investments in land and real estate. Most other investments, in particular tech hardware and software, were counted to the AIA.

The idea was that if businesses invest more in tech and other equipment, it will boost productivity, economic growth, and, ultimately, tax revenues for the government. Once the conservative government came in the level of the AIA was constantly fiddled with but in 2019, the Conservative government ultimately increased it massively to £1,000,000, providing effectively a large tax break for businesses that increased capex.

Maximum Annual Investment Allowances

Source: UK HMRC

A team around Timothy DeStefano analysed how these government incentives worked.

First the good news. Businesses that became eligible to the AIA increased investments, particularly in IT. Over the period 2007 to 2013, businesses that were eligible to claim AIA increased their investment in IT hardware and software by 61.7% on average. That’s good news. Or is it?

You see, the problem is that IT hardware and software are old-fashioned IT. Today, most applications (whether it is AI or big data) are cloud-based and businesses don’t actually ‘buy’ the software anymore but rent it. In accounting terms that means they are buying IT services, not IT goods. And IT services are not eligible for the AIA.

As always, businesses react to the incentives they are given and that means that they are eager to buy hardware and software and not so eager to buy cloud-computing services and cloud-based apps. While investment in IT hardware and software increased, investment in IT services increased by 28% or an estimated 16.5% less than without the AIA. Put simply, the AIA incentivised UK businesses to invest in older technology and reduced investment in cutting edge cloud-based solutions by almost 40%.

Today, UK businesses lag behind their peers in other countries in the adoption of cloud-based applications, including big data applications and AI. This effect can also be seen in the job prospects of data analysts. UK businesses are slower to hire data analytics specialists because they don’t have analytics teams that could give them a competitive advantage because, well, they didn’t spend that much money on analytics applications to begin with.

As long as the AIA is not adjusted to include modern forms of IT like big data analysis and AI, UK businesses will constantly shoot themselves in the foot because they prefer to get a tax benefit over thinking about how to best increase productivity and international competitiveness in the long run.