Tourism Taxation in Uk

Tourism Taxation in the UK
Ramesh Durbarry and M. Thea Sinclair

Christel DeHaan Tourism and Travel Research Institute
University of Nottingham
Executive Summary
1. Introduction
2. Trends and Issues in UK Tourism
(i) Tourist Arrivals in the UK
(ii) Trends in the UKs share of international tourism receipts
(iii) Current and real tourism earnings in the UK
(iv) The tourism price index and effective exchange rates
3. Tourism Taxation in the UK
(i) Types of tourism taxes
(ii) The current tax situation in the UK and value added tax
(iii) Corporation tax
(iv) Pay as you earn tax
(v) Other tourism taxes
i) Air passenger duty
iii) Entry clearance (visa) fees
4. Tourism Taxation in the UK and other Countries
(i) Value added tax in Europe
(ii) Tourism taxes in other countries
5. Measuring the Price Sensitivity of UK Tourism Demand, Tourism Taxation and
Competitiveness
(i) Empirical Evidence on Price/Tax Changes
(ii) An econometric model of UK tourism demand
(iii) Results: price and expenditure sensitivities of tourism demand
(iv) The incidence of tourism taxation on tourists and businesses
(v) Investment incentives for tourism
6. Conclusions
7. References
2
8. Appendix I Rates of Corporation Tax, 1969 to 1999
9. Appendix II Tourist Arrivals in the UK from Overseas.
10. Appendix III Entry clearance fees
3
List of Figures
Figure 2.1: Tourist Arrivals in the UK (000's), 1982-1998
Figure 2.2: Number of Tourist Arrivals in the UK, 1997 and 1998
Figure 2.3: UK's Share of International Tourism Receipts
Figure 2.4: Current and Real Tourism Earnings in the UK
Figure 2.5: Current tourism expenditure in UK ( millions), 1985-1998
Figure 2.6: Real tourism expenditure in UK ( millions), 1985-1998
Figure 2.7: Real average tourism earnings per visit in the UK (), 1982-1998.
Figure 2.8: Consumer and tourism price indices, Base = 1990
Figure 2.9: Real Effective Exchange Rate (1990=100) and Average Tourism
Expenditure
Figure 2.10: Percentage Change in Real Effective Exchange Rate and in Tourism
Earnings.
Figure 3.1: Total Net Income, Deductions and Corporation Tax from Hotel and Catering
Figure 3.2: Total Net Income, Deductions and Corporation Tax from Distribution and
Repairs
Figure 3.4: PAYE Tax collected from the Hotel and Catering industry ( millions).
Figure 3.5: PAYE Tax collected in Distribution and Repairs industry ( millions).
Figure 4.1: VAT Rates on Hotels in Europe
Figure 4.2: Percentage Change in Nights Spent in Collective Tourist Accommodation
and VAT Rates on Accommodation.
Figure 5.1: Tax Incidence in the Case of Price Elastic Supply of Hotel Accommodation.
Figure 5.2: Tax Incidence in the Case of Price Inelastic Supply of Hotel
Accommodation.
Figure 5.3: Tax Incidence in the Case of Price Elastic Demand for Hotel
Accommodation.
Figure 5.4: Tax Incidence in the Case of Price Inelastic Demand for Hotel
Accommodation.
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List of Tables
Table 2.1: International Tourism Receipts and Market Shares, 1998.
Table 2.2: Percentage of overseas residents' spending by year and spending category
Table 3.1: Main Types of Tourism Taxes
Table 3.2: Estimated Total Tax collected by type of Industry, 1998 ( millions)
Table 3.3: Changes in the UK VAT rate
Table 3.4: Employment in Tourism-related Sectors in the UK, September, 000's
Table 3.5: Taxes applicable to Tourism in the UK.
Table 3.6: Receipts from Air Passenger Duty.
Table 4.1: VAT Rates in the Hospitality and Catering Sector in European Countries,
April 1998.
Table 4.2: Tax Expenditure in City Destinations, Autumn 1999.
Table 4.3: Index of Tax, October 1999 (Base year 1994 = 100)
a
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Table 5.1: Panel Results using FGLS: Dependent variable is Ln EXP
juk
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Table 5.2: VAT and Occupancy Rates in Tourism Establishments.
5
TOURISM TAXATION IN THE UK
Executive Summary
This report is presented as a stand alone analysis of tourism taxation in the UK.
Tourism is a major source of income, employment and foreign currency receipts for the
UK and the its effects spill over to other sectors of the economy. However, tourism
businesses have been experiencing a number of problems in recent years, reflected in the
UKs declining share of the world tourism market, as well as the decreases in the levels
of real receipts per visit for many of the UKs major tourism markets. The level of price
competitiveness of tourism relative to other countries, along with the effects of changes
in price competitiveness on tourism receipts, are issues of particular concern.
Tourism taxation is an important determinant of price competitiveness and the report
focuses on two key questions in this respect:
1. How sensitive are tourism receipts by the UK to a change in the price
competitiveness of tourism?
2. What is the likely effect of a change in tourism taxation, in particular, Value Added
Tax, on the level of price competitiveness and, hence, on tourism receipts?
An econometric model is specified and used to provide quantitative estimates of the
price sensitivity of tourism demand for the UK. This is important because no other
statistically valid estimates of the price sensitivity of UK tourism demand are available.
The estimated results constitute an essential component of the ensuing examination of
the effects of taxation on the competitiveness and receipts of the UK tourism sector.
Tourism makes an important contribution to the UK economy:
In 1999, tourism and day visitors provided around 5 per cent of GDP, totalling over
61 billion.
The number of people employed in 125,000 tourism businesses was around 1.78
million.
It is the largest invisible export of the UK.
The highest numbers of tourist arrivals are from the USA, France and Germany.
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However, UK tourism is experiencing considerable problems:
The UKs share of world tourism receipts has declined to around 4.5%.
Receipts from overseas tourism declined in real terms by 1.5% per annum between
1995-99 and by 3.7% between 1998-99 and the growth rates for tourist arrivals were
0.2% and -2.1% during the same periods.
Tourism receipts per capita per visit decreased, in real terms, for key origin countries
including the USA and Germany, during the latter half of the 1990s.
The price index for items purchased by tourists has risen faster than the consumer
price index for the UK, indicating a fall in the price competitiveness of the UK.
The exchange rate for sterling appreciated during the late 1990s, causing a further
decrease in competitiveness.
Appreciation of the real effective exchange rate for sterling was associated with a
fall in average expenditure per tourist.
Tourism makes a major contribution to the UKs tax yield:
Much of the contribution of tourism to the UKs tax yield is hidden within
the yields obtained from taxes on goods and services purchased by both
tourists and local residents.
There are two main types of tourism taxes: general, for example, profits and
Value Added Tax and specific, such as Air Passenger Duty.
The emphasis of taxation has switched from direct to indirect taxes, notably from
corporation tax to expenditure tax.
Receipts from Value Added Tax are particularly important; for example, in 1999,
approaching 1 billion was provided by hotels and other accommodation
establishments.
Pay As You Earn is also a major type of tourism taxation; the hotel and catering
sector contributed around 1 billion in PAYE in the same period.
The yield from corporation tax is relatively low, owing to the large number of small,
low profit businesses that provide tourism services.
Direct charges are also significant; for instance Air Passenger Duty contributed over
824 million in 1998, although APD charges will decrease from April 2001.
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Tourism businesses are not competing on a level playing field:
The rate of Value Added Tax levied on tourism businesses in the UK is high, at
17.5%, relative to the rates levied in most other European Union countries.
The rate of VAT levied on hotel accommodation in the UK exceeds the rates in
other European countries with the exception of Denmark.
The rate of VAT levied on restaurant, bar and caf services in the UK is more similar
to the rates in other European countries.
Taxes on tourism-related services have proliferated, not only in the UK but also in
other major tourist destination countries.
Increases in the rates of taxation on tourism have occurred in most countries and
appear to be more common than reductions.
There is a lack of standardisation across countries with respect to the types and rates
of taxation that are levied on tourism services.
Hence, tourism businesses in different countries are not competing on a level playing
field.
The UKs tourism receipts are sensitive to changes in price competitiveness:
The results of the econometric model showed that rises in UK prices and
appreciation of the exchange rate for sterling result in significant falls in tourism
receipts.
The sensitivity of overseas tourism demand to changes in effective prices (which
take account of exchange rates) was found to approximate unity.
The incidence on tourists of a change in taxation, such as the rate of Value Added
Tax, appears to be high for the UK at the national level.
A decrease in tourism taxation, such as the rate of Value Added Tax, would improve
competitiveness and could generate a significant increase in tourism receipts in the
UK, ceteris paribus.
The crucial proviso is that any decrease in the rate of taxation must be passed on to
tourists in the form of a fall in prices.
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The results from the econometric model highlight the need to ensure that prices in
the UK remain competitive not only relative to prices in key tourist origin countries
but also relative to prices in tourist destinations that compete with the UK.
Occupancy rates in tourism accommodation establishments in the UK are low
relative to many other European countries but vary by category of accommodation
and area so that, at the micro level, the incidence of a change in tourism taxation and
the associated effects on price competitiveness also vary.
A decrease in taxation on services that are provided directly for tourists, such as
VAT on accommodation, could be accompanied by stable rates of taxation and
charges on complementary goods and services, to ensure that tourism contributes
towards the cost of the infrastructure and other public services that underpin a
successful tourism industry
Fiscal policy can also be used to stimulate tourism activities, for example, lump sum
grants towards capital investment.
The findings from the report were constrained by its stand alone status. In reality,
tourism contributes to income, employment and foreign currency generation by other
sectors of the economy, and changes in the tourism sector will impact on them.
Similarly, exogenous or policy changes in other sectors of the economy have significant
effects on tourism businesses. These interrelationships should be taken into account by a
modelling procedure which examines the changes on a sector-by-sector basis.
Computable General Equilibrium modelling is a leading edge methodology that enables
economy-wide interrelationships to be quantified and forecasts to be made. The
application of the methodology would permit taxation and related policies to be
formulated within a general rather than a partial context.
9
TOURISM TAXATION IN THE UK
1. Introduction
This report is concerned with examining tourism taxation in the UK:
the main types of taxation in terms of their yields,
the rates of taxation, notably Value Added Tax, that are levied relative to other
countries,
the likely effects of a change in tourism taxation on the competitiveness of tourism
businesses and associated foreign currency receipts for the UK.
The issue of tourism taxation has come under the spotlight in recent years as the
numbers and types of tourism taxes have mushroomed. The World Tourism
Organisation (WTO, 1998) has identified around forty different taxes levied on tourism.
Among fifty destinations surveyed, 73 per cent have increased taxes on tourism in the
past five years and only 13.5 per cent have reduced them in any way. Tourism is
relatively easy to tax and is also a popular target for taxation owing to its high revenue
growth potential. The question, then, arises as to whether tourism is taxed appropriately
or excessively.
Tourism taxation may be disadvantageous. The application of discriminatory or
inequitable taxes may distort the competitive position of the sector, both against other
industries and across rival tourist destinations. It may also depress demand through the
increases in costs to consumers stemming from the tax increases. This can lead to
business failures and job losses, both in the tourism sector and in other sectors dependent
on tourism. The WTO cites examples where governments have ended up with less
revenue after increasing a tax. This situation results especially in cases where taxes are
levied or introduced arbitrarily. One reason for arbitrary tax setting is that governments,
particularly in developing countries, are confronted with difficulties in finding good tax
handles in the tourism sector (Bird, 1992). It is also due to the fact that many tourism
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taxes are imposed incrementally over time, rather than as part of an integrated strategy
responding to accepted economic principles. Further problems arise because tourism
taxes tend to worsen the price competitiveness of the imposing country. Hence, as for
any goods or services that are exported, knowledge of the tourism price elasticities is
vital with respect to the effects on demand, receipts and associated employment.
However, it is also accepted that tourism, like other goods and services, should
contribute to the general revenue fund that is used to finance the public services and
infrastructure that underpin economic activity. Tourists have the ability to pay for such
services and also benefit from them. Tourism is particularly dependent, for example,
upon a clean, litter-free environment, an efficient transportation network and good
communications. Effective public health and security systems also provide reassurance
to those who visit the destination. Some countries or regions, including a number of
American states, have introduced mechanisms whereby a proportion of the revenue from
tourism taxation is hypothecated for such purposes. Hypothecated revenue can also be
used for investment in human or physical capital, in the form of employee or
management training, or for assistance towards the establishment, expansion or
renovation of tourist accommodation or facilities. Tourism also has social implications
which other exports do not face as it is consumed at the point of production. It may
impose costs on the residents of the locality, such as congestion or pollution, as well as
raising distributional issues owing to the demonstration effect of conspicuous
consumption by relatively affluent tourists. It is important to ensure that local residents
benefit from tourism, as goodwill towards tourists is an essential feature of popular
destinations. The revenue from taxation may provide a means for achieving this end.
This raises the further questions of how to tax tourism, by how much and who will pay.
These questions have been posed in the context of the UK, which has experienced a
decreasing share of international tourism receipts and a fall in its level of
competitiveness. It is obviously useful to identify the extent of the UKs dependence on
the yield from different sources of tourism taxation, for example, tourism-related Value
Added Tax (VAT) compared with the yield from Air Passenger Duty (APD) or
corporation tax. A specific issue that has been the subject of considerable debate is
whether a decrease in the rate of tourism-related VAT (which is high in the UK relative
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to other European countries) would improve the countrys competitiveness and tourism
receipts. Measurement of the price elasticity of tourism demand, along with estimates of
the probable incidence of the tax on producers and tourist consumers, would shed light
on this issue.
This report will examine the ways in which the tourism industry is taxed in the UK and
will make a number of comparisons with other major tourist destinations in
industrialised countries. The main focus of the report is on overseas tourism in the UK
rather than domestic tourism, which merits further, detailed investigation. The report is
structured as follows:
Section 2 of the report provides a context for the analysis of tourism taxation by
discussing the overseas market for UK tourism and the problems that the industry is
facing. The most important tourist origin countries are identified and the evolution
of demand over time is traced. It is shown that the major challenges that the industry
confronts include a declining share of the world market, a considerable fall in
competitiveness and decreases in foreign currency receipts per tourist, per visit, from
a number of major origin countries.
Section 3 discusses the main taxes that are levied on tourism in the UK, notably
corporation tax, Value Added Tax, pay as you earn (PAYE), Air Passenger Duty and
visa fees. The switch in emphasis from direct to indirect taxation is identified and
the relatively low yield from corporation tax on hotels and restaurants is explained
by the small size and low profits levels of most of the businesses in the sector. In
contrast, the tax yields from Value Added Tax and PAYE are high.
Section 4 examines the rates of Value Added Tax in the UK relative to other
European Union countries. It also considers tourism taxation policies in the UK in
the context of changes introduced by the USA, France, Germany, Italy, Spain,
Australia and Canada. It is shown that increases in the types and rates of taxation on
tourism have occurred in the other major tourist origin and destination countries, as
well as in the UK. However, the rate of Value Added Tax in the UK remains high
relative to most other countries.
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Section 5 provides a model that is used to measure the price elasticity of tourism
demand in the UK, in order to indicate the extent to which receipts from tourism
change as the price of tourism rises (or falls). These results provide an initial
indication of the effects of changes in the price competitiveness of UK tourism. The
incidence of tourism taxation between tourists and businesses also depends upon the
price elasticity of tourism supply and so supply-side considerations are also taken
into account. Examination of both tourism demand and supply indicates the extent
to which a rise (fall) in tourism taxation results in a rise (fall) in the price that tourists
pay and, hence, the change in its price competitiveness and the foreign currency
receipts generated by tourism businesses.
It is demonstrated that tourism receipts are sensitive to changes in price
competitiveness. Hence, changes in the rates of tourism taxation and other
determinants of price competitiveness are likely to have significant impacts on the
contribution that tourism makes to the UK economy.
Section 6 provides some conclusions.
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2. Trends and Issues in UK Tourism
This section of the report examines the international context for UK tourism and the
issues that confront tourism businesses. The discussion will focus on:
The trends in arrivals from abroad.
The distribution of arrivals by major tourist origin countries.
The market shares of the UK and other major tourist destination countries.
Changes in the tourism price index in the UK.
Changes in the effective exchange rate for sterling.
Trends in the UKs real tourism receipts from major tourist origin countries.
Trends in real tourism receipts per tourist per visit for major origin countries.
2 (i) Tourist Arrivals in the UK
Tourism makes a major contribution to the UK economy. Tourism and day visits
account for around 5 per cent of national GDP and 7 per cent of employment, employing
1.78 million people in 125,000 businesses in 1999 (British Tourism Authority,
www.staruk.org.uk., 2001). The value of tourism in the UK economy was around 61
billion in the same year. Spending by overseas tourists accounts for 20% of this amount,
spending by UK residents on domestic tourism accounts for 27%, while the rest comes
from expenditure on day visits. It is estimated that UK residents spent 16 billion on
overnight stays and 32 billion on day visits, while overseas tourists spent 12.5 billion
in the UK and an additional 3.2 billion in fares to UK carriers. Tourism is the UKs
largest invisible export and in 1998 business tourism accounted for 27% of all visits to
the UK.
14
The numbers of tourist arrivals have grown over time, as depicted in Figure 2.1.
Overseas visitors mainly come from the USA, Japan, Australia and Europe, representing
around 80% of total arrivals. However, arrivals from the USA are subject to
considerable volatility and arrivals from some countries have decreased in recent years.
For example, arrivals from France, Belgium and Germany decreased between 1997 and
1998. The relative importance of arrivals from 11 major origin countries that are
considered in this study, in 1997 and 1998, are shown in Figure 2.2. These countries
account for around 70% of tourists visiting the UK annually. It can be seen that the
USA was the most important origin in terms of tourist numbers, followed by France,
Germany, the Irish Republic, the Netherlands, Belgium, Italy, Spain, Australia,
Switzerland and Japan.
Figure 2.1: Tourist Arrivals in the UK (000's), 1982-1998.
Source: Compiled using data from Travel Trends (1999).
Tourist Arrivals in the UK (000's)
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Figure 2.2: Number of Tourist Arrivals in the UK, 1997 and 1998.
2 (ii) Trends in the UKs Share of International Tourism Receipts
The UKs earnings from overseas tourism have increased over time, although its share of
international tourism receipts has deteriorated over the years, as shown in Figure 2.3.
The decline in the UKs share began in 1980/81, when the rate of VAT applicable to
tourism and other services increased from 8 per cent to 15 per cent. The rate was further
increased to 17.5 per cent in May 1981. Since then, there has been a gradual decline to
around 4.5% in the mid 1990s, and the share has remained fairly constant thereafter. The
UK, along with Denmark and Germany, still applies the standard VAT rates on tourism
that are among the highest VAT rates in Europe, as will be discussed in Section 4 (i) of
the report.
Number of Tourists Arrivals (000's) in 1997 and 1998
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Figure 2.3: UK's Share of International Tourism Receipts.
Source: Compiled using data from WTO (2000).
The market shares of the main tourist destination countries, in terms of tourism receipts
from abroad, are given in Table 2.1. It is evident that the market shares of the USA,
France, Italy and Spain considerably exceed that of the UK.
Table 2.1: International Tourism Receipts and Market Shares, 1998.
US $
Million
Market
Share %
USA 71,250 16.15
France 29,931 6.78
Italy 29,866 6.77
Spain 29,737 6.74
UK 20,978 4.75
Germany 16,429 3.72
Canada 9,396 2.13
Australia 7,335 1.66
World 441,255 100.00
Source: WTO (2000).
UK's Share of International Tourism Receipts
4
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%
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2 (iii) Current and real tourism earnings in the UK.
The growth in tourism receipts for the period 1978-1998, in both current and constant
terms, is shown in Figure 2.4. The real tourism earnings figures are derived by deflating
receipts from tourism expenditure by the tourism price index (see Section 2.iv) rather
than the consumer price index. The base year is 1990.
Figure 2.4: Current and Real Tourism Earnings in the UK.
Figure 2.4 demonstrates that the growth over time in real tourism receipts has been fairly
low, in contrast to the view that would emerge from inspection of the growth of receipts
in current terms. Moreover, there was a decline in the real value of receipts at the end of
the 1990s.
The changes that have occurred in tourism earnings from the seven main origin countries
that account for around 55% of total tourist arrivals are depicted in Figures 2.5 and 2.6,
in current and constant terms respectively.
Current and Real Tourism Earnings in the UK
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Figure 2.5: Current tourism expenditure in UK ( millions), 1985-1998.
Source: Compiled using data from ONS and Travel Trends (1999).
Figure 2.6: Real tourism expenditure in UK ( millions), 1985-1998.
Current Tourism Expenditure in the UK ( millions)
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It can be observed that tourism receipts, in real terms, have decreased in recent years for
most countries, excluding the USA. Tourism receipts from the USA increased, mainly
due to significant increases in the number of tourist arrivals; for instance, for the period
1997-98 tourist arrivals increased by 13.1%. For some other countries, such as France,
Germany, Belgium, Japan and Australia, tourist arrivals decreased during the same
period, as was shown in Figure 2.2. Overall, tourist arrivals increased slightly, by
around 1% between 1997-98, while real tourism earnings increased by only 0.27%.
It is clear that tourist arrivals and tourism receipts have not experienced similar changes
over time and that increases in arrivals have not been accompanied by proportionate
increases in receipts. Hence, it is also important to examine changes in the amounts that
tourists spend per visit. Real average tourism earnings per visit by country of origin are
shown in Figure 2.7.
Figure 2.7: Real average tourism earnings per visit in the UK (), 1982-1998.
Real Average Tourism Expenditure per visit in the UK,
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The trends in the figure reveal that there is cause for concern regarding real expenditure
per visit in the UK. In fact, for most of the countries, real average spending per visit has
declined over recent years. For example, although total real tourist earnings and tourist
arrivals from the USA have been rising in recent years, real average expenditure per visit
has fallen. On the other hand, tourist arrivals in France fell by 8.7% in 1997-98 but real
average tourism expenditure per visit rose by 22.6%. Figure 2.7 shows that, in recent
years, real tourism expenditure per visit has declined for all countries, except France.
Possible explanations for the decreases in average expenditure per visit include rising
tourism prices in the UK, the high rate of value added tax on hotels in the UK and the
high exchange rate for sterling, particularly vis--vis other European currencies.
2 (iv) The Tourism Price Index and Effective Exchange Rates
Most studies use the consumer price index as an indicator of the cost of tourism in a
particular country (see Sinclair, 1998; Song and Witt, 2000; Durbarry, 2000). On this
basis, using the consumer price index, it would seem that the cost of tourism in the
United Kingdom has increased over the years 1978-98, as depicted in Figure 2.8 below.
This implies that tourism in the United Kingdom has gradually become more expensive.
An important caveat when using the consumer price index to reflect the cost of tourism
is that the basket of goods and services included are those purchased by UK residents,
for example, house prices, rather than those purchased by tourists. A list of items on
which tourists spend is available from the International Passenger Survey, as
exemplified in Table 2.2. A price index based on these items would be more appropriate
for measuring the cost of tourism than the consumer price index. Fortunately the Office
for National Statistics computes retail price indices for these components.
The trend in the tourism price index for the years 1978 to 1998, based on the items
consumed by tourists, is also depicted in Figure 2.8. Although it seems that tourism
price indices in the 1980s were lower than the consumer price indices, in the 1990s the
trend has reversed. This is not surprising, as the spending pattern of tourists has
changed. The changes in the weights that are used to compute the tourism price index
21
are included in Table 2.2. For instance, the percentage spent on accommodation and
food has increased significantly, from 27.5% for accommodation in 1979 to 33.3% in
1997, while the percentage spent on food increased from 14.7% in 1979 to 20.6% in
1997.
During the period 1990-98, tourism prices increased by 4.2% per annum, on average,
while the consumer price index increased by only 3.3%. Hence, use of the consumer
price index would understate the cost of tourism. Furthermore, the tourism price index
would have been higher if changes in Air Passenger Duty had been included. It would
be interesting to observe how the UK performs relative to other European destinations
by comparing the cost of tourism. Unfortunately, similar tourism price indices for other
countries are not available, precluding comparison of competitiveness.
Figure 2.8: Consumer and tourism price indices, Base = 1990.
Consumer Price Index and Tourism Price Index (Base =1990)
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9
2
1
9
9
4
1
9
9
6
1
9
9
8
Year
I
n
d
e
x
Tourism Price Index Consumer Price Index
22
Table 2.2: Percentage of overseas visitors' spending by year and spending category
Spending Category 1979 1986 1992 1997
Accommodation 27.5 32.3 36.1 33.3
Eating out/alcohol 14.7 22.5 21.9 20.6
Travel within UK 11.5 8.6 7.8 9.2
Clothes 19.9 14.1 12.6 12.8
Other shopping 15.9 13.0 11.9 13.2
Other expenditure 10.5 9.5 9.5 10.9
Total % 100 100 100 100
Source: Travel Trends (1999).
The exchange rate for sterling, particularly relative to other European countries, is a
further variable affecting the tourism sector. Exchange rates are important determinants
of consumers' decisions in choosing particular destinations. The consumer knows how
much his/her currency is worth in terms of the visiting countrys currency. It was
observed for the UK that in 1987 and 1995, when sterlings external value was low, an
increase in the UKs share of international receipts occurred (see Figure 2.3). The
relationship between the real effective exchange rate and average tourism expenditure is
depicted in Figure 2.9, where 1990 = 100 and an increase in the index indicates currency
appreciation. The exchange rate for sterling appreciated considerably from 1995-98 and
average expenditure per tourist fell from 390 in 1995 to 350 in 1998.
The percentage change in the real effective exchange rate and the percentage change in
tourism earnings are illustrated in Figure 2.10. From the figure, it seems that
appreciation of the real exchange rate is associated with decreases in tourism earnings.
In fact, statistically, the correlation between the percentage change in the real effective
exchange rate and the percentage change in tourism earnings is found to be -0.80, which
indicates that they are highly negatively correlated. The UK also performed poorly,
compared with other European destinations, in terms of tourist arrivals. While in the
UK, the growth of tourist arrivals between 1997-98 was only 1%, growth in other
countries was much higher, for example, in France (7.4%), Spain (8.9%), Portugal
(9.6%), Italy (4%) and Germany (4%).
23
Figure 2.9: Real Effective Exchange Rate (1990=100) and Average Tourism
Expenditure.
Source: Own compilation.
Figure 2.10: Percentage Change in Real Effective Exchange Rate and in Tourism
Earnings.
Real Effective Exchange Rate and Average Tourism Expenditure
0
100
200
300
400
500
600
1
9
7
5
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
Year
0
20
40
60
80
100
120
I
n
d
e
x
Average Expenditure () Real Effective Exchange Rate
Percentage Change in Real Effective Exchange Rate and in Tourism
Earnings
-40
-30
-20
-10
0
10
20
30
40
50
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
Year
%
% change in REER % change in Tourism Earnings
24
The discussions of UK tourism in Section 2 have shown that although the sector has
experienced significant growth in arrivals from overseas, it is also faced by considerable
problems. The main findings from this section are that:
Tourist arrivals from abroad have grown over the past two decades but some
declines occurred in the latter part of the 1990s.
The major origin countries for arrivals in the UK are, in order of importance in1997-
98, the USA, France, Germany, the Irish Republic, the Netherlands, Belgium, Italy,
Spain, Australia, Switzerland and Japan.
The UKs share of international tourism decreased to around 4.5% in the mid 1990s
and remained fairly stable thereafter.
The growth of real tourism receipts from abroad has been fairly low.
Real tourism receipts per capita per tourist visit have decreased for many of the UKs
major origin countries.
The tourism price index for the UK has risen faster than the consumer price index.
The effective exchange rate for sterling increased considerably during the 1990s,
resulting in a deterioration in the UKs price competitiveness.
Overall, it is clear that the tourism industry in the UK is facing major problems,
particularly in the form of a falling share of world tourism receipts, decreasing price
competitiveness and falls in the value of receipts per tourist visit from key origin
countries. This is the context against which the discussion of tourism taxation, the price
sensitivity of tourism and the international competitiveness of the UK tourism industry
must be considered.
25
3. Tourism Taxes in the UK
This section of the report is concerned with examining the main types of tourism
taxation that are levied in the UK. This is important for a number of reasons:
Taxes on tourism have often been hidden within the tax yields that have been
obtained from goods and services purchased by both tourists and local residents.
The provision of data quantifying the yields from different types of tourism taxation
gives an indication of the scale of the tax burden that the industry faces.
Examination of the relative importance of the different types of tourism taxation
indicates the ways in which the tax burden is distributed.
Information about the tax yields and relative importance of different types of tourism
taxes is a prerequisite for any evaluation of the appropriateness of the rates of
taxation that are currently levied.
The section begins by identifying the main categories of tourism taxation that are levied,
general and specific, and continues to examine the taxes that have a particularly
important impact on tourism in the UK, namely value added tax, corporation tax and
pay-as-you-earn, as well as considering direct charges Air Passenger Duty and entry
clearance (visa) fees.
3 (i) Types of Tourism Taxes
There are two main categories of tourism taxes: general taxes, for instance, import
duties, profits and sales tax or value added tax, and specific taxes mainly on tourism
activities such as hotels and restaurants tax, tax on gambling, airport tax, visa fees, and
arrival and departure taxes. General taxes fall on both tourists and residents, for
example value added tax (VAT), which is probably the most significant tax on the
tourism sector in many countries. VAT is an important tool for capturing revenue from
tourists not only in developed nations but also in developing countries, where the
informal sector is significant and effective taxation of profits is difficult. In Europe,
26
some special VAT rates are applicable to the tourism sector. For instance, the VAT
rates on hotels and restaurants vary between 3% in Luxembourg and 25% in Denmark,
with the UK rate of 17.5% being at the higher end of the spectrum.
Numerous specific taxes are levied on tourism activities. For example, in many
countries, hotels are not only subject to general taxes on profits and dividends but there
are also taxes ranging from hotel room charges to taxation on foreign currency
exchanged in the establishment. The International Hotel Association (IHA, 1996)
conducted a survey among its members in order to assess the extent of the tax burden on
hotels and found that around 39 separate taxes were levied in 1995-96. Such taxes have
the disadvantage of contributing to increases in the price of accommodation. On the
other hand, hotel room taxes are relatively easy and inexpensive to administer and also
embody an element of progressiveness, which helps to account for their popularity with
many governments and tourism authorities (Weston, 1983).
The types of taxes that are directly charged to tourists and those that are borne by
tourism-related businesses are listed in Table 3.1.
.
Table 3.1: Main Types of Tourism Taxes
Directly Charged to Tourists Charged to User Businesses
Arrival/Departure Taxes e.g. Visas,
Travel Permits
Transportation Tax e.g. Road Tax
Travel Taxes e.g. Air Passenger Duty,
Car Rental Tax, Fuel Tax
Import Duties on Tourism Inputs
Accommodation e.g. Bednight Tax Corporation Tax
Expenditure Tax e.g. VAT on restaurant
meals
Land and Property Taxes
Environment Tax e.g. Ecotax levied on
arrival/departure
Environment Tax e.g. Levy on night
take-offs/landings by Aircraft
27
There are many instances where the imposition of direct charges may be desirable but is
costly to administer or collect. In these circumstances it is possible to tax products that
are complementary to tourism activities, for example access to museums, artisan
products and souvenirs, entertainment and night clubs. This is becoming a common
practice, especially in industrialised countries, as it does not affect the basic prices of
tourism, such as air flight tickets, and thereby enables the destination to remain
competitive. Once the tourists are in place, the amount of tax desired can be reaped
from their expenditure on complementary products.
It has been argued that taxes on domestic commodities are an appropriate way of taxing
tourism. For example, Copeland (1991) argues, in a general equilibrium setting, that the
presence of domestic commodity taxes will typically increase the benefits of tourism,
since they allow some extraction of rents from unpriced natural amenities which are
consumed jointly with priced goods and services. The problem is that if domestic
residents consume the taxed products more intensively than tourists, then domestic
opposition to increases in such taxes would arise. Taxes on complementary products
(which also widen the tax base) seem preferable to direct charges in that price
competitiveness is not much affected and domestic residents do not bear the burden.
3 (ii) The Current Tax Situation in the UK and Value Added Tax
The tax contribution of the tourism industry to the UK economy is indicated in Table
3.2, which presents corporation tax, Pay As You Earn tax and net tax (taxes less
subsidies) for a range of industry groups in 1998. For the tourism industry, only the
group Hotels and Restaurants gives a direct indication of taxes collected in the tourism
sector. However, it is well known that tourism activities are not specific to the hotel and
catering sector; other sectors are involved as well. For instance, overseas tourists spend
considerable amounts on clothes, alcoholic and soft drinks, which are grouped under
Manufacturing. In this respect, the figure under Hotels and Restaurants
underestimates the total amounts of the tax yield that results from tourism activities.
28
The amount of tax collected from income tax, in particular Pay As You Earn (PAYE)
tax, is also understated as tourism generates indirect and induced employment through
its multiplier effects. Therefore, tourisms contribution to tax revenue is spread across a
wide range of economic activities.
Table 3.2: Estimated Total Tax collected by type of Industry, 1998 (
millions).
Industry based on SIC 1992 Corporation
Tax
PAYE Taxes less
subsidies
a
Total
b
Agriculture, forestry and fishing
159 520 -2,458 -1,779
Mining and quarrying
1,596 693 81 2,370
Manufacturing
5,591 18,542 66,851 90,984
Electricity, gas and water supply
2,767 1,213 1,084 5,064
Construction
887 2,859 4,903 8,649
Wholesale, retail and repairs
4,491 10,137 1,122 15,750
Hotels and restaurants
365 1,386 4,678 6,429
Transport, storage and communication
1,940 5,632 2,561 10,133
Financial intermediation
9,666 215,744 10,235 235,645
Public administration and defence
850 6,931 - 7,781
Education, Health and social work
1,921 14,642 709 17,272
Other services
999 2,513 5,792 9,304
Total tax ( million) 31,232 86,643 96,357 214,232
Source: Compiled using data from Inland Revenue Statistics, Financial Statistics, and Input-
Output Supply and Use Balances.
Note: a. Taxes include VAT, excise duties, air passenger tax, insurance premium tax and
subsidies include agricultural and transport subsidies.
b. Social security contributions have not been included.
29
The amounts of VAT contributed by the tourism industry are not separately available in
the table, owing to restrictions on the publication of VAT yields from tourism
businesses. These restrictions are due to the possibility that the data would reveal
information about individual businesses in sub-sectors of tourism services in which there
is only a small number of firms or which are dominated by a few firms. However,
unpublished data not included in the report demonstrate that the figures for Hotels and
Restaurants included in the Taxes less Subsidies column provide a reasonable indication
of the large order of magnitude of the yield from VAT for all of the industry types
included in Table 3.2
The relatively large amounts included in the Taxes less Subsidies column reflect a shift
in taxation policy in the UK from corporation tax to expenditure taxes. The VAT rate
applicable to the tourism sector was increased from 8 per cent to 15 percent in 1979 and
further increased to 17.5 percent in 1991. The changes in the rate of VAT that have
been implemented since its introduction in 1973 are shown in Table 3.3. With the
exception of food (where no VAT is applied), other items such as restaurant services,
bars and caf services, non-alcoholic and alcoholic beverages, and accommodation are
all charged at the standard VAT rate of 17.5 per cent. This is higher than the rate levied
in many other European Union countries, as will be discussed in Section 4 of the report.
30
Table 3.3: Changes in the UK VAT rate.
Date of
introduction
Rate (per cent) Principal goods and services covered by
higher/reduced rates
Standard Reduced Higher
1.4.73 10 - -
29.7.74 8 - -
18.11.74 8 - 25 Higher rate applicable to petrol (but not derv).
1.5.75 8 - 25 Higher rate applicable to petrol, domestic electrical
appliances, radios, TVs and hi-fi equipment,
pleasure boats and aircraft, towing caravans,
photographic equipment, furs and jewellery and
services associated with these goods.
12.4.76 8 - 12.5 Reduced higher rate applicable to all higher rated
goods and services
18.6.79 15 - - Higher rate abolished
1.4.91 17.5 - -
1.4.94 17.5 8 - Reduced rate applicable to fuel and power for
domestic and charity use
1.10.94 17.5 8, (5) - Reduced rate of 5 per cent introduced in the Isle of
Man, applicable to hotel accommodation on the Isle
of Man only.
1.9.97 17.5 5 - Reduced rate of 5 per cent applicable to fuel and
power for domestic and charity use and Isle of Man
hotel accommodation.
1.7.98 17.5 5 - Reduced rate of 5 per cent also applicable to
installation
of energy saving materials when funded by certain
grants and schemes
Source: HM Customs & Excise Annual Report
31
3 (iii) Corporation Tax
The total amount of corporation tax derived from the tourism sector is not substantial
compared with the yield from other taxes such as PAYE and VAT, as indicated in Table
3.2. For example, corporation tax accounts for around 6 per cent of total tax collected
from the Hotels and Restaurants sector. It is interesting to note that the revenue from
Air Passenger Duty in 1998 was 824 million, exceeding the amount collected from
corporation tax. It is perhaps surprising that a sector such as hotels and catering, which
in 1998 generated net total income of around 2.3 billion (see Figure 3.1), contributes
such an amount. A similar finding applies to the distribution and repairs sector (see
Table 3.2 and Figure 3.2). The reason for the relatively small contribution of
corporation tax to the total tax yield stems from the small size of the majority of
businesses in these sectors, as will be explained below.
Figure 3.1: Total Net Income, Deductions and Corporation Tax from Hotel and
Catering.
Source: Compiled using data from Inland Revenue Statistics.
0
500
1000
1500
2000
2500
1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98
Net Total Income,Deductions and Corporate Tax from Hotel and Catering (millions)
Net Total Income Deductions Allow ed Tax Payable
32
Figure 3.2: Total Net Income, Deductions and Corporation Tax from Distribution
and Repairs
.
Examination of the yield from corporation tax on the tourism sector is facilitated by
consideration of the method according to which incomes are charged, the tax rates
applicable, deductions allowed and other tax reliefs to which businesses are subject, as
depicted in Figures 3.1 and 3.2. Profits made by companies in the tourism sector are
liable for corporation tax payments, similarly to companies in other industries. The tax
is charged on the profits made in each accounting period, i.e. the period over which the
company draws up its accounts. Companies have been charged with corporation tax
since 1965. Prior to 1965, they were liable to income tax on their total income and also
to profits tax. The system introduced in 1965 charged a uniform rate on all profits and
an additional charge to income tax was made when profits were distributed. It is
interesting to note that in the UK, a 'partial imputation system' was introduced in 1973 to
mitigate the double tax charge when profits are distributed. This was achieved by the
twin mechanisms of Advance Corporation Tax (ACT) and tax credits.
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98
Total Net Income, Deductions and Corporation Tax from Distribution and Repairs (millions)
Net Total Income Deductions Allowed Tax Payable
33
In July 1997, the new Labour government initiated a series of reforms of tax credits and
corporation tax payments. Payments of tax credits to pension schemes and UK
companies were abolished on dividends paid on or after 2 July 1997 and the remaining
payments of tax credits were cut from 6 April 1999. ACT was abolished for dividends
paid on or after 6 April 1999 as were Foreign Income Dividends, which allowed
companies to pay dividends without tax credits. A system of quarterly instalment
payments of corporation tax was introduced for large companies for accounting periods
ending on or after 1 July 1999.
The rates of corporation tax that have been levied since 1969 are shown in Table A1 in
Appendix I. Rates were substantially reduced from 1983 to 1986 as part of a range of
measures which included the abolition of stock relief and major changes to capital
allowances. The rate of ACT changed in line with the basic rate of income tax until
1992-93. From then until its abolition, the rate was linked to the lower rate of income
tax of 20 per cent with a transitional rate for ACT (equivalent to 22.5 per cent) in 1993-
94.
Since 1973, there has been a lower rate of corporation tax for companies with small
profits. The rate applies when the profits are below a lower limit of profits (as shown in
Table A1, Appendix I). Between that limit and an upper limit, a higher marginal rate is
applied to produce a smooth progression in the average tax rate from the lower rate to
the main rate which applies above the upper limit. The profit limits are restricted for
companies associated with one or more other companies according to the number of
associated companies, in order to prevent abuse by a company fragmenting into smaller
ones. From April 2000, there was a new starter rate of 10% on profits up to 10,000 but
it was agreed that the benefit will be withdrawn for more profitable companies with a
higher marginal rate on profits in the band 10,000 to 50,000.
It is now clear that the reason why the amount of corporation tax that has been collected
from the tourism sector is relatively low is because of the large number of small
businesses in the sector and their low levels of profits. Moreover, capital allowances and
deductions are further allowed on incomes. Capital allowances provide relief, for
corporation tax purposes, for the consumption or depreciation of capital assets incurred
34
for the purposes of carrying on a trade. Deductions are allowed from a company's total
profits for any charges (interest and other payments) it pays and, in the case of an
investment company, its management expenses. Hence:
The amount of corporation tax that tourism businesses pay is limited by their
relatively small size and associated low profit levels.
Tourism businesses also pay relatively high amounts of value added tax.
Tourism businesses generate employment and tax revenue in the form of PAYE tax.
3 (iv) Pay As You Earn Tax
For the vast majority of employees who receive income from employment, the tax due
on that income is calculated by the employer and the appropriate amount deducted
before the employee is paid. The Pay As You Earn (PAYE) system ensures that the
majority of these individuals do not need to complete an annual tax return or make any
direct payment to the Inland Revenue as employers become collectors for the
government. In the UK, receipts from PAYE account for around 30% of total
government revenue collected.
For the tourism sector, the amount of tax collected from PAYE in hotels and restaurants
is around 1.6% of total PAYE tax collected, while in the wholesale, retail and repairs
industry it is around 11.7%. The amount of PAYE collected for the period 1982 to 1997
is depicted in Figures 3.4 and 3.5 for these two industry groups respectively. The
amount of PAYE tax contributed by other tourism-related businesses, such as travel
agencies, bars, night clubs, are not available but employment figures in these sub-sectors
can indicate the approximate amounts of income that could be derived. Employment in
key sectors of the tourism industry is given in Table 3.4. Generally, it can be observed
that as the number of employed increases, the amount of PAYE tax collected has
increased. For example, in 1990 and 1997 when total employment in hotel and catering
together was 1,074,700 and 1,258,000 respectively, the amounts collected from PAYE
were 637.5 million and 926.4 million respectively.
35
The amount of tax collected also depends on the number of tourist arrivals. This
becomes obvious from examination of the trend of tourist arrivals in the UK (see Figure
A1 in Appendix II). Over the years, the number of tourist arrivals has been increasing
and a similar trend is observed in the amount of tax collected under both the hotels and
restaurants, and distribution and repairs industry groups. While tourist arrivals have
increased by 40% in numbers between 1990 and 1997, the number of jobs in hotels and
catering has increased by 5.26%. During the same period, PAYE tax collected
increased by around 16% in real terms for both industry groups.
Figure 3.4: PAYE Tax collected from the Hotel and Catering industry ( millions).
PAYE Tax Deducted from Hotels and Catering ( millions)
348.6
344.5
408.8
481.5
540.8
535.5
562.5
637.5
802.4
795.2
779.2
861.9
810
934.4
926.4
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
36
Figure 3.5: PAYE Tax collected in Distribution and Repairs industry ( millions).
Table 3.4: Employment in Tourism-related Sectors in the UK, September, 000's
Year Hotels and
other
accommod
ation
Restaurants
cafes, etc
Bars,
public
houses, etc
Travel
Agencies,
Tour
operators
Libraries,
museums,
etc
Sport &
other
recreation
Self
employed*
Total
1990 318.2 308.4 448.1 71.7 77.4 312.5 190 1726.3
1991 306.7 285.5 442 69.7 75.3 319.4 183 1681.6
1992 308.6 295.7 400 68.6 72.4 311.9 178 1635.2
1993 318.7 305.1 374.3 69.3 75.9 317.2 196 1656.5
1994 325.3 318.3 371.4 76 78.2 315.1 204 1688.3
1995 326.7 333.1 400.2 82.5 77.1 312.4 220.9 1752.9
1996 365.1 402.1 442.7 94.4 78.4 370.8 - 1753.5
1997 345.5 415.8 497.1 108.8 81.5 368.5 - 1817.2
1998 367.8 421.4 481.3 108.2 78.5 357.5 - 1814.7
1999 372.2 419.8 462.3 118.6 78.3 364.6 - 1815.8
Source: Compiled using data from Annual Abstract of Statistics.
Note: * From 1996, the number of self-employed was included in different sub-sectors. From 1996-99, the
numbers of self-employed (in 000s) in each year were 231.8, 228.1, 178.6 and 148.9 respectively.
PAYE Tax Deducted from Distribution and Repairs (millions)
2564.7
2703
2978.4
3531
3718
3927
4200
4675
5286.4
5516.7
5308.3
5678.4
6156
6891.2
6774.3
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
37
3 (v) Other Tourism Taxes
Apart from VAT, corporation tax and income taxes, a host of other taxes are applicable
to the tourism industry in the UK. Table 3.5 below summarises some types of taxes that
are applied to the tourism industry. For example, airlines are subject to taxes on aviation
fuel, import duties are paid on goods that originate from outside the European Union and
property taxes are levied on hotels and resorts. Although these taxes provide revenue for
the government, it is not clear whether they are efficient in terms of administrative and
collection costs. Further research on the cost effectiveness of each form of tax would be
useful.
Table 3.5: Taxes applicable to Tourism in the UK.
Type of tax directly charged to tourists Tax involved
Exit taxes Air Passenger Duty
Entry taxes Visa fees
Terminal charges Principally user charges
Consumption taxes VAT
Type of tax charged to user businesses Tax involved
Fuel Taxes on Aviation Fuel Petroleum Tax
Duty on imports of tourist equipment Import Duties
Property taxes directed at hotels and resorts Uniform Business Rate
Source: WTO, 1998.
3 (v) (i) Direct Charges to Tourists - Air Passenger Duty
Air Passenger Duty (also commonly, but inaccurately, known as Airport Tax or
Departure Tax) was introduced in the budget of November 1993 and came into effect on
1 October 1994. It is an excise duty, collected from airlines by HM Customs and
Excise. Airlines pay an amount of duty for each passenger whom they carry from UK
airports. The rate of duty depends on the passenger's final destination and was 5 for
passengers departing from any UK airport on a domestic flight or a flight elsewhere in
the European Union (EU) and 10 on long-haul flights terminating outside the EU.
Exemptions are permitted for transit passengers.
38
Governments have claimed that these charges are small. In 1996, Air Passenger Duty
(APD) doubled and the UK Chancellor of the Exchequer referred to it as a modest
increase. Following the increase, an analysis undertaken by British Airways observed
that traffic was adversely affected in five scheduled services to very different
destinations (WTO, 1998). It was announced in the budget for 2000/01 that the duty
will be brought back to the level that prevailed when it was initially introduced. In
particular, on economy flights within the European Economic Area (EEA) the duty will
be halved from 10 to 5 and from 20 to 10 to other countries as from April 2001.
Where passengers are not in the lowest class of travel on a flight, the duty will be 10
for flights to destinations within the UK and EEA, and 40 for flights to destinations
outside the UK or EEA.
Most airlines pass the duty charge on to passengers by increasing air fares but they do
not have to do so. It is estimated that the loss to British Airways, through taxes which it
fails to add to tickets amounts, on average, to between one and two per cent of total
ticket sales. The UK government makes more revenue from levying APD than British
Airways makes in operating profit from its world-wide activities. Thus, APD has been
an effective revenue-raising mechanism for the government, as is shown by Table 3.6,
which includes the total receipts from APD.
Table 3.6: Receipts from Air Passenger Duty.
Year Total Receipt
( millions)
1994 (Oct-Dec) 22
1995 331
1996 357
1997 411
1998 824
1999 875
2000 (Jan-July) 489
Source: Compiled using data from HM Custom and Excise Annual Report.
39
For the UK government, APD is also very attractive as it is the airlines that act as
collection agencies, which reduces the governments administrative and collection costs.
The government argues that the APD is levied on those best able to pay, such as
business travellers and the more affluent travellers who can afford air as opposed to
other forms of travel. However, this view is not entirely shared as it has been argued
that air travel is a no longer a luxury but has become a necessary means of transport.
Low cost air travel would benefit the younger generation who participate in education
and cultural exchanges. It was also argued that the level of APD resulted in a
considerable increase in the cost of package holidays and, notably, the tax burden on
relatively low-income families who wished to travel abroad. Following these
arguments, the government agreed to halve the current level of APD, commencing in
April 2001.
3 (v) (ii) Entry Clearance Fees (Visa Fees)
Entry clearance, more commonly known as visas, is the legal term used to describe the
application process for foreign and Commonwealth nationals who want to come to the
UK but who must show they qualify for entry before they arrive in the country. A visa
can be shown as granted by way of a vignette which is placed in a travel document,
usually a passport, and suitably endorsed. In 1999 one and a half million people applied
for a visa to come to the UK and 1.32 million visas were issued. The vast majority want
to make holiday and family visits. There are also business people, students and those
who apply for other purposes, such as for cultural purposes or medical treatment.
Visa fees constitute an arrival tax and act as a barrier to international travel. Different
countries levy different fees. For the UK, the entrance fee for a single entry visit for a
tourist is 33 but ranges from 20 to 240 depending on the category, as shown in Table
A2 in Appendix III. Travellers who need a visa often argue that the process for its
procurement is cumbersome and time consuming. In this respect the UK government
has set up a Joint Entry Clearance Unit which was launched in early June 2000 to take
over the management of the overseas entry clearance operation from the Foreign and
Commonwealth Office's Migration and Visa Division. The Unit has been set up as a
40
joint initiative by the Foreign and Commonwealth Office and the Home Office, as part
of the governments wider commitment to achieve more joined-up government. It
offers a one-stop-shop service designed to meet the objective of providing a fairer, faster
and firmer entry clearance process.
The governments objective is for the regulation of entry to the UK to be conducted in
the interests of social stability and economic growth. The Unit will explore ways of
integrating pre-entry controls with other parts of immigration control, help to develop
proposals for the use of information technology in support of this approach and look at
new ways of working to improve performance and service delivery in a cost-effective
manner.
The main findings from this section of the report are that:
There has been a switch in emphasis from direct to indirect taxes in the UK.
Value added tax and pay as you earn tax provide the major yields from tourism
taxation.
The yield from corporation tax is relatively low, owing to the small size and low
profit levels of most tourism businesses.
The figures for the yield from the Hotels and Catering sector under-estimate the true
contribution of tourism to tax receipts in the UK, since tourist expenditure is
distributed across a wide range of sectors of the economy, for example,
transportation and retailing.
Direct charges have also been important, notably Air Passenger Duty.
Further examination of the rates of taxation on tourism in the UK relative to other
countries will be undertaken in the following section of the report.
41
4. Tourism Taxation in the UK and other Countries
Section 2 of the report showed that the UK has experienced a fall in its share of
international tourism receipts and, furthermore, that there has been a decrease in the
value of receipts per tourist visit from a number of major origin countries. It could be
argued that the deterioration in the UKs market share is due to a fall in its price
competitiveness relative to other countries resulting, in part, from relatively high levels
of taxation. Therefore, it is useful to compare the amounts of tax that a tourist pays
when staying in different countries. This section of the report will examine:
The rates of Value Added Tax (VAT) that are charged in the UK relative to other
European countries.
The relationship between rates of VAT and nights spent in tourist accommodation.
4 (i) Value Added Tax in Europe
For many countries, VAT is the most significant tax on the tourism industry. The VAT
rates in the European Union vary across countries, not only in terms of the standard rates
applied but also on hospitality services. Member countries can deploy reduced rates
and apply such rates, if they choose, to tourist facilities. The VAT rates applicable in
tourism industry in sectors such as accommodation, restaurants, and bars and caf
services are shown in Table 4.1. As can be observed, only three states, Denmark,
Germany and the UK, still apply their standard VAT rate to the tourism industry.
Among the countries that have deployed reduced rates to the tourism-related sectors,
there appears to be widespread acceptance that reducing taxes on tourism services is
beneficial.
42
Table 4.1: VAT Rates in the Hospitality and Catering Sector in European
Countries, April 1998.
Rates in
General
Standard
VAT Rates
on Goods
Accommo-
dation in
Hotels
Restaurant Services Bars and Caf Services
and
Services
Restaurants Alcoholic
Beverages
Bars and
Cafs
Night
Clubs
Alcoholic
Beverages
Austria 20 10 10 20 10 10 20
Belgium 21 6 21 21 21 21 21
Denmark 25 25 25 25 25 25 25
Finland 22 8 22 22 22 22 22
France 20.6 5.5 20.6 20.6 20.6 20.6 20.6
Germany 16 16 16 16 16 16 16
Greece 18 8 8 18 8 8 18
Ireland 21 12.5 12.5 21 12.5 21 21
Italy 20 10 10/*20 luxe 10 10/*20 luxe 20 10
Luxembourg 15 3 3 3 3 3 3
Netherlands 17.5 6 6 17.5 6 6 17.5
Norway 23 0 23 23 23 23 23
Portugal 17 5 12 12 12 12 12
Spain 16 7 7 7 7 7 7
Sweden 25 12 25 25 25 25 25
Switzerland 6.5 3 6.5 6.5 6.5 6.5 6.5
UK 17.5 17.5 17.5 17.5 17.5 17.5 17.5
Source: HOTREC (1998).
The majority of tourism expenditure within destinations is spent on accommodation. As
Figure 4.1 shows, the rates of VAT on accommodation range from 3% to 25% in
Europe. With the exception of the three states mentioned above, all EU countries levy a
reduced VAT rate on hotels, at rates at least 50 per cent lower than the standard rate.
Although reduced rates of VAT are in place in most European countries, the differing
rates put many businesses in the tourism industry at a disadvantage relative to suppliers
in other countries where minimal or zero rates are levied. The Confederation of Hotels,
Restaurant and Cafs in Europe (HOTREC) has been lobbying for reduced VAT rates in
the sector and is also aiming to harmonise the VAT rates at a lower rather than higher
rate. Harmonisation of rates would decrease distortions in the tourism markets and
encourage fair competition.
43
Figure 4.1: VAT Rates on Hotels in Europe
Source: Compiled using data from HOTREC (1998).
It has been observed that in countries where VAT rates have remained high, the numbers
of nights spent in collective tourist accommodation have either fallen or grown very
little. Notable examples are the UK, Denmark and Germany, which have experienced
declines in their shares of international tourist arrivals in Europe. In contrast Norway,
where VAT on accommodation is zero, received the greatest percentage increase in
nights spent.
From the perspective of tourists and businesses, the UK is less competitive relative to
other countries, for example, France and Spain, where a preferential VAT rate applies to
the tourism sector. Outside the EU, countries such as Israel and Estonia have
implemented a VAT refund system, which includes the hospitality services, and all
foreign visitors paying in foreign currency are exempt from VAT. It has been argued
0
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VAT Rates on Hotel
44
that if the UK government wishes to increase tourist inflows and encourage tourists to
spend more nights in the country, a commitment to reduce VAT in this sector should be
undertaken.
A reduction in the rate of VAT in the hospitality and catering sector may not imply less
revenue for the government. In the case of Ireland, where VAT on hotels and
restaurants was halved in 1986, the tax yield doubled between 1984 and 1993 as a result
of the large increase in the number of businesses in this sector and in their volume of
business. The government earned more revenue despite lowering the rate. The
simulation results from the BTA (1998) study also indicate that the yield from VAT in
the UK could increase in the context of a reduction in the current rate of VAT in the
hospitality and catering sector. The proviso concerning these results is that the
correlation between the decrease in the rate of VAT and the increase in the tax yield may
not imply a causal relationship.
Examination of the rates of VAT in the UK relative to other countries indicates that:
The high rate of VAT in the UK appears to disadvantage businesses relative to their
competitors in most other European Union countries and in some non-EU countries.
The role of VAT on hotel accommodation in the UK is particularly high relative to
other European countries.
A decrease in the rate of VAT on tourism services could increase tourism demand so
long as the decrease in the rate of taxation is passed on to tourists in the form of
lower prices and, hence, results in an improvement in the price competitiveness of
the industry.
.
This issue of the likely effects of a decrease in the rate of VAT on the competitiveness of
the UK tourism industry will be considered further in Section 5 of the report.
45
4 (ii) Tourism Taxes in other Countries
Further indications of the competitiveness of the UK relative to other countries may be
obtained by comparing estimates of the total amounts of tax that tourists pay in the
different destinations. Calculation of the total amount of tax that a tourist pays is not
straightforward as, apart from some fixed charges such as arrival and departure taxes,
the total amount of tax paid depends on the number of days spent in the destination and
on the amount and types of expenditure. Estimates of the amounts that a traveller is
expected to contribute in the form of taxes in around 50 high-traffic city destinations are
provided by surveys undertaken for the World Travel and Tourism Council (WTTC).
Although approximate (since many travellers stay in destinations other than the cities
under consideration), the figures give a first estimate of the amount of tax being charged.
The weights for the hypothetical trip are constructed using data from Runzheimer
International and include purchases of four nights lodging, five days car rental, twelve
meals and one set of international arrival and departure travel taxes. Taxes imposed on
all of these purchases are identified and recorded. The amounts of tax paid for different
categories of expenditure in a range of destinations are included in Table 4.2.
Table 4.2: Tax Expenditure in City Destinations, Autumn 1999.
Country City Car
Rental
Tax
US$
Lodging
Tax
US$
Meal
Tax
US$
Air
Passenger
Tax
US$
Total
Tax
US$
%
of
Total
Cost
UK London 71.56 187.99 38.52 43.33 341.40 19
Italy Rome 142.55 73.77 28.67 8.35 253.34 15
USA New York 47.70 126.87 24.36 48.86 247.79 14
France Paris 67.90 56.75 46.02 15.10 185.77 12
Germany Frankfurt 30.53 111.96 26.88 15.16 184.33 16
Canada Montreal 40.27 51.01 17.22 16.78 125.28 18
Spain Madrid 49.35 41.15 13.54 7.27 111.31 10
Australia Sydney 3.57 69.14 0 21.14 93.85 8
Source: WTTC (1999).
46
The taxes on car rental, lodging, meal and air travel are shown in the table. The figures
indicate that, in dollar terms, tourists are taxed more highly in London than in the other
city destinations, both in absolute and relative terms. For example, a tourist is expected
to pay around US$340 as tax in London compared with US$110 in Madrid. According
to the WTTC, the percentage of the total bill devoted to taxes was 19% in London
compared with 10% in Madrid in autumn 1999. These estimates would, of course,
change if the weights for the hypothetical trip were altered. For example, most visitors
to London do not, in fact, hire a car so that it could be argued that the weight attributed
to car hire should be lower, resulting in a lower estimated tax burden for London. A
similar argument could be applied to other cities. Moreover, depreciation of sterling
relative to the dollar would also reduce the tax burden for London, in dollar terms. The
main item that increases the tourist tax burden in London is the accommodation
component, for which the tax component is high relative to other destinations.
Examination of the relative competitiveness of different destinations should also take
into account the changes over time in the rates of taxation on different categories of
expenditure. These changes in taxation on key items of tourist expenditure, relative to a
base year of 1994, are included in Table 4.3.
Table 4.3: Index of Tax, October 1999 (Base year 1994 = 100)
a
.
Country City Car
Rental
Tax
Lodging
Tax
Meal
Tax
Air
Passenger
Tax
Overall
Index
Value
UK London 125 100 100 200 112
Italy Rome 110 111 111 110 111
USA New York 100 67 100 156 85
France Paris 107 109 111 141 111
Germany Frankfurt 105 107 107 128 108
Canada Montreal 104 122 107 100 111
Spain Madrid 104 117 117 125 111
Australia Sydney 100
b
100 167
c
Source: WTTC, 1999.
Note:
a
Index < 100 = Tax Decrease; Index =100 = No Change; Index > 100 = Tax Increase.
b
In 1998 a new lodging tax of 10% was introduced.
c
Due to the introduction of the lodging tax the index computed was 578, which does not
appropriately reflect the overall tax increase.
47
The index numbers in Table 4.3 reflect the cumulative change in the amount of tax paid
in US dollars between June 1994 and October 1999, bearing in mind the provisos
concerning the weights that are attached to the different components of expenditure and
the exchange rates with the dollar. The figures indicate, for instance, the amount of tax
paid on accommodation in New York, in US dollars, has decreased by 33% since 1994.
In the UK, the introduction of the APD and a daily Road Tax/Vehicle Licensing Fee
increased the tax burden by 12%. However, the UKs rate of VAT remained at 17.5%,
explaining why the index on lodging and meals remained constant for the UK, and the
charges for Air Passenger Duty will fall from April 2001.
In Italy, there was a VAT increase of 1% on lodging and restaurants in 1995 and a 920
Lira increase in the International Embarkation Tax collected at Rome airport. The
embarkation tax was reduced from 15,000 Lira to 14,000 Lira at the beginning of 1999,
and was again raised to 15,500 Lira by the end of 1999. In 1999, a new road tax
affecting car rental rates was also introduced.
In New York, in 1990, a 5% occupancy tax was imposed on hotel room rates of over
US$100, in addition to other state and local government taxes. A continuous survey
was carried out during the four years when the tax was in effect, by the local and New
York State hotel associations. It was found that the 5% increase in room rates resulted
in a 2.5% decrease in demand. This resulted in lower revenues for hotel operators and,
therefore, lower tax revenues for the state. Consequently the occupancy tax, along with
a further hotel tax, was abolished in 1995. However, in 1997, the United States
increased several of its taxes on international passengers, affecting all US cities. The
changes included a US$6.00 increase in Transportation Tax (US$12.00 total), a new
US$12.00 Arrival Tax and the lowering of the Customs User Fee from US$6.50 to
US$5.00. In 1999, the United States increased both its International Transportation Tax
and International Arrival Tax to US$12.20.
In Paris, in 1995 a new nightly room tax of FF7.00 was introduced in addition to the
existing VAT of 5.50%. The standard VAT was increased from 18.60% to 20.60% in
1996. Between 1996 and 1999, there were some changes in the International Air
48
Passenger Service Charge. In 1996, it was increased from FF50.84 to FF52.87 and there
was a further increase to FF54.00 in the following year. In 1998, the Safety and Security
Charge in Paris was increased from FF21.00 to FF35.00 and an airport surcharge of
FF80.00 was charged on all car rentals. During the first half of 1999, both the Safety
and Security Charge and Air Passenger Service Charge were increased from FF35.00 to
FF39.00 and FF54.00 to FF61.00 respectively. In the second half of 1999, the
International Air Passenger Service Charge was reduced from FF61.00 to FF56.00. The
Safety and Security Charge was renamed as the Civil Aviation Tax.
In Frankfurt, the tax burden has increased since 1994, mainly due to the increases and
changes in the International Passenger Service Charge and VAT increase. In 1996,
Frankfurt increased its Airport Security Charge from DM 6.50 to DM 8.00 and its
International Passenger Service Charge (IPSC) from DM 17.50 to DM 19.00. In 1997,
the car rental fee was raised from DM 10.00 to DM 20.00 and the IPSC was further
increased to DM 20.00. In 1998, the IPSC was further raised by DM 0.50 and the
national VAT rate was increased from 15% to 16%. In 1999, the airport access fee was
changed from a flat DM 20.00 charge to a 6% tax computed on the base rental rate plus
time and mileage, up to a maximum of DM 50.00.
In the city of Montreal, the tax increase was mainly on lodging. For instance, a new
lodging tourist tax of C$2.00 per day was introduced in 1997 and in 1998, the lodging
tax was increased from 6.5% to 8%. The sales tax on meals and car rentals was also
increased from 6.5% to 7.5%. In 1995, the airport departure tax was increased by
C$2.50. In 1998, the Canadian Air Transportation Tax was reduced from C$27.60 to
C$15.00 and Montreal introduced a new Airport Improvement Fee of C$10.00.
In Madrid, the national consumption tax for car rentals, lodging, and restaurant meals
was raised by 1% in 1995. The tax rate on car rentals increased from 15% to 16%, while
the tax rate on lodging and restaurant meals increased from 6% to 7%. In 1997, a new
Airport Security Tax on international passengers was introduced at a rate of 175 pesetas
and in 1998, Spains International Departure Charge was increased from 927 to 985
pesetas. In Australia, in 1995, the departure tax was increased from AUS$20.00 to
AUS$27.00 and to AUS$30.00 in 1999. In 1996, a Noise Levy Tax of AUS$3.40 was
49
levied on all international passengers arriving at Sydney. Although proposals for a bed
tax had been rejected in 1994, owing to the possible adverse effects that the tax would
have had on hotel revenues, the wider tourism sector and employment, 1998 saw the
introduction of new lodging tax of 10%.
It is clear, therefore, that increases in tourism taxation are the norm. For example, at
least six of the countries raised their arrival/departure taxes. Increases in Air Passenger
Service charges, Safety and Security Charges, and road, transportation and car rental tax
were also implemented. In fact, the number of increases in tourism tax far exceeded the
number of tax cuts.
A number of comments and conclusions are relevant to the preceding discussion:
The UKs position at the top of the tourism tax ranking stems partly from the
appreciation of sterling relative to the US dollar.
It is not only the UK that has introduced increases in some types of tourism taxation;
all the countries considered have done so.
There has been no standardisation of increases across types of taxation or countries.
The tourism industries in different countries are not competing on a level playing
field.
International negotiations concerning competition in the service sector have taken place
under the auspices of the General Agreement on Trade in Services (GATS). However,
there is, as yet, no standardisation, even across regions such as the European Union.
Therefore the UK government must decide on the rates of tourism taxation that it will
implement within an internationally unregulated context. It is important that any
decision to introduce changes in taxation are taken in the light of knowledge about the
probable effects that they will have on tourism demand, revenue, the tax yield and the
incidence of taxation on tourists and businesses. These issues are examined in Section 5
of the report.
50
5. Measuring the Price Sensitivity of UK Tourism Demand,
Tourism Taxation and Competitiveness
Changes in prices, resulting from changes in taxation policy, have important effects on
tourism demand and the performance of the tourism industry, as well as induced effects
on income, foreign currency, fiscal revenue and employment. Hence, the degree of
responsiveness of tourism demand to changes in prices (taxes), i.e. the price elasticity of
tourism demand, becomes a key element for policy analysis. Estimation of price
elasticities has been undertaken at both micro and macro levels of analysis. While
surveys are the most common form at the micro level, regression analysis has been the
technique adopted at the macro level. This section of the report provides evidence about
the sensitivity of UK tourism demand to changes in price as follows:
Evidence from past studies of the UK and Ireland are presented and evaluated.
A model for estimating the price elasticities of tourism demand is presented.
The results of the model are presented, in particular, the value of the price elasticity
of tourism demand in the UK.
Additional supply-side evidence for the UK are provided.
The incidence of a change in taxation on tourism businesses and tourists are
considered in the light of the values of the price elasticities of demand and supply.
The use of fiscal policy as an incentive for investment in tourism is discussed.
5 (i) Empirical Evidence on Price/Tax Changes
Very few studies have been conducted to estimate how tourists in the UK react to
changes in prices or taxes, despite the fact that many parties have expressed views about
the likely effects of price increases (Frewin, 1998). Particular concerns were raised
when VAT was introduced and subsequently increased. It was found that the UKs
share of international tourism receipts started to deteriorate in 1980/81 when the rate of
VAT applicable to tourism and other services was increased from 8 per cent to 15 per
cent. The rate was further increased to 17.5 per cent in 1991. Up to the mid 1990s, there
51
was a gradual decline in the UKs share of international tourism receipts. The VAT
Working Group of the British Tourist Authority (BTA) indicated, in its preliminary
findings, that many tourism operators believe that the markets in which they compete are
price sensitive. It was claimed that high VAT rates in the UK place tourism businesses
at a disadvantage in relation to their European competitors. On the demand side, a
survey of consumers of tourism services in the UK and from overseas indicated that they
regard price as an important variable when choosing a holiday destination and that they
perceive the UK as either very expensive or quite expensive as a holiday destination.
The BTA subsequently carried out a further assessment of the economic effects of
changing VAT rates in the British tourism and leisure industry (BTA, 1998). The study
emphasises that VAT in the UK tourism sector is very high relative to the other
European Union (EU) member states, with the exception of Denmark. The VAT rate
applicable to visitor accommodation in the UK is more than twice the EU average. The
study examines the possible economic and fiscal effects of reductions in the rate of VAT
applicable to the tourism and leisure industry. A simulation exercise was performed and
some scenarios were modelled.
The study found that if the rate of VAT is reduced from 17.5 percent to 8 percent on
three major categories of tourism services (accommodation, meals out, and visitor
attractions and entertainment), there is an annual loss in VAT receipts of approximately
2.9 billion. This is counterbalanced by gains in income and corporation tax and savings
in social security payments, resulting from over 100,000 new jobs. The indirect fiscal
gains amount to around 1.2 billion and do not offset the direct reduction in VAT.
However, there are considerable positive additional economic effects. This scenario also
indicates that expenditure on tourism services will increase by approximately 4.1
billion per annum by the fourth year after the reduction in VAT. It was found that there
is a net fiscal gain in the fourth year of 419 million for the Exchequer if VAT is only
reduced on accommodation, but a net loss of 186 million if VAT is reduced on all
tourism services. In both fiscal and economic terms, the simulations indicate that there
is a case for reducing VAT on all tourism services but in fiscal terms alone, a reduction
on the accommodation sector is likely to represent a more cost effective option.
52
It was argued that reducing the tax rates will not only be financially beneficial to
businesses but will also generate employment opportunities. An example is the Irish
case where VAT in the mid-1980s was halved on visitor accommodation and restaurant
meals. Overseas visitors to Ireland increased from 1.9 million in 1986 following this
measure, to 3.1 million in 1990. Between 1986 and 1990 around 30,000 jobs were
created and foreign currency earnings increased by 50 per cent in real terms. Tax
receipts from overseas tourism, which were 254m when VAT was levied at the
standard rate on tourism, rose to 818m in 1996 when VAT had fallen to 12.5%.
Reducing or removing taxes is a delicate issue, which has to be addressed in an
intelligent way, and policy decisions should be based on proper research work.
Although the case of Ireland depicts a situation where a reduction in the rate of the VAT
was followed by significant positive results, it does not necessarily follow that the
reduction in VAT has caused them; i.e. correlation does not presuppose causation. No
government should undertake tax changes without a proper assessment of its possible
impact. In fact, referring back to the Ireland case, prior to 1987, the tourism sector was
achieving low levels of growth (not more than 2%). The reasons were many, including a
lack of investment in new products and low levels of marketing expenditure. Other
barriers to growth of the sector included the industrys underdeveloped state, inadequate
product quality and range, price and marketing problems, access difficulties to
peripheral island locations, the cost of transportation and some irregularity of service.
Some of these problems were addressed after 1987 and since then, with the help of
funding from the EU, progress in tourism has been dramatic. Ireland has outperformed
every country in Europe, consistently achieving annual tourism growth rates far above
the international average. These indicate that tourism development is stimulated not
only by changes in fiscal policy but also by the introduction of measures to overcome
additional barriers to development.
Other studies have tried to assess the sensitivity of tourism demand to rises in prices. For
example, respondents in a survey were asked to predict the percentage changes in
attendance if prices of attractions were increased or decreased by 10% and 20%
respectively on tourist attractions (Rogers, 1995). Forty-five per cent of the respondents
were unable to make any prediction of the likely impact on visitor numbers, while 24%
53
believed that there would be no change, the remaining 31% perceived demand as
inelastic. On the other hand, in the BTA (1998) study, most of the tourism and leisure
operators surveyed believed that the markets in which they compete are very price
sensitive. Almost two-thirds thought that customer numbers would rise by more than
10% if prices were cut by 10%. The results of these surveys provide no consensus
about the price sensitivity of demand in the tourism industry; while the former suggests
that it is inelastic, the latter suggests that it is elastic. This is not surprising given the
methods by which the estimates were obtained. Overall, it is clear that:
There is a lack of firm evidence about the degree of price sensitivity of the demand
for UK tourism and the question of whether tourists will travel elsewhere when faced
with higher VAT and other tourism taxes remains unresolved.
There is a need for further quantitative information about how tourists respond to
changes in prices, taxes and exchange rates.
5 (ii) An Econometric Model of UK Tourism Demand
This part of the report is concerned with specifying the model that will be used to
measure the sensitivity (elasticity) of tourism demand in the UK to changes in prices,
exchange rates and expenditure. The studies of tourism demand that have been carried
out to date have focused on destinations other than the UK. The survey studies that have
been carried out take into account only a small proportion of the population and may
give biased estimates, while results from simulation studies are vulnerable to slight
changes in the underlying assumptions. It is important that elasticity estimates should be
based on economic models with a sound theoretical framework. The elasticity of
demand for tourism in the UK can be estimated using an econometric model, commonly
known as the gravity model, which has a sound theoretical background
1
(Durbarry,
2000). The analysis of overseas tourists expenditures in the UK is undertaken at an
aggregate level, and the results are useful for policy formulation regarding taxation. The
model is particularly relevant as it considers tourist expenditure from different origins.

1
The model has also been used to explain international trade flows. For a theoretical exposure see
Bergstrand (1987,1989), Deardoff (1995), Gagnon (1993), and Oguledo and MacPhee (1994).
54
The general specification of the gravity model takes the following form (see Mtys,
1998):
Y
ijt
=
i
+
j
+
t
+
1
X
ijt
+
2

*
X
it
+
3

* *
X
jt
+. + u
ijt
where Y
ijt
is the dependent variable (e.g. volume of expenditure by country i in country j
at time t); X
ijt
are explanatory variables with variation in all three dimension i, j and t
(e.g. exchange rate);
*
X
it
are explanatory variables with variation in dimensions i and t
(e.g. GDP);
* *
X
jt
are explanatory variables with variation in the dimensions j and t;
i
is
the local country effect,
j
is the target country effect,
t
is the time effect and u
ijt
is a
white noise disturbance term. When estimating the model, the specific effects (,

and
) can be treated as random variables (error components approach) or fixed parameters
(fixed effects approach). Although Hausmans (1978) chi-squared statistics can be used
to infer whether the Generalised Least Squares estimator is an appropriate alternative to
the Least Squares Dummy Variable (LSDV) estimator (see Greene, 1993 or Judge, et
al., 1985), the choice of the model should rest on the purpose for which the model is
used and economic propositions. The use of random effects and fixed effects models in a
gravity model give different results (Mtys, 1997); it is not only the signs of the
coefficients that differ, but also their magnitude. Hence care must be taken in selecting
the appropriate estimation technique.
Time series studies, the prevailing methodological approach for estimating tourism
demand, have been subject to criticism in that the results might have been spurious in the
presence of nonstationary data leading to biased and inconsistent estimates. Some
studies have, instead, relied on pooled and cross-sectional data. The models involve
regressing tourism demand on a range of variables that are thought to influence demand,
for example, income per capita, exchange rates, tourism prices in the destination,
tourism prices in substitute destinations, advertising expenditure, transport costs and
dummy variables for one-off events. The results have indicated the need for careful
pricing in certain areas. It has been found, for instance, that the demand elasticities for
lodging are more price sensitive than previously assumed (see for example Arbel and
Ravid, 1983a, 1983b; Fujii, Khaled and Mak, 1985; and Sakai, 1985). A summary of
estimated price elasticity values for various destinations from previous studies can be
found in Sinclair (1998).
55
We model the demand for tourism in the UK for a set of countries using the more recent
panel data approach and specify the following panel setting in log form:
Model 1:
Ln EXP
UKjt
=
0
+
j
+
t
+
1
Ln Y
UKt
+
2
Ln Y
jt
+
3
Ln DIST
UKj
+
4
Ln PRICE
UKjt
+
5
Ln P
jt
+
6
Ln EXCH
UKjt
+ u
UKjt
where EXP
UKjt
is the tourism expenditure of origin country j (j = 1 to 11) in the UK at
time t (t = 1968 to 1998). Tourism expenditure is generally considered as being a more
appropriate variable for measuring tourism demand rather than the number of tourist
arrivals. For policy purposes the amount of money tourists spend is often more
important than the number of arrivals, as increasing flows of tourists do not necessarily
imply increasing revenue. Y
UK
and Y
j
are the incomes of the UK and country j
respectively. Y
UK
in the model represents the attraction capacity of the destination and is
associated with the supply capacity of the country, while Y
j
is the generation capacity
and is a demand determining factor. DIST
UKj
in the model is the distance between UK
and j, and in trade models it is usually maintained that countries tend to trade more with
neighbouring countries. In our model the interpretation is similar and the variable also
proxies for the cost of travel. The cost of travel is not easily quantifiable, as the costs
involved could include air fare, other transport costs or travelling time in terms of hours,
so that we can reasonably assume that cost is a function of distance.
The decision to select a particular destination is similar to the demand for goods, in that
it depends on prices in that destination. Hence tourists choose a particular destination
by, among other things, comparing prices in alternative destinations and two sets of
prices become of particular importance for the tourists in making a decision:
(i) The price of tourism in the destination relative to their domestic price, which we
define as:
Ln PRICE
UKjt
= Ln
jt
UKt
CPI
CPI
where CPI
UK
(
j
) is the consumer price index in UK (
j
). This price variable gives the
relative price of tourism and influences the decision of the tourists in deciding whether
56
to travel to the UK as a destination or to stay at home. It also characterises the cost of
living between the two countries.
(ii) In trade models, the gravity model indicates that prices in other countries also have
an impact on the trade flows between two countries. Similarly, in the context of tourism,
the price of tourism in other potential destinations is another variable that influences the
decision to travel and how much to spend in a particular destination. This price can be
regarded as the price of substitutes available to origin j. Given that the potential traveller
has a range of countries from which to select, we define this price as the effective price
of competing destinations, given by:
Ln P
jt
= Ln
} {
base , UK
t t
t
E x CPI
E x CPI
x
where x
t
is a weight and is the proportion of tourists visiting destination from country
j at time t, where = 1,N excluding the UK. E
is the exchange rate between and

UK, and E
,base
is the exchange rate in the base year. This substitute price index to origin
j is expected to be positive in that an increase in this price will lead to an increase in
tourism expenditure in the UK.
The generalised gravity model also includes an exchange rate variable. In tourism, the
exchange rate is regarded as the price of tourism in the sense that tourists may be more
aware of the value of their currency in terms of other currencies than prices in the
destinations. We therefore define EXCH
UKj
in the model as the exchange rate between
country j and the UK, deflated by the base year. This variable also captures the cost of
living for tourists, as explained earlier. It is expected that appreciation of the
destinations currency will lead to a fall in demand for tourism. The way the exchange
rate is defined implies that an increase in the exchange rate is equivalent to a
depreciation of the sterling.
The way that Model 1 has been specified provides variables that account for own
tourism-prices, ln PRICE
UKjt
and ln EXCH
UKjt
. These two prices can be combined to
give the effective price of tourism as follows:
57
Ln P
UKjt
= Ln
jt jt
jbase
UKt
E x CPI
E x CPI
where E
j
is the price of js currency unit in terms of sterling (i.e. /j
th
currency unit) and
E
jbase
is the exchange rate of j in the base year. This price makes adjustments for
differences in the exchange rate in the relative price and hence, adjusts for purchasing
power parity. In this context we re-specify the model as follows:
Model 2:
Ln EXP
UKjt
=
0
+
j
+
t
+
1
Ln Y
UKt
+
2
Ln Y
jt
+
3
Ln DIST
UKj
+
4
Ln P
UKjt
+
5
Ln
P
jt
+ u
UKjt
For econometric purposes, in the above panel setting we can reasonably treat the specific
effects as random variables and use the Feasible Generalised Least Squares (FGLS)
estimation method. This is because, first, the sample of countries in the study does not
exhaust the population so that it would be preferable to take these effects as non-
observable random variables, and second, the presence of some size variables (for
example, distance, GDP
j
) would give rise to the statistical problem of heteroscedasticity.
Hence the use of the FGLS would generate more efficient estimators than the LSDV
technique.
5 (iii) Results: Price Sensitivities of Tourism Demand
This part of the report is concerned with the results that were provided by the model of
tourism demand in the UK. The 11 countries specified in Section 2 were used to model
the UKs inbound tourism for the period 1968-1998 for the panel estimation. These are
the USA, France, Germany, Ireland, the Netherlands, Belgium, Italy, Spain, Switzerland,
Japan and Australia. The data for the model were obtained from the International
Financial Statistics CD-ROM, Business Monitor MA6, Overseas Travel and Tourism
(1970-1993) and Travel Trends (1994-1998). The distance variable was obtained from
Haveman (1999). Regarding the computation of the substitute price index for origin j, ln
P
jt
, data to compute x
t
were not available for the time period.
58
Consequently, only the five most visited countries apart from the UK were selected in
the year 1998 to compute the index. The estimates of the above model using the
Feasible Generalised Least Squares method are presented in Table 5.1.
Table 5.1: Panel Results using FGLS: Dependent variable is Ln EXP
ukjt
.
Independent Variables Model
1
Model
2
Constant -21.6982
(2.479)***
-18.8645
(2.266)***
LnY
Ukt
0.8573
(0.147)***
0.7824
(0.132)***
Ln Y
jt
0.5981
(0.122)***
0.6518
(0.110)***
Ln DIST
Ukj
-0.2135
(0.429)
-0.2815
(0.384)
Ln PRICE
Ukjt
-0.5968
(0.175)***
Ln P
Ukjt
-0.9895
(0.317)***
Ln P
jt
0.9963
(0.318)***
1.0006
(0.317)***
Ln EXCH
Ukjt
0.5159
(0.152)***
OLS Adjusted R
2
0.80567 0.80623
LM Test 2253 2418
Hausman Test Statistic
[
2
critical value at 5%]
11.71
[12.59]
9.10
[11.07]
Note: Standard error in parentheses. ***, ** and * indicate significant at the 1%, 5% and 10% level.
The OLS R
2
is reported as a more approximation of the goodness of fit. Note that in using the Feasible
GLS, the R
2
no longer has its usual interpretation (see Judge et al., 1985, pp 31).
59
While the Lagrange Multiplier Tests (LM) suggest that individual effects are present in
both models, the Hausman test statistics favour the use of the FGLS over the LSDV,
suggesting that the errors are not correlated with the explanatory variables. In Model 1,
the parameter estimates are consistent with our expectations. The income variables are
in line with the findings of trade flows gravity models in that both the attraction and
generation capacity variables have positive and significant impacts. The generation
capacity (demand) variable implies that a 1% increase in the income of the origin
countries will increase total expenditure by 0.6%, ceteris paribus. Although the distance
variable is negative, it is not significant at the conventional level.
The price competitiveness of the UK as a destination is measured by the price variables
Ln PRICE
UKjt
, Ln EXCH
UKjt
and Ln P
UKjt
, which are of particular interest to policy
makers. They are also consistent with theoretical expectations. Considering Model 1,
when the price of tourism and exchange rate are used as separate variables, ceteris
paribus, they suggest that an increase in the relative price level or an appreciation of
sterling by 1% decreases tourists' expenditure by 0.6% and 0.5% respectively. The
magnitude of both the coefficients of these variables is almost the same. Tourists are
concerned with the effective price of tourism, which takes into account the price level
and the purchasing power of the tourist, and so the effective price of tourism is
considered in Model 2. Model 2 performs better in terms of goodness of fit and we also
perform a test of structural stability
2
.
The parameter estimate of the effective price variable, Ln P
UKjt
, is highly significant and
has a value of around unity. This suggests that tourism expenditure has unitary price
elasticity and is sensitive to price changes. In fact, any increase in the effective price
(for example, due to an increase in tax on tourism activities in the UK) will result to a
significant loss in terms of revenue from tourism.

2
From an econometric point of view, the way the model is specified assumes that the parameters are
stable and the same for all the j countries. Mtys (1998) pointed out that although this has been a
maintained hypothesis in all previous applications of the gravity model, none of the researchers bothered
to actually test it. To test whether can be assumed to be stable for all the j countries, Mtys (1998)
suggested the use of an F-test by generalising the Chow test (Chow, 1960) and the poolability tests used
for panel data (Baltagi, 1995). Under the null hypothesis all parameters are stable. Using the F-test
60
Both models not only highlight the pricing policy in the UK relative to the tourists
country of origin, but also supply evidence about pricing policies in competing
destinations. It was pointed out earlier that the VAT rates in Europe vary considerably.
Let us assume, for example, that the VAT rate changes in one country but remains the
same elsewhere. This policy action is bound to impact not only on the country effecting
the change but on other countries as well. How tourism demand will be affected depends
on the degree of responsiveness, i.e. its elasticity. The price elasticity of tourism
demand in the UK due to price changes in competing destinations is given by the
coefficient of Ln P
jt
. The coefficient is positive and highly significant in both models
and has a value around unity. This implies, for instance, that holding all other variables
constant, a decrease of 1% in the UK VAT rate applicable to the tourism sector will lead
to a proportionate increase in tourism expenditure in the UK. It is assumed that that the
decrease in VAT in the UK is passed on in the form of a decrease in prices and that there
is no change in the VAT policy of competing destinations. This highlights the
importance of monitoring closely prices (taxes) in competing destinations when
formulating pricing policies in order to remain competitive.
The main results from this section of the report are that:
The demand for tourism in the UK is sensitive to changes in prices.
An increase of 1% in effective prices in the UK relative to the origin countries under
consideration (changes in the rate of inflation and the exchange rate of the UK
relative to other countries) would lead to a decrease in tourism expenditure in the UK
of around 1%.
An increase of 1% in effective prices in the UK relative to competing tourist
destination countries would lead to a decrease in tourism expenditure in the UK of
around 1%.

described in Mtys (1998), we obtained an F value of 0.09798, which is insignificant at the conventional
level, indicating that the relationship for all the j (visiting) countries is stable.
61
The results relate to the demand for tourism in the UK by tourists from overseas, in
aggregate, and are consistent with the reports aim to examine the overall effects of
tourism taxation in the UK and its focus on overseas tourism. Clearly, effective price
elasticity values vary between different origin countries and market segments, for
instance, leisure, business or visits to friends and relatives. Policies that are concerned
with domestic tourism, individual country markets or different market segments should
have recourse to price and expenditure elasticity values that are specific to domestic
tourism, individual countries and market segments. Further research to estimate these
values would be useful.
5 (iv) The Incidence of Tourism Taxation on Tourists and Businesses
This sub-section of the report will discuss the likely incidence of tourism taxation on
businesses and tourists. The results from the econometric model showed that increases
in prices in the UK relative to other countries are likely to result in significant decreases
in the demand for UK tourism. These, in turn, generate associated falls in the levels of
income and employment not only in those sectors of economic activity that cater directly
for tourists but also in other sectors of the economy, via multiplier and accelerator
effects. Hence, there is a strong case for UK policy-makers to prevent a deterioration in
the price competitiveness of the UK and, further, to consider measures that might
improve it.
The level of tourism taxation is of particular relevance in this context as tax rises (falls)
can contribute to falls (rises) in competitiveness, and consequent decreases (increases) in
tourism demand. However, knowledge of the extent to which changes in taxation are
likely to result in price changes is also important. For example, in some cases, the major
proportion of changes in taxation is passed on to tourists in the form of a change in
prices but, in others, the major burden of the tax changes is borne by businesses in the
form of a change in profits. The issue of the distribution of tax changes between
consumers and businesses is known as tax incidence.
62
Knowledge of the likely incidence of tourism taxation should underpin taxation policy
for tourism. The example of a value added tax on hotel bednights may be used to
illustrate the incidence of taxation. The effects of the bednight tax are to increase the
price paid by tourists, to decrease the volume of sales and to decrease the net price
received by hotel operators, assuming that neither tourists nor hotel operators bear the
entire tax burden. It has been shown that, under competitive conditions, the ratio of the
change in the price paid by tourists, P
t ,
to the net change in price received by hotel
operators, P
h
, approximates the ratio of the price elasticity of supply,
S,
to the price
elasticity of demand,
D
(Fujii et al., 1985). Thus:
The terms
S
and
D
refer to the responsiveness of supply and demand, respectively, to a
change in price. If
S
is high relative to
D
, tourists pay the majority of the tax.
Conversely, if
D
is high relative to
S
, hotel operators bear the major burden of the tax.
Under monopolistically competitive conditions, which apply when hotels have very
distinct characteristics and demand is inelastic with respect to a change in price, hotel
operators can pass a greater share of the tax on to tourists (Fish, 1982).
The incidence of a tax on hotel accommodation is illustrated in Figures 5.1 to 5.4. The
demand curves are the same in Figures 5.1 and 5.2, to facilitate comparison of the effects
of the tax when supply is more or less elastic with respect to a change in price. The price
elasticity of the supply is elastic (supply is highly responsive to a change in price) in
Figure 5.1. In contrast, the price elasticity of supply is inelastic in Figure 5.2. In both
cases, a tax equal to the value T is imposed, raising the supply curve from S
1
S
1
to
S
1
'S
1
' in Figure 5.1 and from

S
2
S
2
to S
2
'S
2
' in Figure 5.2. It can be seen that the price
paid by tourists increases from P to P
1
' in Figure 5.1 and by the lower amount from P
to P
2
' in Figure 5.2. Tourism demand falls from Q to Q
1
' in Figure 5.1 and from Q to
Q
2
' in Figure 5.2. The price, net of tax, received by hotel operators is P
1
'' in Figure 5.1.
The decrease from P to is P
1
'' is small compared with the considerably larger decrease
from P to P
2
'' in Figure 5.2. Hence, hotel operators bear a larger share of the tax
burden in the case when supply is inelastic (Figure 5.2) than when supply is elastic
D
S
h
t
P
P
63
(Figure 5.1). Conversely, tourists bear a larger share of the tax burden when supply is
elastic, ceteris paribus (Figure 5.1).
Figure 5.1: Tax Incidence in the Case of Price Elastic Supply of Hotel
Accommodation
denotes incidence of tax on tourists
denotes incidence of tax on hotel operators
P
P
1
'
T
S
1
S
1
Price
Quantity 0
S
1
'
D
D
Q
1
' Q
P
1
''
S
1
'
Figure 5.2: Tax Incidence in the Case of Price Inelastic Supply of Hotel
Accommodation
Q
2
'
P
2
'
S2
S
2
'
T
P
S
2
Price
Quantity 0
S2'
D
D
Q
P2''
64
Figure 5.3: Tax Incidence in the Case of Price Elastic Demand for Hotel
Accommodation.
P
1
'
P
T
S
S
Price
Quantity 0
S
1
D
1
D
1
Q
1
' Q
P
1
''
S
1
Figure 5.4: Tax Incidence in the Case of Price Inelastic Demand for Hotel
Accommodation.
Q2'
P2'
P
T
S
S
Price
Quantity
0
S
1
D2
D2
Q
P2'' S
1
65
The effects of a tax in the case of differences in the elasticity of demand to a change in
price is illustrated in Figures 5.3 and 5.4. In this case, the responsiveness of supply to
price changes is held constant, to facilitate comparison. A tax equal to the value T is
imposed, raising the supply curve from SS to S'S' in both figures. It can be seen that
the price paid by tourists increases from P to P
1
' in Figure 5.3 and by the greater
amount from P to P
2
' in Figure 5.4. Tourism demand falls from Q to Q
1
' in Figure 5.3
and from only Q to Q
2
' in Figure 5.4. The price, net of tax, received by hotel operators
is P
1
'' in Figure 5.3. The decrease from P to is P
1
'' is large compared with the
considerably smaller decrease from P to P
2
'' in Figure 5.4. Hence, hotel operators bear
a larger share of the tax burden in the case when demand is elastic (Figure 5.3) than
when demand is inelastic (Figure 5.4). Conversely, tourists bear a smaller share of the
tax burden when demand is elastic, ceteris paribus (Figure 5.3).
The question is, therefore, what are the values of the elasticities of supply and demand
for the case of the UK and under what conditions (for example, competitive or
monopolistically competitive) do producers compete? Information about the value of
the price elasticity of demand,
D
, was provided by the econometric model, where it was
shown that the relevant value approximates to unity. Knowledge of the value of the
price elasticity of supply,
S
, is problematic owing to the complex nature of tourism
supply, which encompasses a wide range of services. In general, such services as
restaurants, public houses, foreign currency exchanges and retail outlets have the
capacity to cater for additional demand, i.e. the elasticity of supply is high. This
argument is supported by the fact that areas of increasing tourist demand tend to be
characterised by the growth of new businesses shops, cafes and other services that
cater for tourists. Therefore, the main issue relating to the price elasticity of supply of
tourism within the UK concerns the ability of the accommodation sector to meet
additional demand. Occupancy rates provide a good indicator of capacity availability in
the accommodation sector. The occupancy rates for tourism establishments in the UK
and some other European countries are given in Table 5.2.
66
Table 5.2: Occupancy Rates and VAT in Tourism Establishments.
Country UK Denmark Germany France Spain Ireland Greece
Year Occupancy Rates
1993 39 34.4 36.6 33.9 52.5 58 56.77
1994 43 35.4 34.7 50.2 58.43 58 60.63
1995 44 35.5 33.9 49.5 60.7 65 56.62
1996 N/A. 37.4 33 50.3 59.6 62 54.37
1997 44 37.8 34.9 53.5 61.73 65 58.37
1998 44 39.8 35.2 55.6 63.55 63 61.55
VAT Rates
Standard VAT %
17.5 25 16 20.6 16 21 18
VAT on Accommodation %
17.5 25 16 5.5 7 12.5 8
Source: Compiled using data from WTO (2000) and HOTREC (1998).
The occupancy rates in Table 5.2 show the relationship between available capacity (beds
or rooms) and the extent to which it is used. Occupancy rates are based on the number
of nights that both domestic and international tourists spend in the establishment (WTO,
2000). In the case of the UK, between 1993 and 1998, occupancy rates were relatively
low, varying between 39% and 44%. This suggests that, overall, there is excess capacity
in the accommodation sector, although there may be some constraints in particular
categories of establishment during peak periods.
The preceding discussion indicates that although the elasticity of tourism supply in the
UK is not infinite, it is, nonetheless, very high. When considered in conjunction with
the unitary elasticity of demand, the value of the ratio of the supply and demand
elasticities is likely to be high. Hence, for those categories of accommodation which are
both similar and highly price competitive, the majority of an increase in the tax burden is
likely to be paid by tourists. Furthermore, given the significant, unitary value of the
price elasticity of demand, any increase in tourism taxation is likely to result in a
considerable decrease in demand. Conversely, a decrease in taxation would result in a
considerable increase in demand, so long as the decrease is passed on to tourists in the
67
form of a fall in prices rather than being absorbed in the form of an increase in profits.
However, hotel operators who supply accommodation with characteristics that are
distinct from those of potential competitors, and/or who have a local monopoly over
the particular type of accommodation in specific areas of the country, tend to hear a
greater share of an increase in tax. Conversely, they would experience a greater share of
a decrease in tax in the form of an increase in profits.
It is interesting to note the inverse relationship between accommodation occupancy rates
and the rates of VAT in the European countries included in Table 5.2. For instance, the
UK, Denmark and Germany have occupancy rates of less than 50 per cent compared
with Ireland and Spain, which have rates above 60 per cent. Although no study has
tested for causality rather than simple correlation in the relationship between occupancy
rates and VAT, the low occupancy rates in countries where the standard VAT rate is
applicable to accommodation suggest an additional argument for a reduction in the VAT
rate applicable to the tourism industry. This evidence relates to the national level and
further information pertaining to different areas within countries would be useful.
A number of provisos should also be added. First, occupancy rates vary between season
and location. In peak periods, occupancy rates are higher, so that the price elasticity of
supply is lower as hotel operators have only limited ability to provide additional
accommodation for tourists and to pass the tax on to them. Hence, the ratio of the price
elasticity of supply to the price elasticity of demand is lower and the burden of taxation
switches away from tourists and towards hotel operators. Therefore, during peak
periods, hotel operators are particularly affected by increases in taxation or, conversely,
would experience particular gains from any reductions in taxation.
A similar argument applies to categories of accommodation for which the supply is
limited in specific areas of the country, for example, in London (Page and Sinclair,
1989). In such areas, the incidence of the taxation on the operators supplying the scarce
type of accommodation is likely to be higher, and on tourists lower, than in other areas.
It follows that a decrease in taxation would have relatively little effect in stimulating
tourism demand in areas of high tourist concentration, as the main beneficiaries of the
tax cut would be the accommodation operators. However, the tax cut could be more
68
effective in encouraging tourists to visit areas of the country where the supply of
accommodation is more price elastic, in accordance with the governments objectives of
diversifying tourism demand across the UK regions.
5 (v) Investment Incentives for Tourism
It should be noted that higher value added tax may act as a disincentive to the supply of
tourism services under monopolistically competitive conditions when businesses bear
the major burden of the tax. Conversely, a decrease in taxation might serve to stimulate
supply in areas of the country that could benefit from an increase in tourism businesses.
However, although changes in the rate of VAT may stimulate supply, they may not be
the most effective means of doing so. It can be argued that a lump sum subsidy can be
particularly effective in increasing profitability, following the work of Fish (1982), who
showed that a lump sum tax can result in losses for hotel operators. The argument
accords with the findings of Wanhill (1986), who examined alternative policies for
stimulating investment in tourism and demonstrated that lump sum grants were most
effective.
Wanhills results hinge on the question of whether incentives for investment in tourism
should be used to reduce the operating or capital costs of the business. The volatility of
profits (or financial risk) depends on the operating leverage of the business and, hence,
on the ratio between the fixed and variable costs. The effects of allocating a lump sum
grant to the business were compared with those of a tax holiday or a flat rate subsidy per
unit of sales. It was found that the provision of a lump sum grant, to reduce the fixed
capital costs at the start of the business, resulted in a greater reduction in the risk
associated with losses than did the other two types of incentives. For businesses with
relatively high ratios of fixed to variable costs, the provision of lump sum grants to
reduce capital costs during the start-up phase of the business would appear to be more
effective in stimulating investment than tax holidays or subsidies which reduce operating
costs.
69
The Hotel Development Incentive Scheme is one example of a policy designed to reduce
the capital costs of tourism investment. It was generally regarded as an effective means
of stimulating hotel construction and expansion in England during the 1970s (Clarke,
1976; Goodall, 1992). A further example is the case of the Canary Islands, where the
government operated a policy of freeing profits from taxation on condition that the
profits were invested in hotel building. This policy resulted in a huge expansion in
construction. A moratorium on new building was subsequently introduced and the tax
incentive was transferred to investment in existing buildings. This is an interesting
example of the way in which a tax incentive scheme was so effective as to result in a
level of construction that was viewed as excessive.
Another case is that of the tax holiday schemes that have operated in a number of
developing countries. In the Caribbean, for instance, tax holidays were effective in
stimulating some additional investment in hotels. However, it has been argued that
much of the investment would have taken place with lower or even zero incentives, so
that the effect of the incentives was to transfer income abroad, in the case of foreign-
owned hotels, or to redistribute income within the country in the case of investment by
local residents (Bryden, 1973). The range of findings about investment incentives are
relevant to areas of the UK that are relatively underdeveloped in terms of tourism and
where policy-makers wish to stimulate investment.
The final sub-sections of the report have shown that:
The occupancy rates of tourism establishments in the UK are low relative to a
number of other European countries.
The incidence on tourists of a change in tourism taxation is likely to be high under
conditions where occupancy rates are low, the characteristics of accommodation are
similar and price competition is high.
The incidence on tourists of a change in tourism taxation is also likely to be high
under conditions where the characteristics of accommodation are distinct and
demand is more inelastic.
70
A decrease in taxation is likely to result in a significant improvement in price
competitiveness and an increase in tourist expenditure when hotel accommodation is
more uniform, there are no constraints on supply and the tax decrease is passed on in
the form of lower prices.
In areas where hotels are more dissimilar, producers rely more on competition via
product differentiation and the incidence of a decrease in taxation on tourists is likely
to be lower when demand is more inelastic with respect to a change in price.
As occupancy rates vary by category of accommodation and area of the UK, the
incidence of a change in tourism taxation and the associated change in price
competitiveness will also vary.
Fiscal policy can be used as an incentive for tourism investment, for example lump
sum grants to reduce capital costs during the initial phase of investment.
71
6. Conclusions
This report has examined the nature, size and possible effects of tourism taxation in the
context of the problems experienced by the UK tourism industry. In particular, the report
has concentrated on providing econometric evidence concerning the sensitivity of
tourism demand to changes in prices, brought about by changes in taxation among other
causes, and has discussed the likely incidence of tourism taxation on tourists and on the
businesses that meet the tourists needs. It has been seen that:
Tourism remains a major source of income, employment, foreign currency earnings
and tax revenue.
However, the UKs share of the tourism market has been decreasing over time.
The real value of foreign currency receipts by the UK from tourism has experienced
low growth.
There has been a decrease in the real value of receipts per tourist visit for key origin
countries.
The UK could be achieving greater benefits from the sector than is currently the
case.
There is potential for deriving a greater amount of fiscal revenue from tourism, for
instance, by reducing the rate of VAT on accommodation, thereby increasing
tourism demand and receipts from other forms of taxation.
The UK has been experiencing problems in terms of the price competitiveness of the
tourism industry:
The tourism price index has increased faster than the consumer price index.
The exchange rate for sterling appreciated considerably during the late 1990s.
Tourism businesses in the UK, notably accommodation operators, are subject to a
higher rate of value added tax than most of their European competitors.
72
The main types of tourism taxation considered in the report are VAT, corporation tax,
PAYE, Air Passenger Duty and visa fees, amongst the range of taxes that confront
businesses in the sector. The report showed that:
The UK has not been alone in raising the number and level of many tourism taxes.
International comparisons have shown that increases in taxation are more common
than reductions.
The shift of emphasis in the UK from corporation tax to VAT has not resolved the
problems of small enterprises in the tourism sector, for example attractions, many of
which are experiencing low or negative profits, while some have ceased trading.
Particular attention was paid to the issue of the rate of VAT in the UK. In the context of
the problems faced by small businesses in the sector, the issue of whether the rate of
VAT should be reduced has come under scrutiny. It is clear that:
The rate of VAT in the UK, particularly on accommodation establishments, is high
relative to most other European countries.
Studies that have considered this issue previously have not provided conclusive
evidence. Therefore this report has made use of an econometric model that provides
additional evidence about the nature of tourism demand for the UK and its sensitivity to
changes in prices (taxes) and exchange rates. The model of inbound tourists
expenditure in the UK is based on a well-defined gravity equation, which is a reduced
form from a partial equilibrium sub-system of a general trade model with nationally
differentiated products. The results suggest that:
Tourism expenditure in the UK is sensitive to changes in prices, with an elasticity
value of unity.
This implies that a percentage increase in price in the UK will result in a percentage
decrease in tourism expenditure.
The model highlights the importance of keeping a close watch on prices in
competing destinations to ensure that the price level in the UK does not increase
significantly, not only relative to that in the origin country under consideration but
also relative to prices in competing destinations.
73
Further research to estimate the price sensitivity of domestic tourism demand, as
well as demand from different countries and market segments, would be useful.
The UK could become more price competitive if the VAT rate applicable to the
hospitality and catering sector were reduced.
The availability of excess capacity in tourism service provision indicates that the price
elasticity of supply is likely to be high relative to the price elasticity of demand.
Consequently, under competitive conditions, a reduction in the rate of VAT is likely to
result in a significant increase in tourism demand, so long as the reduction is passed on
in the form of a decrease in the prices that tourists pay. This proviso is important, as
competitiveness will not improve if a decrease in tourism taxation is assimilated in the
form of an increase in profits. The scale of the effects varies between different types of
tourist expenditure, for example, categories of accommodation, and between different
areas of the country. If the price elasticity of supply for particular categories of
accommodation is low in some areas, the incidence of a decrease in the rate of VAT
would switch away from tourists and towards accommodation suppliers, and the effects
on competitiveness and tourism demand would be lower. For products that are supplied
under monopolistically competitive conditions of significant product differentiation, the
incidence of a tax reduction on suppliers is likely to be greater and the increase in
quantity demanded greater when demand is more price elastic, ceteris paribus.
Overall, the results of the econometric model in the report suggest that international
visitors to the UK are sensitive to changes in the price of tourism in the UK, to prices in
competing destinations and to exchange rate movements. To summarise, an
improvement in the price competitiveness of the tourism sector in the UK could be
achieved by means of depreciation of the exchange rate for sterling and also by a
reduction in the rate of VAT, so long as tourism businesses respond to the tax
reduction by decreasing their prices. This, in turn, would have a significant impact on
the level of tourists expenditure, associated income and employment generation and
foreign currency receipts throughout the economy. Further investigation of domestic
tourism in the UK, which was not the focus of attention of this report, is necessary.
74
The report has been presented as a stand alone analysis. However, it is clear that
tourism should be examined in the context of the wider economy, taking into account its
effects on different sectors of economic activity and, conversely, their effects on tourism
and travel. It is also clear that tourism creates both positive and negative externalities
that are not subject to explicit market prices. Hence, further research should be
undertaken to quantify the interrelationships between tourism and other economic
sectors, on a disaggregated sector-by-sector basis.
An internationally accepted methodological procedure for quantifying such
interrelationships is Computable General Equilibrium analysis, which is used by such
bodies as the World Bank and the OECD among others. It has previously been applied
to a wide range of agricultural and industrial sectors in major industrialised economies,
for example, the USA (United States Department of Agriculture) and a range of
industrial and service sectors in Australia (Adams and Parmenter, 1995). Its suitability
for modelling tourism and travel is exemplified by an analysis of tourism taxation in the
Spanish economy (Blake, 2000). It is surprising that this leading edge technique has not
yet been applied to the UK. Its application would permit tourism taxation policy, as well
as policy for other economic sectors, to take account of the impacts and forecast effects
on each sector of the economy. This would provide the detailed microeconomic
information that is necessary to complement the research on taxation policy that has
been undertaken to date.
75
7. References
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79
8. APPENDIX I
RATES OF CORPORATION TAX, 1969 to 1999
Financial Full rate Advance Capital gains relief Small companies
3
Co-opera-
year rate on tive and
commencing distribu- General
1
Unit and Rate Range of profit for Marginal building
1 April tions investment % marginal relief relief societies
trusts
2
fraction rate
4
Lower Upper
limit limit
% %
1969 42.5 - - - 42.5 - - - 42.5
1970 40 - - - 40 - - - 40
1971 40 - - - 40 - - - 40
1972 40 - - 5/8 40 - - - 40
1973 52 3/7 11/26 37/52 42 25,000 40,000 1/6 40
1974 52 33/67 11/26 71/104 42 25,000 40,000 1/6 40
1975 52 35/65 11/26 69/104 42 30,000 50,000 3/20 40
1976 52 35/65 11/26 69/104 42 40,000 65,000 4/25 40
1977 52 34/66 11/26 21/26 42 50,000 85,000 1/7 40
1978 52 33/67 11/26 21/26 42 60,000 100,000 3/20 40
1979 52 3/7 11/26 21/26 40 70,000 130,000 7/50 40
1980 52 3/7 11/26 - 40 80,000 200,000 2/25 40
1981 52 3/7 11/26 - 40 90,000 225,000 2/25 40
1982 52 3/7 11/26 - 38 100,000 500,000 7/200 40
1983 50 3/7 2/5 - 30 100,000 500,000 1/20 40
1984 45 3/7 1/3 - 30 100,000 500,000 3/80 40
1985 40 3/7 1/4 - 30 100,000 500,000 1/40 -
1986 35 29/71 1/7 - 29 100,000 500,000 3/200 -
1987 35 27/73 - - 27 100,000 500,000 1/50 -
1988 35 25/75 - - 25 100,000 500,000 1/40 -
1989 35 25/75 - - 25 150,000 750,000 1/40 -
1990 34 25/75 - - 25 200,000 1,000,000 9/400 -
1991 33 25/75 - - 25 250,000 1,250,000 1/50 -
1992 33 25/75 - - 25 250,000 1,250,000 1/50 -
1993 33 9/31 - - 25 250,000 1,250,000 1/50 -
1994 33 20/80 - - 25 300,000 1,500,000 1/50 -
1995 33 20/80 - - 25 300,000 1,500,000 1/50 -
1996 33 20/80 - - 24 300,000 1,500,000 9/400 -
1997 31 20/80 - - 21 300,000 1,500,000 1/40 -
1998 31 20/80 - - 21 300,000 1,500,000 1/40 -
1999 30 20/80 - - 20 300,000 1,500,000 1/40 -
1
Chargeable gains realised after 16 March 1987 are taxed at the same rate as income.
2
Gains accruing in relation to disposals after 31 March 1980 are not chargeable gains and are therefore exempt from
corporation tax (section 81, Finance Act 1980).
3
From 1 April 2000 the corporation tax rate for companies with profits of up to 10,000 will be 10 per cent.

Companies

with profits between 10,000 and 50,000 will receive marginal relief at the rate of one fortieth.
Companies with profits between 50,000 and 300,000 will continue to pay corporation tax at the small companies' rate.
4
Normal corporation tax rates apply from 1985 after abolition of the special rate.
80
9. APPENDIX II
Figure A1: Tourist Arrivals in the UK from overseas, (000's).
Tourist Arrivals in the UK
0
5,000
10,000
15,000
20,000
25,000
30,000
1
9
6
8
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
Year
T
h
o
u
s
a
n
d
s
81
10. APPENDIX III
ENTRY CLEARANCE FEES
All of the fees below are quoted in pound sterling. However, entry clearance fees are
payable in local currency.
Category Fee ()
Single Entry Visit 33.00
Six Month Multiple Entry 44.00
One Year Multiple Entry 55.00
Five Year Multiple Entry 80.00
Medical Treatment 33.00
Student Single Entry 33.00
Student Six Month Multiple Entry 45.00
Student One Year Multiple Entry 55.00
Student Two Year Multiple Entry 65.00
Student Five Year Multiple Entry 80.00
Visitor in Transit 33.00
Direct Airside Transit Visa 25.00
Joining Ship/Aircraft 33.00
Work Permit (6 months and under) 33.00
Work Permit (6 months and over) 50.00
Employment (6 months and under) 33.00
Employment (6 months and over) 50.00
Self-Employed (6 months and under) 33.00
Self-Employed (6 months and over) 50.00
Established Business 50.00
Retired Person of Independent Means 50.00
Investor 50.00
UK Grandparent 50.00
Working Holiday-maker 33.00
Husband/Wife 240.00
Child for Settlement (including adoption) 240.00
Marriage (i.e. fianc(e)s) 240.00
Certificate of Entitlement 100.00
Confirmation of Right of Abode 100.00
Sole Representative 50.00
Returning Resident 33.00
Entry Clearance for a Commonwealth Country 20.00
Entry Clearance for a Dependant Country 20.00

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