Tax on tourism comes with share of unknowns for an industry yet to recover from COVID-19

This article appeared originally in Gulf News: link to original article

Tourism, which was once a beacon of hope for countries to diversify their economies, has been taking some serious battering since the spread of COVID-19.

Its association with aviation, another main casualty of the pandemic, further deepened the scars for a sector that will need years to regain its pre-pandemic number of international arrivals – and with it – spending. While how long is anyone’s guess, preserving a country’s standing in tourism would take more than the pandemic going away and travellers getting back on planes.

Akin to any other sector expected to drive diversification efforts, and overall economic growth in the country, tourism must be supported and nurtured to ensure its long-haul survival.

COVID-19 has highlighted the importance of tourism, except that such importance is not linked to the number of travellers arriving at or going through a country’s points of entry. Rather, the economic activity that they generate in sectors directly associated with tourism, like hospitality.

Pick an option

For a hotel, the business model is one where a tourist stays for longer, hence avails a lower nightly rate, and hopefully spends more within the premises. Alternatively, a tourist stays for a shorter duration, but spends more on products and services provided by the hotel, including overpriced in-room dinning.

An optimal scenario for a hotel would be if a tourist stays for a longer duration and spends more within the hotel premises, improving the hotel’s average occupancy rate. At closing of the financial cycle, all of the above need to be taken in account to show whether a specific hotel property has lost money, made money, or just broke even.

The occupancy rate – used by hotels on an operational level and by cities/countries as an indicator of the health of the hospitality sector – will show early on where a hotel is headed in terms of profitability.

Alone though, it forms part of the story and its profitability is subject to the average nightly rate during each level of occupancy. The same rate, when consistently high for a period of time, can entice governments to tax the nightly rate, in one way or another.

That is, in effect, a tax on tourism.

In principle, there is nothing wrong with taxing tourism as long as the government believes that tourism has reached the intended maturity level. This could be determined from occupancy rate obviously, which could encourage supply of more hotel rooms that would eventually lower the average city/country rate. Or from a targeted number of international visitors achieved.

In-built biases distort

With that, the target itself, no matter the amount of extensive quantitative analysis that has gone into it, may be biased for multiple reasons. That, in turn, would mean that the taxes are costing the economy more than the collected taxes are benefitting it.

Here is how.

First, a city/country interested in growing its tourism sector would keep expanding its hospitality-related infrastructure, such as handling capacity by airports and the availability of main attractions. Thus, whatever the set target is for international arrivals, it will need to be constantly increased as the city/country keeps expanding the said infrastructure.

In other words, the number of international arrivals is a moving target that can only be fixed by the city’s/country’s capacity to host a certain number of individuals within a given period of time. Whether the city/country boasts of a national carrier or not, placing the destination on the international route of airlines would serve as a catalyst towards further expansion in hospitality.

Subsequently, the city/country keeps hosting a higher number of international arrivals.

Not a true benchmark

Second, the occupancy rate is not an all-out indicator as to the health of the hospitality sector. Governed by market forces, the occupancy rate can go up and down depending on the nightly rates imposed by hotels, whereby those go up and down based on the hotel’s own occupancy rate and not the average city/country one.

Therefore, the introduction of taxes on nightly rates could distort market mechanism through which a hotel can set the right nightly rate at the right time. The higher those taxes are, and the less mature the tourism sector is, the higher is the level of distortion and the wider the damage that is being done to sectors that are directly and indirectly associated with the hospitality and tourism sectors.

Get them back

Third, the arrival of tourists, subject to their overall stay durations, could make up for part of the infrastructure and other costs that the city/country cannot recoup from its population alone. While domestic tourism – i.e., arrivals from other cities across the country – could also make up for that, there is no doubt that the higher the number of international arrivals is, the better positioned a city/country is to justify its infrastructure spending, both hospitality and non-hospitality related.

That being said, a city/country is better off allowing market forces to be at play without the distortion caused by tourism-related taxes. This would mean that a hotel’s occupancy rate, and the average rate in a city/country, would move up and down in liaison with nightly rates and the supply of hotel rooms.

As such, the number of international arrivals that a city/country can host at any point in time would be subject to market forces instead of an urge to collect taxes from a sector that may still have a long way ahead towards maturity. In fact, this may choke a thriving sector in its infancy.

The last thought that I want to leave you with: Are governments better off collecting taxes from tourists via hotels? Or by allowing tourists to spend less on hotel taxes and more in the economy, including consumption-related taxes?