Question

5. Briefly explain why the local city authorities in major cities of tourist destinations in the US and US territories imposes very high surcharges (between 205 and 30%) on car rentals and hotel guests, while impose very low taxes on local residents. The purpose of high surcharges is to raise enough revenue to improve and maintain local roads, bridges, airports and other infrastructures. Is this economically and politically justified? Why or why not?

Answer 1

The reason behind the different tax structure between resident and foreign tourists can be attributed to their different elasticity of demand. To illustrate this proposition, we consider two groups of people – Home and Foreign, where the Home Group currently resides in City ‘X’ and Foreign Group wants to visit City ‘X’ during the vacations. Let us analyze the situation carefully:

           

• Foreign Group:

1. The foreign group have a relatively high income elasticity of demand for City ‘X’, i.e., they view the City as a luxury and that is exactly why they have opted for the tour to City ‘X’.
2. Also, the foreign group have a relatively inelastic price elasticity of demand in City ‘X’, i.e. they are willing to pay a higher price for goods and services.

Seeing this, the mayor levies a higher tax on tourists visiting the city abroad in order to maximize his tax revenue, since for an inelastic demand

• Home Group:

1. On similar lines, the home group have a relatively low income elasticity of demand for City ‘X’, i.e., they view the City as a necessity rather than a luxury, and hence its consumption is normal in nature, rather than a luxury,
2. Also, the home group have a relatively elastic price elasticity of demand for goods and services in City ‘X’, since, they clearly know about the whereabouts in the city.

Thus, the different taxation regime is definitely economically justified. It is also politically motivated, as when residents of the City ‘X’ notice that they are paying a lower tax rate than the tourists, they might feel inclined to the current regime.