The fiscal impact of lower VAT rates on visitor accommodation and attractions in the United Kingdom. Final Report. July 2014

Transcription

1 The fiscal impact of lower VAT rates on visitor accommodation and attractions in the United Kingdom Final Report July 2014 Nevin Associates Ltd Kilgour Spencer Place Trinity Edinburgh EH5 3HF Tel: Mobile:

2 Table of Contents Glossary of Terms... i Executive Summary... ii 1 Purpose and Structure of the Report Background and Objectives Structure of this Report 3 2 The Computable General Equilibrium model analysis, Developments elsewhere in the EU since Trends in VAT on tourism and hospitality services Evidence of the Impact of Changes in VAT rates Conclusions 9 4 The updated fiscal model Introduction Sector development since Assumptions driving the DPE fiscal model How a Reduction in VAT would be passed through the Base Case How a Reduction in VAT would be passed through the Rapid Adjustment Case Results The Base Case The Overall Picture Key Sensitivities Results The Rapid Reduction Scenario Results The position after four years 29 5 Conclusions Annexe 1: VAT Rates applying to Hotels and Amusement Parks in EU Member States, Annexe 2: DPE Fiscal Model Assumptions and Sources Annexe 3: Forecast Outlook for the UK s Tourism Balance Annexe 4: Fiscal Impact for Accommodation and Attractions... 49

3 Glossary of Terms The following acronyms have been used in this report (in alphabetical order): ABS CGE DPE EU FTE GDP GVA HMRC HMT ITR OECD ONS SIC TWER VAT Annual Business Survey Computable General Equilibrium Dynamic Partial Equilibrium European Union Full Time Equivalent (job) Gross Domestic Product Gross Value Added Her Majesty s Revenue and Customs Her Majesty s Treasury International Tourism Receipts Organisation for Economic Co-operation and Development Office of National Statistics Standard Industrial Classification Trade-Weighted Exchange Rate Value-Added Tax VAT on Visitor Accommodation and Attractions in the UK i

4 Executive Summary Current Position The visitor accommodation and attractions sector in the UK currently pays VAT at the full standard rate of 20%. Most other member states of the European Union apply a reduced rate. The average rate of VAT applying to visitor accommodation in the EU is 10.8%, and 19 EU member states apply a VAT rate of 10% or less. Industry and political concerns Leading sector operators are concerned that the additional burden of VAT on the UK tourism sector has held back the sector s development in a highly price-sensitive international market. 1 This view is shared by dozens of parliamentarians, many of whom expressed their support for a more competitive VAT rate during a Westminster debate last February. The debate witnessed strong support from MPs for the proposal from Conservative, Labour, Liberal Democrats, Green, SNP, DUP, SDLP, and Alliance parties. Conclusions Under a "business as usual" VAT scenario, it is likely that the UK's share of the international tourism market will contract. By contrast, a reduction in the VAT rate will stimulate the growth in overseas tourism to Britain, and domestic tourism, helping to increase the taxation base. The impact of a cut in tourism VAT will also be felt by the wider economy. For each 1 spent in the tourism industry, 70p extra is spent in other sectors of the economy. Cutting tourism VAT will therefore not only benefit hotels and tourist attractions, but also the construction industry, the retail sector, the airline companies and so on. Because of the highly price sensitive nature of the sector, lower VAT rates that feed through to lower prices will stimulate higher turnover and employment. This in turn will increase income and corporation tax receipts and reduce benefit payments. Overall, when both the direct and indirect effects of a lower VAT rate are taken into account, our estimates indicate that there will be a net 45 million gain for the Exchequer. The source of these gains is shown in the diagram overpage. 1 In order to assess the full impact of reduced VAT on the sector, Bourne Leisure Group and Merlin Entertainments Group commissioned a report completed in February 2011 on Tourism Sector VAT: A Report on the Impact of Reduced VAT rates on British Visitor Accommodation, Attractions and the Wider Economy, by Deloitte, Graham Wason and Michael Nevin. The report concluded that lower VAT would feed through to lower prices, stimulating greater demand for accommodation and attractions, increasing the total revenue base on which VAT is levied. In aggregate, the February 2011 analysis estimated that there would be a net fiscal gain to the Exchequer. VAT on Visitor Accommodation and Attractions in the UK ii

5 VAT on Visitor Accommodation and Attractions in the UK iii VAT on Visitor Accommodation and Attractions in VAT the UK on Visitor Accommodation and Attractions in the iii UK iii

6 A VAT reduction could help meet the Prime Minister s goal of raising the expenditure of domestic British tourism from 36% to 50%, as more visitors would choose to stay at home for their vacations rather than travel abroad. Additional spending from both foreign and domestic tourists would be circulated and spent in the UK economy and would continue to benefit the Exchequer over a longer period of time By growing the tourism sector, the UK can reduce its balance of payments deficit. In 2011, travel expenditure by non-residents visiting the UK accounted for 4.4% of total UK exports. A VAT reduction for the tourism industry would provide a significant boost to the UK export market a goal that George Osborne has signalled as a key aspect of the recovery Another indirect benefit to the Treasury would be a reduction in the so-called shadow economy. The UK tourism industry is populated by a large number of small firms that may choose not to expand or invest in order to keep below the VAT threshold to avoid paying tax. In France, the shadow economy has been estimated to have reduced by 720 million a year due to VAT reductions implemented. Another study using the government s own Computable General Equilibrium (CGE) economic model (conducted by Treasury Advisor Professor Adam Blake) noted that cutting tourism VAT is one of the most efficient, if not the most efficient, means of generating GDP gains at a low cost to the Exchequer. This result was reinforced by a number of scenarios run through the CGE model. One scenario envisaged a commitment by the tourism industry to take on an additional 10,000 workers who had previously been long-term unemployed as part of an agreement with the Treasury underpinning a VAT reduction (similar to the French Contrat d Avenir ). In this scenario, GDP gains peaked at 4 billion per year rather than 3 billion in the base case. There was also a positive fiscal impact for the first 4 years. In summary, a lower VAT rate would represent a "win : win" strategy helping to stimulate Britain's tourism industry, increase foreign exchange earnings, create additional jobs, and generate a net fiscal gain for Her Majesty's Treasury. On this basis, we believe that the case for lower VAT on tourism services merits further consideration by Her Majesty s Treasury. VAT on Visitor Accommodation and Attractions in the UK iv

7 1.1 Background and Objectives 1 Purpose and Structure of the Report The visitor accommodation and attractions sector in the UK currently pays VAT at the full standard rate of 20%. Most other member states of the European Union apply a reduced rate. The average rate of VAT applying to visitor accommodation in the EU is 10.8%, and 19 EU Member states apply a VAT rate of 10% or less. The additional burden of VAT that the UK tourism sector has to bear relative to its competitors has held back the sector s development, which operates in a highly price-sensitive international market. In certain parts of the UK, the effects of this competitive disadvantage are particularly acute. For example, in Northern Ireland hotels and attractions paying 20% VAT are faced with direct competition from operators in the Republic of Ireland who are charged VAT at 9%. For this reason, a Parliamentary debate was secured by Margaret Ritchie MP (SDLP) which took place on February 11 th The debate witnessed strong support from MPs for the proposal from Conservative, Labour, Liberal Democrats, Green, SNP, DUP, SDLP, and Alliance parties. In order to assess the wider impact of reduced VAT on the sector, Bourne Leisure Group and Merlin Entertainments Group commissioned a report completed in February 2011 on Tourism Sector VAT: A Report on the Impact of Reduced VAT rates on British Visitor Accommodation, Attractions and the Wider Economy, by Deloitte, Graham Wason and Michael Nevin. This report indicated that most EU Member states levy reduced rates of VAT on visitor accommodation and visitor attractions. This continues to be the case, as shown in Annexe 1 to this report which sets out the rates of VAT that have applied to visitor accommodation and attractions in each Member State of the EU since This suggests that national governments across the EU recognise that higher tax rates could have the perverse effect of reducing tax yields, because of the negative impact high tax rates would have on inbound tourism. The report accepted that the immediate impact of cutting VAT in the UK from its current rate of 20 per cent to a reduced rate of 5 per cent would be a loss of VAT yields, but concluded that this would be offset by lower prices, stimulating greater demand for accommodation and attractions. This would increase the total revenue base on which VAT is levied. There would be a number of other benefits from lower VAT rates: higher levels of employment in tourism and related services; this increase in employment will generate additional income tax receipts and savings in social security payments; higher expenditure will also generate an increase in profits and corporation tax payments by sector operators; VAT on Visitor Accommodation and Attractions in the UK 1

8 higher tourism incomes will feed through to higher expenditure in other sectors of the economy, which in turn will generate further tax receipts. In aggregate, taking all these indirect effects into account, the February 2011 analysis indicated that, while the Exchequer would suffer an initial net loss in taxation receipts, once the stimulus imparted by lower taxes and prices fed through to higher demand there would be a net fiscal gain to the Exchequer, which would increase year by year over a 10-year period. In Year 4 following a reduction by which time most of the adjustment to lower VAT rates has occurred the February 2011 analysis indicated the following impact on tax yields: Impact on the Exchequer s Position Value, million (1) Net direct loss of VAT receipts - 1,145.8 (2) VAT Yield on increased turnover at 5% 67.1 (3) VAT Yield on wider base at 5% 33.6 (4) Income and national insurance derived from new jobs & previously unreported (Shadow Economy) jobs (5) Income and national insurance derived from higher wages (6) Savings in social security payments (7) Corporation tax from higher margins on current turnover including previously unreported (Shadow Economy) turnover 90.6 (8) Corporation tax from higher turnover 95.2 (9) Income tax paid on dividends 40.9 Sub-total, direct and indirect fiscal impact (10) Multiplier impact Net fiscal impact As shown in the Table, the February 2011 analysis estimated a net fiscal gain following a VAT reduction of 315 million p.a. by Year 4 compared to a no policy change scenario. These findings were contested by HM Treasury, who, in a collaborative exercise, suggested that the analysis be run through their own Computable General Equilibrium (CGE) Model which assesses the fiscal impact of changes in taxation policy. This exercise was completed in VAT on Visitor Accommodation and Attractions in the UK 2

9 1.2 Structure of this Report Section 2 of this report summarises the results of the analysis undertaken through the Treasury's CGE Model in 2012, which was carried out by Professor Adam Blake of Bournemouth University, who helped to develop the model and is an authorised user of it (the CGEM is protected under the Official Secrets Act and therefore was not directly available to the Deloitte / Wason / Nevin team). Section 3 summarises developments that have occurred in the VAT regime particularly applying to visitor accommodation and attractions across the EU since the February 2011 report was completed. Section 4 sets out an updated analysis of our Dynamic Partial Equilibrium (DPE) model as applied in 2011, inputting the latest available information on sector turnover, employment and cost structure provided by the Office of National Statistics (ONS). Section 5 sets out the conclusions that emerge from this analysis. VAT on Visitor Accommodation and Attractions in the UK 3

10 2 The Computable General Equilibrium model analysis, 2012 The Report on the Impact of Reduced VAT rates on British Visitor Accommodation, Attractions and the Wider Economy was published in February Consultants who carried out the report met HMT officials in September 2011 to discuss the findings of the report. At this meeting, HMT officials suggested that this impact be modelled using the Treasury s own Computable General Equilibrium (CGE) model, and that the Campaign could work with Professor Adam Blake of Bournemouth University who built and helps to maintain the CGE model. Permission was granted by HMT for Professor Blake to use the model for the exercise. The analysis was carried out in 2011/12 and a further meeting was held with HMT to discuss the findings of the CGE analysis in September Unlike the DPE model, the Treasury s CGE Model does not take account of the potential dynamic effects of a VAT reduction in stimulating sector investment and growth over time. It is a comparative-static model, measuring HMT s fiscal receipts before and after a specified tax change. Nevertheless, the results were broadly consistent with those reported in the February 2011 report, showing a modest net loss to the Exchequer as a consequence of a VAT cut from 20% to 5%. Professor Blake s conclusion was that reduced VAT on tourism services represents one of the most efficient, if not the most efficient, means of generating GDP gains at low cost to the exchequer that I have seen with the CGE model. This result was reinforced by a number of scenarios run through the CGE model. One scenario envisaged a commitment by the tourism industry, as part of a collaborative package similar to the French Contrat d Avenir, to take on an additional 10,000 workers who had previously been long-term unemployed as part of an agreement with HMT underpinning a VAT reduction. In this scenario, GDP gains peaked at 4 billion per year, rather than 3 billion in the base case. There was also a positive fiscal impact for the first 4 years and a cumulative fiscal impact over the period that is only slightly negative at million, excluding multiplier effects. The DPE and CGE models are constructed in very different ways and comparison between the two is not straightforward. However, the estimated direct fiscal loss to the Exchequer as a result of cutting VAT on visitor accommodation and attractions after four years is quite close at 479 million in the CGE base case scenario 2 compared to 439 million in the DPE model. The composition of this net effect is different in the two models and, in addition, the DPE model estimated a multiplied gain of 754 million for the Exchequer from taxation gains elsewhere in the supply chain which are not included in the CGE model. 2 i.e. before additional scenarios such as the Contrat d Avenir scenario involving a commitment to create 10,000 jobs for those previously long-term unemployed VAT on Visitor Accommodation and Attractions in the UK 4

11 Professor Blake and the consultants to the Campaign came to the agreement that in summary, based on reasonable and plausible assumptions, the modelling exercise seems to support a general case that a reduction of VAT on tourism services would be fairly close to fiscal neutrality. VAT on Visitor Accommodation and Attractions in the UK 5

12 3 Developments elsewhere in the EU since Trends in VAT on tourism and hospitality services While HMT have not altered their policy with respect to VAT on tourism and hospitality services, this has not been the case elsewhere in the EU. Total VAT revenue currently generates approximately a fifth of all taxation receipts collected in the EU, and therefore is a core source of revenue for all Member State governments. At EU level, the European Council of Ministers and European Commission have sought to harmonise the regulatory framework applying to VAT, in order to ensure that it is applied consistently across different Member States. The EU does however allow Member states to apply a reduced rate of VAT to labourintensive services, and Council Directive 2009/47/EC of May 5 th 2009 included a list of these services. Visitor accommodation and attractions are included on this list. Of the EU s 28 Member States, all but one (Denmark) applies at least one reduced rate. These reduced rates are widely used: approximately one-third of all consumption is taxed at reduced rates, with the average reduced rate being between 7.5% and 10.5%. The rates of VAT applying to accommodation and attractions (amusement parks) between 2007 and 2013 are set out as Annexe 1 to this report. The Annexe indicates that the standard rate of VAT has shown a general tendency to rise across the EU as a whole since 2007, as EU governments have sought to reduce their budget deficits, which rose sharply in the aftermath of the global financial crisis of 2007/08. Since 2007, not one Member State has reduced its standard rate. The best that has happened is that the standard rate has remained stable but this has generally occurred where it was already at a high level, in countries such as Sweden and Denmark, where the standard rate stayed at 25% throughout the period. A number of major EU Member states have increased the standard rate of VAT: in Italy, the standard rate of VAT has increased from 19% in 2009 to 22% in 2014; in the Netherlands, the standard rate increased from 19% in 2009 to 22% 2014; in Spain, the rate increased from 16% in 2009 to 21% in 2014; and in the UK from 15% in 2009 (a level to which it was temporarily reduced from 17.5%) to 20% in Overall, across the EU, over the period from May 2007 to January 2014, the average standard rate of VAT of the 28 EU Member states increased from 19.5% to 21.5%, or by 10.3%. VAT on Visitor Accommodation and Attractions in the UK 6

13 However, while there has been a general upward drift in standard VAT rates, recent years have also witnessed a reduction in certain VAT rates applying to price sensitive, labour-intensive sectors. This suggests that national governments are aware of the adverse impact that high VAT rates can have on employment, turnover, and ultimately the taxation base in such sectors. Since the unanimous decision by the Ministers of Finance of the European Union to permit Member states to apply a reduced rate of VAT to catering and restaurants on May 5 th 2009, there have been significant VAT reductions on hospitality services across the European Union. In chronological order, the reductions in VAT that have occurred since then which are of particular relevance to accommodation and attractions include the following: July 1 st 2009: France reduced VAT for the restaurant industry from a standard rate of 19.6% to a reduced rate of 5.5% with immediate effect. The reduced rate was adjusted to 7% in 2012, and the President of France increased the rate further to 10% in While the French President has progressively increased the reduced rate from 5.5% to 10% as a deficit-reduction measure, the French rate remains half of the rate applying in the UK. December 18 th 2009: In Germany, the Bundesrat confirmed the decision of the Bundestag in approving a reduction in the VAT rate for hotel accommodation from 19% to 7% with effect from January 1 st This did not follow directly from the decision by the Council of Ministers in May 2009 to permit a reduced rate of VAT to apply to restaurant and catering services, but was part of the wider trend by EU Governments to apply lower rates of VAT to price-sensitive sectors in order to stimulate a recovery from the recession that followed the financial crisis of 2007/08. July 1 st 2011: In Ireland, the parliament approved a VAT reduction from 13.5% to 9% for room accommodation and restaurants. VAT on tourism in the Republic of Ireland was reduced first during the 1980s which led to a significant increase in tourism. Since then, the rate has gone up and down but has always been at a reduced level. Ireland suffered a greater proportional national debt crisis following the 2007/08 credit crisis than the UK, and reduced government spending and increased taxes, including the standard rate of VAT. However, recognising the potential for job creation and growth through tourism and hospitality, the Irish government further reduced the rate applying to tourism from 13.5% to 9% from 1 st July 2011 until the end of December According to the Irish Hotels Federation (IHF) and the Restaurants Association, over 96% of their members passed on at least some of the decrease in VAT, and more than half of those businesses responding to the IHF survey reported an increase in business compared with the same time last year, with 90 per cent saying that the reduced tourism VAT rate had boosted their business. There was a net increase in the sector of 6,200 jobs (5.7%) between the second quarter of 2011 and the second quarter of 2012, at a time when total employment in Ireland fell overall. VAT on Visitor Accommodation and Attractions in the UK 7

14 In late 2013 the Irish Government announced that VAT on tourism would remain at 9% indefinitely. 2013: In Greece, negotiations with the International Monetary Fund and the Euro Group (the European Commission and European Central Bank) on a package of measures to bail out the Greek Government and enable it to continue to service its national debt led to agreement that the government could reduce the VAT rate of restaurant and café services from 23% to 13% from August 1 st Evidence of the Impact of Changes in VAT rates FRANCE. According to INSEE the Institut National de Statistiques et Etudes Economiques, France s official office of national statistics employment in the hotel and restaurant sector increased from 898,100 to 973,100, or by 75,000, between June 30 th 2009 and September 30 th 2011, which were the first nine quarters following the VAT reduction on restaurant meals from 19.6% to 5.5% on July 1 st Several reports for the National Assembly and the Senate, including Senator Houel s report, showed that 40% of the VAT decrease was passed through to higher staff remuneration, 23% to price decreases, 20% to investments, and the balance to cash improvements. In addition to the net impact on job creation, President Nicolas Sarkozy declared on television in early 2012 that the VAT decrease had saved 30,000 cafés and restaurants that were struggling financially. On the basis that, on average, each of these small cafés employed three people, this would imply that 90,000 jobs were safeguarded in the sector. On the assumption that there is a sectorial multiplier of 70%, then the 75,000 jobs directly created in the sector would have supported 50,000 jobs further down in the supply chain. On this basis, a total of 215,000 jobs were created or safeguarded by the VAT reduction, being the sum of 75,000 jobs directly created (INSEE), 50,000 jobs indirectly created (through the multiplier effect) and 90,000 jobs safeguarded. It is too early to fully assess the impact of the increase in VAT to 10%, but early indications are that it is having a negative impact on sector employment. GERMANY. A press release issued by the German Hotel Association, DEHOGA, on March 29 th 2012 reported the results of a study on the impact of the VAT reduction carried out by the German Institute of Management Tourism (IMT) at the University of Applied Sciences Westkueste, headed by Dr Bernd Eisenstein. This study reported that the decrease in value added tax on January 1 st 2010 has resulted in a massive surge in investment. In the two years following the introduction of reduced VAT rates on accommodation, the owners of hotels, guesthouses and bed and breakfasts stated that it had resulted in a significant stimulus. The survey covered 5,000 accommodation businesses, which between them had invested million and created over 11,000 new jobs and apprenticeships as a result of the VAT cut, and had also reduced average room rates by 1.6%, during a period of rising demand. Those interviewed stated that they planned to invest a further million and hire an additional 6,000 employees later on in VAT on Visitor Accommodation and Attractions in the UK 8

15 IRELAND. In its 2013 budget, the Irish Government extended the 9% VAT rate into 2014 and at the same time reduced travel tax (airport departure tax) to zero, giving the Republic a significant tax advantage over its competitors in the UK in both respects. SPAIN. A counter-example is provided by the experience of Spain. Whereas most EU Member states have sought to maintain a reduced rate of VAT for visitor accommodation and attractions, the Spanish Government, faced with a mounting budget deficit, opted to apply the full VAT rate to theme and amusement parks from September 2012, at the end of the 2012 season. The Spanish association of theme park operators reported that Spanish parks suffered a reduction of nearly 13% in attendance in 2013, even though most operators sought to absorb some of the increase in their pricing structure. The consequence has been a squeeze of profitability, and 7 of the 10 Spanish parks have reduced staff number by an average of 10.2%. The Association stated in March 2014 that, Since September 2012, when VAT rates were increased in Spain, theme and amusement parks have been clearly discriminated by the Spanish Government, as our activity has not been considered as part of the tourist sector, in which the VAT rate is 10%. Our activity has suffered a VAT increase from 8% to 21% which directly provoked a reduction in the number of visitors of nearly 13% (and some decline in spend per visitor) resulting in a decline in turnover of 17%, and a reduction in employment in most of the parks by an average of 10%. These magnitudes, if they are compared with the record numbers of the tourist sector emphasized by the Spanish Prime Minister in Madrid on January 21 st 2014 (arrivals of foreign tourists 60.4 million, with 250 million hotel nights) clearly leave theme and amusement parks in a situation of marginality and lacking competitiveness, which will be sharpened if the Government applies a VAT reduction to the cultural sector and a positive response is not given to our submissions for lower VAT. 3.3 Conclusions The evidence of the impact of changes in VAT across the EU since 2011 confirms several key findings: Most EU member states apply reduced rates to visitor accommodation and attractions the UK remains an exception in charging the full rate of VAT to this sector; More reduced rates have been applied since 2011, and where reduced rates have been introduced, they have been maintained even where, as in the case of the Republic of Ireland, the government is seeking to reduce the budget deficit. This suggests that the governments that have introduced reduced rates VAT on Visitor Accommodation and Attractions in the UK 9

16 believe that they have been effective in stimulating growth and jobs in their tourism sectors; One exception is Spain, which has applied the full standard rate to theme and amusement parks (although not to tourism services in general), precipitating a sharp downturn in turnover, profitability and jobs, thus eroding the base on which taxation is levied; Otherwise, EU governments recognise that competitive VAT rates need to be applied to tourism, which is a highly price sensitive and labour-intensive sector. VAT on Visitor Accommodation and Attractions in the UK 10

17 4 The updated fiscal model 4.1 Introduction This section sets out the key assumptions and results of a fiscal modelling exercise to update analysis previously conducted in 2011 of the full fiscal impact of the proposed VAT reduction. As in 2011, the analysis is based on a reduction in VAT from a current standard rate of 20% to a reduced rate of 5%. It should be noted that the reduced 5% rate already applies to certain specific parts of the sector, including static caravans and ski lifts. The same methodology has been applied to undertake this analysis as in the 2011 report, applying a fiscal model which measures not only the direct impact of lower VAT rates, in terms of the direct loss of VAT receipts, but also indirect gains that would accrue to the Exchequer, arising from: higher turnover as sector demand would be stimulated by lower prices; greater income and national insurance payments generated by new jobs and higher wages in the sector; savings in social security payments as a consequence of lower unemployment with some of the new jobs created in the sector taken up by those previously unemployed; increased corporation tax payments as a result of higher margins and higher turnover; increased income taxes paid on dividends generated by the accommodation and attractions sector; and multiplier impacts from additional taxes generated further down the supply chain for accommodation and attractions. The assumptions underpinning the model have been updated to take account of the latest information on sector turnover and employment. This is based on official data provided by the Office of National Statistics, drawing on the latest version of their Annual Business Survey, released on November 14 th Thus the updated analysis has been prepared on a like-for-like basis with the earlier 2011 analysis. 3 3 The 2011 report was based primarily on 2008 ONS data, which was the latest data available when that report was prepared, drawing on the ONS, 'Annual Business Inquiry: Section I - Accommodation and food service activities', Release date 15/06/2010. This 2014 report is based primarily on 2012 ONS data, drawing on the ONS, 'Annual Business Inquiry: Section I - Accommodation and food service activities', Release date 14/11/2013. VAT on Visitor Accommodation and Attractions in the UK 11

18 4.2 Sector development since 2011 The Office for National Statistics (ONS) has provided data on turnover, jobs and employment costs in the accommodation and attractions sector based on its Annual Business Survey (ABS). It covers the period the years between 2008 and 2012 inclusive (i.e. five years). The accommodation sector comprises the entirety of SIC Code 55. (The Standard Industrial Classification (SIC) is a system for classifying industries by a four-digit code established in the late 1930s). Our definition of the visitor attractions sector for the 2011 study covered the following SIC codes within Section R (arts, entertainment and recreation): 91.03: Historic sites and buildings, 91.04: Botanical and zoological gardens and nature reserves, 93.21: Amusement parks and theme parks. The data provided by the ONS covers: number of enterprises, total turnover net of VAT, approximate Gross Value Added at basic prices, total employment, total employment costs and net capital expenditure. The ONS data also shows the VAT element and gross turnover (= net turnover + VAT) for the accommodation sector. This is not available for the attractions sector, so for the purposes of our analysis we have assumed that the proportion of gross turnover accounted for by VAT is the same for the visitor attractions sector as for the accommodation sector. Trends for each sector are assessed below. Accommodation Both net and gross turnover dipped in 2009 compared to 2008, before recovering slightly in nominal terms in 2010 and However, in real (inflation-adjusted) terms, both showed a decline over the period between 2008 and For example, net turnover increased in nominal terms from 17,532 million in 2008 to 18,667 million in 2011, or by 6.5%. Over the same four-year period, the UK Retail Price Index increased from (in June 2008) to (in June 2011), or by 8.5%. Thus, there was a real terms decrease in net accommodation turnover over the period. The same applies to gross turnover, which increased only marginally in money terms from million in 2008 to million in 2011, representing a decline in real terms. VAT on Visitor Accommodation and Attractions in the UK 12

19 However, in the most recent year for which data is available 2012 there was a real increase, with net turnover up from million to million (4.8%), and gross turnover up form million to million. It is likely that this was driven by both business and leisure demand, and may have been assisted by the Olympics which were held in London. Sector employment, after being static over the period between 2008 and 2010, increased ahead of the upturn in real turnover from 388,000 to 429,000 in 2011, stabilising at that level in This represents total employment, including parttime employees, although the same pattern is evident in the FTE data. This suggests that accommodation businesses started hiring staff almost immediately they experienced an upturn in business. Attractions Going through each of the subsectors in turn: 91.03: Historic Buildings. Net turnover fell quite sharply from 377 million in 2008 to 303 million in It then recovered in 2010 and more strongly in 2011 (possibly reflecting the staycation effect) before stabilising in Interestingly, total employment increased from 11,000 to 13,000 in 2009 i.e. the year of the sharp decline in turnover since when it has remained steady : Botanical Gardens and Zoos: the decline in turnover was more severe and prolonged in this sector than in historic buildings, probably not helped by wet weather in the summer and snows in the winter, falling from 559 million in 2008 to 306 million in 2011, before recovering to 419 million in The ONS data shows negative gross value-added for the sector in 2011 and 2012 i.e., it was only surviving with the aid of public subsidies or loss-making equity at macro level. However, total employment did not fall, increasing slightly from 17,000 in 2008 to 19,000 in : Amusement and Theme Parks. Turnover increased from 611 million in 2008 to 733 million in 2009, before decreasing sharply to 605 million in 2010 i.e. the downturn in this sector seems to have occurred one year later than the rest of the accommodation and attractions sector. But amusement and theme parks then recovered strongly in 2011, up to 776 million, before falling back slightly to 752 million in This may have been due to the "staycation effect" in Employment has risen gradually from 16,000 in 2008 to 18,000 in Conclusions The statistics for the accommodation and attractions sector are consistent with wider macroeconomic indicators which suggest that a recovery is underway in the UK. Indeed, it could be argued that the attractions and accommodation sector helped to lead the economic recovery, as they started to grow in 2011, one year ahead of the overall economy where recovery commenced in 2012/13. VAT on Visitor Accommodation and Attractions in the UK 13

20 4.3 Assumptions driving the DPE fiscal model All the assumptions driving the DPE fiscal model, and their sources, are set out in Annexe 2 to this report. Key changes in assumptions compared to the 2011 analysis are as follows: 1. Updated net turnover. ONS data indicates that, after allowing for inflation, turnover in the accommodation sector was flat in real terms over the five years between 2008 and In the attractions sector, the turnover of historic sites and buildings has fallen slightly, while the turnover of botanical and zoological gardens dropped significantly in both nominal and real terms. The turnover of amusement parks and theme parks has grown strongly. We estimate that onethird of hotel turnover is generated by food and beverage (F&B) sales, to which a 20% standard VAT rate continues to apply. However, not all hotels have restaurants, nor do guesthouses, bed and breakfast establishments, youth hostels, self-catering establishments, etc. ONS statistics indicate that, of total accommodation sector turnover, 76% was accounted for by hotels, most but not all of which have restaurants, and 24% by other forms of accommodation, most of which do not have an F&B offer. On this basis, we estimate that, overall, 25% of total visitor accommodation turnover will not benefit from the VAT reduction, and 75% will. 2. Changes in VAT payments. One striking result that emerges from ONS statistics is that VAT payments by the accommodation sector have increased much more rapidly than the increase in the sector s net turnover with VAT up from 2.7 billion in 2008 to 3.5 billion in 2012, or by 29%, against an increase in turnover of less than 12%. This reflects the increase in the standard rate of VAT to 20%. Overall, VAT payments as a percentage of net turnover increased from 15.5% in 2008 to 17.9% in The ONS does not report VAT payments made by the attractions sector, so estimates have been imputed by applying the accommodation VAT rate to historic sites, botanical gardens, amusement and theme parks. This gives a total estimate of VAT paid by the attractions sector of 283 million, which is close to the 2011 estimate of 274 million. 3. Personnel expenses and investment as a percentage of sector turnover has been calculated from the latest ONS data (as in 2011) and are broadly similar to the percentage rates calculated in One exception is personnel expenses in the attractions sector, which increased from 51% to 62% including payments to subcontractors. 4. Turnover per job in both the accommodation sector and visitor attraction sector appears to have fallen in real terms based on ONS data over the past five years, although average remuneration per job has increased slightly in the accommodation sector. It has fallen sharply in the attractions sector, on the basis of the ONS data. VAT on Visitor Accommodation and Attractions in the UK 14

21 5. The average rate of income tax and National Insurance contributions used in the model has fallen from 36% to 32%, reflecting the reduction in the standard rate of income tax to 20%. The figure of 32% is equal to the 20% standard rate income tax plus 12% employee s National Insurance (NI). A worker paid the average UK wage of 26,500 would contribute approximately 32% of this wage to the Exchequer in income tax, employees NI and employers NI. 6. The estimated annual value of Social Security payments paid to the unemployed, including housing benefit etc has been increased in line with inflation from 7,500 to 8,360 p.a. The altered values entered into the updated fiscal model are set out in the Table below. Description % change 55 Visitor Accommodation net turnover, m 19,559 17, % Of which: 55.1 Hotels and similar accommodation 14,920 13, % 55.2 Holiday and other short stay accommodation 1,505 1, % 55.3 Camping grounds, recreational vehicle parks and trailer parks 2,777 2, % 55.9 Other accommodation % 55 Visitor accommodation VAT Payments 3,509 2, % Of which: 55.1 Hotels and similar accommodation 2,873 2, % 55.2 Holiday and other short stay accommodation % 55.3 Camping grounds, recreational vehicle parks and trailer parks % 55.9 Other accommodation % 3,510 2,718 Visitor accommodation VAT payments as a % of net turnover 17.9% 15.5% Attractions sector turnover net of VAT, million Historic sites and buildings % Botanical and zoological gardens & nature reserve activities % Amusement parks and theme parks % 1,580 1,542 Attractions sector VAT Accommodation sector Personnel expenses - % of turnover net of VAT 31% 29% Investment - % of turnover net of VAT 10% 11% Attractions sector Personnel expenses - % of turnover net of VAT 62% 51% Investment - % of turnover net of VAT 12% 16% VAT on Visitor Accommodation and Attractions in the UK 15

22 Description % change Turnover per job: visitor accommodation sector 47,820 45, % Turnover per job: visitor attraction sector 30,980 35, % Average remuneration per job: visitor accommodation sector 14,145 12, % Average remuneration per job: visitor attraction sector 15,800 15, % Average rate of income tax & National Insurance 32.0% 36.0% Social security payments - average per person unemployed p.a. 8,360 7, % Since the original report was presented in 2011, it has been pointed out that one source of tax revenue was omitted from it, which is included in HMT s own CGE model, namely business rates. In 2012/13, 26.1 billion was paid business rates across the UK, representing approximately 1.67% of UK GDP at 1,570 billion. However, HM Government s supply use tables indicate that the proportion of turnover paid in rates by the visitor accommodation sector is significantly higher than this, at approximately 6% of value-added, reflecting the sector s property intensive cost structure. In order to compute the likely gain to the Exchequer from business rates, a business rates factor has been incorporated into the fiscal model at 1.67% of increased turnover, which we regard as a conservative estimate, being lower than would be implied by the supply use tables. It is calculated on the basis of the overall proportion of business rates in total UK GDP. It is assumed that the adjustment in rates will occur in line with the adjustment in sector turnover, rather than lagging behind it, for the following reasons: a/ A lagged response would be based on the assumption that sector operators wait until demand turns upwards before commissioning new capacity. b/ An alternative model would be based on investment driving an upturn in turnover, which occurs in innovative sectors and where a sector has historically underinvested. Reports on the impact of lower VAT on hotel accommodation in Germany, introduced in January 2010, suggest that this is what has happened there. The reduction in VAT rates fed through to higher investment ahead of an increase in demand, and higher investment in turn helped to drive an increase in hotel sector turnover, through increased capacity and enhanced quality. c/ The question is whether investment would lead or lag an upturn in turnover in the UK. The most reasonable assumption, in the absence of other information, is that it would broadly match the gradual adjustment in turnover, in part because it is possible that an agreement in the form of a "Contract of the Future" could underpin any decision by HMT to reduce VAT, and could include a commitment by operators to utilise some of the VAT reduction for greater investment. VAT on Visitor Accommodation and Attractions in the UK 16

23 4.4 How a Reduction in VAT would be passed through the Base Case The point made in [c] above, regarding the likely pass-through of lower VAT, is consistent with the assumptions made regarding the allocation of a VAT reduction, which are the same in the updated model as in the previous 2011 model. Overall, the base case fiscal model assumes that a 15 per cent reduction of VAT from 20 per cent to 5 per cent will feed through as follows: 60 per cent of the reduction will feed through in lower prices; 10 per cent will be used to recruit more workers and pay higher wages; 3 per cent will be allocated to training; 22 per cent will be allocated to investment; and 5 per cent will be allocated to higher profit after investment. These adjustments will not happen instantaneously. The evidence from countries that have reduced VAT indicates that it may take 3 to 4 years for a full pass-through of reduced VAT to lower prices. Initially, some operators may seek to retain the VAT reduction and hold their prices at a constant level. However, the evidence from Ireland and France indicates that some operators in a price-sensitive market will take the lead in reducing prices in an effort to increase their market share. This in turn will force an adjustment by competing operators in order to protect their sales. On the basis of the international evidence, the base case model assumes the following adjustment path: 30% of the total price adjustment occurs in Year 1 following the VAT cut; 70% in Year 2; 90% in Year 3; and 100% in Year and thereafter. 4.5 How a Reduction in VAT would be passed through the Rapid Adjustment Case An alternative scenario posits that the Base Case is too conservative, in two regards: 1. The assumption that only 60% of the VAT cut gets passed through, whereas Copenhagen Economics, in their report for the European Commission on labour-intensive services 4 concluded that full pass-through will be achieved. 2. The assumption that it would take 4 years to reach that position, compared to 2-3 years in Copenhagen Economics analysis. Accordingly, we have also modelled a "rapid adjustment" scenario, where: 75% of the VAT reduction will pass through to lower prices, and the full price adjustment will take a total of three years, with 50% of the full adjustment occurring in Year One, 80% in Year Two, and 100% by Year Three and thereafter. 4 Study on reduced VAT applied to goods and services in the Member states of the European Union. Final Report by Copenhagen Economics, Thursday, 21 June dy_reduced_vat.pdf VAT on Visitor Accommodation and Attractions in the UK 17

24 Such a scenario could occur if industry leaders gave a positive commitment to government that they would seek to pass at least 75% of the VAT reduction through in lower prices. The evidence from one country where such an agreement was entered into Finland is that it was honoured in practice, and consumers did indeed benefit from significantly lower prices as a result of a reduced VAT rate. Further reassurance could be provided by a Government commitment to retaining the lower rate of VAT provided that the reduction was passed through in lower prices, subject to review after three or four years. 4.6 Results The Base Case Based upon these assumptions, the "comparative static" results indicate a net annual gain to the Exchequer from a VAT reduction of 45 million. A direct loss of VAT yields of billion is offset by indirect gains from higher yields from income and corporation tax, savings in social security payments, a smaller shadow economy and multiplier effects. These indirect gains generate additional tax revenues of billion in total. The net gain of 45 million compares to a net gain of 68 million computed in the 2011 model. The comparative 2014 and 2011 figures are shown in the Table below (1) Net direct loss of VAT receipts ( 1,558.4) ( 1,234.0) (2) VAT Yield on increased turnover at 5% (3) VAT Yield on wider base at 5% (4) Income and national insurance derived from new jobs & previously unreported (Shadow Economy) jobs (5) Income and national insurance derived from higher wages (6) Savings in social security payments (7) Corporation tax from higher margins on current turnover including previously unreported (Shadow Economy) turnover (8) Corporation tax from higher turnover (9) Income tax paid on dividends (10) Business rates (11) Multiplier impact Net fiscal impact VAT on Visitor Accommodation and Attractions in the UK 18

25 The Table above is based on a simple before and after comparison. In reality, transition to a post-vat reduction equilibrium will not be instantaneous. There will be lags in the adjustment process: firstly, it takes time for operators to pass through the VAT reduction in lower prices, and secondly, it takes further time for consumers to respond to lower prices. The evidence from the French VAT reduction on restaurant meals in July 2009, and the German VAT reduction on hotel accommodation in January 2010, indicates that the first response of many operators will be to retain the proceeds of any VAT cut in higher profits. However, this is not an equilibrium position. Some operators will attempt to gain market share by reducing their prices, and this will provoke a competitive response from other operators, so tending to reduce prices over a period of approximately two years after a VAT reduction. Once operators begin to reduce their prices, it will take time for consumers to adjust their purchasing patterns in response to lower prices. The evidence from econometric analysis of the path of adjustment in tourism expenditure after a change in prices suggests the response time from consumers may take between 18 and 24 months. However, it is possible that this consumer response lag may be getting shorter, reflecting more efficient information flows as a result of the growth of the Internet, and a tendency for holidaymakers to book their holidays closer to the date of departure than 10 or 20 years ago, when holidays were often booked many months in advance. Taking these factors into account, we have estimated that 30 per cent of the total impact of a VAT reduction will be felt in the first year following the reduction, rising to 70 per cent in the second year, 90 per cent in the third year and 100 per cent by Year 4. The implication of this is that the full indirect and multiplied impact of a VAT reduction will take time to feed through, with the result that the Exchequer may suffer net losses in the years immediately following a VAT cut, because the loss of yield is not immediately offset by indirect and multiplied gains generated by the demand stimulus. However, once the effects of the VAT cut begin to feed through in lower prices and higher demand, the indirect gains from VAT deriving from a higher revenue base start to offset the direct loss of VAT yield. By Year 3 the net receipts to the Exchequer are greater than under a "no VAT change" scenario. Indirect fiscal gains are projected to increase over time compared with a no change baseline, because a VAT cut will provide a stimulus to the entire sector, as was seen in the Republic of Ireland following the VAT reduction there in the mid-1980s, and is currently being witnessed in France and Germany. VAT on Visitor Accommodation and Attractions in the UK 19