Examination of Witnesses (Questions 260-271)
Mr Michael P Devereux and Ms Judith Freedman
12 MAY 2008
Q260 Lord Barnett: Do you think the
government should not get involved in the area of encouraging
enterprise at all? They are involved in enough areas. Would it
be better in your view if they did not do anything?
Mr Devereux: That would be one possibility.
That is not what we are advocating here particularly. There is
evidence that small and particularly new businesses do on occasion
face difficulties in raising finance for their investment. You
might see that as a market failure and the government might want
to intervene to try and improve the position of small and new
businesses in that context. Starting from first principles, I
would then ask what is the best way of doing that? The two things
that you have been discussing, the entrepreneurs' relief and the
enterprise investment scheme, approach that in different ways.
The entrepreneurs' relief would give a lower rate of tax on the
returns to that investment. The enterprise investment system is
much more focused on the particular problem we have identified,
which is lack of access to finance. There are other ways in which
the government may address that question. We should identify what
evidence there is that these particular schemes are having a beneficial
effect. It may be that if they are not having a beneficial effect
it would be better to spend that money in some other way.
Q261 Lord Powell of Bayswater: It
seems to me you are saying that tax has very little role in all
this and the better system is things like the small firms loan
guarantee which provides help in a different way. Could you just
enlarge a bit on that?
Mr Devereux: The issue there is one of focusing
on the lack of access to finance and the extent to which small
businesses cannot raise finance. If that is the market failure
which the government is trying to correct, the question would
be what is the best way of doing that. The small loans guarantee
scheme seems a well targeted way of dealing with that. To some
extent the investment enterprise scheme would be as well in that
it is encouraging investors to make funds available for those
kinds of business. Perhaps we could discuss exactly the terms
and conditions of that scheme and whether it could be better targeted
still. Those schemes are at least addressing what seems to be
a particular failure in the market.
Q262 Lord Powell of Bayswater: You
also seem to be saying that it should not just target small business;
it should look at all new and start-up businesses?
Mr Devereux: The evidence we cite here suggests
that it is new businesses rather than small businesses which are
particularly hit by this problem. We suggest that it would be
better to target new business.
Q263 Lord Powell of Bayswater: As
distinguished academics, how many years do you think one would
need to reach a real judgment on whether schemes like this are
being effective or not?
Mr Devereux: It is possible to look at the evidence
now and make judgments, as indeed the studies that you have been
discussing do. There is plenty of evidence there to draw on to
identify its impact.
Q264 Lord Powell of Bayswater: Quite
a lot of your paper refers to needing a couple of years to reach
a clear view on these schemes.
Mr Devereux: As a general principle, what we
need for statistical studies is change, wherethere are differences
across companies or differences over time. It is not really a
fixed number of years. We need to be able to compare different
kinds of companies or compare before and after tax reforms. Those
are the kinds of things which help us to identify the effect of
any particular measure.
Q265 Lord Powell of Bayswater: The
Sussex study seems to suggest that these schemes have not been
very effective in helping the companies they are intended to help.
Do you agree with what the Sussex study says?
Mr Devereux: I have no quarrel with their empirical
evidence. Their conclusion seems to be consistent with companies
receiving this form of relief investing more and employing more
people and having greater sales. One can question the policy response
to that. Are these companies growing faster or having more investment
because they have relief, or is it companies which are growing
faster and want to do more investment getting the funds which
this relief helps them to get? The direction of causation there
is still open to doubt and needs further work. The other interesting
thing from that study was the suggestion that companies which
have used this relief tend to have lower rates of profit than
companies which have not. That is what you might expect given
that post tax returns on investors are more or less fixed across
different kinds of investment. If you tax one investment less
heavily than another, you would expect the pre tax return on the
one which is less heavily taxed to be lower. That is consistent
with the result which they find. Whether that means the system
is not worth having is another question. It just means that we
get more investment there but it is not as profitable as the investment
which would otherwise have taken place.
Q266 Chairman: Sticking with the
University of Sussex study, you also raised what seems to be a
fairly fundamental problem that like is not being compared with
like here when the study looks at companies that received EIS
finance with those that did not. Can you just expand a little
on that for the benefit of the Committee?
Mr Devereux: Yes. There is a large number of
companies which have benefited from the scheme and a large number
which have not. The paper compares those two to see what differences
there are between them. The problem with that approach is that
this is not a random set of firms. It is not random whether you
get relief or whether you are part of the scheme or not. If you
are a fast growing company in search of finance, it may well be
that you are more likely to raise external finance than if you
are a small company which is not seeking to expand at all. What
I would like to have seen in the study is an attempt to distinguish
between those two groups and to identify which companies are more
likely to try to raise funds under these schemes.. Then I would
do the comparisons which they have made. One can control for that
statistically and make a more informed judgment on the direction
of causation.
Q267 Chairman: In effect there is
no study which has been done yet which would really prove the
thing one way or another?
Mr Devereux: I am not aware of any studies which
would answer those questions to my satisfaction.
Q268 Lord Powell of Bayswater: The
government would not have dreamed this up just out of its own
head. It must have been coming up with this scheme originally
under pressure from business of one form or another, whether it
was the CBI, the Federation of Small Businesses or something.
There must be businesses out there that do believe this is a valuable
thing to have and it does help them grow. Are they wrong?
Mr Devereux: We do not yet have sufficient evidence.
There are always plenty of investors and other taxpayers who would
welcome a reduction in the tax rate on a particular form of investment.
Q269 Lord Powell of Bayswater: It
sounds as though you are quite sceptical. I get the impression
that you do not think this is a particularly well designed or
necessary concession to make.
Mr Devereux: Not entirely. The fact that it
is targeted at the problem of lack of access to finance is a good
point about the scheme. The problems with it are that it is not
targeted well enough to the kinds of companies which face that
problem.
Q270 Lord Powell of Bayswater: You
are suggesting that a better way to do that is the small firms
loan guarantee, as you said in your paper.
Mr Devereux: That seems better targeted than
the EIS scheme.
Ms Freedman: There have been two studies so
far, the Cambridge study earlier and this one. Neither of them
has really been very encouraging. One would want more evidence
and it may be that further work could be done so we should not
dismiss the results without that further work perhaps.
Q271 Chairman: Can I ask you about
the increase in the investment limit? In your written evidence
you comment that the increase in the investment limit for EIS
from £400,000 to £500,000 is unobjectionable but it
is not clear whether the increase will affect the total amount
of funds invested. What kind of work would need to be done up
front to test whether such an increase is likely to be worthwhile?
Do you know whether any such work has been done by the Treasury
or HMRC?
Mr Devereux: The way I would address that in
a statistical study like the University of Sussex one would be
to see whether companies seem to be limited by the £400,000.
How much do they raise in this scheme? If all the companies raise
£400,000, it suggests that that may be a constraint. If they
are raising only £200,000, then it suggests they are not
under constraint. I have not seen any data on exactly how much
they are raising so I do not know what the answer is, as to whether
that is a constraint or not.
Chairman: May I thank you very much indeed both for
your written evidence which we found very refreshing and for your
open answers to our questions. You have been very helpful. Thank
you.
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