Does a VAT rise harm the tourism industry? Portuguese evidence

This paper estimates consequences of the VAT increase on tourism industry, by analysing the impact of the significant VAT rise in Portugal on profitability and survival of firms related to food and beverage service activities. The analysis is divided into 3 periods: before and after the VAT hike and during the financial crisis, with the total time period from 2003 to 2013. The sample is composed of 23,388 Portuguese unique firms with 5.1 year-observations per firm. The impact of the massive VAT change is assessed in comparison to the performance of 4,969 Greek and 59,841 Spanish (for robustness) unique firms for the exact time period. The results show that a dramatic VAT increase significantly affects firm profitability in the country of implementation, with the effect even more dramatic than the recent financial crisis. The equivalent to the proposed 10 percent VAT rise in Portugal has caused a significant decline in firm profitability (an average drop of 8.7% compared to 1.5% during the financial crisis), a massive increase in the number of inactive firms and amplified the likelihood of firms to become bankrupt by about three times. Such consequences inevitably affect unemployment and may cause a slump in tax revenue in the long run. Hence, this research has wide practical implications and should be considered by the Greek and Portuguese governments before taking a next step of intervening in the tourism sector.