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Proiect cofinanţat din Fondul Social European prin Programul Operaţional Sectorial Dezvoltarea

Resurselor Umane 2007- 2013

Speech given on 27.09.2013 in Bucharest, Romania

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Loukas Spanos Economist

Hellenic Parliament and Center of Financial Studies, University of Athens

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One of the central questions in both public finance and development is the effect of corporate taxes on investment and entrepreneurship. This is a central and crucial question and this effect matters not only for the better evaluation and design of tax policy, but also, and maybe more importantly, for thinking about economic growth, for the better investment strategy that the business world design and implement. The dilemma often governments and policymakers face is quite clear: On the one hand, governments need tax revenues to finance infrastructure and social policies, while on the other hand they are competing to attract Foreign Direct Investments, for which the level of corporate tax is seen as a key location determinant. And all these debate and challenges refer to a central question that every economy faces: How to attract investments for business development? How to attract and retain foreign direct investment (FDI) from around the world? For economic recovery? For new jobs? For poverty reduction? Attracting investments is, of course, a multi-stage process which usually involves many different stages.

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Taxation is one of the most important factors and therefore is essential to clearly understand how important is corporate tax for FDI. Watch Graph XX…This graph comes from a recent study of fDI Intelligent and shows the correlation between GDP (the key indicator of market size) and number of FDI projects attracted. A sample of 46 countries was included, covering most of the largest economies in the world and biggest recipients of FDI. The 46 countries used in the Graph accounted for more than 80% of world GDP in 2011 and attracted more than 70% of FDI projects from 2010 to 2012. What the Graph shows is a clear strong correlation between GDP and number of FDI projects – as rather expected as most FDI is market-seeking. The larger a country’s GDP, the higher the number of FDI projects it attracts. Previous studies have found that GDP is also the most important determinant of FDI at a city level. As GDP is the most important determinant of FDI, what the next Graph shows is the correlation between the corporate tax rate of each of the 46 countries and the number of FDI projects they attracted relative to size of their economy. A clear correlation between lower tax rates and stronger performance in attracting FDI relative to economic size can be seen. In fact, more than 70% of the variation in FDI performance can be explained by the level of corporate tax. The strong relationship between tax and FDI has also been found at the city level. In 2011, a study of 25 cities in Europe found that corporate tax, market size, labour costs, and agglomeration were the key determinants of FDI job creation. The study found that for every one percentage point decline in corporate tax, FDI job creation increases by at least 4%, depending on the starting level of corporate tax. So, coming back to our initial questions and the global debate, it’s more than clear that corporate tax is likely to have a significant impact on FDI. And any moves to change the European/global tax system may have a major impact on FDI project attraction as well as the future location on FDI. And this is not only the case. Raising corporate tax rates is expected to lower investment and also to discourage entrepreneurship. This is actually the result came from another study using data and statistics of 85 countries – including Romania and Greece. Raising the corporate tax rate by 10 percentage points reduces the investment rate by 2.2 percentage points and FDI rate by 2.3.

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A 10 percentage point increase of corporate tax rate reduces business density by 1.9 firms per 100 people. That means that almost 2 less corporations per 100 people are created. And again a 10 percentage point increase of corporate tax rate reduces the average business entry rate by 1.4 percentage points. Also interesting are the findings on the informal economy. The finding suggests that at least part of the adverse, of the negative, effect of taxes is to keep economic activity - such as investment and new business formation - but informal, rather than to eliminate activity altogether. So again, it’s obvious that – using cross-country evidence –high corporate tax rates have a large and significant negative effect on corporate investment, entrepreneurship and the development of the informal economy.

Given these clear effect that corporate taxes have on investment and on Foreign

Direct Investment, what actually is the current trends – one might ask – ? What the

governments do?

Well the answer is not much promising.

Most of the tax reforms introduced in 2012 were designed to increase government

revenues rather than encourage investment and FDI particularly.

The majority of new tax regulations introduced in 2012 revolved around increasing tax rate for multinationals. Although tax reforms intended to attract more inward FDI were introduced in some countries, governments were more active in introducing measures to secure additional revenues for their crisis-burdened budgets.

To spotlight some example, France, introduced measures where limitations on carrying forward losses on company profits have been reinforced, Belgium, introduced capital gains tax on shares held for less than 12 months, and Spain and Sweden, limited interest cost deductibility.

Additionally, countries across the globe did little to simplify their tax regimes in 2012.

Surprisingly, Greece, the most crisis-ridden country in Europe, made the most encouraging changes in taxation in 2012. The Greek Government took commendable steps to overhaul and streamline fiscal provisions and quicken the country’s dispute resolution procedures.

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Apart from Greece’s efforts to improve its tax regime, other countries, including Italy, Ireland and the UK, took efforts to implement steps to attract cross border investments. Italy, for example, launched tax reliefs for high-tech start-ups, Ireland lowered tax rate for foreign dividends received in the country and the UK presented new controlled foreign company rules, which are set to make the country more attractive for holding companies. Finland, Japan, Korea, Sweden, Switzerland and the UK were also took initiatives to further reduce rate of corporate income tax.

Let me highlight a little more the level of success in attracting FDI in three countries that have received EU bailouts - Ireland, Portugal and Greece. The results are mixed and varying among them.

Out of the three countries to have received EU bailouts, Ireland is the only one to have enjoyed an increase in recorded FDI since the financial crisis began in 2008. Data shows that Ireland recorded 77% more projects in 2011 than it did in 2007. Conversely, Portugal recorded 63% fewer projects in 2011 compared to 2007 and Greece recorded 20% fewer.

In 2007, Ireland's financial services sector enjoyed a significant level of investment from UK-based banks. In 2011, a number of investments from US-based banks such as Citigroup helped Ireland's FDI levels recover. The growing levels of investment in Ireland’s software and IT sector have also helped bolster the country's FDI levels. Again, it is the US-based firms that have invested most heavily. Online auction site Ebay, search engine Google and social networking site Twitter have all established or expanded their presence in the country.

Before the financial crisis, in 2007, Greece experienced FDI investment across a diverse range of industries, but particularly in the energy sector. In the same period, 2007, Portugal attracted a broad range of investments, in the communication sector and automobile. However, the financial crisis and the ongoing recession especially in Greece, reduced investment. Moreover, political and social instability discouraged investment opportunities who were seeking more stable and more predictable business environments within the eurozone.

Having point out these interesting relationships between taxes and investments let me focus on the tourism sector.

Apart from any other sector, there are many groups of taxes and fees related to the tourist activity, directly or indirectly. There are:

taxes or fees for travelling (such as visa fees, entry and exit charge);

air and ship transport costs (such as airport and harbour charges and fees, charges on travel tickets, contributions and taxes on the fuel, tax on the transit, allowance for the safety);

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hotel and other accommodation taxes and fees (overall there exist about 15 different taxes and fees);

restaurant tax (the well-known value added tax, tax on the alcohol);

road traffic;

car rental (municipal and local taxes, other taxes, excises on the gas);

tax and fees for visiting tourist attractions; and, finally,

taxes on the casino and gambling industry.

Among all these taxes and fees in the tourism sector, the main attention has been dedicated to the corporate income tax and Value Added Tax (VAT), because these tax rates are usually more high than others and mostly burden business activities in hotel industry and in tourism.

Governments across the globe are recognising the importance of promoting and developing tourism, both as an industry in itself and as a way to improve their country's image, which can help attract investment in other sectors.

Tourism is a major contributor to the world economy, since it provides jobs for millions and grows faster than GDP, doubling the jobs created every 10 to 15 years. Tourism sector play, particularly, a central role in many South-East Europe countries, and hence a good business environment for tourism is always a key element for its growth potential, producing positive spillovers on poverty and unemployment reduction.

Countries often look to develop their tourism sectors in the hope that it will also boost the wider economy. They want the benefits to pass on to other business sectors and the community at large.

If you ask finance and trade ministers, which sectors they would most like to develop in their countries, tourism is frequently near the top of the list. They describe tourism sector as one less vulnerable sectors to economic downturns, as one of the easiest sectors to develop and one that brings benefits to the wider economy.

It is not surprising then that when the G-20 leaders met in Mexico a year ago, in June 2012, they recognised the role of travel and tourism as an engine for job creation and economic growth. And no wonder then that so many countries are developing and initiating policies aimed at attracting FDI in the tourism sector. That legislations and regulations are aiming to further promote projects that support tourism and liberalize air travel.

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So there is no doubt that a developed tourism sector, with an efficient infrastructure, attracts foreign investors, something that is confirmed by the World Economic Forum Travel & Tourism Competitiveness Index, with most European destinations at the top 20 of the rankings. Europe is considered to be the safest place in the world to do business. The impact of tourism on the European economy and its role as an economic engine corroborate this trend.

And with more consumers from emerging markets now travelling, the tourism sector is starting to respond to these developments. Europe’s main tourist market is Europe itself: the intra-European (regional) market is responsible for some 80% of the total volume of arrivals.

Growth opportunities for European tourism are promising if we consider three factors:

First, the fast-growing overseas markets, especially China, India (known as 'the 1 billion markets') and Brazil, because of its cultural ties with Europe and its booming middle class who are keen on travel.

Second, established overseas markets such as the US and Canada, where Europe already has a good market share and can compete with other destinations for a bigger slice of the business.

Third, emerging markets in Europe, such as Russia – which has definite potential in terms of population and spending power, although this is dependent on certain national reforms – and other European countries such as Turkey and Poland, which are performing above average both as destinations and as source markets.

Among the factors that determine the profile of a country as a tourism investment destination is price competitiveness. Price competitiveness in the tourism sector takes into account – among others – factors like airfare ticket taxes and airport charges as well as taxation in the country, which can be passed through to travelers.

For that reason – for price competitiveness – a properly constituted tax regime in the tourism sector is a fundamental element for attracting investments and business projects. The need to understand how important taxation for the development of the tourism sector is, is often ignored or to better say underestimated by governments. Tourism sector it’s always an “attractive target” for taxation by governments. When you have a well established and developed tourism sector, that produces revenues and profits, then you tax them a lot to receive more revenues for the budget. That’s why the tourism sector is a natural candidate for higher-than-average pressure when tourism represents a significant share of economic activity.

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This trend, to overtax tourism, is further facilitated by cases where destinations have no clear substitutes, because - for example - of particular geographical or climatic reasons, distance, quality, etc. Another reason for increased tourism taxation is the following: An intensive, a strong tourist activity may lead to the need for a larger supply of services or infrastructures, such as medical services, road maintenance, garbage collection systems, safety, water supply, etc., whose costs may not be covered by the taxes already paid by tourists. Furthermore, local authorities and municipalities must provide adequate infrastructures to meet the demand in high seasons, investing in facilities which however underused during the rest of the year. For this reason, an increased taxation in tourism may provide the necessary money to cover these costs. In short, tourism taxes – which exist in a variety of forms and are imposed by national and local governments – is a mean of financing public services that are used by both tourists and residents of tourism destinations. However, there is a growing concern regarding a proliferation of taxes on tourism. Most of the criticism concentrates on the fact that usually the taxes which travellers pay are not passed on to the tourism industry. It is recognized that a negative impact of high taxes on tourism can have substantial economic downside. Furthermore, since tourism and aviation are closely linked sectors, an increased tax burden on tourism can have a significantly negative impact on air transport. Let me specify a little bit. An analysis of the relationship between VAT rates and tourism sector growth in the EU shows that this relationship is negative. That means, higher rates of VAT are associated with a slower rate of growth in international tourism receipts. The main argument in favour of reduced VAT rates is mainly on the grounds that the demand for tourism is highly elastic. Highly elastic demand for tourism means that even a small price cut for the tourist, made possible as a result of reduced VAT, could stimulate a large rise in demand in the tourism sector. The effect of the increased demand would be a growth in employment but it would also impact on the demand in other sectors such as manufacturing (for example aircraft industry) and construction (for example hotels and other accommodation) through the multiplier effect. Another negative impact of over-taxation in the tourism industry is the distortion of competition among different tourist destinations. According to this argument, lowering taxation in tourism is a necessary condition for the EU countries to maintain competitiveness compared with the non-EU countries. The less tax imposes in tourism the more competitive the country is and the more demand for tourism increase. Competition is also a key policy aspect that has to be taken into

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account within the EU. For example, it is well known that taxes are too high for the coast line tourism in Romania to meet the competition with the Bulgarian one. Furthermore, taxes in tourism produce unequal tax treatment between the tourist product and any other export product, given that the latter is tax-exempted. So, to summarize, VAT plays a crucial role in competitiveness-loss terms, given the reactions from the part of the hoteliers and the restaurant owners because it affects competitiveness both through the package price that they offer and its competitors price, as well as in terms of outdoor entertainment of the individual tourist over and above the price of the package.

Therefore, tourism and aviation taxes appear to be counterproductive. In many

cases, the revenue raised from such taxes is far outweighed by the economic

benefits that are foregone as a result of reduced demand for tourism and air travel.

Thinking from and economic point of view, generally a government increases taxes

or tariffs on a specific product when it wants to discourage its consumption, not to

promote it – take for example tobacco. Having in mind this basic and simple

principle its irrational when tax policy increase tax rates in tourism industry.

Tax policy in the tourism sector is largely debated in many European countries.

Recently, hospitality and tourism industry in the UK has launch of a big campaign for

tax relief, under the name "Cut Tourism VAT Campaign". Just to remember you, the

UK Government decided on January 2011 to apply a standard VAT rate, including the

hotel and tourism industry, of 20 percent from 17.5 percent. This decision, not to

exclude the tourism industry, has created many concerns. Whilst the UK tourism

sector struggles under a twenty percent rate, Ireland, a tourism competitor, has

taken advantage of a lower rate in tourism (from 13.5 percent to 9 percent in July

2011) to increase its visitor numbers and create new jobs. The UK's high tourism VAT

encourages actually British holidaymakers to take a break abroad in Ireland, France

or elsewhere in Europe.

The UK is among just a handful of European states that imposes its headline VAT rate on the hospitality and tourism industry despite a growing number of European states that have introduced tax breaks in recent years. Switzerland has recently extended its reduced VAT rates on tourism services for four years and Portugal is tipped to implement similar concessions.

As you know, the European Union allows a reduced VAT on a limited number of goods and services, which includes tourism. Out of 27 EU member States, only four countries - Denmark, Lithuania, Slovakia, and the UK - do not take advantage of a

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reduced rate of VAT on visitor accommodation. Thirteen countries have also a reduced VAT rate for restaurant meals.

So, the idea is rather than increasing tax rates or the number of taxes is better to provide incentives to attract more tourists, to encourage more investment in the tourism sector, and through that way to grow and expand the tax base and consequently to increase tax revenues. In other words, a growing and flourishing tourism industry will be able to contribute more revenue, even if the tax rate remains the same. These are the so called taxation strategies which towards growth and long-term sustainability.

It is also important to avoid increase in fees in industries directly related with the tourism industry. For example, government decisions leading to an increase of the costs of air travel imposes a new barrier to the development of the aviation and tourism industries. Increased aviation taxes may result in unprofitable routes and reduced frequencies for destinations to, from or within a country. In turn, such an effect will reduce the wider economic benefits available from aviation, resulting in a negative impact on economic growth and overall government revenue bases. And taxes on aviation charges will negatively impact tourism, an industry that is essential to the economy of many countries. In sum, taxes that are only applied to aviation are discriminatory and have an adverse effect on the air transport industry, a key engine for economic development. Four are the key elements to take into consideration before increasing cost to passengers: Fisrt, air travel is increasingly sensitive to price, due to the Internet, no frills competition and centralised corporate purchasing power. Second, the rise of corporate buying and the increased transparency of price have lead to more price sensitivity for business travel. Third, several studies demonstrate that amongst all travellers, tourists travellers are most sensitive to price and will therefore experience the greatest decrease in demand if there is a cost increase. For example, a price increase of 10% is estimated to generate a decline of 15% in the number of leisure passengers travelling. Fourth, when a new tax on aviation is introduced it will be transferred to the price of the ticket. As a result, the demand will be significantly impacted Even if the revenue of these taxes is allocated towards tourism promotion overseas, the result of these campaigns would be offset by a real reduction in the number of tourists actually visiting the country.

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Tourism is currently the most dynamically growing sector of the Greek economy, is one of the main engines of growth in the Greek economy:

Tourism’s contribution to the GDP is steadily over 15% and, occasionally, has exceeded 18%. In 2012, the latest available data was 16.4% of GDP and in 2013 is expected to growth by 1.9%, reaching almost 17% of GDP.

Tourism creates employment that encompasses a wide range of activities and spans across different levels of knowledge and expertise, especially for young people and in the regions. The employment in tourism in 2012 was 688.800 employees.

One (1) in five (5) persons living in Greece is directly or indirectly employed in the tourism sector. The contribution of tourism sector to employment was 18.3% in 2012.

International tourism receipts in Greece in 2012 were 10 billion euro and are the country's biggest foreign-currency earner. Tourism receipts from independent travelers accounts for the 65.8% of the total tourism receipts and the rest 34.2% comes from package tours. The data in the first seven months of 2013 show a further increase of total tourism revenue to about 15.4% compared with the same period last year, when fears of a Greek eurozone exit kept tourists away. The local tourism industry is forecasting a 10% rise in tourism receipts for the full year to 11 billion euros, expecting more than 17 million visitors in 2013.

International tourist arrivals were 15.5 million people in 2012, where the average per capita tourism expenditure – for the same year – was 646 euro.

Every Euro spent in tourism leads to more than double secondary consumption in the rest of the economy.

Tourism sector in Greece is the most competitive, since the European Market share was 2.9% in 2012 and the World Market share was 1.5% in 2012.

The world ranking, places Greece in the 17th position according to arrivals, in the 23th position according to receipts and in the 32th position according to total competitiveness.

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In comparison with its main competitors with regard to international tourist arrivals, Greece is ranked third after Spain and Turkey, and higher than Egypt, Croatia and Cyprus. It is worth mentioning that among these coundries, Greece was the only which realized reduction in 2012 because of the fears of exiting eurozone. This trend is not expecting for the current year.

Market share – based on the origin country of the international tourist arrivals – identifies five main countries: Germany, UK, FYROM, France and Russia. All of them account for the 46.3% of the total tourist arrivals. If we breakdown the international tourism receipts by country of origin, we conclude that the 5 most important are Germany (16.5%), UK (14.16%), Russia (9.42%), France (7.62%) and Italy (5.42%).

These figures clearly show that tourism is one of the most important branches of the Greek economy. As a member-state of the European Union, Greece has introduced reduced VAT in tourism. The general VAT rate is 23%, but a reduced VAT rate is also applied, ranging from 6.5% to 13%. Let me point out that the standard rate of 23% is now higher than the previous years: it was 21% in 2010 and 19% in 2005. The reduced VAT of 6.5% is applied in the hotel accommodation, in the theater industry, while the 13% VAT rate is applied in the transport sector, admission to cultural services and amusement parks.

A new law issued in the end of July 2013 reintroduced the reduced VAT rate of 13% on restaurant services, the supply of takeaway foods and the delivery of prepared packaged meals. The new reduced rate – it was 23% - is applied on a temporary basis from 1 August 2013 through 31 December 2013. However, all services provided by night clubs and the sale of alcoholic beverages by any type of business are subject to the standard VAT rate of 23%.

It is worth noting that the VAT reduction in catering industry is implemented as a pilot program and made possible after strong negotiations between the Greek Government and the international lenders – the troika – and it was the Prime Minister himself who announced the decision, since it was the first tax reduction after three years of tax increases.

The main prerequisite for the successful outcome of this pilot VAT reduction program after the five-month trial period is for entrepreneurs not to continue tax evasion but to issue receipts to their customers. If the program fails and the tax evasion in the sector continues, then the VAT rate will be increased again and the government will not be able to reduce more taxes.

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Let me tell this: For Greece and the government, the symbolism of the VAT reduction is perhaps more important than its economic impact. It represents something of a milestone in the Greek bailout program as tax increases have been the norm and a regular source of much anger over the last three years. It was billed as the first tax cut since the program began.

The Greek government hopes the VAT cut will boost one of the biggest employers in Greece’s and make the country’s tourism sector more competitive against its competitors. However, introducing the tax reduction on August 1 for a trial period seems to undermine the aim of attracting more customers and more tourists.

One imagines that an agreement earlier this year, which could have been communicated widely and loudly to visitors, could have achieved a better result. A reduction of the rate to 13 percent, where it was two years ago, is far from enough to give Greece an advantage over its competitors for tourists’ spending money. In Italy and Spain, for instance, restaurants charge 10 percent VAT. In Cyprus it is 8 percent.

And one can also say that what Greece negotiated is much less than what other bailout countries did. For example, the Ireland, where the standard VAT rate is 23% as in Greece, achieved much more. From July 1 2011 VAT on restaurants, hotels and tourist attractions in Ireland cut from 13.5% to 9%, where it will remain until December 2013. The scope of this reduced VAT rate extends also to cinemas, theatres, sporting events, golf fees, newspapers and magazines due to their links with the tourism industry. This measure of the Irish Government was combined with a cut to the €3 Air Travel Tax, on the condition that airlines use it to boost passenger numbers and open new routes. All these measures came as part of a larger Jobs Initiative and competitiveness improvement, through boosting tourism and investment initiatives.

Returning to what Greece did, there is also the question of whether restaurateurs and cafe/bar owners will pass on the savings to their customers. It is difficult to imagine they will follow this path in the middle of the tourist season when they stand to gain little or no extra business from doing so. Instead, paying less VAT will allow them to hold on to more profits. It is worth noting that after the UK government implemented a VAT cut in late 2008, the Office of National Statistics found that about a third of businesses did not reduce their retail prices.

We have to wait until to see the full impact of the reduced VAT rate in food industry. Economic theory suggests that where competition exists and demand is relatively responsive to price, a VAT reduction will lead to lower prices, increases in demand and the possibility of greater aggregate tax revenues. This theory was examined in depth in a report commissioned for the EU. The report analysed the impact of a change in the VAT rate in six case studies, and suggests that permanently lowering

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the VAT rate leads, in typically up to two years, to a reduction in prices of goods or services corresponding to the value of the tax cut. These price cuts will lead to increased consumption, production and employment, especially in labour-intensive, price-elastic services such as hotels and other Tourism services. Fiscally, usually in the first year after a VAT reduction there would be a loss in direct VAT revenues for the Budget. However, there will be almost immediate gains to offset this loss as lower VAT leads to lower prices increasing demand, job creation and longer-term fiscal returns.

So, in the case of Greece the lowering of VAT rate is not permanent, but only temporally and is still too early to evaluate the measure. But it’s important to mention that during August the top tourist destinations of Mykonos, Santorini and Crete had tax avoidance rates of more than 56 percent, and tax authorities ordered about 15 establishments closed for a month and additional 14 shut down.

In general of course, there are some case-studies where countries recently have changed the rate of VAT applied to Tourism and experienced better results:

Germany, where the rate of VAT on hotels was reduced from 19 per cent to 7 per cent from 1st January 2010. Reports suggest increased demand for hotels, employment, salary levels and investment by hoteliers;

France, where the rate of VAT applied to meals in restaurants was reduced from 19.6 per cent to 5.5 per cent from 1st July 2009. In the first period since the cut, an estimated 28,200 jobs have been created, 15,000 businesses have been saved from closure safeguarding a further 30,000 jobs and there has been a signifcant decrease in the ‘Shadow Economy’.

Let me summarize:

Tourism is a significant contributor to many economies generating a significant proportion of the country’s GDP and supporting many jobs. Tourism sector provides significant growth potential, even in downturn economic times. High Tourism taxes, including VAT, Air Passenger Duty and visa charges, make the country less attractive as tourist destination. Tourism is one of a limited number of goods and services to which the EU permits Member States to apply a reduced rate of VAT. Nearly all Member States exercise this option because they recognize that:

Tourism is highly price sensitive

Reduced VAT can result in increased demand and thus the creation of jobs

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Hotel accommodation and visitor attractions have a significant export element

Tourism is also unusual in its position as the only export sector which is subject to VAT. An effort to improve the framework conditions and market characteristics for attracting investment and boosting the tourism sector include simplification of the tax system, elimination of tax distortions, removal of unnecessary administrative and compliance costs and increased transparency. The general principle of keeping taxation simple, transparent, and fair should be practiced, and policymakers should be careful in the way they treat tourism sector.