Why China matters

We at Maldives achieved a major milestone in 2013 when we recorded more than one million tourists by the end of the year. The world achieved the one billion mark in 2012 when it recorded more than a billion tourists crossing international borders for the first time, from 995 million in 2011. According to the World Tourism Organization (UNWTO), international tourism receipts reached more than one trillions US dollars in 2012, when it recorded US$ 1,075 billion worldwide. In 2012, China became the number one source market in the world, and recorded a total spending of US$ 102 billion on international tourism.

In 2013, China outbound tourists reached 97.3 million from 83.1 million in 2012. How much are we able to attract from this? Less than 1%. In fact, in 2012 we recorded 229,551tourists from China visiting Maldives, which is 0.28% of the total Chinese who traveled abroad during the year. In 2013 we attracted 331,719 visitors from China, which is only 0.34% of the total. So, even if we are able to attract 1%, we are looking at about a million tourists from China. The question is can we get there?

Looking at the arrival statistics of China tourists into Maldives, we had only 41,511 tourists from China in 2008, however, we had a 46% growth in 2009, and a 96% growth in 2010 when we recorded 118,961 by the end of 2010. Now China has become our number one source market, overtaking the European markets. A Maldivian airline, Mega Maldives Air played a key role in this development. An estimated 35% of the total Chinese arrivals are contributed by Mega, and in 2013 it is estimated that more than 95,000 Chinese visited Maldives via Mega Air. The state owned airline ‘Maldivian’, operated by Island Aviation, has also started flights to China, in addition to the Chinese local airlines like the ‘China Eastern’.

Well, I guess the point that I’m trying to make; as we talk about Chinese tourists, since China is expected to grow, we need to make further adjustments and come up with innovative plans to increase our share, to at least double the arrivals from China, and target to achieve at least one million from China by specified time period. That way, will be able to double our earnings from tourism.

Maldives Tax system review: What is the optimal tax rate on tourism?

We have been taught in school that the objectives of a tax are to raise government revenue, discourage the consumption of certain types of goods, and most of all to redistribute income and wealth. Government needs to raise revenue so that it can achieve its development objectives, and finance the services to be provided to the public and in the form of public goods, like roads, bridges, airports and ports. Some types of goods like alcohol, cigarettes, and environmentally harmful products are taxed heavily in order to discourage people from using or consuming such goods. Redistribution of income and wealth among the population is an important objective of taxation, as the government collects a higher percentage or a higher amount of money from the rich, and provides social-security benefits or subsidies to the poor, so that the income gap between the rich and the poor can be narrowed.

An efficient and effective tax system in trying to achieve those objectives mentioned above, also should be targeting to maximize social welfare by having the optimal tax structure. If the government’s fiscal policy ignores the concept of ‘optimal tax’, it can actually harm the aggregate production efficiency of the economy. In other words, if the government is careless and over-burdens the businesses by ‘over-taxing’, it can actually decrease the economic activities or production, leading to lower tax revenue over the medium to longer term. Hence, in order to increase the government revenue in the shorter-term we should not be recklessly increasing the tax rates or playing with the tax system.

Prior to the introduction of GST on general goods and services, we had the import tax or the import duties, which required the importer to pay a certain percentage of the value of the goods to Customs as duty, before even the goods are being cleared or sold to the customers. We replaced the import duties with GST, so that importer will not be paying any tax to the government before selling a product. When the customer buys the product, tax is paid and the seller collects it, pays it to the government. We have seen that total government tax revenue has actually increased, and increased significantly since the tax reforms brought in 2011. Has it hurt the aggregate production efficiency? In some areas yes. And with the proposed new changes to the tax rates, it may hurt even more. In the short term it can increase the government revenue, however, in the longer term it can do more harm, as total production may fall, and so can the total tax revenue in the medium term.

The issue of Withholding Tax (WHT) needs special mention, as I have been tackling this issue from the business side, both in my own business and also others whom I am advising. Under Section 6 and 7 of Business Profit Tax (BPT) Law, businesses are required to pay 10% of all the payments made to any foreign party for business services obtained.  The total amount of revenue raised through WHT comes to about 3% of total tax revenue of the State. It may be a huge burden for some individual companies to pay tax on the company’s expenditure paid to a foreign company, and at the same time pay tax on the net profit of the company. Most of the time, the foreign company will not allow to deduct the 10% tax from their payments. Hence, individual companies may face bankruptcy or incur a loss that threatens the continuity of the business. Had the government removed the WHT from the law and let go of the 3% revenue, many individual companies will benefit from it, and actually be paying more than 3% collectively as Business Profit Tax and GST.

Then comes the issue of Bed Tax. High-end resorts sell rooms for as high as $2,000 per night, and still pays $8 to the government. It’s just 0.4% of the room rate. However, a guest house selling a room for $50 per night also pays $8 per night as bed tax, but which is 16% of the room rate. Of course, it’s the guest who bears the tax. But for Tom Cruise who comes to ‘One & Only’, $2,008 plus GST may not be much for a night. However, for Markuss who is from a lower income level, even $58 plus GST may be too much for a night, especially, comparing this price to the same standard rooms in other countries. Most of all, considering the fact that Bed tax is very ‘unfair’ as both the rich and the poor pay the same amount, makes the tax regressive in nature. For this reason, it cannot be considered as part of an optimal tax structure.

GST on the other hand is more equitable, as a certain percentage is paid on the room rate and other prices, and those with higher incomes and who pays more for their services, will pay more as tax. At present, GST rate for tourism sector is 8%. Most of the resorts, hotels, and guest houses will also include service charge (normally 5-10%) in their prices, and add on GST. With this, guests will be paying more than 18% on top of the prices quoted for room and other services. If we increase the GST rate to 12%, with service charge, guests will be paying 23% more on top of the quoted prices. And if we continue charging bed tax that’s an additional $16 per night for a couple, and makes it 39% in addition to room rate. In the case of hotels in Colombo, it comes to about 26% with service charge and taxes. Which means, with bed tax, and GST of 12%, our tourism product will lose competitiveness, and may actually lead to Maldives becoming less attractive to tourists; especially mid-market tourists. In that case, total national income and total tax revenue may decrease over the medium and longer term. So, the tax rate or tax system should not be played as we wish, so as to increase short-term revenues. It has to be carefully analyzed, its impacts identified,  its optimal level determined, so that social welfare is maximized.

Maldives tourism tax policies

Back in 2011, the Government introduced a comprehensive tax system; whereby a Goods and Service Tax (GST) was introduced generally on all consumer goods and services for the first time in the history of Maldives. That is when so many international donors and development partners have been advising and recommending to introduce such a tax system long long ago, even when I first joined the Ministry of Finance in 1995. There have been many reports and documents by international donors like World Bank, ADB, and IMF on the importance of introducing Business Profit Tax, and GST. Well, I’m not sure exactly the reason, but the fact remains, it was not done!

When the new tax system was formulated, we were embarking on a huge economic reform program. This program was prepared after careful and consistent research of the Maldives economy, and after considering the recent international developments and its impact on the Maldives economy. We did a lot of work in terms of in-depth study of the Maldives exchange rate regime, and the dynamics of the Maldives economy. During my work at Maldives Monetary Authority (MMA) research division, I wrote a paper in 2010 on the real exchange rate of Maldives.

It was obvious from our research and analyses, that we had to increase our fiscal revenue, and that we cannot continue with huge fiscal deficits. Almost everybody working with us, those in MMA and those in Ministry of Finance agreed that monetization is not an option, and relying on printing Rufiya can never be a means of deficit financing. Printing Rufiya can only lead to increased inflation, and thus pressure on the dollar.

I was working as a State Minister at Ministry of Finance, and we worked real hard during those one year, when we actually saw the drafting of the bill, passing of the law, and enforcement of the law by collecting the tax money. We spend days and nights educating and creating awareness on the new tax laws. We did presentations to the MPs first, so that they can pass the bills after having a understanding of what they are actually passing. We educated the Police, MNDF, political party members, school children, and the general public through various presentations, TV and radio interviews.

We met with almost all the major resort owners, and briefed them on the state of the economy, and almost all of them supported us, and were prepared to provide their cooperation in bringing the economic reforms.

We had a lot of support from the MIRA, and we worked very closely with the entire team there. We abolished the import duties of many consumer goods being imported into the country, and we reduced the import duties of various other items. To compensate,  we introduced GST on general goods, with exclusions on very basic food and other consumer goods and services.

We proposed the abolition of the $8 bed tax after a grace period, so that the tourism sector will be taxed at a rate of 8%. We considered the price elasticity and the income elasticity of our tourism product, and worked on the optimal tax rate that cannot harm the competiveness. Hence, the following tax rates were passed for the tourism sector when it actually became law.

From the introduction until 31^st December 2011 – 3.5%

1 January 2012 to 31^st December 2012 – 6%

1 January 2013 onwards – 8%

Resorts, hotels, tour operators and travel agents always had the complaint of too many changes and within such a short period of time. And this complaint will always be there and it’s a valid one too. As holiday bookings are made so many days in advance, and also promotional materials are printed beforehand, any changes to the tax regime or the tax rate has to be known at least one year in advance. The 3.5% in 2011 made sense, as many businesses actually absorbed it and paid from their profits, in order to not to burden the agents or the customers. The rates in 2012 and from 2013 onwards were being given enough notice, and we all had certainty that it won’t change. Our understanding when we were working on the new tax policies was that tax rates will not and should not be going up after this, and it actually should be going down year by year, as we move on to fiscal surpluses.

We believe that even without increasing the tax rates, we can still have high tax revenues as we expand our production, and as we make new investments. As we cannot continue increasing the tax rates on tourism every time a new government comes into power and every time a new government project or pledge has to be fulfilled. Any changes to the tax rates has to be brought after careful analysis of its impacts on the tourism competitiveness, and the impact on the overall tax revenue in the medium to longer term. Rather we need to focus our attention in increasing more businesses, investing on tourism infrastructure so that we can increase the arrival numbers so that tax revenue can increase.