Investment Tax Credit for Information and Computer Technology in the UK
Introduction
Gaggl and Wright (2017) study the impact of a tax incentive for Information and Communication Technology (ICT) investments provided by the UK government to small firms. Between 2000 and 2004, the program provided a 100 percent tax allowance on ICT investments to UK firms below 50 employees. The authors exploit the program’s firm size eligibility threshold to implement a regression discontinuity identification strategy. They first document that the tax credit indeed increased firm-level investments in computer hardware and software. They then estimate the resulting impact of the program on worker-level outcomes. Gaggl and Wright (2017) find that workers in nonroutine, cognitive-intensive production tasks experience wage gains, while workers performing routine manual tasks are not affected and workers performing routine cognitive tasks experience a decline in both earnings and employment.
Paradisi (2021) uses these results to compute the MVPF of the tax incentive policy.
MVPF = 4.3
Net Cost
To compute costs, Paradisi (2021) considers the mechanical cost of providing the tax allowance and the fiscal externalities caused by firms’ behavioral responses to the policy. The mechanical cost is given by the change in the investment tax rate (-0.5) times the average level of annual ICT investment of affected firms (£805,080) times the corporate tax rate (19%), for a total of £76,482.
Behavioral responses consist of i) increases in labor earnings caused by increases in hours worked and wages, ii) increases in profits, and iii) increases in investment. For i), Paradisi uses the main estimates by Gaggl and Wright (2017) on the impact of the policy on average weekly earnings due to hours and wage changes (£23). He multiplies that by the relevant firm size (50 workers at the RD cutoff) to arrive at the increase in firm-level annual earnings caused by the policy change (£23 x 50 workers x 52 weeks = £59,916 per firm per year). The government collects payroll and personal income taxes on this figure, while the government loses tax revenues through the corporate income tax. (Increases in labor expenditures reduce taxable profits.) Paradisi calibrates payroll and personal income taxes using the effective tax rates that apply to the average income in the sample and draws upon Gaggl and Wright (2017) for other tax rates. The total effective tax rate then applied to increase in earnings is ~0.7%. This yields a total decrease in government revenues caused by earnings increases of £59,916 x 0.32 = £418 per firm per year.
For ii), the fiscal externality from rising firm profits, Paradisi multiplies the estimated impact of the policy on annual firm revenues (£569) by the corporate tax rate (19%) to get a fiscal externality of -£108. For iii), the fiscal externality from increased investment, Paradisi multiplies the pre-period effective tax rate on either ICT or non-ICT investments (9.5%) by the changes in annual firm-level ICT investment (£84,187) and non-ICT investment (£-14,540). This produces a total fiscal externality due to investment changes of 9.5% x (84,187-14,540) = £6,616 per firm per year. This fiscal externality increases government costs, since increases in investment lead to higher deductions from taxable income and therefore lower corporate tax revenue. Adding up the mechanical cost and the three fiscal externalities, Paradisi gets a total cost of 76,482+418-108+6,616 = £83,409 per firm per year.
Willingness to Pay
To compute the willingness to pay for a marginal increase in the tax incentive, Paradisi considers the benefits experienced by both workers and producers. Workers’ WTP is given by the increase post-tax income caused by the policy change. Gaggl and Wright (2017) find that the ICT investment incentive causes an average increase in wages of approximately £0.4. Average weekly hours in the sample are 33.75/week. Therefore, workers experience an average increase in weekly earnings of 52 x 33.75 x ~0.4 = £710 due to the wage increase caused by the policy change. (Hours are kept constant in this calculation because, by the envelope theorem, changes in hours do not cause changes in welfare.) The relevant size of firms in the sample is 50 employees (RD cutoff). Workers must pay both income and payroll taxes on these earnings, so they take home 89% of pre-tax earnings. Measured at the firm level, average annual WTP amongst workers is 0.89 x 710 x 50 = £31,594.
Producers WTP is equal to the mechanical increase in net-of-tax profits caused by the policy. Firms experience a mechanical increase in after-tax profits equal to their average pre-period ICT investment level (£805,080) times the change in the ICT deduction rate (50%) times the net-of-corporate-tax rate (81%). This gives a total WTP among producers of 805,080 x 0.5 x 0.81 = £326,057. Total WTP is then £31,594 + £326,057= £357,651.
MVPF Summary
Dividing the WTP by the cost, Paradisi (2021) arrives at an MVPF of 4.29.
References
Gaggl, Paul and Greg C. Wright (2017). A Short-Run View of What Computers Do: Evidence from a UK Tax Incentive. American Economic Journal: Applied Economics, 9(3), 262-94. https://www.aeaweb.org/articles?id=10.1257/app.20150411
Paradisi, Matteo (2021). Firms and Policy Incidence. Working Paper. https://www.matteoparadisi.com/working-papers/firms-and-policy-incidence
Policy Features
- Category
- Taxes
- Sub-Category
- Firm Taxes/Subsidies
- Beneficiary Type(s)
- Firms
- Country of Implementation
- United Kingdom
- Year of Implementation
- 2002
- Empirical Method
- Regression Discontinuity
- Research Type
- Secondary
- Peer Reviewed
- No
- MVPF Publication Link
- www.matteoparadisi.com/working-papers/firms-and-policy-incidence