Tourist levies and tourist spending

The New Zealand Herald reported earlier this month:

An international tourism levy charged to visitors to New Zealand will increase to $100 – a jump of almost 200% – in a decision the Government believes will help boost economic growth and support conservation.

But it has some in the sector concerned the increase will be a barrier to visitors coming to New Zealand.

The International Visitor Conservation and Tourism Levy (IVL) is currently set at $35 and is charged to most tourists, people on working holidays, some students and some workers coming to New Zealand.

The IVL acts as a form of two-part pricing (which you can read about here). A firm uses two-part pricing when it splits the price into two parts: (1) an up-front fee for the right to purchase; and (2) a price per unit. If the consumer wants to buy any of the product, they must first pay the up-front fee. In the case of the IVL, it isn't a firm that's using two-part pricing, it is New Zealand as a whole. Tourists to New Zealand, if they want to buy any tourism experiences in New Zealand, must first pay the IVL.

The effect of the IVL on tourist spending is shown in the consumer choice model diagram below. In this case, the consumer is a tourist. They can spend their income (M) on either of two goods: NZ goods (as a tourist) with price Px, or overseas goods with price Py. The tourist's budget constraint with no IVL is the black line. The highest indifference curve that they can reach is I0, and they will buy the bundle of goods E0, which includes X0 NZ goods, and Y0 overseas goods. Now consider the impact of the IVL. The IVL takes income away from the tourist, but they don't receive any NZ goods in exchange for it (they just receive the right to buy NZ goods, as they can enter the country). That shifts the tourist's budget constraint inwards to the blue line (note that the end points on the budget constraint now have income (M-F), where F is the amount of the IVL). The tourist cannot buy the bundle of goods E0 anymore, as it is outside their budget constraint (it is outside the feasible set). The highest indifference curve that they can reach is now I1, and they will buy the bundle of goods E1, which includes X1 NZ goods, and Y1 overseas goods.

Now consider what this means for the government and for tourism operators in New Zealand. Overall, the tourist is spending more money in New Zealand now. We know this because they are buying fewer overseas goods (Y1 instead of Y0), and since they are still spending all of their income, they must be spending less on overseas goods (because the price of overseas goods is still Py), and more in New Zealand (made up of the IVL and what the tourist spends on NZ goods). The government might see that as a good thing.

On the other hand, the tourist is now buying fewer NZ goods (X1 instead of X0). That clearly isn't a good thing for New Zealand tourism operators, because tourists are spending less on NZ goods. It is little wonder that tourism operators are not happy about the IVL increasing. [*]

It gets worse for NZ tourism operators though, when we consider heterogeneous tourists. The diagram below shows two different consumers - a high-demand tourist (who spends a lot on NZ goods) shown in blue, and a low-demand tourist (who spends very little on NZ goods) shown in red. After the IVL is introduced, the high-demand tourist moves from buying bundle EH0 to bundle EH1. This means that they buy fewer NZ goods (XH1 instead of XH0), but spend more in NZ in total (just like the previous diagram, because they are buying less overseas goods - YH1 instead of YH0). However, the low-demand tourist's best affordable choice after the IVL is introduced is to stop buying any NZ goods at all, and not pay the IVL at all. They would consume the bundle EL1, spending all of their income on overseas goods (and buying no NZ goods at all instead of XL0).

Tourism operators might console themselves that while there will be fewer tourists, the remaining tourists are those that buy a lot of NZ goods. However, high-demand tourists could even end up spending less in NZ overall, as shown in the diagram below. In this diagram, I only show the high-demand tourists (for simplicity). Notice that in this case, once the IVL is introduced the high-demand consumers move from buying bundle EH0 to buying bundle EH1, and they end up buying less NZ goods (XH1 instead of XH0), but more overseas goods (YH1 instead of YH1). Since they are buying more overseas goods, they must be spending more on overseas goods (because the price of overseas goods is still Py), and therefore spending less in NZ overall (even when you add the IVL plus their spending on NZ goods).

Which of these scenarios will play out? Will consumers end up spending more overall (combining the IVL and spending on NZ goods)? Low-demand tourists will stop visiting, but how many will do so? Will high-demand tourists spend more overall, or less? These are all relevant questions that it would be worthwhile to answer. And the New Zealand tourism industry really needs some answers, because it will be really consequential for their revenue and profits.

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[*] Note that the diagram doesn't show the effect of increasing the IVL. However, comparing IVL with no-IVL is qualitatively the same as comparing smaller-IVL with larger-IVL.