In the post-independence era from the 1950s to 1960s, many countries looked at their colonial agricultural sectors to drive growth and industrialise as part of a larger economic diversification effort. The effort, however, was not directed at expanding their agricultural sectors, rather planning and enacting economic policies that effectively taxed colonial commodities, including food crops like maize and wheat as well as cash crops like cotton.
The way this was accomplished was nothing short of fascinating, despite its shortcomings. Countries retained and empowered colonial marketing boards that were responsible for buying food in bulk at previously set prices from farmers before selling them later to domestic industries or channelling them to world markets. The role of those marketing boards served as a check on food prices by making sure cheap food is available for urban populations even as they disadvantaged rural populations.
The case for cash crops like cotton was quite similar, except that cheap cash crops were beneficial mainly for domestic industries, which by way of import licenses and quotas were, in effect, further subsidised.
Taxes can be a growth hurdle
While industrialisation and economic diversification are key for economic growth, premature taxation of an economic sector that is driving such growth can result in negative consequences for the whole economy. Countries are now repeating the same when it comes to tourism, a key sector for economic diversification and a significant earner of foreign currencies for many.
Taxes on tourism vary and imposed for one or more of the following reasons. One, to limit the number of tourists and thus reduce a strain on countries’ resources and infrastructure. Two, to discourage certain segments of tourists from visiting. Three, to increase government revenues and diversify their sources.
Some countries impose flat rates paid directly by tourists such as the one imposed in Bhutan. Other flat rates are referred to as “departure” fees in countries such as Japan and islands in the Caribbean. In US and the UAE among others, tourism taxes are reflected in hotel rates. For a country like the UAE, premature and excessive taxation on tourism would negatively affect its economic diversification efforts and undermine its position as a tourist hub.
Similar to the case of high taxation on colonial agricultural sectors post-independence, those tourism-related taxes are not necessarily imposed on tourism sectors that have matured fully into drivers of economic growth. At high enough rates, those taxes can cause permanent damage to tourism as they deprive the sector from income that is not only important to sustain it, but essential to drive future investments and growth.
Premature taxation of tourism can also hinder economic diversification efforts, more so for countries that have become significantly reliant on it for growth.
Therefore, and for countries to better balance income from tourism with limitation on arrivals for whatever reason, the following must be taken into account when deciding on tourism-related taxes, whether flat and departure rates or taxes reflected on hotel rates.
* First, and before the imposition of tourism-related taxes, countries must have a clear understanding of their standing in international tourism and how price elastic their tourists are to hikes in prices because of tourism-related taxes. After all, higher taxation rates will lower the number of arrivals, but with revenues from tourism-related taxes compensating for that.
This is again subject to tourists’ price elasticity.
*Second, before imposing those taxes too, countries must study the maturity level of their tourism sectors and whether or not there is further room for thes to grow in prominence and support of economic diversification. As hinted earlier, this is even more important for countries like the UAE. A premature and excessive taxation on tourism, in the context of regional and international competition, could impede tourism in the long term.
* Third, tourism-related taxes that affect hotel rates and restaurant bills lower tourism spending in the country, which consequently and by association alters the mix of tourists visiting as cities become too expensive to visit. This could be observed in cases where the number of international tourist arrivals have gone up, but their overall spending has gone down.
In the long-term, this would lower income from both the sector and its taxes.
The last thought that I want to leave you with: Why are hotels and restaurants in the UAE allowed more than 40 per cent plus of taxation?
Abdulnasser Alshaali is a UAE based economist.