Taxes act as a wedge between the price paid by consumers and the price received by suppliers.  The imposition of a tax (represented by "t" in the diagram) will shift quantity demanded from the original market equilibrium (Q1) to the post tax quantity (Q2).  If consumers are relatively price sensitive, suppliers will be forced to factor the cost of any new tax (aircraft fuel taxes are a good example) into their cost structure.  However, if suppliers are relatively more price sensitive, the tax will be passed onto consumers.  The revenue raised by the tax is represented by the shaded rectangle formed by P2, P1 and the quantity at Q2.  The excess tax burden or, in other words, the loss to society in the form of reduced consumer and producer surplus, is represented by the shaded triangle to the left of Q1 and to the right of Q2.

Figure A

When considering tax policy, governments seldom have ready access to information about demand and supply such as that depicted in Figure A.  Without this information, they may demonstrate an insensitivity to the basic economic realities that function in competitive markets.  Whatever the reasons, governments appear to derive simple and naïve assumptions about market demand.  To project added tax collections from new tax, it is common for government analysts to simply multiply the per unit tax by the level of current sales.  For example, a new $2 room tax in a market where 1,000,000 room nights were sold last year might be expected to yield $2,000,000 in new tax revenues.  However, for this projection to hold, the room demand would have to be totally inelastic as depicted in Figure B. 

Figure B

Under such circumstances, the quantity sold would not be altered by the tax, new tax revenues would equal those projected and the tax would not alter the function of the economy with respect to the product taxed.  Unfortunately, this view generally proves to be inaccurate, because few markets are totally insensitive to price increases.
 

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Issues in Tax Policy 

• Foreword/Preface
• Economics of Travel & Tourism Taxes
• Tax Theory
• Principles of Intelligent Taxation
• Key Issues in Travel & Tourism Development
• Tax Policy Guidelines
• Global Forces Shaping International Tax Policies
• Travel & Tourism Taxes: A Reference Guide
• References

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