Are reduced VAT rates unique to the tourism industry?

Value added taxes are applied to a wide range of products and services and are not unique to the tourism industry. However, certain industries, including accommodation providers, currently receive more favorable VAT treatment than others. As noted above, hotel services are included in Annex H of the 92/77 Directive, giving Member States the choice of applying a reduced rate to hotels. Twelve Member States currently apply a reduced rate, while three (Denmark, Germany and the United Kingdom) levy the standard rate.

Among the other goods and services listed in Annex H are:

This diverse grouping of goods and services were included in Annex H because they were of a “social or cultural nature.”

The decision to include accommodation providers in Annex H and the fact that the majority of Member States have chosen to apply a reduced rate indicates that there is widespread agreement that their economies benefit from a reduced rate on their hotels.

How does the nominal and effective tax burden on this industry compare with other economic activities in the economy?

While hotels have benefited from the optional reduced VAT rate, the same cannot be said for sectors such as restaurants and car rental services. Neither restaurants nor car rental companies are eligible for a reduced rate as neither are included in Annex H or Annex K. However, a derogation allowed Member States who were applying a reduced rate to restaurants in January 1991 the option of continuing to do so. Therefore, eight Member States currently apply a reduced rate on restaurant meals. The only Member State to apply a reduced rate to car rentals is Ireland (12.5% “parking” or transitional rate).

It is interesting to note that restaurants are often taxed differently if they are a take-out or a traditional full-service restaurant. Five Member States (Belgium, Finland, France, Germany and Sweden) levy considerably lower tax rates on take-out than they do on full-service restaurants. In Belgium, for example, full-service restaurants are taxed at 25%, while take-out restaurants are only taxed at 6%.

By way of example, listed below are selected VAT rates on various goods and services in France:

How do VAT rates on accommodations compare with rates on other purchases?

Listed below are the current general VAT rates levied in EU countries along with the applicable rate on tourism-related purchases.

The current structure of VAT rates, and the scope of reduced rates in particular, reveals two factors which obstruct the smooth working of the internal market and create distortions of competition: the discretionary or optional nature of the application of reduced rates and the lack of common definitions of the categories making up Annex H.

Several aspects of the current tax structure has given rise to complaints from various sectors. These complaints relate to:

• The discretionary nature of the application of reduced rates;
• The difference between reduced rates, which range from 5% to 14%, and super-reduced rates;
• The lack of Community definitions of the categories of goods and services figuring in Annex H and the restrictive nature of the Annex;
• The piecemeal application of reduced rates: Member States availing themselves of the option are not obliged to apply the reduced rate to all goods and services in the category or categories chosen;
• The conflict between the principle of a single rate of VAT and the possibility of applying reduced rates: derogations from the principle should be explicitly worded and strictly applied;
• The complexity caused by the fact that some derogations are permanent and others transitional.

The fact that only some Member States apply reduced rates means that rates for such products or services can vary from 3% to 25%, much to the dissatisfaction of service providers in Member States not currently levying reduced rates.

Principle No. 1 summary: Is this an equitable taxing scheme?

Disparities between neighboring Member States in the application of reduced rates, the failure to harmonize the level of reduced rates and the optional nature of the provisions in the matter are all cause for concern among tourism industry leaders in the EU. The wide disparity in standard and reduced rates illustrates the flaws of the current transitional VAT system and has created an uneven playing field for tourist industries in Europe. Despite the fact that the Sixth VAT Directive calls for similar VAT rates for the same transactions, tax rates are far from harmonized. According to a study by Deloitte & Touche, industry operators in the EU would prefer to operate in an environment where VAT rates applied to their industry are at least approximately the same across the Continent. Until the same rate for all is set in place, there is always going to be an element of discontent within the tourist industry.

“Taxes must generate revenue without a significant impact on the demand for a good or service (unless the tax is designed to modify behavior). At a certain threshold, the revenue gained from a tax increase can be lost because of reduced demand. Even more, the decrease in demand sends a debilitating wave throughout the economy as suppliers are affected. The negative impact swells, because of the subsequent loss of tax revenue in many sectors.”
 

Are value added taxes designed to modify travelers’ behavior?

Value added taxes are not designed to modify behavior; rather they are imposed to generate revenue for the central government of each Member State. However, studies have shown that increasing or decreasing tax rates on tourism-related businesses, especially accommodation providers, can greatly influence travelers’ behavior. A Deloitte & Touche Study in 1998 for the British Tourist Authority titled “The economic effects of changing VAT rates on the British tourism and leisure industry” demonstrates that across Europe, higher rates of VAT are associated with a slower rate of growth in tourism receipts. The correlation coefficient of 0.65 suggests that there is a 99% probability that the two factors are related and only a 1% probability that it is due to chance. Therefore, increasing or decreasing tax rates, even if not specifically intended to modify travelers’ behavior, often have an impact on the travel decision-making process.
 

What will be the monetary impact on total accommodation costs?

The WTTC annually publishes the World Travel & Tourism Tax Barometer, an economic index of travel-related taxes in 52 cities worldwide. The following table is based on information from Tax Barometer 10, December 2001.  Included in the table are the current average room rate, current VAT rate, total tax dollars paid per night, total tax dollars paid per night at a reduced VAT rate of 5%, and the difference between the two.

The average per night room costs are based on the “rack rate” price published by Runzheimer International. Note that additional charges such as service fees and local lodging and bed taxes are not included.

Using Copenhagen hotels as an example, reducing the VAT rate from 25% to 5% would result in a total tax savings of $184.20 for a person staying six nights. Savings of $100 or more for six nights would also occur in Frankfurt, Munich, and London. A change in the VAT rate would result in both minor ($1.25/night in Paris) and major ($34.08/night in London) reductions to rooms costs.

A frequent argument against lowering VAT rates concerns the stability of state revenue; that is, the amount of tax revenue the government could possibly lose as a result of a lower tax rate. However, a number of case studies have shown that lower tax rates can yield more revenue and that national treasuries need not worry about an initial tax shortfall resulting from a VAT cut as they will be more than compensated by the ensuing increases in VAT and other tax receipts due to greater activity in the sector.

A 1998 Deloitte & Touche Study titled “The economic effects of changing VAT rates on the British tourism and leisure industry” examines the budgetary effects of reducing VAT rates in the medium and long term. The report makes the following conclusion: if the UK government were to reduce VAT from 17.5% to 8%, the loss in VAT would be compensated by gains in income and corporation tax and reduction in social security payments. The indirect gains to the Treasury from these sources rises from £426m in the first year following VAT cut to £753m in ten years.

A University of Linz study titled “An economic analysis of the effects for tourism in Austria of a reduction of VAT on accommodation from 10 to 5%” demonstrates that the apparent loss incurred by the State as a result of the reduction in the VAT rate would be compensated by the increase in the volume of VAT paid due to a greater number of nights spent by tourists combined with the multiplier effect of this increased activity.

It is important to note that the opposite reasoning holds true: if the VAT rate is increased to demand-depressing levels, a net loss in overall tax revenue may possibly occur.
 

Will a reduced VAT rate allow the countries to remain price-competitive with non-EU countries?

Tourism is one of the fastest growing economic sectors in Europe, and it is an essential sector for some European countries. But it faces very strong competition from overseas and should not be made to bear the burden of heavy taxation. In order to be competitive with non-EU countries, and especially with some Mediterranean countries where no VAT is levied, tourism industry leaders throughout the EU have argued that tourism-related services should be in the scope of the reduced VAT rate.

Most Mediterranean countries, as well as Austria and Ireland, apply the reduced rate on accommodations. In Greece it is even more visible, where the reduced rate applied to accommodations and catering is further reduced to 6% for the islands in the Aegean Sea.

An important concept concerning competition is Price elasticity. Elasticity is a measure of the correlation between two values. For example, a demand/price elasticity of -2.5 means that a price cut of 10% would stimulate a 25% increase in the volume of demand. A Deloitte & Touche Study for the British Tourist Authority established that price elasticity in UK tourism might reach -2.5. Other studies have shown tourism’s price elasticity to range between –1.0 and –2.5. Given this high elasticity, even a small increase or decrease in prices (or taxes) can stimulate a large increase or decrease in demand in tourism-related services.

Travelers by definition are mobile and, more often than not, have freedom to choose their travel destinations. They are increasingly well informed and exhibit normal consumption behavior, meaning they are sensitive to product prices and will select less expensive products when presented with the opportunity to choose. Therefore, it is important to seek the advantage of lower tax rates than one’s competitors, or at least maintain equality. A reduced standard VAT rate will enable EU tourism to compete on a more even footing with non-EU destinations.

Some Member States are at a competitive disadvantage because of high VAT rates. The Single Market neutrality principle should apply in this case and VAT rates on tourism should be harmonized.
 

Principle No. 2 summary: Is this (i.e., reduced VAT on accommodations) an efficient taxing scheme?

Efficiency refers to the extent to which the tax system distorts the free market system. An efficient system is one which minimizes those inevitable distortions. In the case of the tourism industry, a high VAT on hotel rooms increases the price per room, thereby making it less attractive to the consumer. As noted above, 12 Member States currently levy a reduced rate on hotel accommodations. The Member States levy the standard rate (Denmark, Germany, and the United Kingdom) are clearly at a disadvantage, both within and outside of the EU. The Travel & Tourism industry is exceedingly price sensitive. The price competitiveness of the industry has been intensifying as a result of improved sales opportunities, particularly through the Internet, and with the advent of low cost airlines and other travel services, brought about through liberalization, technology and other facts. When coupled with local lodging taxes, service fees, and the taxes in place in other tourism-related sectors, the tax rates in some EU countries are most likely reaching a point where demand will begin to decrease, and a net loss in tax revenue is likely to occur.

“Complicated taxing schemes eat up revenues through administrative costs. These costs include both those borne by government in the process of collecting and enforcing taxes, and those borne by taxpayers. One objective of good tax policy is to achieve the highest possible ratio of revenues generated per dollar invested in collecting the tax. Special note should be made to consider the taxpayers’ costs of compliance in calculating this ratio. Simplicity in taxing also dictates that governments should make it clear what the tax rates are, and how the revenues are to be used.”
 

Is this a complicated taxing scheme?

In its present state, the VAT regime is very complex. One of the primary goals of moving toward a “definitive” VAT regime is to streamline the entire process. Hoteliers, like many small businesses, are concerned at the increasing complexity of taxation and other bureaucracy. New financial regulations issued every year and their attendant requirements for form-filling by hoteliers create the need for extra assistance from accountants, adding to costs for hoteliers as well as the direct cost of the taxes involved.
 

What will be the government’s cost of collection?
What will be the taxpayers' cost of compliance?

Both the governments’ and taxpayers’ cost of compliance is low; many tourism related taxes are considered to have low collection costs. However, in a number of instances, the misreporting of business (to minimize taxation) is thought to be a problem. A reduced VAT rate would also take away some of the incentives to join the underground economy. It is generally regarded that the VAT system does not function well in local, labor-intensive industries, because the payment of VAT is easily avoided.
 

Is it clear how the tax revenues will be used?

VAT revenue accrues in each Member State’s general fund and is used to fund the full-range of government functions. There is no clear definition of when and how the revenue is to be used.
 

Principle No. 3 summary: Is this a clear and simple taxing scheme?

The current VAT system is neither clear nor simple, as evidenced by the lack of harmonization in rates between Member States. The EU has stated that simplifying, modernizing and standardizing the VAT system is one of the primary reasons behind establishing a definitive system.

“Fair revenue generation arises from the concept of equity. In the evenhanded capturing of tax revenue, it is unreasonable to assess special fees or levies on specific goods or services. These types of taxes are often cloaked by language and terminology to hide their real intent. Although special charges and fees may appear on face value to be modest, they can quickly accumulate and become an unreasonable burden to a sector.”
 

Are value added taxes a special charge or fee?

Value added taxes are not special charges; they are in essence a sales tax applicable to nearly all goods and services, the revenue from which pays for government services.
 

What percentage of the tax revenue will be used in ways that will benefit tourists or the tourism industry?

The documentation does not suggest that there is any design to use VAT collected from hotels for any special purposes related to the tourism industry. It will be pooled with other taxes into a general fund and used to support the full range of government operations.
 

Will the tax be changed at some specified future date?

The VAT system in the EU is evolving, and changes in rates on the hotel sector are probable. The current rates are deemed “transitional” and are especially subject to change as the EU moves toward establishing a “definitive” system. It is known that the new system will contain both standard and reduced rates, but it is not known which category hotels will fall under. The European Commission is scheduled to release a report at the end of 2002 on the experiment of reduced VAT rates for labor-intensive services. This should be followed in 2003 or 2004 by measures permitting a final decision on the VAT rates of such services.
 

What other special charges or fees are already in place in these countries' tourism sectors?

Listed below are special fees and charges currently levied on various tourism sectors in selected EU countries.

• Hotel: Local lodging tax (2.8%).
• Car rentals: Airport Access Fee (13.0%), Contract Tax (1.2%), Road Tax (ATS 7.00/day), Registration Fee (ATS 50/day).
• International air passengers: International Passenger Service Charge (€ 11.63), Passenger Terminal Use Charge (ATS 142.10), International Passenger Security Charge (€ 4.36).
   

Principle No. 4 summary: Does this tax generate revenue in a fair manner?

The current unequal rates of taxes on accommodations across the EU is inherently unfair as is the disparity in VAT rates across industries. EU hoteliers also raise fairness as an issue with respect to EU subsidies provided to developing countries’ hotel industries, and they note that they in effect are being taxed to subsidize their competitors.

“Tax incentives and disincentives should be imposed with the underlying goal of stimulating growth. Taxes that support infrastructure will ideally result in the attraction of investment and new employment. However, when taxes become excessive, economic growth often grinds to a halt.”
 

Is the goal of a reduced VAT rate to stimulate industry growth?

Certain industries have been granted reduced VAT rates in order to make them more competitive and to increase employment. A reduced VAT rate on the accommodations industry would likely accomplish both goals; it would become more competitive vis-à-vis non-EU countries and the ensuing growth would result in greater employment.
 

Will the tax revenue be invested in productive infrastructure improvements, destination marketing/promotion or tourism-related government services?

While governments will surely elect to allocate some funds to support their tourism industries, there is currently no information to suggest that the intent is to earmark hotel VAT for any specific tourism-related purpose. Therefore, while it is unknown to what extent Member States will use this revenue for infrastructure, destination marketing and tourism-related government services, in all likelihood at least a portion of the revenue will be expended on these items.
 

Principle No. 5 summary: Would a reduced VAT rate be an effective stimulus to industry growth?

The European Council has stated on numerous occasions that employment should be kept “at the top of the political agenda of the European Union.” Unemployment continues to be a major problem facing the EU, and it is important to stress the importance of tourism as a recognized source of jobs.

The Travel & Tourism industry employs a vast number of people in Europe. It is estimated that the industry directly employs over 8 million people in the EU, representing roughly 5 percent of total employment. While many of these workers are highly qualified, the industry is also a major source of employment for the less skilled. Tourism-related businesses are primary sources of young persons’ first jobs and this experience prepares them for future positions within or outside the industry.

Given tourism’s high price elasticity, a reduction in the VAT rate on hotels and other tourism-related businesses would increase the demand for these services, thereby stimulating employment and economic growth.