What is special or different about VAT?
Unlike most aspects to do with taxation, VAT is regulated by the EU. Every member state within the EU must apply VAT at a standard rate that can be anything between 15 and 25 per cent. All countries can also have up to two reduced rates between five per cent and 15 per cent. Reduced rates can only be applied to a limited range of goods and services specified in the regulations. A few items are permitted to have ‘super-reduced rate’ of less than five per cent, a ‘parking rate’ or a zero rate, and others may be exempt from VAT.[/wptabcontent]
Why does the EU allow member states to apply reduced rates of VAT?
The situation regarding VAT rates is complex but the EU’s intention is to permit the use of reduced rates where:
- There is a social or welfare benefit, e.g. food, medicine, housing;
- There is a cultural or educational dimension, e.g. books, theatre;
- Increased energy-saving and efficiency are promoted;
- Labour-intensive services are supplied locally, e.g. gardening, personal care, house repairs.
Does every country use reduced rates?
There are 28 member states in the EU. Every country except Denmark has at least one reduced rate. Fourteen of the remaining countries have two reduced rates and the remaining twelve have a single reduced rate. The UK currently has a single reduced rate of five per cent which is applied to a limited range of goods and services including domestic fuel, children’s car seats and insulation materials.
So hotels and attractions are included amongst those services that can have a reduced rate?
Yes. The permitted goods and services include:
- Accommodation provided by hotels and similar establishments including the provision of holiday accommodation and the letting of camping sites and caravan parks,
- Admissions to shows, theatres, circuses, fairs, amusement parks, concerts, museums, zoos, cinemas, exhibitions and similar cultural events and facilities
- Restaurant services
Does every country then have a reduced rate of VAT for these services?
No. Each member state can choose whether or not to apply the reduced rate to permitted services, but not all do so. As regards hotel accommodation, every country except Denmark, Slovakia, Lithuania and the UK has a reduced rate of VAT. In France and Germany, for example, it is seven per cent. Nineteen of the 28 EU member states have a reduced rate for at least part of their visitor attractions sector. Fourteen countries have a reduced rate for restaurant meals.
Why have most countries applied reduced rates of VAT to tourism?
Most EU governments recognise that:
Tourism is highly price-sensitive and subject to intense international competition; reducing VAT leads to lower prices which increases tourism demand, and this can stimulate other parts of the economy.
Increasing tourism in this way is a highly cost-efficient way of creating jobs, and these jobs span the socio-economic spectrum.
Direct revenues foregone because of the reduced VAT rate by government treasury departments can be more than made up by tax income from increased employment and company profits and by reduced social security payments for the unemployed.
Does the UK not recognise these benefits?
Ironically, yes. The rate of VAT on hotels in the Isle of Man has been five per cent since 1994. Thus, a previous UK government recognised that lowering VAT would help the sector in the Isle of Man to compete more effectively for short breaks with hotels in the Channel Islands, for example, which are exempt from VAT (though a five per cent Goods and Services Tax has since been introduced in Jersey). And in the 2012 Budget, the Chancellor reduced the rate of VAT on cable car rides for up to ten people.
Isn’t there a move towards abandoning reduced rates?
The European Commission has a vision of applying a single standard rate of VAT throughout the EU, with every country applying the same rate of VAT. This vision is echoed by the findings of the Mirrlees Review in the UK which sought to identify the characteristics of a good tax system for any open developed economy in the 21st century. However, this vision is not realistic in current economic and political circumstances.
A major report into the use of reduced rates of VAT in Europe commissioned by the EU and undertaken by the consulting firm Copenhagen Economics supported the EU’s vision of a single standard rate of VAT from the standpoint of economic theory. However, the report also found numerous circumstances where the use of reduced rates has benefits, with tourism often quoted as a suitable case.
Thus, the use of reduced rates of VAT in Europe is increasing, to the extent that roughly a third of VAT income across the EU is derived from goods and services that are taxed at reduced rates.
Doesn’t reducing VAT just mean that operators will make more profits?
Even if that were so, this would not necessarily be negative. Increased profits means more money for investment in the sector and raising quality will in turn lead to growth in the sector through increased competitiveness. It would also mean more funds available for recruitment, training and higher wages, which would generate increased income tax for government. And increased profits generate higher corporation tax receipts and tax on dividends.
In practice, however, competition within the sector eventually compels operators to lower prices. The Copenhagen Economics study analysed six case studies where a VAT rate reduction had occurred. The report concluded that: ‘…there is little doubt that permanently lowering the VAT rate on particular goods (or services) sooner or later will lead to a reduction in the price of the goods more or less corresponding to the monetary equivalent of the lower VAT rate … In economics jargon, there will be a strong tendency towards full pass-through.’
(‘Pass through’ here means that the full impact of the reduction in VAT is reflected in lower prices equivalent to the reduction in VAT.)
Similarly, there is little doubt, according to Copenhagen Economics, that the price cuts that result from a permanent lowering of VAT rate will lead to increased consumption and consequently to increased production and employment. Such increases will occur more rapidly and be more significant in sectors with high price elasticity, strong competition and labour-intensive sectors. Tourism displays all three of these characteristics. It can typically take two to three years for this full effect to be realised.
In a survey of BHA members in January 2012, over 95 per cent of over 200 respondents said that if a five per cent VAT rate was achieved some or all of it would be passed on. 82 per cent said they would invest more in their product/facilities, 67 per cent would employ more people, 57 per cent would invest more in training and just under half (48 per cent) would increase staff wages.
So, would a guarantee by the hospitality and attractions industry to reduce prices be effective?
Rack rates exist but many hotels operate yield management systems which use flexible pricing strategies which increase or reduce prices according to demand, similar to the airlines but unlike manufactured goods which normally have a standard price. A room selling at £100 at a time of slack demand may well rise to £200 at peak demand; as a result it may appear that the level of VAT has had no impact when, in fact, the benefit will be there but not obvious.
Will reducing the rate of VAT benefit everyone?
No. Most VAT-registered UK and overseas business travellers can already reclaim the VAT paid as a legitimate business expense so the impact on these tourists will be nil.
The operators of businesses that are outside the VAT scheme, either because their turnover is below the VAT registration threshold or because they declare turnover below this level, will face increased competition from VAT-registered businesses that lower their prices. However, overall demand will increase and therefore there is the potential for all operators to benefit.
The reduced rate of VAT is also likely to encourage some operators to register for VAT so that input VAT on supplies can be off-set. In France, reducing the rate of VAT on restaurants has helped to reduce the extent of the ‘shadow’ or ‘black’ economy.
What examples are there of countries that have reduced the rate of VAT on tourism?
Many examples are quoted in the Deloitte/Tourism Respect report on which the industry’s VAT campaign is based. Recent examples include Germany where the VAT rate on hotels was reduced was reduced from the standard rate of 19 per cent to seven per cent from 1st January 2010. Previously, the high rate of VAT was making Bavaria, a region of considerable tourism importance, uncompetitive with southern neighbours such as Austria and Switzerland. In addition, the reduced rate was intended to stimulate hotel investment. Initial findings indicate that investment has been encouraged, while more jobs have been created, wage levels have increased and prices have been reduced.
In France, a lower rate for hotels has been in force since 1967. In the 1980s, four- and five-star properties were removed from the reduced rate and subjected to the standard rate. Hoteliers downgraded the star-rating of their hotels to three-star because having to charge higher prices made them uncompetitive; all hotels have been subject to the reduced rate of 5.5 per cent since 1994. Visitor attractions have also been subject to the reduced rate of 5.5 per cent since 1992, coinciding with the opening of Disneyland Paris. The reduced rate increased from 5.5per cent to seven per cent on 1 January 2012.
Since 1st July 2009, restaurants in France were initially on the reduced rate of VAT of 5.5 per cent but this was increased to seven per cent in 2011. This was following a change in EU rules that made this possible, and was tied to a formal agreement regarding job creation between the government and the industry. Whilst the full effect of the VAT reduction on restaurants has yet to be seen, to date it is estimated that 15,000 bankruptcies and 30,000 job losses have been avoided, 35,000 apprenticeships were created and some 25,000 jobs were created in 2010. The minimum monthly wage in the restaurant industry has increased from €1,350 to €1,620, with staff turnover falling from 80 per cent to 40 per cent.
Ireland further reduced the rate of VAT on hotels, tourist attractions and restaurants from 13.5 per cent to nine per cent on 1st July 2011. It is too early to identify the results but the aim is plainly to make Ireland more attractive as a tourist destination. The reduction extends to cinemas, theatres, sporting events, golf fees, newspapers and magazines due to their links with the tourism industry. This measure sits with a cut to the €3 Air Travel Tax, on the condition that airlines use it to boost passenger numbers and open new routes. Some easing of visa restrictions has also been introduced. These measures demonstrate the government’s assessment that tourism can be stimulated and jobs created, notwithstanding the country is facing a far worse deficit crisis that that faced by the UK.
But don’t Scandinavian countries have higher tax regimes than the UK?
Yes - the three Scandinavian countries all have a higher standard rate of VAT than the UK at 25 per cent. But Sweden and Norway (not a member of the EU) both have reduced rates of VAT for hotels and food services and for some parts of the attractions sector. Denmark is the only country is the EU that has no reduced rates of VAT.
VAT is only one tax; aren’t tourists subject to other taxes?
Indeed they are and, overall, the level of taxation to which visitors to the UK are subject is higher than almost all other countries.
The World Economic Forum (WEF) compiles a Travel & Tourism Competitiveness Report every second year. At the time that the Deloitte/Tourism Respect report was completed in February 2011, the 2009 WEF report was the latest available. At that time, the UK was ranked 133rd out of 133 countries on price competitiveness. The WEF results are based on a wide variety of factors that affect price, including business taxes, labour taxes and local taxes including bed tax.
In the 2011 report, the UK was ranked 135th out of 139 countries on price competitiveness. This improvement came about primarily as a result of the fall in the value of sterling against most other currencies. It cannot be relied upon, nor is it desirable, that sterling will continue to fall.
What about bed taxes?
In Europe and North America, bed taxes have been contemplated or initiated mainly at the city rather than at national level, so the impact on overall national or pan-European tourism has been limited. In some cases the experience has been that bed taxes have been counter-productive in that they increase overall price, making destinations uncompetitive – in exactly the way that occurs with high rates of VAT. Examples of where a bed tax has been introduced and subsequently removed include Rotterdam and the Balearic Islands.
How much will it cost the government to reduce VAT on hotels and visitor attractions?
According to the estimates in the Deloitte/Tourism Respect, report, the government will lose up to £1.2bn in foregone VAT per annum. However, as soon as the VAT reduction measure is introduced, it will set off a virtuous growth cycle – prices will come down, stimulating increased demand, leading to recruitment, investment and expansion in the sector. According to our detailed fiscal model, income will be generated for the Treasury that more than compensates for the foregone VAT revenue. HMT begins to recoup its investment within three years and, over a ten year period, this would become a net gain of £2.6bn.
Why aren’t you campaigning for reduced VAT on restaurants?
According to our research, there is a strong case on the grounds of job creation for reducing VAT on restaurants. If VAT on all ‘out-of-home’ meals were reduced to five per cent we estimate that some 222,800 full- and part-time jobs would be created (148,500 full-time equivalents).
The direct loss of income to the Treasury caused by the reduction in VAT on restaurants would be around £2.9bn over 10 years at net present value. According to our estimates, this loss would be partially offset by other Treasury receipts due to expansion of the sector, jobs created, reduced social security payments etc. In the present economic climate, we recognise that it is contrary to the government’s current policy to contemplate such a level of loss of taxation income.
Why should accommodation and visitor attractions be singled out for preference by the UK government?
On three main counts:
1. The higher rate of VAT in the UK makes the UK uncompetitive with nearly all other European competitor countries.
2. Tourism is the only export which is subject to a domestic tax.
3. The independent study by Deloitte/Tourism Respect forecasts that if VAT were reduced to five per cent, 78,000 full time equivalent jobs will be created in the accommodation and attractions sector.
What’s to stop other industries also asking for a reduced VAT rate?
Because the UK would not be allowed to reduce the rate for most other industries. The others goods and services to which EU member states are permitted to apply a reduced rate are:
Books, newspapers, magazines (incl audio)
The work of writers, composers, artists
Use of sporting facilities
Charities and welfare organisations
Equipment for the disabled
Children’s clothing, nappies
Street cleaning, refuse disposal, waste water treatment
Live plants and firewood
Heating, light and power
Many of these in the UK already have a reduced or zero rate.
But if London hotels are operating at 80 per cent plus average year-round occupancy, why do they need a reduction in VAT?
It’s not just London hotels that will benefit. Provincial hotels, which operate at ten per cent lower occupancy, will also gain. The major factor keeping London hotel occupancy high is the rate of exchange which has greatly encouraged overseas visitors to the UK. This benefit has over-ridden the negative impact of the rise in VAT to 20 per cent but it reinforces how competitive international tourism is.
If the value of sterling rises to previous levels, inbound tourism will be severely affected. Even during the last few years, when the value of sterling has been low, the number of visitors from the US has declined by 27 per cent with spend down by 23 per cent since 2006. The USA is our third largest overseas visitor market. Overall, visitor numbers to the UK are down – from 32.8m in 2007 to 30.7m in 2011, so the need to boost visitor numbers is clear and urgent.
And it is not only hotels. Visitor attractions and all other forms of visitor accommodation will benefit including self-catering, B&Bs, holiday camps, caravan and chalet parks, camping sites.
In any case, if exchange rates stay as they are and London hotels continue to trade at high occupancy levels, this will stimulate further hotel construction which, in turn, will create jobs in construction as well as jobs in the new hotels – all the time increasing London’s capacity to host visitors.
How solid are these arguments?
Certainly, compared with France’s seven per cent for example, the UK operates at a significant cost disadvantage. The UK (and London in particular) already has a reputation of being an expensive tourist destination. The 20 per cent rate of VAT exacerbates this. If hotels were able to reduce their prices by a reduction in VAT, it would put the UK on a more level playing field.
The BHA estimates that 236,000 jobs can be created by 2015 provided the industry has the right support framework. Reducing VAT is part of that support. Between 1998 and 2010 the hospitality industry created 207,000 new jobs; it is not unrealistic to suggest that, as a result of a VAT reduction in accommodation and admission to attractions, Deloitte/Tourism Respect’s forecast of 80,000 additional jobs will be achieved.
So how would you summarise the impact of a VAT reduction?
In short, a reduced rate of VAT would:
1. Generate higher levels of employment, with increased wage levels and training. These benefits would occur throughout the age and socio-economic spectrum and throughout the UK.
2. Increase additional tax receipts as a result of this additional employment with consequential savings on social security payments.
3. Increase profits, corporation tax payments and shareholder dividends.
4. Lead to further investment in the industry, improving overall quality and therefore further improving the UK’s competitiveness.
5. Feed through to higher expenditure in other sectors of the economy, which in turn will generate further tax receipts – the ‘tourism multiplier’. Every additional £1 of tourism expenditure generates 70p of extra expenditure in other sectors of the economy,
But what will happen if VAT is not reduced on hotel accommodation and visitor attractions?
If VAT is not reduced, it’s likely that:
1. The UK’s share of international tourism receipts will continue to fall in comparison with European competitor countries.
2. The decline in domestic tourism expenditure by UK residents will continue (inflation adjusted domestic tourism expenditure fell by four per cent per annum between 2000 and 2008, before recovering slightly in 2009).
3. The decline in the proportion of total UK tourism expenditure spent on holidays at home relative to holidays abroad will continue. This has fallen from 50 per cent of total UK tourism expenditure in 2000 to 36 per cent in 2008.
All three scenarios conflict with the prime minister’s stated aims for UK tourism and the aim of the government’s tourism strategy.