Caveat: Donohoe boxes clever this time round on tourism’s special 9% VAT rate

The Government’s €250 million decision to extend the tourism sector’s special 9 per cent VAT rate to next spring was skilfully handled this week by Paschal Donohoe, the Minister for Finance.

He has stolen a political march on Cabinet colleagues who would have used the issue to pressure him. He has taken the sting out of the tourism industry’s lobbying efforts for further State support in the run-up to the budget. He has also given the sector one full, unimpeded tourist season free from anti-virus restrictions to use the lower rate to repair some of the pandemic’s financial damage.

Yet Donohoe has managed to do this without hemming himself in to the commitment of a longer-term extension of the 9 per cent rate, which he is likely to abolish at the first opportunity.

The minister does not believe in giving tourism a special VAT break in perpetuity – he made that clear when he first abolished the lower rate in 2018 to raise cash for other priorities, before restoring it to avert crisis in the pandemic. He will need to raise revenue soon, and the special VAT rate may well be sacrificed.

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The biggest mistake that tourism businesses could make now would be to plan for a long-term future with the 9 per cent VAT rate. The biggest mistake Donohoe could make would be to string the sector along as he and his predecessor, Michael Noonan, did for years until 2018.

Dose of reality

A dose of reality is required from one side, and a dose of clarity from the other. The truth is everybody’s friend.

Fraught discussions around the VAT rate have been central to the Irish tourism industry for more than a decade, since the Fine Gael-Labour coalition cut it from 13.5 per cent to 9 per cent as part of a stimulus programme when it took power during the financial crisis in 2011.

It was a clever move, helping to repair the profit margins of battered tourism businesses that were struggling to compete with “zombie” hotels and other undead businesses that were being kept on life support by the banks.

Cutting the rate from 13.5 to 9 per cent effectively doubled, at the stroke of a pen, the overall profitability of every qualifying tourism business in the State. In 2011 and 2012, it prevented many of them from going bust.

The industry quickly recovered and led the first big post-crash wave of jobs growth in the domestic economy. The payoff was immediate.

But by 2014 or 2015, the measure had outlived its usefulness for the wider economy as a stimulus measure, and its impact for consumers was outstripped by price rises as the sector boomed. Yet year after year, Noonan bowed to lobbying in the run-up to the budget and delayed the restoration to 13.5 per cent.

This gave the industry the space to argue that the 9 per cent rate was the reason for all its success, when this was not really true: a weak dollar, an international economic recovery and a boom in aviation capacity did most of the heavy lifting for tourism’s record performance.

Record levels

By 2018 tourism was at record levels, undermining the credibility of the industry's years-old lobbying campaign, which held that it faced immediate disaster if the higher rate was restored. Donohoe enlisted the help of officials at the Department of Finance, who produced a handy (for him) report neatly concluding that the lower rate was a "deadweight" with no enduring economic value.

That gave Donohoe the political cover to raise the rate, which it was argued would bring in more than €450 million annually to spend on health and housing.

The tourism sector had predicted tens of thousands of job losses if the rate was changed, but that did not transpire over 2019. The sector’s growth curve topped out, but that was coming anyway. Numbers stayed high. Disaster stayed away.

Catherine Martin, the Green Party's deputy leader and the Minister for Tourism, has proven to be a capable advocate for the sector at the Cabinet table during the pandemic. She demanded buckets of cash and Donohoe had no option but to give it to her, especially as the tourism sector was being so cruelly sacrificed for the good of the State in the fight against coronavirus.

The lower rate was restored in the budget announced in the autumn of 2020. That was very clearly the correct decision.

But to get the full financial benefit of a lower VAT rate, the industry must be operating at full capacity. Businesses need to maximise the flow of customers through the door at the lower rate, when each transaction is twice as profitable as it otherwise would have been. Make hay while the sun shines.

Apart from a busy summer of domestic tourism, much of 2021 was a write-off for the sector as restrictions kept it shut for the first five months, while worries over Delta and, later, Omicron kept a lid on customer demand later in the year. In terms of maximising the benefit of the lower rate, 2022 represents the first full run at it that the tourism industry has gotten.

It would have been incongruous to whip away the lower rate just as tourism was hitting full stride this August, as was planned before this week’s extension.

Extension

In recent weeks, Martin was beginning to make renewed noises about battling at Cabinet for the retention of the 9 per cent in the run-up to this year’s budget. Last year, she came off looking like the industry’s warrior minister who convinced Donohoe to extend it. This year would have been the same. By appearing to take control of the debate and proposing the extension to Cabinet himself, Donohoe has stolen a little of her political thunder.

The industry’s various lobbyists welcomed this week’s extension to February 2023, even though they want it extended for far longer than that. Instead of a summer screaming blue murder at Donohoe about the previously-planned expiration of the lower rate in August, the industry now has a more complicated case to make for additional State supports. Donohoe will be able to say he has done his bit.

It is in nobody’s interests to drag out the issue of the long-term restoration of the 13.5 per cent rate, as Noonan did from about 2014 until Donohoe changed it at the end of 2018. The Irish tourism sector needs significant capital investment in new attractions of scale. Investors look for certainty, above all else, and the issue of the VAT rate will have a major impact on debt repayment capacity of tourism businesses.

If Donohoe truly believes there is a long-term future for the 9 per cent rate, he would be better off clearly saying so now, rather than appearing to cave on the issue each year as the budget approaches.

But if February is to be the final extension, he should expend genuine effort on making that absolutely clear now, and the industry would be wise to accept it and plan accordingly.