The repercussions of the 2011 VAT increase on the tourism industry

Does a significant increase in VAT rates harm the tourism industry and if so how much? This paper investigates the consequences of a large increase in VAT rates on firm profitability and survival. In 2011, the Portuguese government increased the VAT by ten percentage points on catering services, restaurant meals, and beverages.

The tourism sector in Portugal represents the biggest sector of the economy, and is composed of many small and medium-size firms, which are generally affected the most by such tax changes, at the same time being essential contributors to job creation and economic development. Hence, it is essencial to understand the costs of tax increases on firm profitability and survival.

The paper analyzes 23,388 Portuguese firms related to food and beverage service activities. The analysis is based on accounting data obtained for the period from 2003 to 2013. The results show that the consequences of the ten percentage point VAT rise in Portugal were much more harmful to the tourism sector than the financial crisis. The average decrease in profit (EBITDA) levels after the tax introduction reached 8.7 percent compared to a decrease of 1.15 percent for the years 2008-2009, with the largest decline occurring in the year after the implementation of the VAT reform. In the years 2012-2013 the ratio of inactive versus active firms rose to 8.1% and 9%, respectively, compared to 2-3% during the time of the financial crisis. The implemented VAT change increased the probability of firm bankruptcy by three fold.

While the direct effect of an increase in VAT is the increase in tax revenue, this paper documents a sizable indirect negative consequence to firm profitability and survivals. This negative indirect channel is likely to contribute to a decrease in VAT revenue in the long term. In addition, the price of specific labor skills in the industry is likely to be affected and unemployment is likely to increase, potentially affecting the competitiveness of the tourism industry domestically and internationally.

Click here to go to the paper by Cesário Mateus and Irina B. Mateus.