Tourism Taxation in the UK

Transcription

1 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 UK s 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 Appendix II Tourist Arrivals in the UK from Overseas. 10. Appendix III Entry clearance fees 2

3 List of Figures Figure 2.1: Tourist Arrivals in the UK (000's), 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), Figure 2.6: Real tourism expenditure in UK ( millions), Figure 2.7: Real average tourism earnings per visit in the UK ( ), 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. 3

4 List of Tables Table 2.1: International Tourism Receipts and Market Shares, 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 Table 4.2: Tax Expenditure in City Destinations, Autumn Table 4.3: Index of Tax, October 1999 (Base year 1994 = 100) a. Table 5.1: Panel Results using FGLS: Dependent variable is Ln EXP juk. Table 5.2: VAT and Occupancy Rates in Tourism Establishments. 4

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 UK s declining share of the world tourism market, as well as the decreases in the levels of real receipts per visit for many of the UK s 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. 5

6 However, UK tourism is experiencing considerable problems: The UK s 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 and by 3.7% between 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 UK s tax yield: Much of the contribution of tourism to the UK s 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

7 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 café 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 UK s 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. 7

8 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. 8

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 9

10 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 UK s 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 10

11 to other European countries) would improve the country s 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. 11

12 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. 12

13 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 UK s 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, ). 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 UK s largest invisible export and in 1998 business tourism accounted for 27% of all visits to the UK. 13

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 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), Tourist Arrivals in the UK (000's) Source: Compiled using data from Travel Trends (1999) USA France Germany Irish Republic Netherlands Belgium Australia 14

15 Figure 2.2: Number of Tourist Arrivals in the UK, 1997 and Number of Tourists Arrivals (000's) in 1997 and USA France Germany Irish Republic Netherlands Belgium Italy Spain Switzerland Japan Australia Source: Compiled using data from Travel Trends (1999). 2 (ii) Trends in the UK s Share of International Tourism Receipts The UK s 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 UK s 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 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. 15

16 Figure 2.3: UK's Share of International Tourism Receipts. UK's Share of International Tourism Receipts % Year 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, US $ Million Market Share % USA 71, France 29, Italy 29, Spain 29, UK 20, Germany 16, Canada 9, Australia 7, World 441, Source: WTO (2000). 16

17 2 (iii) Current and real tourism earnings in the UK. The growth in tourism receipts for the period , 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 Figure 2.4: Current and Real Tourism Earnings in the UK. Current and Real Tourism Earnings in the UK millions Current Tourism Earnings Real Tourism Earmings Source: Compiled using data from Travel Trends (1999). 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. 17

18 Figure 2.5: Current tourism expenditure in UK ( millions), Current Tourism Expenditure in the UK ( millions) million Year USA France Germany Irish Republic Netherlands Belgium Australia Source: Compiled using data from ONS and Travel Trends (1999). Figure 2.6: Real tourism expenditure in UK ( millions), Real Tourism Expenditure in the UK ( millions) 2000 million Year USA France Germany Irish Republic Netherlands Belgium Australia Source: Compiled using data from ONS and Travel Trends (1999). 18

19 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 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 , 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 ( ), Real Average Tourism Expenditure per visit in the UK, Year USA France Germany Irish Republic Netherlands Belgium Australia Source: Compiled using data from ONS and Travel Trends (1999). 19

20 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 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-à-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 , 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 20

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 During the period , 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 = Consumer Price Index and Tourism Price Index (Base =1990) Index Year Tourism Price Index Consumer Price Index Source: Compiled using data from ONS and Travel Trends (1999). 21

22 Table 2.2: Percentage of overseas visitors' spending by year and spending category Spending Category Accommodation Eating out/alcohol Travel within UK Clothes Other shopping Other expenditure Total % 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 country s currency. It was observed for the UK that in 1987 and 1995, when sterling s external value was low, an increase in the UK s 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 and average expenditure per tourist fell from 390 in 1995 to 350 in The percentage change in the real effective exchange rate and the percentage change in tourism earnings are illustrated in Figure 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 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%). 22

23 Figure 2.9: Real Effective Exchange Rate (1990=100) and Average Tourism Expenditure. Real Effective Exchange Rate and Average Tourism Expenditure Index Year Average Expenditure ( ) Real Effective Exchange Rate Source: Own compilation. Figure 2.10: Percentage Change in Real Effective Exchange Rate and in Tourism Earnings. 50 Percentage Change in Real Effective Exchange Rate and in Tourism Earnings % Year % change in REER % change in Tourism Earnings Source: Own compilation. 23

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 in , the USA, France, Germany, the Irish Republic, the Netherlands, Belgium, Italy, Spain, Australia, Switzerland and Japan. The UK s 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 UK s 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 UK s 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. 24

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, 25

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 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 Table 3.1: Main Types of Tourism Taxes Directly Charged to Tourists Charged to User Businesses Arrival/Departure Taxes e.g. Visas, Travel Permits Travel Taxes e.g. Air Passenger Duty, Car Rental Tax, Fuel Tax Accommodation e.g. Bednight Tax Transportation Tax e.g. Road Tax Import Duties on Tourism Inputs Corporation Tax Expenditure Tax e.g. VAT on restaurant meals Environment Tax e.g. Ecotax levied on arrival/departure Source: Own compilation. Land and Property Taxes Environment Tax e.g. Levy on night take-offs/landings by Aircraft 26

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 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. 27

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, tourism s 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 ,458-1,779 Mining and quarrying 1, ,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, ,744 10, ,645 Public administration and defence 850 6,931-7,781 Education, Health and social work 1,921 14, ,272 Other services 999 2,513 5,792 9,304 Total tax ( million) 31,232 86,643 96, ,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. 28

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 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 café 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. 29

30 Table 3.3: Changes in the UK VAT rate. Date of introduction Rate (per cent) Standard Reduced Higher Principal goods and services covered by higher/reduced rates Higher rate applicable to petrol (but not derv) 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 Reduced higher rate applicable to all higher rated goods and services Higher rate abolished Reduced rate applicable to fuel and power for domestic and charity use , (5) - Reduced rate of 5 per cent introduced in the Isle of Man, applicable to hotel accommodation on the Isle of Man only Reduced rate of 5 per cent applicable to fuel and power for domestic and charity use and Isle of Man hotel accommodation 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 30

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. Net Total Income,Deductions and Corporate Tax from Hotel and Catering ( millions) Net Total Income Deductions Allowed Tax Payable Source: Compiled using data from Inland Revenue Statistics. 31

32 Figure 3.2: Total Net Income, Deductions and Corporation Tax from Distribution and Repairs Total Net Income, Deductions and Corporation Tax from Distribution and Repairs ( millions) Net Total Income Deductions Allowed Tax Payable Source: Compiled using data from Inland Revenue Statistics. 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 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. 32

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 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 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 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 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 33