VAT at airports – flying in the face of economic analysis

When the current government is not regulating prices by imposing floors, such as the minimum wage, it is regulating prices by imposing ceilings such as on consumer credit and pensions products. When it is not doing either, it is complaining and cajoling firms. This all produces an atmosphere in which it is less pleasant to do business in Britain. In the long term, this will reduce productivity, wages and competition.

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.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

3 thoughts on “VAT at airports – flying in the face of economic analysis”

  1. Posted 13/08/2015 at 06:37 | Permalink

    Yes, the stores say that it is administratively difficult to charge different prices to different sets of travelers. Whether this is true or not, I don’t know. But on the basis that airside sales to non-EU passengers do not incur tax, surely the subsidy inherent in the lower prices is one from non – EU to EU travelers. As I recall, airside prices were allowed to be duty free because sales on planes are necessarily duty free, since they are not in any particular jurisdiction

  2. Posted 13/08/2015 at 18:03 | Permalink

    Philip is spot on with his analysis, almost. The exception would be at Heathrow (possibly Gatwick) where airlines are able to charge rents to passengers reflecting scarce capacity in the face of high demand. Airfares are pitched to clear the market so here VAT savings do not necessarily flow through to all passengers.

    The economic misunderstanding of agency leaders is also despairing. The press quote the retail ombudsman as saying the government should legislate for the VAT saving to be passed on!

  3. Posted 14/08/2015 at 07:09 | Permalink

    Philip – I think that the objection is to the deception where it is implied that it is a requirement to show your boarding pass for security or legal reasons. Your arguments make sense, but you would think that if people had been honestly informed about the reasons, at least some retailers would have broken ranks and offered different prices to traveller to EU and non-EU countries.

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