UK stock relief legislation and the short run-tax elasticity of inventory investment

Abstract

This paper analyzes the effects of UK stock relief legislation on the cost of capital for inventory investment, taking account of the tax position of individual companies. A sample of large UK companies, representative of the UK non-oil non-financial corporate sector, is used to make calculations of the cost of capital, both for aggregate corporate inventory investment and for various industrial sectors. Stock relief legislation reduces the cost of capital by between 4% and 8% per annum. The tax position of individual companies generally makes only a small difference to the aggregate cost of capital. Stock relief legislation induces a pronounced seasonality in the cost of capital due to the uneven distribution of the end-date of company accounting years. This seasonality is exploited in time-series estimates of the short-run elasticity on the pre-tax and post-tax cost of capital for six manufacturing subsectors. There is some evidence of a significant effect from the pre-tax cost of capital on inventory investment, but no evidence of any response to the tax incentives created by the stock relief legislation.