Matthew Vella Government has declared that a reduction in VAT on restaurant charges would dent the public coffers by €22 million, and in any case the reduction would not be successfully passed onto consumers.
In rejecting demands for a reduction by the Malta Hotels and Restaurants Association, Finance Minister Tonio Fenech quoted a study which appears to confirm his government’s previous claims to that such a reduction would cost the economy €32 million in earnings.
The MHRA had argued that reducing VAT for restaurants would stimulate consumer spending, and called on the government to apply the reduced 5% rate after the European Council of finance ministers adopted an amendment to VAT laws.
The first country to make use of this option was France, where the VAT rate for restaurant services was reduced from 19.6% to 5.5% in July. Around 40% of restaurants in France reduced their prices, although not to the full extent of reduction, the ministry of finance said.
The government’s report drew on an analysis of Malta’s tourism and the effects of price changes, and compared it with main competitors’ such as Cyprus, Greece, Spain and Turkey. It said Malta was the most price-sensitive destination for the UK outbound market: making it more sensitive to reductions in travellers when prices increase.
But additionally, the report claims studies show that VAT reductions in the EU rarely pass on to consumers in the form of reduced prices.
“In case of VAT reductions, the highest pass through estimate observed was 82% in the case of Sweden’s reduction of VAT on books in 2002,” the report said, while pass through for reduced VAT on restaurants was just 19%.
Effects of reduction The immediate effect of a VAT reduction for restaurants will primarily be the reduction of prices on food, but this would be limited compared to the effect of the measure in the long term.
Costs of production for industries which make use of restaurants as an intermediate service would also be reduced and other prices may consequently decline, improving competitiveness of other sectors.
Since one of the main effects of the reduction of VAT on restaurants is on the tourism sector, the significant multiplier effects involved are likely to be an important consideration.
Higher output and lower costs of production would increase profit margins for the hotels and restaurants sector. Higher output will also result in higher employment and therefore an increase in total wages paid in the economy.
However, such changes would also affect public finances – negatively as well as positively. Directly as a result of the reduction in VAT on restaurants, government will have to forego VAT revenue. Estimates based on 2009 data indicate that this direct impact would be roughly €30 million in 2010. The total impact would be less - €29.3 million – due to higher VAT revenue from increase consumption, higher income tax and NI from the increase in employment and also profits, and higher revenue from import duties as a result of increase consumption.
The main positive impact of the measure results in 2011, with GDP growth expected
to rise by 0.6 percentage points above the baseline. Most of this increase is coming
from exports, as a result of the gradual increase in tourist expenditure, estimated at 5.6
percentage points above the baseline forecasts.
Net result The government’s report states that the final outcome of a VAT reduction can only be guaranteed if such a reduction is passed on to the consumer.
“Whilst the exact degree of pass through cannot be determined, empirical studies on similar measures adopted in other countries indicate that the degree of pass through was not full,” the report said.
The government claims that in Malta, product differentiation in the restaurant sector gives some market power to a number of restaurants that won’t pass the reduction on to consumers.
However in other types of restaurants or in certain areas, competition may be such that restaurants are forced to reduce their prices.
With this reduced pass-through at 50%, prices in restaurants are not reduced by the full amount of the VAT reduction. “Initially government loses the same amount of government revenue from VAT. But because the positive economic impact is reduced accordingly, the claw back by government is also reduced.”
The impact would be €25 million less VAT for government in 2010, which takes €3 million back in direct taxation.
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