Londoners will pay Ivan Massow's Hotel Tax

November 26, 2014 5:16 PM

Financial advisory boss Ivan Massow launched his bid to become the Tory candidate for the election of Mayor or London in 2016 with an article in the Evening Standard.

Tax for tourists, spending for Londoners?
Unfortunately, his flagship policy appears to be a commitment to increase tax and spending:
"As Mayor I also want to create a sense of citizenship in the capital and roll out a new Londoners’ Card — available, free of charge, to all who live and work here. It is a card that will come with an array of benefits paid for by new levies on tourism, a city tax, for example as they have in Barcelona and Rome, and a museums charge, so that those five million tourists a year help support our city. These Londoners’ Cards will be all-in-one smart cards — incorporating your Oyster travel card, for example — and will come with benefits specific to Londoners, including free access to museums and events."
Lots of freebies for Londoners paid for by all the tourists who visit the city in a tax on, presumably, the hotel rooms they stay in. Surely something Londoners should vote for? Not quite.
Raising prices affects sales volumes
Unfortunately, as the graph below illustrates, the effect of this tax will be a reduced supply of hotel rooms, as they become less profitable at the same price leading operators to increase prices to recoup some of the difference. This in turn would lead to fewer bookings. The dashed lines represent the supply curve and equilibrium before a tax and the solid lines represent the curve after a tax.
As you can see, it's not just tourists who would bear the brunt of the tax. Some will end up being paid for by the hotels. On the graph, the share is indicated by the length of the vertical section of the 'taxed equilibrium' (dashed red) line between where it intersects the 'supply' line (green) and the 'taxed supply' line (dashed green). The proportion of it over the old equilibrium price is paid for by the consumers (ie, the tourists), indicating the new higher price level. But the proportion of it that continues down below the old equilibrium price (the solid horizontal red line) to where it intersects with the old supply line (the solid green one) illustrates the proportion that is paid for by the suppliers (ie, the hotels) because they can't pass all of the tax onto their customers. And it wouldn't just be the owners, either. A tourist tax would reduce demand for hotel staff, leading to unemployment and downward pressure on wages.
And hotel prices are especially hard to raise
It gets worse. The supply of hotel rooms isn't terribly 'responsive'. New hotels can open to react to demand, and existing ones can expand or contract or even close. But such moves are expensive and not taken lightly. On the other hand, tourists are very mobile. They can easily choose alternative destinations to spend their time and money, so prices have a disproportionate effect on their numbers. This is represented in the steeper supply curve and the flatter demand curve in the graph below.
As you can see, with these supply and demand curves, a tax has relatively little effect on the price level, meaning the suppliers bear most of the burden, not buyers.
A hotel tax just isn't the free lunch for Londoners that it might at first seem
It wouldn't be tourists who would pay for Mr Massow's tax, it would be Londoners.

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