Atslēgvārdi:

Who doesn't understand economics? 22

There is a curious argument between Nellija Jezdakova, acting head of State Revenue Service, and Ainars Šlesers, Riga's vice-mayor. The point of contention is whether VAT rate should be reduced for the hotels. Mrs Jezdakova argues that hotels should not get a special treatment, because then "all the tax-payers will have to pay for the hotel and tourism industry". Mr Slesers angrily retorts that Mrs Jezdakova "is not capable of understanding economic relationships", and that "hotels are paid for by tourists, and not tax-payers". Well, non-economists should think twice before accusing someone of not understanding economics. That's trespassing on our turf - and we don't take it lightly.

Iesaki citiem:

So, who doesn't understand economics here? What are the effects of reducing VAT rate for the hotels? A tax reduction reduces the wedge driven the prices received by the producers and prices paid by the customers. Usually, producers (hotel owners) will get higher prices and, therefore, higher profits. Buyers would benefit by paying less for the service. Of course, a crucial question is whether a tax reduction can increase tax revenue? In theory, it's possible, provided both demand and supply are sufficiently elastic. In other words, a VAT cut may increase revenue if the resulting decline in prices will bring lots of new tourists to the hotels (and if the hotels would accommodate this increase at given prices). Naturally, if the inflow of foreign tourists were to increase as a result of lower hotel prices, we would expect higher tax revenue above and beyond that generated by the VAT on hotels. As rightly pointed by Mr. Šlesers, tourists spend on taxis, restaurants, etc. So it might well happen that VAT reduction for the hotels is a good idea.

At this point it's worth noting that commodity exports are not subject to VAT, which amounts to subsidization of exports vis-a-vis trading partners. It's an example of what is known as a "beggar-thy-neihbour" policies, where one country is trying to gain at the expense of the others. And of course, it only 'works' for as long as your neighbors don't do the same thing. Since all of Europe uses VAT taxation, this policy only works vis-a-vis countries like the U.S., that don't have VAT. Thus, one might make a point that since hotels export services, one may try to increase the competitiveness of our hotels vis-a-vis competitors by making them exempt from the VAT. And of course, the policy would stop working the moment everyone else adopted it, which is what would inevitably happen if such policies became widely used.

Does this make Mr. Šlesers right? It might, if these supply and demand elastisticities are sufficiently high. Basically, Mr. Šlesers would be right if VAT reduction would lead to two things. A first necessary (but not sufficient) condition is that it should reduce prices charged by the hotels. Whether it would do so depends on the market structure. The second condition - a necessary and sufficient one - is that reduction in prices would attract sufficient number of new tourists. 'Sufficient' meaning that the additional tourists need to make up for the loss from VAT revenue resulting from 'existing' tourists (who would come anyway) paying lowers prices for the hotels. Is this plausible? Some of my colleagues think it's a long shot. Potential tourists consider many things, hotel prices being just one of them. If at least one of the above conditions is not fulfilled, VAT reduction for the hotels would result in net revenue loss, and the taxpayers would have to make up for this if we want a balanced budget (but hotel owners would still gain). Then, Mrs. Jezdakova would be absolutely right.

I haven't answered the question of whether we should cut VAT for hotels, have I? The answer is we don't know. Moreover, we CANNOT know unless we have some estimates of these demand and supply elasticities (also average tourist spending on other goods and services). Simply economic theory allows for both possibilities: Mr. Šlesers and Mrs Jezdakova both might be right. One needs to do some hard work to put numbers on those elasticities in order to answer a question like this.

However, I think I can answer the question posed in the title. Both Mr. Šlesers and Mrs. Jezdakova seem to misunderstand economics. An argument like this is settled with empirical evidence, not with whoever can raise his(her) voice most.

Iesaki citiem:
Creative commons c6ae3e51884b139b45a669ce829ac99646bf0ceb328fc95963f1703a58a032d0 CREATIVE COMMONS LICENCE ĻAUJ RAKSTU PĀRPUBLICĒT BEZ MAKSAS, ATSAUCOTIES UZ AUTORU UN PORTĀLU PROVIDUS.LV, TAČU PUBLIKĀCIJU NEDRĪKST LABOT VAI PAPILDINĀT. AICINĀM ATBALSTĪT PROVIDUS.LV AR ZIEDOJUMU!

Komentāri (22) secība: augoša / dilstoša

5278633172 71b63f7fe4
Komentētājs

Jaņģs 21.02.2010 15:48
There is nothing much as yet in Latvia or Riga to attract foreign tourism except for some personal curiosity and minor curiosities. Attraction lies in the unusual, the elsewhere inaccessible, the elsewhere denied, etc.

How about trying passing laws that permit 70 year olds to die legally at the time of their choice? Let us assume in the countrside, in the peaceable kingdom of Latgale, Vidzeme, etc. Or are the Netherlanders again ahead?

How about the doctor president not being so chicken or lililivered and proposing dna research and possibly cloning of humans? Takes guts to do that today, but the practice is inevitable--sooner than later. Or, again, is South Korea going to beat us to it?

How about letting the countryside survive by allowing the people there to grow Johns grass and not simply romantic "smilgas un margrietiņas", thus not only attracting tourists from Sweden, but allowing the people in Latvia who cannot afford medicine to use Johns Grass (as they used to) for any number of ills--as they allow in many places elsewhere? Or are the Swedes again going to decide that their banks can rob us and they can tell us what to do?

I am sure that there are many other not-unthinkable and yet unthought of ways to improve the economy.

Incidentally, the politicians of Latvia have hawked Latvia to foreign interests for decades into the future, optimistically speaking. The arguments which I hear here are all based on the presumption that all will yet turn out okay, and that those who argue that we are in the process of systems change are full of baloney.

I do not wish to see my countrymen from the countryside leave for abroad and not return. As it is, there are a number of experts who insist that Latvia is in a demographic death spiral. Or perhaps this is not a question of politics?

5278633172 71b63f7fe4
Komentētājs

Kaspars > Kaspars Gasūns 21.02.2010 15:21
Thanks for calling me knauzeris. I should feel flattered because the alternative would be something wanna-be New Russians. Also thanks for indicating the problem with the Latvian tourism industry – targeting only higher class customers.

Even if you are right that Ryanair does provide less comfort that many well-to-do Europeans (Americans don't count because Ryanair does not operate in NA yet) would like, it is still good for total economy.

Slesers is like an unpredictable black swan in economy. As Q says, after many tries one may get lucky but it is not a lottery because one has to do something more than just buying a lottery ticket. We need more people like him not less.

5278633172 71b63f7fe4
Komentētājs

rakstitajs> lasitajam 18.02.2010 16:05
Dry residue you mean

5278633172 71b63f7fe4
Komentētājs

Kaspars Gasūns 17.02.2010 18:24
Bottom line. People go for destinations, not hotels and their prices. They accept the general price level at the spot and choose a hotel that fits their spending or comfort standards (depending on which is priority).
From this point of view Slesers and airBaltic marketing campaign is right move - it makes destination stand out.
But anything these gentlemen say about statistics and effects of this campaign makes me doubt their common sense or at least basic grasp of statistics/economy. Just like in the case Mr. Dombrovskis outlined in this article, there is no empirical proof to anything they say regarding LiveRiga. Actually indirect evidence hints the other way.

5278633172 71b63f7fe4
Komentētājs

Kaspars Gasūns > Kaspars 17.02.2010 18:15
Do not judge the tourism industry by your personal approach. :)

Believe me, as I have worked in tourism, hardly anyone makes decisions about destinations based on 10 Euro difference for hotels. (You must be one of the "knauzeri" sort mentioned above by some other commentator. ;) ) And these categories are not the ones having notable multiplying effect for the industry.

It might have some influence for stag parties and Baltic tourists (a notable proportion of incoming tourism!), but is totally unimportant for higher tier.
But try to imagine a Lithuanian making a decision going to Tallin instead of Riga just because of 5 or 10 Euro difference. Improbable! 1) He/she would spend at least the same amount on transportation anyway. 2) And why should anybody go to Tallin, Tartu or Kuldiga anyway, if they want to go to Riga.

Plus, flight costs and comfort level /image of the airline is a deal breaker to a much greater extent than hotel prices.
From this perspective, Ryanair is both good and bad - good for economy travelers and bad for higher tier, because very few middle-class Europeans or Americans would choose Ryanair due to its lower comfort and image.

5278633172 71b63f7fe4
Komentētājs

Kaspars 12.02.2010 19:47
ES:
>> And are you sure that this "self-serving millionaire" has no business interests in hotels?

He definitely is, and that's why it is foolish to say that he doesn't have economic sense. His suggested measures might not be optimal but he is not suggesting a zero sum game either.

>> If I translate your text about plus one traveler then it means that number of Riga visitors must be 2.05 times higher to have the same VAT amount in hotels.

I played with the numbers it all looks very interesting. Your calculation does not include higher VAT charged by other establishments. If we assume that the total amount spent by each tourist does not change (a big assumption), we need only ~35% more tourists to break it even at VAT level. Realistically looking I expect decline in visitors in either case as the global economy is still in a slump. The expected decline is ~30% but if we can keep it at 10% level with a lower rate we are also getting equal VAT revenues. Still not looking realistic but if it is done as a part of other measures to make Latvia more attractive to tourists, it may be worth it.

>> Why to Riga intead of Tallinn, Vilnius or Kaunas?

It is funny but recently I have been to Tartu and Vilnius for pleasure and stayed at hotels. 40-50 EUR is my comfort price to pay. If it would been above that number I would probably stayed at home. I don't remember how much I paid for meals but I think it was around 10-15 EUR. It didn't seem that important. The hotel price is a deal breaker even if it is not entirely rational. When I got a nice double room including breakfast in Kuldiga for 30 EUR (VAT included) I felt lucky. Unfortunately, there was no other places to spend money in this city but still it was a nice city with wonderful people, the bridge and the waterfall. Those 20 Lats were worth every santime. However, if the initial price would have been the same as for Vilnius, I might have decided not to go. Riga might take a similar position in comparison to other European cities, so it needs lower, not just equal (or, God forbid, higher) prices to attract more visitors.

5278633172 71b63f7fe4
Komentētājs

ES 12.02.2010 15:52
> Kaspars
Last week I compared 4* hotel prices in Riga and Milano (venere.com and tripadvisor.com). They ARE reasonably different if you are comparing hotels in ~ the same area of city. Of course, Riga center and Milano suburb could be at the same price.
If I translate your text about plus one traveler then it means that number of Riga visitors must be 2.05 times higher to have the same VAT amount in hotels. Where from they could come and what for? Why to Riga intead of Tallinn, Vilnius or Kaunas? And if the argument for choice is price for room per night some 5-7 EUR lower, then why are you sure they are not simply "knauzeri" and will be tended to spend 10 - 15 EUR for main course in medium level restaurant?
And are you sure that this "self-serving millionaire" has no business interests in hotels?

5278633172 71b63f7fe4
Komentētājs

Q to Kaspars 12.02.2010 15:29
"I would say that a person who is able to earn a million dollars understands something about economics, even if in a self-serving manner."

Wouldn't this be an equivalent conclusion to the following: "A man who has won a million dollars in a lottery knows something about probabilities"? Or maybe it was just pure luck? If you take risk, then surely you won at some point.

5278633172 71b63f7fe4
Komentētājs

Kaspars 12.02.2010 14:39
The example about generals was really funny because it does not matter who is cautious or reckless but who wins the battle. If the battle outcome could be so easily determined by military intelligence, there would be no need for generals :)

Economy is driven by entrepreneurs not economists. Economic theories, statistical analysis, data mining is the job of economists to help us all to better understand what is going on and what needs to be done. The problem is that they cannot predict the outcome. If they could there would be no need for risk taking entrepreneurs and policy makers anymore. I would say that a person who is able to earn a million dollars understands something about economics, even if in a self-serving manner.

5278633172 71b63f7fe4
Komentētājs

Kaspars 12.02.2010 14:11
>> This is where we're talking about the price for a trip from point A to point B, which is, largely, what the customers care about.

Not exactly. Think about reasons why one would take an airplane vs. driving a car or taking the bus. How much more you would be willing to pay for speed, comfort and flexibility? Different people will give different answers and it is the key to Ryanair success that they were able to realize that there are people who would prefer speed over comfort and flexibility in the same sector. It is not about the price but different services that a fixed price can buy. As a result a number of fliers has increased and the amount of money spent on flying has also increased.

An extreme example would be comparing limousine service to public transportation. While basically it's also about the trip from point A to B, they are so qualitatively different that it is unimaginable they could be ever competing. Yet, public transportation is almost always subsidized.

>> As to "missing the point". I am afraid income distribution matters. If VAT reduction will not generate sufficient inflow of tourists, then other taxpayers would have to pick the tab so that hotel owners would gain.

I am not saying that income distribution doesn't matter. I just reminded that it was never a point between Jezdakova and Šlesers' snappy exchange. As for "to pick the tab" I don't see decreased tax revenue as money taken out of any taxpayer's pocket. It's money taken out of the government's pocket, yes. But for every lat that is taken two lats could be given to businesses (not necessarily hotel owners and could even be state companies, like AirBaltic the tourists used to fly in). The whole thing reeks of "the rich are stealing from the poor so we must make sure that business owners do not get more money".

It is also interesting that while we are so concerned about income distribution, other methods of income distribution like progressive tax rate, VAT exempt basic food items etc. are almost never seriously considered. Ah, of course, there is no empirical evidence that it is in any way beneficial :)

>> Hockey Championship, for instance. Prices probably doubles but did it have a large effect on how many came to the championship? These are all bad news for the view that high-elasticity view.

I think it is a good example of high-elasticity. There will be an equilibrium in atendance of championship and ticket prices. In this case the demand is created by a championship not by hotel prices if they are considerably lower. So hotels can rise prices and earn more. Too high hotel prices, however, could influence the number of attendees, so there could be some equilibrium as well. Otherwise hotels had not only doubled but increased price 10 or 100 times.

Regular tourists, however, do not come for champions but just to hang out, so lower hotel prices can be even more important deciding factor. In turn all other shops earn more.

>> You can build a luxury hotel in the middle of nowhere and making it very cheap, but I doubt it would bring lots of tourists.

It is all relative. If there would be a place without particular appeal, then a cheap but luxurious hotel would be the most important factor to go there. Someone will definitely make use of this opportunity.

>> Because hotel prices in Latvia would decrease, world's tourists would have higher real incomes and, therefore, will demand more trips to Latvia. Ah, a curious theoretical possibility. But is it of practical significance?

I don't know for you but I would personally travel a lot more if hotel prices were lower. If I liked at these places I would be spending more money for entertainment than currently.

5278633172 71b63f7fe4
Komentētājs

x to AJ 12.02.2010 13:27
you must be a famous humorist?:)

5278633172 71b63f7fe4
Komentētājs

Lasītājs 12.02.2010 13:16
The dry remainder, as the Latvians say? Slesers is an idiot. Thanks for the post!

5278633172 71b63f7fe4
Komentētājs

AJ 12.02.2010 11:37
Slava, I think that you are ignoring the depth of the ongoing discussion. Clearly, Šleser's argument emphasizes the potential multiplier effects of a lower VAT. Apparently, his analysis of input-output tables also indicates that there are positive side effects to be harvested in the supporting industries thus supporting development of the whole tourism service cluster. At the same time Jezdakova has focused (perhaps too narrowly) on her empirical estimates of the price elasticity of demand for hotel rooms, which suggest potential reductions in total revenue should VAT be reduced. Also, her econometric research shows that the multiplier effects on the economy are not statistically significant (perhaps due to the small number of observations inflating the standard errors). I am holding my breath to see the next round of this valuable scientific debate.

5278633172 71b63f7fe4
Komentētājs

V Dombrovsky --> Kaspars 12.02.2010 11:33
I am afraid your Ryanair example misses the point. This is where we're talking about the price for a trip from point A to point B, which is, largely, what the customers care about. So demand elasticities can be quite high. In tourism, a hotel is just a part of the package. Tourists are after "attractions". You can build a luxury hotel in the middle of nowhere and making it very cheap, but I doubt it would bring lots of tourists. If you're taking a position that tourists' demand is very elastic wit respect to hotel prices, think about the instances when there where sharp changes in prices. Hockey Championship, for instance. Prices probably doubles but did it have a large effect on how many came to the championship? These are all bad news for the view that high-elasticity view.

"Demand creation". You must be referring to income effect of lower hotel prices in Latvia. Listen to what you're saying. Because hotel prices in Latvia would decrease, world's tourists would have higher real incomes and, therefore, will demand more trips to Latvia. Ah, a curious theoretical possibility. But is it of practical significance? Sorry, that's just ludicrous.

As to "missing the point". I am afraid income distribution matters. If VAT reduction will not generate sufficient inflow of tourists, then other taxpayers would have to pick the tab so that hotel owners would gain.

5278633172 71b63f7fe4
Komentētājs

V Dombrovsky --> Skeptikis 12.02.2010 11:21
I've been waiting for someone to say that. Thanks.

Lets take the following parallel. An army on the eve of a major battle. Two generals are arguing where the main force should strike. For simplicity, lets say there are just two options: left flank, or right flank. So, general S argues to strike at the right flank, whereas general J says we should go for the left flank. Of course, the success of the strike depends on which enemy's flank is relatively weak. The generals have no idea, because they think military intelligence is a waste of time.

Which one is right? Unless we have intelligence data, we don't know. Is someone who insists on collecting intelligence before making decision "stupid and indecisive"? Well, I am sure there were many countless times when this is what reckless generals called the more cautious and prudent types. I mean, you're not the first to say that. Naturally, I stick to my opinion.

5278633172 71b63f7fe4
Komentētājs

Kaspars 12.02.2010 10:47
>> ES: The hotel prices in Riga are 1.5-2 times higher than letš say in Rome or Milano.

Any proof to this? I have always believed this myth myself because I have never been interested in Riga hotel prices. But just a quick search showed that prices are more or less the same. Last year I had to stay in hotels in Kuldiga and Pavilosta and the price was a steal. I have never been able to find such low prices in any other EU country even in similarly remote areas.

Vjačeslavs insinuates that Šlesers is somehow obliged to provide empiric evidence to him before saying anything about economics. I find it rather arrogant. Besides he misunderstands the main point – it is not about increasing VAT revenue but increasing total money owned by tax payers. If tourists are spending a fixed amount in Latvia, it requires only one additional tourist to come to be on the positive side. Even if VAT revenue falls the total amount of money in circulation increases. It may be argued how desirable it is if it creates inequalities but the statement that it will be at the cost of taxpayers is simply false.

>> I used word 'potential' as I'm very suspicious that numerous hotel owners will choose this difference in tax amount to be added to their profit and let prices unchanged.

I have heard the same argument against any suggestion to lower VAT for certain categories of goods, e.g., food, books etc. And one never explains why competition/price economics will not work in each particular case except that merchants are greedy. From economics point of view merchant greed only facilitates competition/price curve.

5278633172 71b63f7fe4
Komentētājs

ES 12.02.2010 08:39
The hotel prices in Riga are 1.5-2 times higher than letš say in Rome or Milano. Newertheless it is not a problem to book a hotel in Riga for nearest weekend while in named cities in Italy it's almost impossible. I'm very doubtful that tax rate cut and potential decrease of hotel prices by ~10% would bring new crowds of tourists to Riga. And I used word 'potential' as I'm very suspicious that numerous hotel owners will choose this difference in tax amount to be added to their profit and let prices unchanged.

5278633172 71b63f7fe4
Komentētājs

Jānis Rainis 11.02.2010 22:53
pilniigi piekriitu raksta peedeejam secinajumam, ka pirms vienam vai otram izteikt saadu apgalvojumu, kas patiesiba ir secinaajums ir vajadziigi skaitlji un to analiize. tipat labi vareetu apgalvot ka nodokljus vajag palielinaat, jo taa velas Jeezus, bet Slesers atkal vareetu atbildeet, tu neko nesaproti stulbaa dura Jeezus negrib paaugstinaat nodokljus!!!

5278633172 71b63f7fe4
Komentētājs

Jānis Rainis 11.02.2010 22:49
Var tikai apbriinot autora anglju valodu ;)
"State Revenue Service" Valsts ienjeemumu dienests, tulkojums nospiests viens pret viens, vai tiem kas nesapot Latviesu valodu un neparzin valsts instituucijas saads termins kaut ko izsaka?

5278633172 71b63f7fe4
Komentētājs

Kaspars 11.02.2010 20:15
correction: they are that easily exchangeable > they are not easily exchangeable

5278633172 71b63f7fe4
Komentētājs

Kaspars 11.02.2010 20:13
Naive thinking that precise economic models that work in real life can be built. Too many unknown variables. We can never know unless we try and even then we will never be sure what exactly made the difference.

I am afraid that there are more empirical evidence supporting Šlesers than Jezdakova. Just look at Ryanair's operations. They sell a lot of extremely cheap tickets and yet make a good profit even when most other airlines suffer big losses. How they do it? They charge a leg and arm from many additional services and it works because the basic price is the deciding factor for too many people.

>> Thus, one might make a point that since hotels export services, one may try to increase the competitiveness of our hotels vis-a-vis competitors by making them exempt from the VAT.

Not necessarily because it is not always about competition but creating demand. While is some cases it may be choice, let's say, between Hungary or Latvia it is even more possible that one would like to visit both. Tourists are looking for new experiences so unlike commodities they are that easily exchangeable. It can be a question if one can afford to include Latvia in his itinerary.

Returning to the Ryanair example, they have created demand and attracted a lot of new fliers who would have never bought a ticket from old school airlines.

>> “Potential tourists consider many things, hotel prices being just one of them”

The hotel price is one of the factors that can be easily compared and evaluated before the trip. It is hard to know how much one will spend on souvenirs, food, booze etc. and most people won't even bother to estimate it. On the other hand, hotels are most often booked in advance so the price is know and easily comparable.

>> first necessary (but not sufficient) condition is that it should reduce prices charged by the hotels.

That is a valid point. Normally it would definitely happen if there was a healthy competition among hotels in Latvia. Is there any evidence that it is not the case?

5278633172 71b63f7fe4
Komentētājs

Skeptiķis 11.02.2010 18:55
"The answer is we don't know."

That is not an option in politics, is it? It takes wisdom of a scientist to say that we do not know that and can't know that unless this and that. Such wisdom seems like indecisiveness and stupidity to the average voter.

Citi autora darbi
Vjaceslavs 165x152

(Un)real money 45 Autors:Vjačeslavs Dombrovskis

Article research 1e4ac20bb63aee5492853c84556a2de54571efc0425d62b84a0cec8d841f82ac

Is anything wrong with higher education in Latvia? 1 Autors:Vyacheslav Dombrovsky