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What motivates a Government to triple VAT on tourism?

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What motivates a Government to triple VAT on tourism?

This morning the following story from eTurbo News caught my attention: “Iceland tourism braces for huge VAT increase.” VAT is going from 7% to a whopping 25.5%, although a decrease in tourism taxation in 2007 resulted in a 2008 increase of 6% in tourism receipts. The story does not explain the Government’s rationale for proposing this, especially since a report from the Ministry of Finance predicts declines in arrivals, overnights and receipts. So, why is this being proposed?

VAT manipulations are one of several fiscal policy tools Governments use to raise revenue, sometimes actually for reinvestment in the tourism industry, but that seems to be more the exception than the rule. How much VAT is too much? At one point does an increase become a disincentive to visitors, businesses and investors?

The Icelandic Tourism Industry Association reported the following highlights of analyses from KPMG and a report for the Ministry of Finance from the Economic University of Iceland:

*From the Economic Report: arrivals could decrease by 48,000, domestic overnights by 82,000.

*Icelandic tourism offers are so unique that foreign visitors are willing to pay more.

*But the change could scare away a portion of the market.

It will be interesting to see where this story goes and how the Government is justifying the increase.