The Consequences of a Sudden Increase in the TGST rate

The hasty implementation of the proposed hike in the TGST rate, may increase uncertain costs to the hoteliers, a plausible decrease in tourist arrivals, and the potential failure to realize the forecasted revenue increase.

Minister of Finance Ibrahim Ameer

Minister of Finance Ibrahim Ameer

The Maldives government collected over MVR 19.7 billion (USD 1.3 billion) in revenue in 2021, which is equivalent to 26 percent of the GDP—a percentage value on par with advanced European countries. Among the government's tax instruments, the Tourism Goods and Services Tax (TGST) is a crucial tool, with MVR 4.7 billion (USD 304 million) collected as TGST in 2021, contributing to 24 percent of the revenue.

In response to the growing government debt and the fiscal imbalance, the government announced changes to tax rates on July 5, 2022, including an increase in the TGST rate from the current rate of 12percent to 16 percent, which represents a 33 percent increase. In addition to the proposed TGST increase, the general GST is also set to rise by 6 percent to 8 percent. The first quarter of 2023 is when this change is anticipated to take effect.

This article explores the consequences associated with the hasty implementation of the proposed hike in the TGST rate, and finds that it may increase uncertain costs to the hoteliers, a plausible decrease in tourist arrivals, and the potential failure to realize the forecasted revenue increase.

Tourism Goods and Services Tax (TGST)

Over a third of government revenue in the Maldives comes directly from tourist spending. Taxes imposed on tourist spending include the TGST, airport service charge, airport development fee, and green tax. 

Tourism-related taxes brought in USD 419 million in 2021, or USD 318 per tourist. TGST accounts for 24% of total government revenue in 2021.

Initially imposed at 3.5 percent in 2011, TGST was increased to 6 percent from January through December 2012 and to 8 percent starting in January 2013. The TGST rate was raised to 12 percent as of November 1, 2014.

In most countries, no dichotomy exists in the goods-and-services tax (GST) imposed on the tourism and non-tourism sectors. However, the non-tourism sector in the Maldives is subject to a 6 percent GST, while the tourism sector is subject to a 12 percent TGST.

The IMF has recommended a gradual closer alignment of the two rates in the long term, depending on the growth of homestay and guesthouse accommodation in otherwise inhabited islands, and after a detailed assessment of administrative and enforcement concerns.

Tourism Tax Rates of Comparable Economies

Economies comparable to the Maldives in terms of high tourism dependency have tax rates equal to or below 15 percent; thus, the proposed TGST increase will place the tourism tax rate in the Maldives above competing destinations, at 16 percent. 

Is this the right time for a Tax Increase?

The global economy is inherently linked to the Maldives' tourism, and the global economic outlook at this time is inconducive to hurriedly increasing the tourism tax. As the World Bank reports, "while the Maldives economy recovered sharply and external imbalances improved in 2021, the outlook remains uncertain given travel and commodity price concerns". The World Bank further adds that the Maldives continues to face significant risks, especially due to the high debt burden and the global uncertainties.

Challenges in the international supply chains and the ongoing Ukraine-Russia war continue to cast a negative light on the global economic outlook. The IMF is forecasting the impact of the Russia-Ukraine War to flow through higher prices of food and energy; disrupted trade and supply chains; reduced business confidence; and higher investor uncertainty.

An unexpected increase in inflation in the US and European economies is tightening global financial conditions. China’s economic slowdown remains worse than expected amid COVID-19 lockdowns.

Thus, global output, as reported by the IMF, contracted in the second quarter of 2022. The global economic growth rate is expected to be 3.2 percent in 2022 and 2.9 percent the following year, reflecting the slowing growth in the world's three major economies: the United States, China, and Europe. Despite this sluggish economic growth, global inflation is forecasted to rise due to rising food and energy prices. Inflation in advanced economies is expected to be 6.6 percent this year, with emerging markets and developing economies experiencing 9.5 percent. 

Potential Failure to Realize the Planned Increase in Revenue

A swift increase in TGST – without ample time for tourism establishments to prepare for it – could result in lower profits for corporations, and in turn lead to lower than anticipated net revenue for the government. Here is how it could happen.

Even though TGST is a consumption tax that is intended to be passed on to the final consumer (the tourist), a sudden increase in TGST would make it nearly impossible for tourist establishments to pass the increase in tax to tourists. This is because resorts, hotels, and guesthouses' room rates are usually sold to tour operators/agents in advance, with a locked-in rate contract. Renegotiating room rates in the middle of an ongoing contract is not only extremely challenging but also unlikely to succeed.

Thus, a sudden TGST increase has to be absorbed by tourist establishments as an unanticipated operational cost in the short term, usually for one year. Such unplanned tax absorption by tourism companies would reduce corporate profits, subsequently plummeting the government’s estimated revenue from BPT.

The result is that while the government could collect a 4 percent increment in TGST by increasing it from 12 percent to 16 percent, the anticipated net revenue from the tourism sector may not be realized in the near term due to decreased BPT from tourist establishments. It will take up to a year before realizing the anticipated revenue increase becomes possible, after tourism companies have had the time to renegotiate rate increases with tour operators and agents.

Uncertain Costs for Hoteliers

The increase in TGST is meant to have no cost implications for tourist establishments.  Yet, the Maldives Association of Travel Agents and Tour Operators (MATATO), after having consulted the Maldives Association of Tourism Industry (MATI), the National Boating Association of Maldives (NBAM) and the National Hotel and Guesthouse Association of Maldives (NHGAM), reports the potentially debilitating impact of the TGST increase for hoteliers.  Tourism corporations—many of them SMEs—are concerned about uncertainty in operational costs, partly arising from the plausibility of being forced to absorb the increase in TGST due to contractual rate obligations with foreign tour operators.

They are worried that the TGST increase is appearing on their doorstep as they are grappling with the escalating cost of production due to historically high commodity prices and ongoing supply chain disruptions. Commodity prices are expected to be significantly higher in 2022 than in 2021 and remain high in the medium term.

Brent crude oil is expected to average $100 per barrel in 2022, a 42 percent increase from 2021 and the highest level since 2013. Non-energy prices are expected to rise by about 20 percent in 2022, with the greatest increases in commodities where Russia or Ukraine is a major exporter. Wheat prices are expected to rise by more than 40 percent this year, reaching an all-time high. 

Hoteliers are also concerned about retaining the destination's competitiveness. Competing destinations such as Seychelles and Mauritius, with a slightly lower rate of 15 percent, would be open and fully operational in 2023 after the COVID-19 pandemic, and are expected to be popular for tourists from traditional markets such as the UK, Italy, Russia, and France.

With escalating operation costs, having to reduce room rates and offer discounts, just to attract enough tourists to keep a healthy occupancy only adds to the uncertainty faced by tourism corporations. Such uncertainty clouds the robustness and creativeness of Maldives tourism, when these qualities are most desired to keep the destination’s competitive edge.

A Plausible Decrease in Tourist Arrivals

The impact of tax increases on tourist arrivals is inconclusive; some studies report negligible impacts, while others report decreasing arrivals in response to tourism tax increases. The plausibility of decreasing tourist arrivals due to a sudden increase in TGST, however, could not be ruled out.

The most relevant study on the subject was unveiled in 2021, and it examined the effects of tax policies on tourist arrivals to the Maldives from 1996 to 2017. It concluded that tourism taxes could adversely influence inbound travel, but with significant differences across source markets.  The study estimated that a 10 percent increase in tourism tax could potentially reduce demand by 5.4 percent.

It also reported that China, the UK, Italy, Russia, France, Thailand, and Switzerland had negative responses to increased tourist taxes, while Germany and most other source markets showed either a positive or insignificant change in response to tax increases.

Based on this research, China, the UK, Italy, Russia, France, Thailand, and Switzerland should be considered as destinations that could respond negatively to a sudden increase in TGST. These should be perceived as "tax-sensitive" source markets.

Additionally, recent research also shows that Indian tourism demand is both price and income sensitive; making India a potential tax-sensitive source market. That brings the number of tax-sensitive source markets to 8, and notably, these 8 markets accounted for 50 percent of the total arrival in 2021.

At the end of July 2022, tourist arrivals from these 8 markets accounted for 49 percent of the total arrivals. Consequently, even a minor decline in arrivals from these tax-sensitive markets would make a significant difference.

Tourist Arrivals from Eight Tax-Sensitive Source Markets

What are the alternatives to the government?

Despite the urgent need to raise government revenue, the government needs to recognize potential risks associated with the sudden increase in TGST, as discussed in this article.

Other alternatives the government could consider include; defer the TGST rate hike until the end of 2023; ensure that the TGST rate increase does not exceed 15 percent to be in line with other tourist-dependent destinations; and spread the TGST rate hike over a duration of 3 years (at 1 percent each year) instead of having an immediate increase from 12 percent to 15 percent.

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