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The aviation industry has a reputation as one of the least-taxed industries. There are practical historic reasons for this (such as the exemption for duty on international aviation fuel). It is also a sign of successful lobbying by the industry (such as the general exemption from any form of environmental taxes), which is convinced that the world would fall apart should anything stand in the way of aviation growth.
Aviation also has a reputation as one of the most whingey industries when it comes to taxation. It issues multiple papers each year, criticising governments for their tax policies and for failing to understand the true impact their fiscal budget is having on passengers and the wider economy. More importantly (but oddly less prominent in these papers) is the fact that taxation also results in higher fares for passengers, and therefore – so the argument runs – subdued demand and thus lower airline profits.
Take taxes on air passengers, the scourge of the aviation industry. The mere mention of it is sufficient of increase the blood pressure of any airline CEO by several points. A recent press release from A4E referred to the UK’s air passenger duty (APD) as ‘fleecing’ passengers and punishing businesses and consumers. That’s the kind of rhetoric we’re dealing with here.
Despite its strongly worded opposition, the industry is making little progress in this area. For every country that announces it is abolishing or reducing its passenger taxes, another one announces its intentions to increase the amount of tax it collects from aviation, whether this is to fund transport projects, healthcare or sporting events.
The popularity of passenger taxes amongst governments can be explained by looking at the economic theory around taxation. Believe us, it’s more interesting than it sounds.
The tax should distort demand as little as possible. The exception to this is taxes that are intended to change negative behaviour, such as taxes on pollution. Air passenger taxes are generally not branded as an environmental tax (although increasingly this is not always clear-cut). Therefore, the question is whether air passenger taxes significantly reduces demand for air travel, and the consequence of this.
This is the main line of attack of the airlines. They argue that a reduction or abolition of air passenger taxes would significantly boost demand for air travel by reducing fares, therefore generating additional jobs and stimulating economic growth. There is some truth in this, and the industry has produced several studies to support this argument.
However, while it is no surprise that lower fares would increase demand, it is important to understand the magnitude of this effect. Taking the example of the UK, the Department of Transport there finds that demand for air travel is relatively unresponsive to changes in the airfare. On average a 10% increase in the airfare would reduce demand by 6%. This means that total revenues would still be higher following an increase in air fares, making APD an effective source of tax revenue. It is worth noting that since the introduction of APD in the UK in 1994, the number of flights to, from and within the UK has almost doubled from just under 44 million to over 80 million.
The tax burden should be borne proportionally more by the rich than the poor. The extent to which this happens is a political decision. However, from a pure economics perspective, distortions to the economy are minimised when the tax rate is higher for those with the greatest capacity to pay. This is because a wealthier individual is less likely to reduce his or her consumption of goods or services in response to a higher tax rate than someone who has lower income.
As air travel is essentially a luxury (despite claims by some as we discussed in this blog post), a tax on air travel will be borne more by the rich in society than the poor. This therefore makes air passengers an attractive source of tax revenue for governments.
Taxes should be transparent and straightforward to collect. This limits tax avoidance, limits opposition to the tax, and enables as much as the revenue collected to be diverted towards public spending, rather than tax administration.
Taxes on air passengers generally meet these conditions. Typically, the tax rate is determined relatively straightforwardly (for example, as a flat fee or based on whether a flight is short or long haul) and usually collected directly from the airline.
There are, of course trade offs that need to be made across these principles. For example, different consumer groups may be more responsive to increases in taxes than others but a decision may be made to tax them the same as the same information required to target these groups separately may be too costly to collect.
Unless the aviation industry can persuade governments to reduce their public spending, based on these principles, passenger taxes are here to stay. The cynic would note, however, that lower airfares and therefore cheaper foreign holidays are always a vote winner.
That is not to say that reforms to passenger taxes may not be necessary, for example to limit the impact of the tax on demand. The industry’s efforts may therefore be more successful on targeting the details of the tax policy rather than calling for its abolition completely.
