VAT at airports – flying in the face of economic analysis
The government seems to be falling over itself to try to avoid understanding basic economics. This was shown in the recent budget which included two notable measures – one which would reduce labour demand (the hike in the minimum wage) and one which would reduce labour supply (the increase in the tax credit withdrawal rate) – justified by the most spurious reasoning.
The latest manufactured controversy relates to airport shops not passing on VAT reductions to passengers. They do pass them on, the only questions are whether they do so implicitly or explicitly and to which group of passengers.
If I turn up at an airport and buy a teddy bear for £5, VAT is charged of £1 if I am travelling to Slovakia (because it is within the EU which does not allow tax exemptions for “havens” within its jurisdiction). However, VAT would not be charged if I travelled to Turkey. The government is suggesting that different prices should be charged to different travellers and that stores should not pocket the VAT exemption given to them by the government.
But, a moment’s economic analysis shows that this is not “rip-off Britain”. It is possible that, given the degree of competition between different airport stores (and there must be some competition), the VAT saving for the stores on non-EU travellers feeds into lower average prices than would otherwise pertain – not lower prices than non-airport stores but lower prices than would otherwise exist within the airport. If such competition is imperfect (or, indeed, non-existent) it will raise store margins. But this does not mean that the stores gain. Higher margins will lead to higher rents charged by the airport’s owners. It would be a very odd economic model that suggested that shops could maximise profits by exploiting the VAT exemption but airports would not maximise profits themselves.
However, those airports with market power are regulated businesses and those that do not have so much market power (such as Stansted) operate in competitive conditions. In both cases, you would expect the profits earned from airport retailing to lead to lower charges to airlines. In the case of the regulated businesses this is because the regulator would take the increased rents into account when setting the charges. In the case of those airports that are not regulated it would be because competitive conditions would encourage airports to lower their prices to get more business.
The airline business is fiercely competitive – of that there is no doubt. As such, we can certainly expect lower airport charges to lead to lower airline prices. The beneficiaries of shops not passing on their VAT perks therefore are passengers in general. A perk that is intended for people flying to outside the EU is shared between all passengers.
This is not obviously a bad outcome. In my view, the VAT perk should be abolished (though that might not be worthwhile because foreign passengers could reclaim VAT and that would be administratively cumbersome). Whilst the exemption remains, it is not a subsidy from taxpayers in general to people who fly to outside the EU (as the government intends); nor is it a subsidy from taxpayers in general to airport stores (as the government pretends); it is a subsidy from taxpayers in general to all flyers.
One wonders whether there is anybody in government who is interested in rising above playing politics with business and, instead, is willing to follow through economic analysis. After all, the arguments are not very complicated. The current government risks becoming like the European Parliament – that is it risks becoming an institution where anti-business rhetoric designed to obtain applause from interest groups counts more than serious economic analysis of economic policy.
Prof Philip Booth is the IEA’s Editorial and Programme Director.