Hotel Tax: Who Really Pays?
A coastal town is considering a €9 per room-night tax on hotel stays, levied on hotels. The town currently has 120,000 room-nights sold per year at an average price of €140. An economist estimates the price elasticity of demand for room-nights in the town at -1.0 and the price elasticity of supply at 2.0. The town council wants to know who will ultimately bear the burden of the tax and how a nearby untaxed resort area changes the picture. Assume linear schedules around the current equilibrium and that the tax is fully collected from hotels. A council member argues that because hotels write the cheque, they will bear the whole tax. The town's budget assumes the tax will raise €1.08 million, calculated as €9 times 120,000 room-nights. Hotel owners say they will simply add €9 to every bill.
1. Using the elasticities, calculate the share of the tax borne by consumers and by hotels. What price change would consumers see?
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The statutory incidence is not the economic incidence. With linear schedules, the consumer share of a per-unit tax is Es ÷ (Es − Ed), using elasticities in absolute terms: 2.0 ÷ (2.0 + 1.0) = 2/3. Consumers bear about €6 of the €9 tax, so the room price rises from €140 to about €146. Hotels bear about €3: their net received price falls from €140 to about €137 after paying the tax. The council member is wrong because hotels can pass most of the tax forward when demand is less elastic than supply.
2. If the nearby untaxed resort area makes demand more elastic, say -4.0, how does the incidence change?
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With Ed = -4.0, consumer share = 2.0 ÷ (2.0 + 4.0) = 1/3. Consumers now bear about €3 and hotels about €6. The nearby untaxed resort gives guests an outside option, so demand is more elastic; hotels cannot raise prices as much without losing business. The economic burden shifts toward hotel owners.
3. The budget assumes €1.08 million. If the tax reduces room-nights sold, is that revenue estimate likely too high or too low? Explain without calculating the exact new quantity.
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The €1.08 million figure is an upper bound, not a forecast. It multiplies the tax by the current quantity, but the tax raises the consumer price and therefore reduces room-nights sold. Revenue is tax × new quantity, so if quantity falls, revenue is below €1.08 million. The estimate would also be too high if some stays shift to the nearby untaxed area. A precise estimate would require the new equilibrium quantity, not just the current 120,000.